At the center of the current fiscal troubles in Greece, Spain, Portugal and elsewhere in Europe are the promises made by governments to fund union salary increases and pension plans. Unions in Europe are much stronger than they are in North America, and in many of Europe’s less-wealthy countries, governments have chosen over the years to appease union demands even though it meant driving fiscal deficits well beyond the level tolerated by EU rules. Now that these governments are finding it impossible to continue to borrow on global markets without firm evidence that these deficits are going to be brought down, proposals to cut union pay or benefits are being met with strikes by firefighters, police, teachers, farmers, and others.

Do not for a moment think that these problems are not to be found in the United States. The difference here is that the “appeasement”, such as it is, has been concentrated at the state and local level, though the federal government has its share of unfunded promises to workers. The 50 states last year ran up a combined deficit of around $180 billion – coincidentally about the same amount that the US has spent bailing out AIG. The federal government has also helped out the states during this fiscal crisis, by lending them money to continue paying normal as well as emergency employment benefits to laid off citizens. This has averted a real crisis, since states are constitutionally required to plug any annual deficits. The real problems will show up later this year and next when the federal loans run out.

The basic cause of these fiscal problems in the states has not been any sudden explosion of spending, but rather an implosion of revenue. Tax receipts across the nation are down due to the economic downturn. States which rely on property taxes and income taxes have been especially badly hurt, but sales tax revenues have also suffered as consumers cut back on their spending. Municipal tax receipts in most communities are lower, especially for cities and towns which took in a bonanza from property transfer taxes during the housing bubble. Even the federal government has seen a dramatic and unprecedented drop in tax revenues, especially in the area of capital gains taxes. The federal government, unlike other governments, can run deficits and certainly has chosen this route rather than seek out savings from spending cuts.

At least when it comes to state and local deficits, the US is now at the stage where government officials must look at spending cuts, and their only real choice if they want to make a serious dent in these deficits is to focus on union workers, their salaries, their overtime, their work hours, and their pension payments. Unions have been banished from many parts of the private economy, and are to be found only in a few manufacturing sectors like automobiles where they have had a traditional stronghold. But unions remain very strong and well represented in the public sector, as teachers, police, firefighters, mass transit workers, and civil engineers.

There are at least two ways to look at union contributions to the public sector. From the union perspective, workers in state and local government have decent middle class salaries because of the unions. An hourly wage may be in the $25/hr. range for typical employees; managers on salaries can earn $100,000 or more in many large to medium size communities, based on salary scales that are public and mandated by the state or local government. In expensive communities throughout California, for example, without the unions there would be no government employees, because middle class workers cannot afford to live in towns where the average home costs $500,000. Additionally, union members get generous pension benefits, on the theory that they have foregone years of wealth-creating bonuses that would have been theirs if they worked in the private sector. There are, obviously, no stock option plans for government workers.

The other way to analyze unions is from the outside looking in, and here the opportunity for outrage is certainly high. In medium to large cities, the pay scales for managers often dictate a salary of $250,000 or more. Retirement for most workers starts at age 50, with a pension being paid out anywhere from 70% - 90% of income at the time of retirement. These pensions are lifetime guaranties, and they are supplemented by generous health care benefits not typically found in the private sector. Many communities allow “double-dipping” during the last five years of employment until retirement, wherein the worker can take home full pay, full retirement benefits, and full pension payments.

These policies lend themselves to anecdotal horror stories that do not sit well with the average taxpayer in the private sector who has seen their wages stagnate, their benefits cut, their working years extended beyond age 65, and their 401k’s wiped out. Stories appear frequently in the press about the ticket taker at the subway station who is earning $85,000 a year, or the recent case of the Under Sheriff of San Luis Obispo county in California, who has taken home $640,000 a year because of double-dipping allowances (his assistant takes home $340,000 under the same plan).

City managers everywhere are looking to reduce salary scales for government workers, cut back on benefits such as the matching contribution government makes to pension plans, and redefine the government’s authority to reduce staffing (in many cases it is very difficult to downsize union staff). On top of this, these managers are being informed that the union pension plan is now seriously underfunded thanks to massive losses in the stock market, and that the state or local government is legally obligated to make up the difference. In many situations these deficiencies total in the billions of dollars – money that local or state government doesn’t have.

You thus have the making of a classic political and economic battle. Unions are showing up in force at council meetings or state legislatures to protest cutbacks. Teacher strikes are becoming more common, and police and firefighters who cannot strike can at least protest and issue dire warnings of fire fatalities and jumps in crime if services are reduced. On the other side, right wing radio commentators have plenty of anecdotal fodder to deride union featherbedding and egregious benefit packages, and it doesn’t take much to stir up the general electorate against appeasing the unions when so many private sector workers can only dream of guaranteed pensions and health benefits for life. In fact, where the general public often finds itself in these battles is voting down any initiatives to raise taxes in order to meet legal obligations to the unions, the result being that the state has to renege on these obligations in order to balance the budget.

Many states and localities can still try appeasement to avoid nasty run-ins with the unions. Phoenix, Arizona chose to increase tax on food by 2% rather than fire public workers or reduce their pay and benefits. Ironically, this tax falls most heavily on the poor, many of whom work for local or state government in menial but stable positions. When it comes to funding the pension plan deficits, one easy accounting gimmick is to change the long term earnings assumptions of the plan. In many cases these plans already have ridiculous assumptions as to asset growth, often using for the stock portion of the plan an assumption that equities will earn 8% p.a. over time. It takes just a stroke of the pen to declare this assumption to be 10% p.a., so that the plan will magically take care of any deficits by itself with superior performance. Another trick is to authorize plan managers to invest in hitherto forbidden financial instruments like derivatives or commodities, on the belief that the returns are greater in these sectors. They are certainly greater, but so is the risk, and inevitably these desperate attempts to reach for risk are bound to fail.

It is not too difficult to determine the outcome of this fight. States and localities have no choice but to close their deficits, and the taxpayer has no appetite for greater taxes. Therefore the unions will have to accept cutbacks in salaries, wages and benefits; reductions in pension plans (amounting to an outright repudiation of legally-agreed payouts); and the loss of job protection, so that government officials can fire workers much more quickly. There will be nasty strikes over the next few years, and lawsuits aplenty as these cutbacks are enforced, but there simply isn’t the money to continue to pay union workers in government anything like what they have received in the past.

The deflation that has ravaged the pay and benefits of the middle class private sector worker is about to work its damage on the public sector as well. The middle class in the US will shrink even more, as one of the last bastions of protection against rampaging globalization and Republican market orthodoxy succumbs. We can say “one of the last bastions”, but there is still one left, a sector of the economy that isn’t even unionized. That is the pay and benefit programs for the military, especially the officer corps who can retire at 50, slip into a well-paying job in the industrial complex, yet also take home generous retirement benefits. The costs of supporting tens of thousands of these retirees is galloping forward year after year, but this is so far a sacrosanct area that no politician will touch.

Even the Department of Defense may not be able to hold out forever, if economic conditions get really bad (and that is likely to be the case). If so, the concept of retirement with a fixed pension payment will be obliterated in this country, as the US continues on its path of erecting third world standards of pay and benefits for all its workers.