Political federations should have exit clauses in order to promote political and fiscal liberties.
A substantial number of states have very large unpaid pension obligations, sometimes amounting to more than ten thousand dollars per capita. Most are “blue” states with entrenched Democratic control. My home state of Illinois is second on the list.
These states face an enduring dilemma. Citizens and businesses are willing to pay for current public services, not past mistakes. Who wants to shoulder taxes for past services, particularly when the costs include inflated compensation to public sector unions? Raising taxes to pay these debts will drive people and businesses out of state. Note that this is not a problem that can be easily solved through redistribution with high taxes on the rich and businesses. Such taxes provide incentives for anyone taxed for past services to leave.
Federalism accentuates this dilemma. It creates competition among states and unpaid pension obligations are a dead weight in the race, undermining a state’s attractiveness vis-a-vis other states. A recent article in the Wall Street Journal shows how Utah, relatively unburdened by pension obligations, has been gaining new residents and thus increasing economic growth. Unfunded pensions make it very hard for states like Connecticut and Illinois to do the same. They face a dismal spiral. Their financial plight drives away citizens and the loss of people makes it ever harder for them to solve their financial plight.
Such states have only two plausible solutions. First, a state can modify past public employee pensions. But these pensions are often guaranteed by states’ constitutions, like that in Illinois. And public employee unions are politically powerful in these states, posing an obstacle to reform. Indeed, the power of these unions is the reason that they have large unfunded pension obligations in the first place.
Second, a state could enact reforms to create such excellent conditions for economic growth that the state would remain very attractive to people and businesses, even given the additional taxes to pay for the past mistakes in governance. But many blue states with unfunded obligations tend to have relatively low economic growth rates. They are not business friendly.
My own state of Illinois is an excellent example of the difficulty of pursuing either solution. The new governor, J.B. Pritzker, gave an inaugural address in which he did not even mention the state’s pension problems. While he did vow to increase economic growth, he has offered no concrete plans that would do so. Many of his plans, like raising the minimum wage, are likely to harm growth. And the legislature, led by a Speaker of the Assembly who has been in office for three decades, defeated most of the efforts of the previous Republican governor to adopt pro-growth policies. Thus, those of us who are stuck here by virtue of jobs or family obligations have no reason to be hopeful about its future political economy.