The Avoidable Bankruptcy Catastrophe

Bankruptcy has become a real danger to municipalities that choose not to address their fiscal problems. And for most, the problem at the top of the list is unfunded pension liabilities.

Recently, certain localities across the U.S. have decided to take responsibility by addressing these daunting pension liabilities, even in traditionally very liberal states. In California, this trend of deep blue pension reform began in San Francisco and recently continued to San Jose and San Diego. Even Mayor Rahm Emanuel in Chicago has taken up the cause of pension reform.

Last month, Stockton, California became the largest city (population 296,000) to declare bankruptcy. While there was more than just one factor that led to the city declaring bankruptcy, experts find themselves in agreement that the biggest issue was public pension liabilities. As more details begin to emerge and settlements begin to take shape, the role of public pensions in Stockton’s bankruptcy will become increasingly clear. In fact, Stockton’s largest creditor was CalPERS (the California Public Employees’ Retirement System). It is still unclear whether pension obligations will be restructured as part of the emerging bankruptcy deal.

This may just be the tip of the iceberg, because as recently as July 10, San Bernardino, CA (population 213,000) made the same difficult choice by filing for bankruptcy protection.  The main driver of San Bernardino’s budget shortfall is in its personnel costs, which amount to about 75 percent of the city’s budget. Furthermore, retirement costs for public pensions are currently taking up 13 percent of the city’s budget and are expected to rise to 15 percent or higher in the next three years.

We can expect trends like this to continue if state and local governments refuse to address the public pension problems that they are facing. In California alone, spending on public pensions rose by 214 percent between 2002 and 2012. This type of spending and projected budgets shortfalls are clearly unsustainable.

It is finally becoming clear to policy makers across the country that the reform of public pensions is not a matter of partisanship, but rather a matter of mathematics – and fiscal responsibility. There are many solutions to addressing the growing cost of public pensions that can be found in ALEC’s State Budget Reform Toolkit, such as transitioning to a defined-contribution, 401(k) style plan for new workers, as opposed to the unsustainable defined-benefit plans. Fortunately, Stockton’s and San Bernardino’s fate can be avoided if cities and states choose to face the challenge and responsibly reform their public pensions.