Pensions: The canary in our coal mine.

Pension funds get the headlines because the numbers are centralized and relatively easy to grasp. Infrastructure systems are more diffuse, the obligations often local and mostly unaccounted for. Both systems are failing as America's Suburban Experiment unwinds. Understanding the numbers behind the pension crisis will help us more completely grasp the depth of the problem.

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Reading the local newspaper this weekend, I came across an article indicating that Minnesota's pension plans are just 75% funded. This is not a shock. We in Minnesota like to think we are prudent and progressive -- certainly not going to get in the problems that a state like California or Illinois is in -- but the numbers prove otherwise. We're human like everyone else and that makes us just as prone to wishful thinking.

The most revealing, and astonishing, aspect of the report was not the fact that Minnesota is $16.7 billion short of being able to make good on our pension promises -- although that is astounding -- but just how rosy the assumed returns going forward are. From the article:

Legislation passed in 2012 dropped the yearly earnings for investment expectation from 8.5 percent to 8 percent and changed some of the assumptions as to how long workers will live.

In other words, to fund 75% of our obligations, we must assume an astounding 8% annual compounding return on our investment. And that only gets us 3/4ths of the way there.

Click for image attribution.Some people who have delved deeply into the Strong Towns message have struggled with the idea that we can't just simply pay to fix our infrastructure and be done with it. Just raise the damn taxes, already! Certainly, if Mn/DOT has a $2.5 billion annual maintenance deficit (and the feds have a ~$180 billion maintenance deficit) then we just allocate the money. Didn't we just spend a couple trillion on some wars and stuff? In comparison, this infrastructure deficit seems like chump change.

We need to step back and understand what infrastructure is. Infrastructure spending is the platform for advances in growth and productivity. In the post WW II framework, it is the catalyst for growth. We spend money on infrastructure, we get growth. That growth allows us to do all of the things we do, from pay pensions to provide medical care and education.

So, our economy requires new infrastructure spending to create new growth opportunities -- all those new housing subdivisions, strip malls and big box stores. This growth in construction then creates all of these second order effects that we tout when we promote infrastructure spending; all of the people working construction have families, their kids need to be educated, they need to buy milk and toilet paper and get haircuts, all of the people that teach kids, sell milk and toilet paper and give haircuts have families with similar needs. This is a virtuous feedback loop cited by economists, particularly those of the Keynesian variety.

Now step back and realize what's happened. Because our infrastructure spending has been speculative -- it has been used to induce growth and not in support of productive patterns of growth -- we have all of this unproductive investment in the ground. Miles and miles of pipes and STROADs that created a modicum of growth but now are sucking up all of our infrastructure budget. Many times over. 

So now we face three basic choices outside of the Strong Towns approach. They are: (1) raise taxes, (2) borrow more money, and (3) experience a long slow decline. These all come with consequences. In some combination we will certainly try all three.

Raising taxes is the most common recommendation I receive. Chuck, people are just going to have to pay more. Okay, let's pretend it is that simple, although I'll attest that I've seen people who oppose spending money to fix their own sewer system even though fecal coliform bacteria is showing up in their well water (in other words, they are drinking their own excrement). Let's pretend we get serious and raise taxes at all levels of government to maintain all of this unproductive infrastructure.

We go to the average family in their single family home and inform them that their local taxes are going to increase to pay for the street and pipe in front of their home. While the initial $30,000 cost was wrapped into their mortgage, they are now going to pay an additional $1,500 to $3,000 annually for the maintenance. On top of that, there is going to be additional thousands for maintaining the common infrastructure of the community; all of the water towers, sewage treatment plants, pumps,wells, etc... 

Then the state shows up. The gas tax increase necessary to maintain all of the stuff we've built is going to be in the $1 per gallon range. That is just for the state and that assumes that nobody reduces the amount they drive and/or switches to a more fuel efficient car. The more likely number when these natural responses are calculated in is somewhere between $2 and $3 per gallon. 

Then the Feds step in. That $2.2 trillion magic number from the Infrastructure Cult is ~$28,000 for a family of four. Now the Feds would make the taxes progressive and so the entire cost would not fall on that working family, but it is hard to see how their taxes would not increase additional thousands per year, especially if the goal was to get caught up in five years as ASCE has suggested (an infrastructure "surge" to borrow popular political rhetoric).

So we've done it. We've made the hard choices and raised the taxes necessary to simply maintain our unproductive infrastructure. Our families now have a lot less disposable income and we're simply treading water. What happens next?

Let's return to our pension assumption of 8% annual growth. How's our economy doing after all these tax increases? How much of that virtuous feedback loop is taking place? We were recently flipping out over a fiscal cliff that would look like a speed bump compared to getting serious on infrastructure; the idea that our economy would continue to grow after such a tax increase at a rate that would support 8% gains in a state pension fund is absurd.

And I think it needs to be repeated because it is the critical insight: this is just to maintain infrastructure systems that are largely unproductive. In a family equivalent, this isn't paying for college. This isn't fixing the roof. This is installing granite counter tops. If we actually did these tax increases, we would finally be paying for the extravagance of our lifestyle, not funding the essential foundation that infrastructure is widely believed to be.

I believe we will raise taxes, although not much. Certainly not anywhere near the levels needed to make a dent in this problem. We will most likely continue with the second and third  options. We'll borrow money to keep up the illusion that everything is okay (while people like Paul Krugman tell us it is okay a moral imperative that we do so) and we'll slowly grow accustomed to a long, slow decline (we already are, actually). 

I've written in the past about deficit spending and don't want to get tangled in those weeds again today. I think we all intuitively get the notion that we're not going to be able to indefinitely support bloated American lifestyles with borrowed money. At some point -- and I'm not going to pretend I know where that point is -- people will stop buying our paper. The fact that 60%-80% of new federal government debt issuances are currently being purchased by the Federal Reserve is a predictable point in that decline narrative. The return of all those (devalued) dollars into our market is another (aka: inflation). History has seen this many times. 

So we will continue to grow used to decline; roads that are not fixed, sewer lines that break, watermains that rupture, bridges that close, etc, etc, etc.... I think one of the tragic tales of the end game of the Suburban Experiment is how the poor will be left isolated in suburban communities while the wealthier among us congregate in urban areas or something akin to walkable communities, places that have (or can create) a productive environment that will be resilient to the general austerity. If you look around the world or back through history you will see that this is a natural order of things. Only in America during the Suburban Experiment was this artificially reversed for a time.

Let's get back to the pension account, which was the original inspiration for this piece. Without the ability to juice growth through speculative investments, how is 8% growth possible? How is 3% growth possible? With the Baby Boom generation on retirement's doorstep, the state pension funds should have the bulk of their revenues invested in ultra safe securities. That has historically meant T-bills, but 90 day paper is currently yielding 0.08%. That's not 8%. That is 8/100ths of a percent. To get anywhere near an 8% return, the managers of these funds will need to invest in very risky and speculative ways. That should not make you sleep well if you are a government employee or a taxpayer.

With the Suburban Experiment, prosperity multiplies on the way up and despair multiplies on the way down. New growth creates the illusion of wealth and prosperity while long term commitments are put off a generation or more. We could have faced up to those obligations when they came due, adjusted our expectations and learned from our folly, but we didn't. We tried to keep it all going with debt. Sure, you can raise taxes now to pay for infrastructure, but this is about so much more than infrastructure. It is the American model of growth. And it doesn't work.

So what can be done? What is Strong Towns approach? In a nutshell, we actually need to start talking about a managed contraction. There are many paved roads that should be turned to gravel. Some gravel roads turned to private trails. Our police and fire departments -- along with our school districts and their busing -- must tighten up their service areas, having high service and low service (or fee for service) areas. We're going to have to abandon some pipe and close some bridges. Taxes will go up in many places and our dwindling revenues need to directed to high productivity investments. This will mean a bottom up approach -- many modest improvements over a broad area -- instead of the large, centralized, bureaucracy-driven, build-it-and-they-will-come type of speculation we have grown accustomed to.

It won't be easy culturally, but we do this and we can once again have a strong America full of strong towns.

This conversation is continuing right now with bonus material that didn't make this post at the Strong Towns Network.

If you'd like more from Chuck Marohn, you should really get a copy of his recent book, Thoughts on Building Strong Towns (Volume 1). It is a primer on thr Strong Towns movement and an essential read for those wanting to get up to speed quickly.

You can also chat with Chuck, Nate Hood, Andrew Burleson, Justin Burslie and many others over at the Strong Towns Network. Join the conversation on how to make yours a strong town.