A pension war is brewing -- and it's likely to pit state and municipal employees against citizens who foot the bill for government pension plans with their state tax dollars.

While employees of most companies have watched their 40l(k) plans -- and their retirement hopes -- shrivel in the bear market, public employees have been smiling. They've been promised lucrative pensions, increased over the years as cities and states negotiated labor contracts. Now those public employees are about to find out that they are not immune from the ravages of the stock market.

The Center for Retirement Research at Boston College estimates that state pension plans have losses greater than $865 billion, a loss of nearly 40 percent in just the past year. Add those current losses to the fact that many municipalities have gotten away with underfunding those pension plans for years, and you have trouble brewing.

Now, the double-whammy of stock market decline and lower tax revenues in this recession is causing state and local governments to take a second look at how they will fund those promises.

The options are few. Tax hikes -- whether income or property or sales tax increases -- will be hard to pass in this economic slowdown, as well as counterproductive. Will the voters stand for cutbacks in services -- from snow removal to education funding? Or will cities ask public employees to make up the gap with a combination of benefit cutbacks and/or increased plan contributions?

All of those choices are political dynamite, which may explain why state legislatures have been so slow to face reality.

The National Bureau of Economic Research says the value of pension promises already made by U.S. state governments will grow to approximately $7.9 trillion in just 15 years.

And they're forecasting that states are unlikely to be able to keep those promises: " We conservatively predict a 50 percent chance of aggregate underfunding greater than $750 billion and a 25 percent chance of at least $1.75 trillion in underfunding."

They say it all adds up to a huge gap: "Insuring taxpayers against funding deficits and plan participants against benefit reductions would cost almost $2 trillion today."

The looming issue of state and local pension deficits has been buried by our national financial issues -- and by state politics. But there is one website that is tracking the pension pile-up: www.PensionTsunami.com. It started out as a watchdog for California pension issues, and now covers state budget and pension deficits across the nation.

They've been the ones highlighting losses in California's public pension plan (CalPERS), which invested heavily in residential real estate, a mistake that wiped out nearly a third of the state employees' pension plan. Bad planning and huge promises helped force the city of Vallejo, Calif., into an unusual Chapter 9 bankruptcy last spring, partly to renegotiate labor contracts and pension promise.

The state of Illinois has a nearly $50-billion gap in its public pension funds. It's trying to sell the state lottery to raise $10 billion, so far with no takers. The legislature hasn't appropriated pension funds, perhaps not recognizing that its own pension plan was only 32 percent funded -- and that was (SET ITAL) before (END ITAL) the stock market crash last fall! Continued...