SADOW: How About Cigarette Taxes To Pay Down Pension Liability?

Proponents of increased tobacco taxes in Louisiana, don’t despair. There’s still a way to get this attempt at behavioral modification into law in a way reasonably related to the activity it regulates that will bring the state other benefits.

A part of the Gov. Bobby Jindal tax plan to shift taxation away from income and towards other kinds included a $1.05 per pack tax hike on cigarettes. But with his retreat from that specific proposal, it’s now in limbo. But a disturbing development in California can provide the vehicle to resurrect something like it.

Recently, a federal bankruptcy court ruled that Stockton could enter into the public sector version of that protection, where one of the major creditors of the city is the state’s public sector pension program. This precedent exposes pension funds to a novel kind of liability, as now the required payments from the city to the fund previously considered absolute and sacrosanct legally may not occur in their entirety or at all.

That means for computation of funded status, pension funds such as Louisiana’s 13 state and statewide systems (there are 20 other municipal and parish systems funds as well) must either increase the actuarial rate of return used by funds or increase the contribution percentage rate for one or both of the employer (government) and/or employee, or both, in order to offset the increased risk of lower total contributions by government. In recent years, the state fiscal situation has discouraged increasing the state contribution rate, and policy-makers have turned away attempts to increase the employee rate. As for the rate of return, the state has allowed it to slide down for some funds in recent years, which has the opposite effect of increasing the unfunded accrued liability now estimated across the state funds as about $20 billion representing 40 percent unfunded.

This just adds to the ticking time bomb these liabilities represent to state taxpayers, precisely because the downward adjustments insufficiently reflect the reality of returns today. Across all 13 funds, Louisiana’s average rate is pretty close to the national average of all state pension funds of 8.18 percent. But ever since the massive deficit spending binge of the Pres. Barack Obama Administration and the consequent anemic economic growth policies it has pursued required a dramatic suppression of interest rates (both feeding into each other: the slow economy sapping borrowing demand, while the monetary expansion devalued the dollar requiring the Federal Reserve to keep rates low to offset inflationary pressure from dollars growing faster than the economic system’s wealth produced), rates of returns on equities and debt have plummeted.

Another way of putting it is, can an actuarial rate of return of 8.18 percent over the next decade really be expected when the ten-year Treasury bond currently trades in the neighborhood of 1.75 percent and domestic equities as a whole in the past five years have increased only around six percent – total (since 2000, the return of the 100 largest private pension funds has been 5.6 percent annually)? In fact, a good estimate going forward for the near future for equities – the inflation rate plus productivity improvements plus the expansion of the price/earnings multiple – is only three percent. Over the next few years, can any fund hope to hit that 8.18 percent rate of return without taking on extraordinary risk and successfully beating the market?

Prudence with taxpayer money dictates very much otherwise. So, in other words, the actual UAL that will manifest over the next several years is badly understated and will increase extra annual costs to state taxpayers to maintain solvency – which already rests in the $1 billion range or four percent of this year’s budget that if available would moot all agonizing over the fiscal picture. And now the precedent that ailing local government units – fortunately, none in Louisiana seem in these straits – can skip their contributions has been established, increases the risk of further UAL ballooning.

While legislation currently lies in wait in this year’s session to address very modestly the understated UAL crisis, it’s here where a tobacco tax increase could prove useful. Simply, dedicate an increase to paying down the UAL, making it effective until the constitutionally-specified due date of 2029 when the UAL must disappear. Better, there is a reasonable relationship between the tax and pensions: with the association between smoking and life spans being inverse, with the increased discouraging of smoking, life spans will increase, necessitating increased pension payouts.

With its 300+ dedications already in existence, normally creating another one to further encase budgeting in restrictions would not constitute good policy-making. But the spending requirement already is in the Constitution and it is known that revenue must be allocated in that direction every year. Further, it does not tie this source of funding that by its nature is designed to decrease to an ongoing program expected to operate without sunset, but to one that its demands also ought to go down over a finite time span.

Current supporters of the idea independent from the Jindal plan may not have envisioned this use for the hike. But it is the best use for a tax with these characteristics, reasonably related to its nature, and fulfills a critical need. And, given Jindal’s opposition to tax increases that would require legislative supermajorities for approval and to override an expected veto, this rationale could get enough legislator support to make it into law.

Tax increases bring only bad economic results, so to justify them much compelling evidence of their other benefits must exist. Given the nature of a bad yet still underestimated UAL situation, that might be argument enough to countenance this rise for many.

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