Monday, October 5, 2015

Why isn't our richest state saving enough for its state pensions?

Conneticut has a ``huge'' pension problem.  They have only 52% of the assets necessary to pay their discounted future pension liabilities, AND they are discounting future liabilities at an 8% rate.

Remember from earlier posts, a higher discount rate makes future liabilities look smaller, so cities and states save less for their pensions.  If they don't earn, e.g., at least 8%, then they wont have enough to pay the pensions when they finally come due.  This is what happened to Detroit.

What makes Conneticut so interesting is that they are the richest state in the USA and have saved the least, behind only Illinois and Kentucky.  Ordinarily, states which have big unfunded liabilities like this would have trouble borrowing money because investors would demand higher compensation (higher interest rates) for holding bonds with a higher risk of default.  However, because Conneticut has high taxes, and many high-income residents, there is a big demand for state's tax-deductible bonds.  This keeps the cost of borrowing low, and allows state politicians to ignore the pension problem:

“There’s almost limitless money to buy Connecticut bonds,” said Matt Fabian of research firm Municipal Market Analytics. Investors “are getting less of a risk premium than I think you deserve because of the high demand created by the wealth of the taxpayers in the state,” added Paul Mansour, head of municipal research at Hartford, Conn.-based Conning.


  1. Investment decisions, look forward and reason back –

    Since I have friends and acquaintances in Connecticut, and they are most likely in the 1% (really 0.1%), and drawing from informal conversations from the past, I would offer the moment to agree with you. There is a huge amount of acreage to draw from to purchase the state tax exempt bonds. Since it is a pleasant state to live in, there is great incentive to stay for the time being, even if begrumbled. So the government has gotten away with underfunding the reserves and asset base for the future retirement accounts.
    Being the wealthiest state, and once settled happily, most people don’t have the full initiative to pack up and move, potentially to a less happy environ. And if the funds are there (and they are in the wealthiest state), the state taxpayers will be taxed a bit more to cover shortfalls.

    Opposingly, in New Jersey, not the wealthiest state, although moderately pleasant to live, the tax rates are quite high. In response, quietly, the wealthier residents move out, the wealthier corporations pack up and move to lower taxing states, and the taxable base changes slowly.

    From personal knowledge, Prudential Insurance Company, once nationally headquartered in NJ (Holmdel) was subjected to a concocted massively over burdening tax scheme (based on total revenues received) in the 1990s. (the Holmdel site was the collection address for all the national billings.) This was to keep the local property taxes artificially low, making minimum property tax on residents. The corporate lawyers of Prudential didn’t tolerate this for a nanosecond. Immediately Prudential shifted the national corporate location to a cornfield in the middle of Kansas (or wherever), split off a separate entity ‘Prudential Insurance of NJ’ and within another year or so, abandoned the Holmdel address altogether and moved operations out of state. A huge empty vacated building and a huge loss of taxable base. (If they had only just left it alone!)

    Several big companies have moved out. Hoffman La Roche pharmaceuticals, a huge facility located in Nutley, NJ since the early 20th century, packed up and left. Merck, Summit, NJ, is packing up, and at least one major European automobile manufacturer, Mercedes packed up and left Bergen County, moving to Georgia. Mercedes reason, the tax structures were overwhelming. So, perhaps to paraphrase those of someone in Washington State, “will the last person leaving New Jersey – please turn out the lights.”
    Lee Lichtenstein
    The Seattle Times
    Feb 2, 2009 - It's been 38 years since Bob McDonald and Jim Youngren put up the iconic billboard reading "Will the last person leaving Seattle — Turn out the lights," and its slogan has been used worldwide any time there is an economic downturn.

  2. makes sense. In general, blue state tax refugees are moving to red states.

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  5. I see that the article leads with Connecticut being our richest state. Based on what metrics and do they relate directly with their ability to support its pensions? Granted, there is a fair number of wealthy Americans that take up residence in Connecticut. I do make the, perhaps naïve, perception that the top 5% have their dollars are protected in tax haven and various tax loopholes, and therefore not contributing to the state’s tax revenue proportionally.

    If we were to look at state tax revenue, you will have seen that Connecticut has seen lower revenue levels than previous quarters. At one point, they even had to dip into their reserves and borrow money to cover operating expenses. Does the tax revenues or expenses directly impact their ability to save for pension plans? Since I am not a tax analyst, I cannot speak accurately if this logic is correct.




  6. As an employee of SUNY, I am in the NY Employee Retirement System (ERS). What concerns me is how these pension fund managers are gambling with the financial futures of their workforce. Through calculations, decisions are being made by discounting and compounding methods, and they believe the amount of money in their hands today is worth more than money at some other time in the future. I feel the biggest issue at hand is that “saving for and funding of future pension benefits is not as politically popular as current spending.” (Froeb, McCann, Shor, & Ward, p. 52) The old adage “robbing Peter to pay Paul” is alive and well in economics.
    NY State has one of the best funded systems public pension systems in the country. This does not mean they have not had issues. They currently have six different tiers in their system, and each tier has corrected errors in the previous. As a Tier 4 employee, I only need to contribute towards my own retirement for 10 years. The subsequent tiers must contribute for the entire length of their employment. They have realized that their discounting practices could have left them vulnerable to future pension liabilities, and took measures to correct them.
    Froeb, L., McCann, B., Shor, M., & Ward, M. (2014). Managerial Economics - A Problem Solving Approach (4th ed.). Boston: Cengage Learning.

  7. I am not surprised at all by this article. Connecticut does not seem in the great financial state that everyone seems to think they are. The website explains that Connecticut is ranked 45 out of the 50 states for economic performance and 47th for economic outlook. The only area they seem to be somewhat excelling in is sales tax burden, otherwise, Connecticut does not seem to have a very strong economic outlook. Although there are many high-income areas in the state, the state itself is performing quite poorly in relation to the rest of the US.