Government Can Only Raise Taxes So Much to Offset the Pension Crisis
It’s a situation with no way out. The pension crisis is real and will get exposed to a greater degree as the economy wanes. Illinois, Connecticut, and Kentucky are just the tip of the spear. Prepare for your tax bill to skyrocket…to a point.
The limiting factor certainly isn’t your state politicians. If they had carte blanche, taxes will increase significantly to narrow the shortfall. The problem is, if the state raises taxes too much, citizens will simply relocate elsewhere.
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This already happened in Illinois. The state actually lost residents in the years after the housing bubble to escape the tax burden. Many escaped to neighboring states like Iowa and Indiana. This served to limit economic activity, as Illinois only grew a combined 4.3% since 2007. That’s the worst growth in the Union, despite the “Great Recovery” still taking place.
Illinois lawmakers raised state personal income taxes by 67% alone in 2011. A new round of taxes was also introduced in the summer, as Illinois tries to dig out from under a $14.5 billion state pension shortfall.
The net result of Illinois’ policies has been poor. Residents have been steadily fleeing the state for years. The few hundred thousand people leaving the state has offset the rising taxes for those who remain. Thus, the state has been unable to make a dent in funding shortfalls.
The worst part: all this is happening in “good” economic times, times where pension fund managers should be raking in investment gains brought about by skyrocketing stock markets. Regardless of the cause of shortfalls—be it subpar returns or too many claimants (or both)—when the economic tide turns, the cockroaches will come scurrying out.
After all, U.S. unfunded public pension liabilities have now surpassed $5.0 trillion. Again, all this is despite a raging stocks market.
Compound Annual Growth Rate (CAGR), S&P 500 (Since 2009)
| 2016 | 11.92% |
| 2015 | 1.31% |
| 2014 | 13.81% |
| 2013 | 32.43% |
| 2012 | 15.88% |
| 2011 | 2.07% |
| 2010 | 14.87% |
| 2009 | 27.11% |
(Source: “Compound Annual Growth Rate (Annualized Return)” MoneyChimp, last accessed September 13, 2017.)
If pension fund managers aren’t getting gangbuster returns now, the die has been cast. Once the inevitable recession takes place and stock markets start sinking, liabilities deficits will increase.
Pension funds are not nimble like certain hedge funds out there. Most are not allowed to short the market and have restrictions on the assets they can carry. Most will not have the ability to capture the downside move because they can’t participate.
The last eight years is as good as it’s going to be in the stock market for awhile.
Expect Pension Crisis Unintended Consequences
If there’s any “good” news in all this, it’s that going forward, tax increases may not be onerous as believed. As discussed, states will be limited in what they can levy. Raise taxes too high, people leave and economic growth cools. You can only squeeze so much blood from a stone.
That doesn’t mean taxes won’t keep increasing. There are reports of tax bills in places like Cook County Illinois which have quintupled since the Great Recession. It just means that the point of diminishing returns has been reached long ago. At some point, the government will look in another direction and tax increases will stabilize (even if we’re not at that point quite yet).
So expect states to get creative in their quest for more revenue.
One area states will probably explore is marijuana legalization. Cannabis has the potential to bring in more tax revenue than alcohol. For states with precarious finances, it’s not a revenue stream they can easily walk away from. If they don’t pluck that low-hanging fruit, neighboring states will.
Some may not consider sprouting dispensaries a “consequence,” but marijuana antagonists might.
The other obvious solution: a government bailout. Piling on more taxes to burdened residents is not an ideal solution. Further increases are being met with stiff resistance, and are not generating bountiful returns. When the situation gets dire enough (next recession), expect Uncle Sam to bail out state pensions, thus averting a crisis.
If the U.S. government starts bailing out individual states on a case-by-case basis, that’s when you’ll know trillions more government debt will be added. Increasingly liabilities is bullish for gold and bearish the U.S. dollar.
In the end, there are no good solutions for the coming pension crisis. States can only tax so far (even though they’ll keep trying). A federal government bailout will incur trillions more in deficit spending. Certain “sin” industries might sprout up in your community, as states desperately search for more tax revenue.
Let’s hope the next recession isn’t as crushing as some fear.
