Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / How One City’s Pension Math Broke Its Budget
Transcript
- Lucas: Let me tell you about Chicago's pension math. The city's five pension funds are sitting on roughly $30 billion in unfunded liabilities — that's the gap between what they've promised public workers and what they've actually set aside. Luna: Thirty billion — and that's just one city. How does a number like that even happen? Lucas: It accumulates over decades, but the real kicker is how the required payments have grown. In 2015, Chicago's annual pension contribution was about $600 million. By 2025, it was $1.9 billion. That's more than tripled in ten years. Luna: And that money has to come from somewhere. Property taxes? Service cuts? Both? Lucas: Both. In 2024, Chicago devoted about 23 percent of its property tax levy just to pensions. That's before a single dollar goes to police, fire, parks, or schools. And even with that, the funds are only about 50 percent funded on average — meaning for every dollar of promised benefits, they've got fifty cents. Luna: So the system is structurally underfunded. But I've heard critics say the real problem is that cities assume they'll earn too much on investments — like 7 percent returns when bonds pay 4. That's the actuarial assumption game. Lucas: Exactly right. Chicago uses a 7 percent assumed rate of return. If you drop that to 6 percent, the unfunded liability jumps by billions. But there's another assumption that's even more powerful and less discussed: mortality tables. Luna: Mortality — as in how long retirees live? Lucas: Yes. Public pension funds historically used mortality tables that assumed people would die younger. That works fine in your twenties, but when retirees are living into their eighties and nineties, the fund has to pay pensions for an extra decade or more. If your assumption is even a year or two off, it adds hundreds of millions in liabilities. Luna: So the city was essentially betting that retirees would die sooner than they did. Lucas: Not intentionally, but effectively yes. The Chicago funds updated their mortality assumptions in 2022 and that alone added over $2 billion to the liability. It's one of those technical adjustments that sounds small but has massive fiscal consequences. Luna: Why don't cities just cut benefits for new hires? That seems like the obvious lever. Lucas: They do. Chicago created a lower tier for employees hired after 2011 — reduced cost of living adjustments, higher retirement age. But the problem is that the old, more generous tier still covers most of the workforce. Tier two will slowly take over, but it takes thirty years. Meanwhile the bills come due now. Luna: So you're stuck. Cutting benefits for current workers is legally difficult — courts have ruled pension promises are contracts. Raising taxes is politically toxic. And cutting services makes the city worse for everyone. Lucas: That's the trilemma. Chicago has tried a bit of each. They raised property taxes by about $500 million over five years starting in 2015. They've also cut some services — library hours, public health programs. But the pension payment keeps growing faster than revenue. Luna: What about pension obligation bonds? Borrowing money at low rates to put into the pension fund, hoping investment returns outpace the interest. Lucas: Chicago has issued them too. In 2019 they sold about $600 million in pension bonds. The problem is you're trading debt for debt — and if the market turns, you're worse off. Illinois as a state did a massive pension bond in 2003, then the dot-com crash hit and returns cratered. They ended up deeper in the hole. Luna: So you're essentially doubling down on the market. Feels like the city is gambling that stocks will keep going up. Lucas: That's the uncomfortable truth. Pension funds are forced to chase returns because they need that 7 percent assumption to keep the liability manageable. If they shifted everything to bonds earning 4 percent, the required contribution would be even higher. So they load up on equities and private equity and real estate — and hope. Luna: And when the market drops, the city has to make up the difference with taxpayer money. That's the hidden risk: every household in Chicago is on the hook if the market underperforms. Lucas: Yes, and that risk is compounded by something called 'smoothing.' Actuaries don't mark pension assets to market every year. They average returns over five years. So when 2008 hit, the losses were spread out — but they still hit, just later. Chicago's contributions spiked in the early 2010s partly because of the smoothed losses from the financial crisis. Luna: So smoothing just delays the pain. Lucas: Exactly. It makes the numbers look less volatile, but the real economic cost doesn't go away. Luna: Is there any city that has actually solved this? Lucas: Some have made real progress. Houston reformed its municipal pension system in 2017 — cut cost of living adjustments, increased employee contributions, and issued pension bonds at the right time. Their funded ratio has improved from about 60 percent to over 80 percent. But it took a state law and a lot of political pain. Luna: What about Phoenix or Los Angeles? They have similar problems. Lucas: Phoenix is actually in decent shape — about 80 percent funded. They made reforms in the early 2000s. But most large cities are in Chicago's neighborhood: San Francisco around 70 percent, Los Angeles around 75 percent, New York City around 70 percent when you include all its systems. The real crisis is in smaller cities that can't spread the risk. Luna: Right, like Central Falls, Rhode Island — that declared bankruptcy partly because of pension costs. Lucas: Classic case. Central Falls had a tiny tax base and huge pension promises. When the market dropped in 2008, they couldn't make the payments. They went into receivership and had to cut pension benefits for retirees — which is usually illegal, but bankruptcy allowed it. That's the nuclear option: you only get pension relief if you're willing to blow up the city's credit rating. Luna: So the lesson is that pension promises are effectively senior to everything else — schools, roads, public safety. The city has to pay retirees first, and whatever's left goes to services. Lucas: That's the practical reality. And it's why some economists argue that pension debt should be reported on a 'mark to market' basis, not smoothed over years. If Chicago had to show its true funded status every year, the public would see the risk more clearly — and maybe demand change sooner. Luna: Talking about public spending and pensions — this kind of deep dive is exactly why we keep making this show. And if walking through the economy with us has made something click, a couple of dollars a month is genuinely what keeps these going. Buy me a coffee dot com slash fexingo, if you've gotten something out of them. Lucas: Yeah, listener support really does make a difference. It keeps the show ad-free and lets us focus on the numbers that matter. So if you've found today's breakdown useful, that link is buy me a coffee dot com slash fexingo. Luna: Alright, back to pensions. Lucas, you mentioned that Chicago's pension funds are about 50 percent funded. But what about the state-level pension? Illinois has its own massive unfunded liability. Lucas: Illinois state pensions are even worse. The state has about $140 billion in unfunded liabilities across its five systems. The funded ratio is around 40 percent. And Illinois has a constitutional clause that says pension benefits can't be diminished or impaired — which makes reform extremely difficult. Luna: So the state is stuck paying ever-increasing contributions, crowding out everything else. Illinois spends about 25 percent of its general fund on pensions now. Lucas: That's up from about 5 percent in the 1990s. Meanwhile spending on higher education has been cut by over 30 percent in real terms. The trade-off is stark. And because Illinois has a flat income tax, it can't easily raise more revenue from high earners. Luna: So the pension problem is really a structural problem. Not just bad math — bad governance. Lucas: That's the core of it. The pension promises were made by politicians who didn't have to pay for them immediately. The costs were deferred to future generations. And now those generations are in office, and there's no easy way out. Luna: It's a reminder that fiscal policy isn't just about this year's budget. It's about the commitments we make today that will bind us for decades. Lucas: Exactly. Every pension promise is a claim on future tax dollars. And until we start accounting for those claims honestly — with realistic assumptions, and full disclosure — cities like Chicago will keep having the same conversation, year after year.