September 02, 2019
It is widely known that for Washington Post columnists writing on economics, ignorance is an asset. Megan McArdle helps make the case in a piece on Chicago’s pensions that tells readers in its headline:
“Chicago kept saying it would pay for pensions later. Well, it’s later.”
The gist of the piece is that Chicago has seriously underfunded public pensions. This is true. Where McArdle combats reality is in implying that this sort of underfunding is typical for public pensions and also that the same logic applies to the federal budget.
McArdle absolves the current mayor, Lori Lightfoot, of blame (she just took office four months ago), as well as her immediate predecessor, Rahm Emanuel, who served two full terms. Instead she tells us:
“Rather, it’s the fault of generations of politicians before them who promised an ever-richer array of benefits to government workers. Particularly, they liked to raise the retirement benefits. …
“Oh, ho, ho, ho. Pay for the pensions? No, we have to stop; some politician might be reading this, and they could really hurt themselves laughing too hard. The whole point of giving workers pension benefits instead of cash was that you didn’t have to pay for them; you could promise the benefits now and gather up the votes that the grateful workers tossed at your feet, all without costing current taxpayers a single dime.”
There are two big problems with McArdle’s story here. First the story of grossly underfunded pensions is not generally true. Most are reasonably well funded because politicians were not hurting themselves laughing, but rather were responsibly setting aside money for the liabilities facing state and local governments. (This briefing paper from Brookings gives a good assessment of the financial state of public pensions.) The real story is that Chicago, along with some other state and local governments with seriously underfunded pensions, are outliers.
But even in the case of Chicago, McArdle did not get the story right. Its shortfall was not the work of “generations of politicians.” Rather it was the result of a specific event – the stock bubble of the late 1990s.
The bubble, which was cheered on by the budget hawks at the time (and is implicitly cheered on by McArdle here, as I will explain in a moment) made pensions look much better funded than they actually were. Even as price to earnings ratios in the stock market were hitting record highs, pension funds assumed that returns in the future would be the same as in the past. They effectively assumed that the bubble would grow ever larger. Those of who tried to warn of this problem were naturally ignored by outlets like the Washington Post.
The story with Chicago, as well as with many other state and local governments, was that they made little or no contribution to their pensions in the bubble years. The run-up in the market was doing it for them.
That ended when the bubble burst 2000-2002. Not only did this plunge in the market mean that pensions were seriously underfunded by standard accounting, it also led to a recession and a sharp deterioration in state and local budgets. This made it a difficult time to increase payments to pensions.
That was the story in Chicago, where then mayor Richard M. Daley decided to ignore the shortfall and hope that the stock bubble would return. It didn’t, and Daley, not “generations of politicians” left behind a hugely underfunded pension.
McArdle concludes her piece by telling us how Chicago’s experience is a lesson for the federal budget:
“The United States, like Chicago, hasn’t run a budget surplus since 2002. We’re headed for a deficit of nearly $1 trillion in a boom economy — thanks to Democrats who refuse to cut spending, Republicans who refuse to raise taxes and an electorate that seems curiously unworried about the increasingly parlous finances of Medicare and Social Security.”
Of course the reason the U.S. government had a budget surplus in 2001 (CBO says the government actually had a deficit of $157.8 billion [1.6 percent of GDP] in 2002) was that the stock bubble was driving the economy. The bursting bubble and gave us a recession, which while relatively mild from the standpoint of GDP was actually quite severe from the standpoint of the labor market. The economy went almost four full years with no net job creation, at the time, the worst downturn since the Great Depression.
But that’s history, suppose the budget hawks got their way today and we got big cuts in spending coupled with large increases in taxes so that we were somewhere close to a balanced budget. How would we do this without a massive hit to demand in the economy, likely causing a recession and mass unemployment?
Perhaps the budget will be closer to balance (recessions lead to increases in deficits), but apart from cultists who worship low deficits, it is hard to see this as a good story for the economy or our children.
One final point that we should demand the deficit hawks finally recognize. When the government grants patent and copyright monopolies, it is creating implicit debt in the form of the rents associated with these monopolies.
These implicit rents are quite large relative to current taxes. In the case of prescription drugs alone patents and related protections add almost $400 billion (1.8 percent of GDP) to the price of drugs. It makes no difference to taxpayers whether they pay another $400 billion a year in taxes to the government or $400 billion in excess payments to Pfizer and Merck because of government granted monopolies.
If someone expects to be taken seriously in talking about debts and deficits, they better include the cost of government granted patent and copyright monopolies. Budget hawks who ignore these implicit debts created by the government deserve only our ridicule. They are either pushing an agenda or are just completely ignorant of basic economics.
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