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.
Heh. It’s just as wicked as it seems. An employees pension tracks with an inflation adjusted salary but generally is fixed at retirement. Inflation depreciates the purchasing power. Do the math, people, for a retirement at 55 and death at 80 with 5% inflation. Bernie Madoff would be proud. And consider that nominal portfolio returns generally escalate with inflation ( although not rigidly so). Inflated taxes and inflated portfolio returns fund that pension obligation. Is it any wonder that inflation is called the wickedest tax and the hidden tax? And the politicians have the benefit of both sides.
Now think about DS’s scenario. The opposite. The government – that would be the taxpayers – are screwedus completus. And the pols have some splainin to do.
Think about this next time you hear impassioned pleas from public sector unions about what they earned and what they are owed. Unless they had perfect COLA adjustments to their pensions their deal is getting relatively better with falling inflation. And the taxpayers ability to fund relatively worse.
And also think about this when some guy tells you a little inflation is actually good. Good for pulling the wool over people’s eyes….
That ain’t the half of it. If they’re receiving 3% adjustments now by contractual requirement, they’re doing better than inflation.
If they are getting 3% straight up by contract that’s a horribly written document and a windfall for sure. My firm does not manage Chicago/IL pension money, but I have a friend whose firm does. I’ll ask.
Rauner’s firm did/does and I could ask him as I met him a number of years back, except, well, I’m not sure he’d take my call. I heard he’s important now…..
I wonder if he’s having a “deer in the headlights” moment at this point? If it hasn’t happened yet, it will.
I will do this once more from a different angle, but first, credit is an asset not an obligation or debt. The end user may be a consumer, pension fund, hedge fund, or other, and it may be used as collateral to be leveraged into more credit.
At one time the credit supply was about $60 trillion, but I do not remember if that included private banking. (I stopped using shadow.) The money supply was around two to three trillion, but I do not remember which M it was. The actual numbers are not important.
The money supply cannot support the credit supply. The credit supply is supported by the value of assets. The credit has varying payoff rates from overnight to 30 years (or more), and somewhere in between is the half-life. If the asset value never changed, the money supply never changed, and the economy never changed, it would take X amount of years to payoff half the debts.
In this scenario, new credit could be created at the rate that the old debt was paid off. In addition, the fully owned assets could be used as collateral for new credit creation. This would produce a very sound system, but it would grow very slowly. The existing economy requires credit creation to grow, and this is not limited to consumer debt.
In order to spur the economy, credit creation must be spurred, and in order to spur credit creation, asset inflation must be spurred. In order for asset inflation to be spurred, the money supply must increase. The inflation that is required is asset inflation not consumer price inflation.
Increases in the price of a gallon of milk will not help the economy, but most of the advocates of inflation do not have a clue of how it works. Fiat money and fractional reserve lending provide an easy way to increase the money supply, but they are dangerous.
There is one scenario where they are positive. If the money supply is grown at a slightly greater rate than the asset creation rate, it would be possible to grow the credit supply without artificial asset inflation.
Hard money causes a natural deflation. With more goods and people, a fixed amount of money must be spread thinner. You can buy more goods with less money, and it costs less money to produce those goods. Done correctly, fiat money and fractional reserve lending can neutralize this deflationary tendency, but if done incorrectly, it introduces an inflationary tendency. (Asset inflation can lead to a bubble.)
The inflationary tendency benefits credit creators and politicians. Fiat money and fractional reserve lending is regulated by politicians and controlled by the financial industry, and amazingly, it benefits both. Others may benefit, but only to the degree that it does not hurt the politicians or financial industry. In the financial collapse, the financial industry and politicians have benefitted greatly.
DS
I doubt Rauner is having a deer in the headlights moment. Probably more like an “awe shit” moment…. I can guarantee you he has been in bare fisted negotiations just as, um, robust as he will face. He doesn’t have long to convey the issue to the general public, make it clear he inherited this mess, and enlist their self interested support as allies against the public sector sector unions and the perps, and cut a deal. I continue to be amazed at the funding gap and what I’m really interested in is what he perceives to be the minimum acceptable deal. I don’t think its hyperbole to say his very term rests on a reasonable outcome, or that the state of IL’s prospects for the next two decades hang in the balance.
TB
Thanks for the clarifications. It should now be obvious to everyone that the Walrus was Paul.
@Drew
Apparently, quite a few people believe that raising the price of a gallon of milk is the way to increase the economy, and as I gather, among these people is an award winning economist. The fact that the same committee gave a peace prize to a warmonger should say something.
If inflation grew an economy, Venezuela would not be on the verge of collapse.
Is that better? Growing an economy through inflation takes a very specific type of inflation, and it is under very specific conditions. I try to give people the tools to defend that statement, but I guess whining could work just as well.