On Oct. 23, Moody’s Investors Service announced that it was downgrading Vermont’s general obligation bond rating from Aaa to Aa1, citing demographic concerns along with the state’s unfunded pension obligations.

It is imperative for Vermont policymakers to heed Moody’s advice and shore up the state’s pension systems. The rating downgrade will hamper Vermont’s ability to borrow money and it will raise the interest rate the state will face when doing so, increasing the costs to taxpayers for public works projects and other activities financed by government.

The low funded ratios facing Vermont are in large part due to structural weaknesses in funding policies, that were brought to light by the 2008 financial crisis and continue to hold the plans back in their recovery. The teachers’ system was 85 percent funded in 2007 and just 65 percent funded in 2009. For the state employees’ system, the funded ratio fell from 100 percent funded in 2007 to 79 percent funded in just two years. In the years since, inadequate funding policies and unmet assumptions have continued a gradual decline in solvency for both plans. The markets may have recovered but Vermont funded ratios have not, and what’s more, the risk of another financial crisis remains unaddressed.

Vermont’s demographics and political system provide further reasons for concern. The latest Census population estimates suggest that Vermont’s population is now lower than it was in 2010. Bureau of Labor Statistics data show the number of people employed in Vermont remains below its 2006 peak. This means fewer taxpayers available to shoulder pension debt burdens.

Vermont is unique among the 50 states in not legally requiring a balanced operating budget. Although the state does not generally exercise this prerogative, the fact that it can legally run deficits is not good from a creditor’s perspective.

A similar effort in Vermont that acknowledges risks, stabilizes costs, and reverses the growth in unfunded liabilities could support a return to a Aaa rating. Such an effort is needed to ensure reliable post-employment benefits for the state’s retirees.

Andrew Abbot is a quantitative analyst at the Reason Foundation. David Flemming is a public policy analyst at the Ethan Allen Institute.

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