"This is a problem of monumental proportion," said Rauh, an assistant professor of finance at the Kellogg School of Management. "Given that we see the same issue in many states, the total size of a federal rescue plan could exceed the seriousness of the recent economic crisis and potentially cost more than $1 trillion total."
In Illinois, Rauh says the pension funds could be insolvent by 2018 at the current rate. And in the following years, the state will owe government workers $14 billion -- more than half of the state's projected revenue for 2010.
To dodge a bailout, Rauh says the state pension system needs an overhaul that includes allowing states to issue tax-subsidized pension funding bonds for the next 15 years if they consent to other reform measures.
For starters, states must agree to close defined benefit plans to the 1 million new workers who start state jobs annually, and instead offer defined contribution plans and guaranteed access to Social Security, to which only a quarter of public workers currently contribute. Rauh estimates the total cost to the federal government would be about $75 billion.
"Existing pensions would become more secure and new workers would get more than an empty promise, while the country would avoid another massive taxpayer-financed bailout," Rauh said.
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