Underfunded pension commitments to public employees is a central, long-term issue for local governments and for the U.S. municipal bond market.
According to a new academic study, even substantial revisions to those pension plans likely will leave taxpayers with a big bill to fill the hole, a $1.5 trillion-sized hole.
Dramatic policy changes such as eliminating pensions’ cost-of-living adjustments and kicking retirement ages up to levels in line with the Social Security regime still leaves a $1.5 trillion hole, said Joshua D. Rauh, co-author of the study and associate professor at Northwestern University’s Kellogg School of Management.
And such changes can hardly be assumed. “While these ‘drastic’ actions may be less politically viable than more incremental policy measures, even these do not come anywhere close to solving the problems associated with states’ legacy pension liabilities,” says the study by Rauh and Robert Novy-Marx of the University of Rochester.
Their findings were presented Thursday at a meeting of the National Bureau of Economic Research.
Without changes, they estimate the unfunded liability stands at $3 trillion.
Throw another worrisome fact into the public pension mix. Most states figure they are going to earn a return on their existing assets of about 8% to help fund future payouts. At least in the current investment environment, that’s quite an assumption.
None of the gloom should stop states from enacting sane reforms for pension schemes. A nascent movement is under way. This column has previously noted a significant ‘agency’ problem exists with public employee retirement benefits. Temporary state political leadership has little incentive to tackle these nasty issues or to be tough in union negotiations, unless they see tangible short-term political advantage.
As more voters understand the pension liability predicament many states are in, that political will may make itself known.
At a minimum, retirement age and other standards should better mirror private industry.
“The debate over the solution is over transfers,” the study’s authors write. “The current situation is one in which beneficiaries view their benefits as secure promises and taxpayers do not perceive that they will be held accountable for guaranteeing those promises.”
Ultimately, Rauh and Novy-Marx figure taxpayers will have to come up with the money to fill the bulk of the gap that remains regardless of the level of reform that takes place. “If unfunded liabilities continue to grow, the bailouts could be even larger.”