Restoring a pay raise for state employees outranks pension reform in the recommendations of the Commission on Employee Retirement Security and Pension reform. The legislative commission voted yesterday to prioritize a 3% pay raise for state employees that Governor Terry McAuliffe has proposed putting on hold in the face of $1.5 billion revenue shortfall.

House Speaker William J. Howell, R-Stafford, who chaired the commission, “struggled” to keep the panel’s focus on his own priority, creation of an optional 401(k)-style retirement plan for newly hired state employees, reports Michael Martz with the Richmond Times-Dispatch. Under the current arrangement, new employees have a hybrid defined benefit/defined contribution plan.

Virginia faces a long-term unfunded liability of $23 billion for the $70 billion Virginia Retirement System (VRS). The liability mounted in the past two fiscal years as the VRS fell short of an assumed 7% investment, although the VRS reported Monday that investment returns the past 12 months, spurred by a booming stock market, achieved 8.7%.

While pushing for the pay raise, the commission gave a watered-down endorsement of Howell’s priority, recommending that the General Assembly “consider” creating a defined contribution plan.

Bacon’s bottom line: In theory, the Virginia Constitution requires the Commonwealth of Virginia to balance its budget every year. The trick is, what constitutes a “balanced” budget? Accruing $23 billion (and that’s probably under-stating the problem) in unfunded pension liabilities technically does not count as “deficit spending.” Neither does short-changing the compensation of state employees, which creates major issues for recruiting and retaining a competent workforce when long-term Baby Boomer employees retire. But these shortfalls are only one step removed from a budget deficit. They pile up future obligations just as the state would if, say, it deferred maintenance on roads and highways year after year.

Legislators face hard, hard choices in a world in which sluggish economic growth and expanding Medicaid enrollment crowd out other spending.  Short of raising taxes, which would create a new set of problems, Virginia has no choice but to radically re-think government from stem to stern.

First principle: State and local governments should focus exclusively on core functions, excel at those functions, and abandon the rest. Corollary of the first principle: It takes good employees to achieve excellence. Second corollary: It takes competitive pay and benefits to recruit and retain good employees.

Second principle: State and local government should not rack up a budget deficit disguised as unfunded future obligations that will bedevil the next generation.

Govern accordingly.