THE ECONOMIST’s cover (in North America only) for the issue out today is "The Unsteady States of America: Why the pensions nightmare is only just beginning … America’s public finances: It is not just Detroit. American cities and states must promise less or face disaster": "WHEN Greece ran into financial trouble three years ago, the problem soon spread. Many observers were mystified. How could such a little country set off a continental crisis? The Greeks were stereotyped as a nation of tax-dodgers who had been living high on borrowed money for years. … But the contagion was powerful, and Europe’s economy has yet to recover. America seems in a similar state of denial about Detroit filing for bankruptcy … Other states and cities should pay heed, not because they might end up like Detroit next year, but because the city is a flashing warning light on America’s fiscal dashboard. Though some of its woes are unique, a crucial one is not. Many other state and city governments across America have made impossible-to-keep promises to do with pensions and health care. Detroit shows what can happen when leaders put off reforming the public sector for too long.

"Nearly half of Detroit’s liabilities stem from promises of pensions and health care to its workers when they retire. American states and cities typically offer their employees defined-benefit pensions based on years of service and final salary. These are supposed to be covered by funds set aside for the purpose. By the states’ own estimates, their pension pots are only 73% funded. That is bad enough, but nearly all states apply an optimistic discount rate to their obligations, making the liabilities seem smaller than they are. If a more sober one is applied, the true ratio is a terrifying 48% … The hole in Illinois’s pension pot is equivalent to 241% of its annual tax revenues: for Connecticut, the figure is 190%; for Kentucky, 141%; for New Jersey, 137%. … Americans are living longer, even in Detroit, so promises to pensioners are costlier to keep. But the problem is also political. Governors and mayors have long offered fat pensions to public servants, thus buying votes today and sending the bill to future taxpayers. …

"Public employees should retire later. States should accelerate the shift to defined-contribution pension schemes, where what you get out depends on what you put in. (These are the norm in the private sector.) Benefits already accrued should be honoured, but future accruals should be curtailed, where legally possible. The earlier you grapple with the problem, the easier it will be to fix. Nebraska, which stopped offering final-salary pensions to new hires in 1967, is sitting pretty.

"Yet sooner or later , some of these problems will end up in Washington, DC. In Detroit, a judge ruled this week that federal bankruptcy law trumps a state law that makes it impossible to reduce pensions. But the issue will arise again, and will not be truly settled until it reaches the Supreme Court. Many places like Detroit will surely have to break some past promises-and rightly so. And given the size of many of the black holes, the state or federal government may have to help out. … Americans in virtuous states and cities will be just as furious about their tax dollars flowing to Detroit and other distressed places as Germans are about euros going to southern Europe. But the truth is that America’s whole public sector still operates in a financial never-never land. Uncle Sam offers an array of ‘entitlements’ that there is no real plan to pay for. Barack Obama is on his way to joining George W. Bush as a president who did nothing about that, while Republicans in Congress imagine they can balance the books without raising taxes." Read the editorial. econ.st/14Pv3D9 See the cover. econ.st/12PNfqX

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