The next big tax threat is coming from your state capital

If you are one of the millions of people celebrating the trimming of federal fat, you’ll want to know that a new taxpayer threat of stunning proportions is rising, fast. This time it’s not coming from Washington, D.C.; it’s coming from your state capital.

A $1.3 trillion pension crisis is barreling toward American taxpayers, and common-sense solutions are being actively ignored. The most likely result: You will no sooner enjoy the federal tax and spending breaks of the Trump years than you will be forced to bail out state employee pension funds, which are insolvent after having been mismanaged for decades. Unless urgent reforms are made, your state property tax tab will increase by a percentage that one shudders to calculate.

My own state of Ohio is, regrettably, at the center of this crisis. According to a new report by the nonpartisan Equable Institute, the State Teachers Retirement System of Ohio (STRS) is between $20 and $30 billion in debt and will be unable to fully pay back the teachers who funded it throughout their careers. Equable also noted in its report that a stunning 44% of unfunded liabilities are from underperforming investments. 

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How could this happen? How could a $90+ billion fund be so poorly managed as to be at a loss? The short answer is ugly: bureaucratic hubris and a sense of entitlement.

Ohio STRS employees have taken unnecessary risks with the teachers’ fund by investing in alternative assets such as private equity and hedge funds that have not yielded the returns that more conservative approaches would have produced. STRS actively manages its gargantuan portfolio, resisting a shift toward passive investment strategies despite overwhelming evidence that active management consistently underperforms. To justify these choices and disguise underperformance, they have engaged in a practice all too common among public pensions in the US—they have contrived a benchmark that no one else can reproduce, allowing them to claim success while taxpayers shoulder the consequences. 

Adding insult to injury, public records requests have revealed that for years, STRS has awarded and spent liberally on luxurious perks for themselves, such as $1,500 monthly plant-watering contracts, a cafeteria with a baby grand piano, and concierge services. Meanwhile, it has failed to deliver the most basic ROI to its funders, including meaningful cost-of-living adjustments (COLAs) to the teachers who contributed to the system their entire working lives.

Investment shortfalls are not unique to Ohio. Across the United States, public pension funds have persistently underperformed passive indexes since the Global Financial Crisis of 2008. In fact, comparative research has found that U.S. public pension funds have underperformed their private-sector counterparts – and public pension systems in Canada and Europe – by approximately 50 basis points annually.

You may be wondering where the teachers’ unions are – why aren’t they ringing alarm bells on behalf of the teachers?

Sadly, teachers’ unions haven’t just failed to fix the system—they’ve helped break it. For decades, their representatives on the board of STRS have blocked transparency, resisted accountability, and vilified those who dared propose changes. 

In June, a union-backed slate of STRS board candidates campaigned on promises of reform. Yet once elected, they quickly embraced the status quo—rubber-stamping staff bonuses and calling for a taxpayer-funded bailout. In response, the legislature began to take meaningful action, restructuring the board and passing a budget that initiates a transition to a flat income tax—important steps toward protecting Ohio taxpayers. But these initial reforms must be followed by stronger measures, including demands for full transparency and accountability from STRS.

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The situation in Ohio is dire and taxpayers there must be warned of what’s likely to come. Also: Taxpayers in all states deserve to know that a bailout in Ohio will likely be the start of a wave that spreads across the country. Other state pension funds are watching, and a taxpayer bailout in one state will set a terrible, expensive precedent. 

Meanwhile, the message of a bailout to irresponsible bureaucrats is unconscionable: Mismanage billions, ignore your fiduciary duty, and you’ll still get paid – just pass the bill to taxpayers.

Fortunately, there is an alternative to this doomsday scenario of taxpayer bailouts. Transparent, passive investment strategies – like those used by many of the world’s best-run funds – can and should replace unnecessarily risky investment strategies. 

State legislatures across the country, starting in Ohio, must act now to protect taxpayers from the $1.3 trillion hole in America’s public-employee pensions.