If that caption confuses you, keep in mind that price increases and inflation aren’t the same thing. “Inflation” generally refers to a sustained increase in the general level of the prices of goods. Basically, it just means that your money is buying less of everything. Price increases may or may not reflect sustained increase in the general level of prices. However, when the things that you buy increase in price it sure feels like inflation to you. One of the problems that state and local governments have is the very low rate of inflation and in this post I’ll try to explain why.
Over at the Wall Street Journal Steve Malanga has a jeremiad of the problems that public pensions are causing for state and local governments:
Decades of rising retirement benefits for workers—some of which politicians awarded to employees without setting aside adequate funding—and the 2008 financial meltdown have left American cities and states with somewhere between $1.5 trillion and $4 trillion in retirement debt. Even with the stock market’s rebound, the assets of America’s biggest government pension funds are only 1% above their peak in 2007, according to a recent study by Governing magazine.
Under growing pressure to erase some of this debt, governments have increased pension contributions to about $100 billion in 2014 from $63 billion in 2007, according to the Census Bureau’s quarterly survey of state and local pension systems. But the tab keeps growing, and now it is forcing taxes higher in many places.
I can’t speak to the situation in California, Pennsylvania, or West Virginia but I’m painfully aware of Illinois’s problems which Mr. Malanga highlights here:
In April two-dozen Illinois mayors gathered to urge the state to reform police and fire pensions, which are on average 55% funded. The effort failed, and municipalities subsequently moved to raise taxes and fees. The city of Peoria’s budget illustrates the squeeze. In the early 1990s it spent 18% of the property-tax money it collected on pensions. This year it will devote 57% of its property tax to pension costs. Reluctant to raise the property levy any more, last year the city increased fees and charges to residents by 8%, or $1.2 million, for such items as garbage collection and sewer services.
Taxpayers in Chicago saw the first of what promises to be a blizzard of new taxes. The city’s public-safety retirement plans are only about 35% funded, though pension costs already consume nearly half of Chicago’s property-tax collections. Strong opposition forced Mayor Rahm Emanuel to temporarily table a proposed a $250 million property-tax increase to help pay off pension debt. Instead, as a stopgap measure Chicago instituted a series of smaller tax and fee hikes, including a boost in cellphone taxes, to raise $62 million. But the city’s pension bill will double next year to more than $1 billion, so a massive property tax hike is still on the table.
Chicago residents also face an enormous state retirement bill. The Civic Committee of Chicago recently estimated that if the Illinois Supreme Court sustains a lower-court decision overturning 2013 pension reforms, Illinois taxpayers will pay $145 billion in higher state taxes over the next three decades.
To place Chicago’s problems in some perspective Chicago’s total revenues are somewhere in the vicinity of $3 billion. Given that a $1 billion increase is nothing to laugh about. Mayor Emanuel did not mention Chicago’s pension problems in his annual message to the city. It’s an election year and it’s not hard to guess the reasons for this omission.
What does all this have to do with inflation? Pensions are nothing more than deferred compensation. Rather than offering your employees a raise, you offer to pay them a pension after they’ve retired. If you expect your revenues to continue to grow, kicking the compensation can down the road is a prudent strategy. When your revenues are flat or decreasing, it’s not nearly as prudent.
State and local governments formed their policies during a multi-generation post-war period during which inflation was persistent and reliable. When inflation is running at 5%, expecting a return of 7% isn’t a bad bet and even 8% isn’t beyond the realm of possibility. When inflation is between zero and 1%, that’s a sucker’s bet but that’s where state and local governments find themselves.
Over the period of the last thirty years or so they’ve made promises in the full expectation that the conditions they saw when the promises were made would continue forever. That’s hasn’t been the case. It’s an entirely different world now than it was thirty years ago and state and local governments are scrambling to adapt.