The pension plans sponsored by states and municipalities will place a substantial burden on state and local public finances in the near future. My recent work has estimated that the present value of already-promised state pension benefits is over $5 trillion when the benefit payments are discounted using Treasury yields, compared to a little over $2 trillion in pension fund assets. Most state constitutions offer special protections to pension benefits that state workers have already earned.
This analysis raises the question of how soon such a situation might lead to an all-out state and municipal fiscal crisis. One important day of reckoning is the day that the state pension funds run out of money. At that point, pension payments to retirees will have to come out of general revenues. This day of reckoning is in fact not as far away as some might imagine. For Illinois, it could be as soon as 2018.
For a paper I presented in January at a conference on America’s looming fiscal crisis, I calculated the year at which each state will run out pension fund money, under a number of stylized assumptions. I assumed, somewhat generously, that going forward states will contribute to their pension funds the present value of any newly accrued benefits. From the model of state pension fund payments I developed with Robert Novy-Marx (University of Chicago), I extracted our estimates of benefit payments that have already been promised to workers as of today. For simplicity, I pooled all the pension funds within each state. Finally, I conducted the analysis under a baseline assumption that states actually will earn 8% on their investments, as well as under alternative scenarios.
As the accompanying table shows, the day of reckoning is in fact not as far away as some might imagine. Under my projections, seven states run out of money before 2020, including Louisiana (2017), Illinois (2018), New Jersey (2018), and Connecticut (2018). Thirty more states are expected to run out of money during the 2020s.
The damage inflicted by this problem depends upon how large the benefits owed to workers actually are relative to the state’s revenues. In Illinois, obligations already promised to workers as of today will result in over $14.5 billion in pension payments in 2019, the year after the funds will run dry. Tax revenues for the state of Illinois were $31.9 billion in 2008, according to a recent U.S. Census Bureau table. Moving to a pay-as-you-go system would therefore be a catastrophic shock to the revenue needs of the state of Illinois, amounting to 46% of 2008 tax revenue. For Louisiana, the corresponding figure is a smaller but still worrisome 28%.
Some states whose funds might not run out of money until the mid 2020s face a very challenging situation when they eventually do. Ohio collected $26.4 billion in tax revenues 2008. If their pension funds run dry in 2023, they will face $19.1 billion of benefit payments owed in 2024 out of general revenues. That’s over 72% of 2008 tax revenues.
What then can states do to stave off this problem? Unfortunately, the only solutions that will work are solutions that are politically not viewed as desirable. Taxes could be raised to increase contributions to pension funds sooner rather than later. Alternatively, spending on some state programs could be cut. A recession is not the best time for either of these measures, but given the lag time with which any programs take effect, now would be a good time to at least implement a program that puts states back on a path to solvency.
As for the benefits themselves, the legal protections mentioned above limit the extent to which they can be cut without complete legal overhauls of state constitutions (see this list by the public pension advocate NCPERS, as well as a nice article by Jeff Brown and David Wilcox). States could test the constitutionality of reducing cost of living adjustments (COLAs) — as Colorado is attempting to do now under substantial resistance — and raising retirement ages for already-accrued pensions. Given that running these programs on an ongoing basis appears fiscally unsustainable, freezing the level of benefits at their current level is also a potentially important option. Employees would then get future retirement benefits in the form of tax-deferred savings vehicles such as the 403(b).
Teachers and public employee unions will doubtless complain that the expectation of accruing a large pension late in life provides a critical incentives for workers to choose and stay within the public sector. Education and public safety are clearly important societal priorities. The problem is that many US states and municipalities have not been paying for the public services they have been consuming, instead preferring to borrow from employees through underfunded pensions.
If we are going to keep providing generous pensions to state workers, taxes will have to rise dramatically in the near future to pay for them. Alternatively, public employee benefits could be limited to the extent possible under the law, and other spending could be cut. The most equitable solution is probably one in which both taxpayers and public employees share in the pain to some extent. One thing is for certain: to continue ignoring the problem until states run bankrupt is not in anyone’s interest.
Table: When Might State Pension Funds Run Dry? |
||||
Year They Run Out |
Benefits Owed the Following Year |
2008 Tax Revenues ($billions) |
Ratio |
|
OKLAHOMA |
2017 |
2.6 |
8.5 |
31% |
LOUISIANA |
2017 |
3.1 |
11.0 |
28% |
ILLINOIS |
2018 |
14.7 |
31.9 |
46% |
NEW JERSEY |
2018 |
10.8 |
30.6 |
35% |
CONNECTICUT |
2018 |
3.8 |
13.4 |
28% |
ARKANSAS |
2019 |
2.0 |
7.5 |
27% |
WEST VIRGINIA |
2019 |
1.0 |
4.9 |
21% |
KENTUCKY |
2020 |
3.9 |
10.1 |
38% |
HAWAII |
2020 |
1.6 |
5.1 |
30% |
INDIANA |
2020 |
3.2 |
14.9 |
21% |
COLORADO |
2021 |
5.6 |
9.6 |
59% |
MISSOURI |
2021 |
4.9 |
11.0 |
45% |
MISSISSIPPI |
2021 |
2.9 |
6.8 |
43% |
NEW HAMPSHIRE |
2021 |
0.8 |
2.3 |
34% |
KANSAS |
2021 |
1.9 |
7.2 |
27% |
OHIO |
2023 |
19.1 |
26.4 |
72% |
RHODE ISLAND |
2023 |
1.8 |
2.8 |
67% |
ALABAMA |
2023 |
4.3 |
9.1 |
48% |
NEW MEXICO |
2023 |
2.6 |
5.6 |
46% |
MARYLAND |
2023 |
5.3 |
15.7 |
34% |
PENNSYLVANIA |
2023 |
10.9 |
32.1 |
34% |
MICHIGAN |
2023 |
6.6 |
24.8 |
27% |
VERMONT |
2023 |
0.4 |
2.5 |
15% |
MAINE |
2024 |
1.4 |
3.7 |
37% |
MINNESOTA |
2024 |
6.7 |
18.3 |
37% |
MASSACHUSETTS |
2024 |
5.2 |
21.9 |
24% |
SOUTH CAROLINA |
2025 |
4.6 |
8.5 |
54% |
MONTANA |
2025 |
0.9 |
2.5 |
39% |
CALIFORNIA |
2026 |
48.1 |
117.4 |
41% |
ARIZONA |
2026 |
5.6 |
13.7 |
41% |
WYOMING |
2026 |
0.7 |
2.2 |
33% |
NEBRASKA |
2027 |
0.9 |
4.2 |
21% |
IDAHO |
2028 |
1.3 |
3.7 |
35% |
VIRGINIA |
2028 |
5.9 |
18.4 |
32% |
WASHINGTON |
2028 |
5.4 |
17.9 |
30% |
ALASKA |
2028 |
1.3 |
8.4 |
15% |
TEXAS |
2029 |
18.9 |
44.7 |
42% |
WISCONSIN |
2030 |
10.1 |
15.1 |
67% |
OREGON |
2030 |
4.3 |
7.3 |
59% |
NEVADA |
2030 |
2.7 |
6.1 |
44% |
GEORGIA |
2032 |
9.4 |
18.2 |
52% |
IOWA |
2032 |
2.6 |
6.9 |
38% |
TENNESSEE |
2032 |
3.4 |
11.5 |
30% |
FLORIDA |
2033 |
12.4 |
35.8 |
35% |
NORTH DAKOTA |
2033 |
0.4 |
2.3 |
17% |
NEW YORK |
2034 |
15.6 |
65.4 |
24% |
SOUTH DAKOTA |
2035 |
0.9 |
1.3 |
65% |
DELAWARE |
2040 |
0.5 |
2.9 |
19% |
UTAH |
2042 |
1.8 |
5.9 |
30% |
NORTH CAROLINA |
NA |
NA |
22.8 |
NA |
Note: For methodology, see “Are State Public Pension Sustainable” by Joshua Rauh, prepared for “Train Wreck: A Conference on America’s Looming Fiscal Crisis,” January 2010.
The pension plans sponsored by states and municipalities will place a substantial burden on state and local public finances in the near future. My recent work has estimated that the present value of already-promised state pension benefits is over $5 trillion when the benefit payments are discounted using Treasury yields, compared to a little over $2 trillion in pension fund assets. Most state constitutions offer special protections to pension benefits that state workers have already earned (see this list by the public pension advocate NCPERS, as well as a great article by Jeff Brown and David Wilcox).
This analysis raises the question of how soon such a situation might lead to an all-out state and municipal fiscal crisis. One important day of reckoning is the day that the state pension funds run out of money. At that point, pension payments to retirees will have to come out of general revenues.
For a paper I presented in January at a conference on America’s looming fiscal crisis, I calculated the year at which each state will run out pension fund money, under a number of stylized assumptions. I assumed, somewhat generously, that going forward states will contribute to their pension funds the present value of any newly accrued benefits. From the model of state pension fund payments I developed with Robert Novy-Marx (University of Chicago), I extracted our estimates of benefit payments that have already been promised to workers as of today. For simplicity, I pooled all the pension funds within each state. Finally, I conducted the analysis under a baseline assumption that states actually will earn 8% on their investments, as well as under alternative scenarios.
As the accompanying table shows, the day of reckoning is in fact not as far away as some might imagine. Under my projections, seven states run out of money before 2020, including Louisiana (2017), Illinois (2018), New Jersey (2018), and Connecticut (2018). Thirty more states are expected to run out of money during the 2020s.
The damage inflicted by this problem depends upon how large the benefits owed to workers actually are relative to the state’s revenues. In Illinois, obligations already promised to workers as of today will result in over $14.5 billion in pension payments in 2019, the year after the funds will run dry. Tax revenues for the state of Illinois were $31.9 billion in 2008, according to a recent U.S. Census Bureau table. Moving to a pay-as-you-go system would therefore be a catastrophic shock to the revenue needs of the state of Illinois, amounting to 46% of 2008 tax revenue. For Louisiana, the corresponding figure is a smaller but still worrisome 28%.
Some states whose funds might not run out of money until the mid 2020s face a very challenging situation when they eventually do. Ohio collected $26.4 billion in tax revenues 2008. If their pension funds run dry in 2023, they will face $19.1 billion of benefit payments owed in 2024 out of general revenues. That’s over 72% of 2008 tax revenues.
What then can states do to stave off this problem? Unfortunately, the only solutions that will work are solutions that are politically not viewed as desirable. Taxes could be raised to increase contributions to pension funds sooner rather than later. Alternatively, spending on some state programs could be cut. A recession is not the best time for either of these measures, but given the lag time with which any programs take effect, now would be a good time to at least implement a program that puts states back on a path to solvency.
As for the benefits themselves, the legal protections mentioned above limit the extent to which they can be cut without complete legal overhauls of state constitutions. States could test the constitutionality of reducing cost of living adjustments (COLAs) — as Colorado is attempting to do now under substantial resistance — and raising retirement ages for already-accrued pensions. Given that running these programs on an ongoing basis appears fiscally unsustainable, freezing the level of benefits at their current level is also a potentially important option. Employees would then get future retirement benefits in the form of tax-deferred savings vehicles such as the 403(b).
Teachers and public employee unions will doubtless complain that the expectation of accruing a large pension late in life provides a critical incentives for workers to choose and stay within the public sector. Education and public safety are clearly important societal priorities. The problem is that many US states and municipalities have not been paying for the public services they have been consuming, instead preferring to borrow from employees through underfunded pensions.
If we are going to keep providing generous pensions to state workers, taxes will have to rise dramatically in the near future to pay for them. Alternatively, public employee benefits could be limited to the extent possible under the law, and other spending could be cut. The most equitable solution is probably one in which both taxpayers and public employees share in the pain to some extent. One thing is for certain: to continue ignoring the problem until states run bankrupt is not in anyone’s interest.
Table: When Might State Pension Funds Run Dry? |
||||
Year Run Out |
Benefits Owed the Following Year |
2008 Tax Revenues ($billions) |
Ratio |
|
OKLAHOMA |
2017 |
2.6 |
8.5 |
31% |
LOUISIANA |
2017 |
3.1 |
11.0 |
28% |
ILLINOIS |
2018 |
14.7 |
31.9 |
46% |
NEW JERSEY |
2018 |
10.8 |
30.6 |
35% |
CONNECTICUT |
2018 |
3.8 |
13.4 |
28% |
ARKANSAS |
2019 |
2.0 |
7.5 |
27% |
WEST VIRGINIA |
2019 |
1.0 |
4.9 |
21% |
KENTUCKY |
2020 |
3.9 |
10.1 |
38% |
HAWAII |
2020 |
1.6 |
5.1 |
30% |
INDIANA |
2020 |
3.2 |
14.9 |
21% |
COLORADO |
2021 |
5.6 |
9.6 |
59% |
MISSOURI |
2021 |
4.9 |
11.0 |
45% |
MISSISSIPPI |
2021 |
2.9 |
6.8 |
43% |
NEW HAMPSHIRE |
2021 |
0.8 |
2.3 |
34% |
KANSAS |
2021 |
1.9 |
7.2 |
27% |
OHIO |
2023 |
19.1 |
26.4 |
72% |
RHODE ISLAND |
2023 |
1.8 |
2.8 |
67% |
ALABAMA |
2023 |
4.3 |
9.1 |
48% |
NEW MEXICO |
2023 |
2.6 |
5.6 |
46% |
MARYLAND |
2023 |
5.3 |
15.7 |
34% |
PENNSYLVANIA |
2023 |
10.9 |
32.1 |
34% |
MICHIGAN |
2023 |
6.6 |
24.8 |
27% |
VERMONT |
2023 |
0.4 |
2.5 |
15% |
MAINE |
2024 |
1.4 |
3.7 |
37% |
MINNESOTA |
2024 |
6.7 |
18.3 |
37% |
MASSACHUSETTS |
2024 |
5.2 |
21.9 |
24% |
SOUTH CAROLINA |
2025 |
4.6 |
8.5 |
54% |
MONTANA |
2025 |
0.9 |
2.5 |
39% |
CALIFORNIA |
2026 |
48.1 |
117.4 |
41% |
ARIZONA |
2026 |
5.6 |
13.7 |
41% |
WYOMING |
2026 |
0.7 |
2.2 |
33% |
NEBRASKA |
2027 |
0.9 |
4.2 |
21% |
IDAHO |
2028 |
1.3 |
3.7 |
35% |
VIRGINIA |
2028 |
5.9 |
18.4 |
32% |
WASHINGTON |
2028 |
5.4 |
17.9 |
30% |
ALASKA |
2028 |
1.3 |
8.4 |
15% |
TEXAS |
2029 |
18.9 |
44.7 |
42% |
WISCONSIN |
2030 |
10.1 |
15.1 |
67% |
OREGON |
2030 |
4.3 |
7.3 |
59% |
NEVADA |
2030 |
2.7 |
6.1 |
44% |
GEORGIA |
2032 |
9.4 |
18.2 |
52% |
IOWA |
2032 |
2.6 |
6.9 |
38% |
TENNESSEE |
2032 |
3.4 |
11.5 |
30% |
FLORIDA |
2033 |
12.4 |
35.8 |
35% |
NORTH DAKOTA |
2033 |
0.4 |
2.3 |
17% |
NEW YORK |
2034 |
15.6 |
65.4 |
24% |
SOUTH DAKOTA |
2035 |
0.9 |
1.3 |
65% |
DELAWARE |
2040 |
0.5 |
2.9 |
19% |
UTAH |
2042 |
1.8 |
5.9 |
30% |
NORTH CAROLINA |
NA |
NA |
22.8 |
NA |
Note: For methodology, see “Are State Public Pension Sustainable” by Joshua Rauh, Northwestern University Working Paper, 2010.
Since I am a public employee retiree of NJ, I found your projections interesting but it is not the whole story. You make the assumption of an 8% return on investments but you do not mention whether there are any contributions from the State & Local Governments, nor do you mention about employee contributions.
In NJ we’ve had scattered “employer contributions” over the last 15 – 20 years but the employees have come through with their contributions ranging from 5.5% to 8.5% every year regardless of the economy.
I understand each State Pension Plan is different with different levels of contributions from employers and employees and to adjust for each pension plan would be difficult at best, since many States including my own have several tiers of pension benefits which also effect the calculations.
I have worked with actuarial tables establishing life estates, annuity payouts, and temporary annuities. I have found that they are OK for one individual at one point in their life, but dealing with 300,000 now retired public workers of different ages and pensions of vastly different amounts is almost impossible.
As if that was not enough you have to then estimate (another term for guessing based on assumed facts) the present 700,000 active workers who will retire in the future but when and how many is a new guess on the actuary’s part.
I will reiterate as long as there are parties (employees or employers or both) contributing to those Public Pension Funds it will change your dates of doom maybe to the point that the return on investments reach a higher level pushing those dates even further in the future.
Joe, Many thanks for your remarks. To be clear, my assumption is that total future contributions to pension funds (from all sources — employers, employees, the state) equal the present value of any newly accrued benefits. That is barely happening now, and as accruals grow, contribution rate increases will be needed just to meet that standard.
So to use contributions to push out the day of reckoning on already-accrued benefits will require charging the employers and employees substantially more than the present value of the marginal benefits that are accruing on a yearly basis. In other words, they will have to be taxed for the fact that the state didn’t make its contributions in the past.
This would be equivalent to cutting the pay of public sector employees, which would indeed be another contentious way to push out the day of reckoning.
Thanks for the research Josh. Very interesting.
One question….It seems like the discount rate is integral to your post and paper. But then why not use a discount rate for the last column in the table above? Comparing the benefits Utah will owe in 2043 to their total tax revenues in 2008 might not be the best measure.
At first impression, the 30% ratio provided seems enormous. However, consider the fact that Utah’s annual revenue growth was 20% in 2008. Factoring in that rate of growth takes the ratio from 30.51% to 0.07%.
Even using a more sustainable growth rate halfway between last years actual growth and treasury yields provides a ratio of 0.65%. Thoughts?
Matt, thanks for your message.
One point I want to emphasize is that my calculation of the year when the funds run out does not depend on either discounting or state revenues. The year of demise is calculated simply from our projections of the benefit cash flows themselves, and I assume every year the state has at least enough revenue to fund newly accrued benefits.
That said, I agree with you that 2008 revenues are only a crude benchmark. I was hesitant to forecast state revenue growth. In Illinois revenues have been shrinking and the governor’s budget presentation showed them shrinking through at least 2011. I also wouldn’t want to extrapolate and compound a recent historical growth rate to the coming decades (particularly something like 20% annually!).
I think a more neutral assumption might be 3% nominal revenue growth, which would give a ratio of 35% for Illinois (in 2018) and 11% for Utah (in 2042). Here is a link to an expanded table if you want to see the ratios to “forecast revenue” under 3% nominal annual revenue growth for all states:
http://www.kellogg.northwestern.edu/faculty/rauh/research/blogtable_20100331.xlsx
[…] professor Joshua Rauh has published a paper in which he estimates that (1) state pension funds will run out of money in an average of 10 to 20 […]
Hi Josh,
Your results of fund insolvency in 2017-18 for the most distressed states seem a bit draconian. Mind you, I think it is unacceptable for a funded ratio of less than 60% or so — let alone dealing with the prospect of insolvency.
I wanted to reconfirm that you were assuming an 8% investment return. Were you also assuming that the current level of employee and employer contributions would be maintained. Thanks, Rick Roeder
Correct, an 8% investment return. The contributions assumption is that states contribute the present value of newly accrued benefits. As a group they have approximately done this in recent years. See the conference paper on which this post is based for further analysis of recent contribution behavior (particularly Figure 2):
Click to access RauhASPSSUSC2010.pdf
On March 15, 2007, Dr. Douglas A Love, Chief Investment Officer for Ryan Labs and a member of the New Jersey Investment Council, an oversight board for NJ’s pension funds made a presentation to the Council. On slide 7 he published the forecast annual cash outflow for NJ’s public pension funds as-of 9/30/06. This is the only such disclosure I can find from from any public plan. (In written comments to GASB last year I strongly urged them to make this a reporting requirement.)
I loaded those cashflow into Excel and Bloomberg Professional service’s “portfolio cash flow report” function (“PCF”).
Given NJID’s then $74.5 billion in assests and using an 8.50% annual return assumption (NJID’s CAFR said 8.25%) the pension fund would be exhausted in 23 years, in 2029. Using the assets’ actual yield at the time (YTM of bonds, E/P of equities), they’d go broke in 2023. And, more comparable perhaps to your figures, using the 30-year T-bond rate (i.e., ignoring the upward sloping yield curve) they’d go broke in 14 years, 2020.
All of that was, of course, before the 2007 meltdown which has brought forward the day of reckoning. Since then more benefits have also accrued.
While we can’t prove that the demographics of al public plans are the same as NJ’s, they can’t be that different. Nationally we cannot escape the fact that over 70 million baby-boomers are now reaching retirement age; about 30% of today’s workforce. Using U.S. Census Bureau’s forecasting tool and assuming current (2005) labor force participation rates, by 2029 the “dependency ratio” of working population to dependent will fall to 0.71:1 (over 65, under 20, plus not working). The ramifications of 5 Americans each trying to pay for and take care of 7 others go well beyond finance. Obviously something must give, but what? (retirement at age 65 probably will the the first to go; participation rate rise — or plummet if taxes go much higher)
While I haven’t read your latest paper, I have read several of your others (we exchanged emails a year or so ago). I came to the same conclusions back in 2005 using data compiled by Wilshire Associates on 225 state & local plans and again in 2006 using data on 102 plans compiled by NASRA. I used Bloomberg Professional service’s data to duration-adjust plan liabilities (using 30-year T-bond yields as-of each plan’s reporting date).
“Let facts be submitted to a candid world.” rather than GASB and ASB’s current practice of condoning materially misleading and deceptive financial reporting by public pension systems.
JRB
Thanks, Jack. I appreciate your comments.
Josh,
Good article about the additional pending financial pressures that will be hard to alleviate going forward.
One comment about your statement regarding both taxpayers and public employees share the burden. I disagree completely. The employees should shoulder the burden either through reduction in benefits or by having them directly contributed into the pension to maintain its solvency. Why should other taxpayers carry the burden of having to support the lavish benefit schemes of these governmental institutions that have over promised and intently underfunded? This is not the burden of the society at large. Additionally, the overall structure regarding defined benefit plans needs to be eliminated and replaced with defined contribution to reduce the risks of further deficits such as these.
Thanks, Trent Curry
Trent, thank you for your remarks.
One question we have to answer (i think the jury is still out) is how lavish these benefit schemes really are on average. We have many documented cases of corruption and abuse in state pensions, particularly so-called pension “spiking” where connected public employees are rotated into high-paying jobs for short periods of time in order to affect their lifetime retirement benefits. The book “Plunder!” by Steven Greenhut is filled with such examples. Taxpayers should obviously not have to shoulder the burden of such corruption.
What makes me a little cautious are statistics I have seen on the average public employee. Here are some figures for Illinois pulled from a document by Charles N. Wheeler, III. 95% of retirees in the IL State Employee Retirement System (IL-SERS) are eligible for Social Security, and they receive pensions that average $22,000 per year. 5% of retirees in IL-SERS are not in Social Security, and they receive average pensions of about $28,000 per year. Retired Illinois teachers are not on Social Security and they receive an average of $43,000 per year. In my view, these figures (assuming they are accurate) do not paint a picture of excess for the average public employee in Illinois, although the concept of “adequacy” is to a large degree in the eye of the beholder.
Another question is what the contractual obligations of the states are and the extent to which states can and should try to get out of them. State employees will certainly argue that they signed an employment contract under certain terms and it is not their fault if the state has not funded them. They viewed their contract with the state as one of deferred compensation (a debt contract), not an equity stake in the fortunes of the state government.
As for your recommendation about the overall structure, I agree that states should consider freezing DB plan benefits at current promises and putting all retirement benefits from future service on DC plans. A big disadvantage of the public DB systems is now becoming very clear: they have provided a vehicle for states to increase their debt in opaque ways off the balance sheet.
Thank you for your work on this important topic. This and topics like it I believe are the most important facing our country and our children right now as they are quickly creating a high probability of a financial reckoning that most people can not imagine. Most concerning to me is the difficulty of getting anything done politically to change this course the state and federal governments are on (not to mention most world governments). These are politically unpopular things to discuss and will the people ever elect anyone running on a platform of cutting benefits and services? I fear they won’t, not until its too late, when borrowing costs have started to climb and the problems become even more impossible to dig out of. I can’t help but think that Greece, though far away and a small financial piece of the worls puzzle, is the first domino to drop in this long game of financial deficit dominoes that governments have been playing for years. There is one glimmer of hope, though. People want to know how this all affects them, otherwise these are all just a bunch of numbers on a page. Only two years into this recession, the financial problems of the State of Illinois have started to impact the finances of local municipalities. And where have they started to cut services? Teachers. Wow, that happened quickly. Finally, people are starting to see that these things directly affect them, and have most likely already started to affect how their children are being educated. I hope we can all wake up in time before some really painful sacrifices have to be made.
Vito, thank you for your remarks. I couldn’t agree more.
Josh, some of the other posts indicated that public employees should contribute to their pensions, most do. Some public employees contribute more then others based on job and state.
In NJ the average public worker contributes 5.5% of his or her salary toward their pensions. Police and Fire contribute 8.5% the highest in the country. All total the public employees contribute about $2+ billion into their pension funds each year. If only the NJ public employers matched it, or matched the national average for public employers which is $2 for every $1 contributed by public employees (Pensions and Investment Jan. issues) NJ would not be so bad off.
NJ’s average pension for those who are the state workers and local government workers (the single largest group of public employees in NJ) is about $22,000 a year. This particular Pension Fund includes labors, clerks, technicians, auditors, engineers, doctors, politicians, etc.
Why is the average pension low, because many public workers come to public service late in their lives and do not accumulate the years of service and still the lowest paid jobs are in the low $20 K range. This balances out the politicians whose pensions always seem to top $80,000 plus.
Latest figure for Pension dismemberment is about $4.8 billion per year (fiscal 2009).
I still honestly believe that this pension fund will go deep into the 21st century as long as all parties make some sort of meaningful contributions.
This was an interesting analysis, but your solution sounds PC but is really not the solution. Asking taxpayers to continue to subsidize state pension funds (along with the state) is absurd and will NOT work. How high can taxes go? All economic analysis shows that when states raise tax rates, the amount of revenues does not actually go up but will go down…its easy for the wealthy (who pay all state income taxes) to move to other states. Other forms of taxes, like sales taxes and property taxes, are already at very scary levels that can not be raised. The only solution is for state pension holders to face the same economic realities as the private sector…when your employer suffers so do you. State employees make too much money, retire way too young, and receive benefits multiples of the contributions made over their working life. Its time for cuts to existing state employees as well as pension holders. Taxpayers do not want to continue paying for them!
@DSB: If you read the blog entry carefully, Josh Rauh is not proposing a single solution to the problem, simply mentioning those that could be on the table, even at a large cost (including recanting on contractual promises… a 403(b) plan is the non profit equivalent of 401(k), a defined contribution plan). I will agree with you that there are many egregious abuses in the public sector, but, on average, the figures quoted in the comments to the entry (for example, here and here)do not suggest ‘lavish’ pensions in an absolute sense. Besides, when the private sector ditches its costly and unfunded defined benefit pension plans, guess where they go: PBGC. Eventually, we, the tax payers, are liable for those pensions, too.
[…] a doctor who has been watching a patient bleed to death and then orders a band-aid. As shown in my previous blog post, the major Illinois pension funds run out of money in 2018, even under some pretty generous […]
I don’t know if the dollar amount paid public pensioners is too high or not, but it is clear that benefits are paid for too long a period–retiremnt ages are simply too low. I’m not arguing for a lower retirment age for police officers and fire fighters, but receiving full benefits at age 50 permits many to live in retiremt longer than they worked. Maybe the answer is to push out the date at which that public safety employees collect full benefits? It shouldn’t be anathema that these workers consider a second career after leaving public service.
Josh,
In many ways, your dates appear to be best case assumptions. With PE ratios in excess of 20, the stock market may well be substantially overvalued at this point. An 8% rate of return seems very high.
With budget deficits in virtually every state and very significant ones in California, New York, New Jersey, Illinois and Florida, the ability/willingness of the states to make continuing contributions would appear to me to be very much at risk.
John Bailey
[…] value exceeding $3 trillion (see my estimates here, or those from Northwestern’s Joshua Rauh here) to reduce the rate at which future benefits accrue. For instance, the typical public employee […]
[…] Should Do About State Pension Liabilities,” jointly authored with Robert Novy-Marx. As I have blogged previously, states are making financial promises that they cannot possibly keep, and the bills are coming due […]
Mr. Rauh —
Thank you for the research and publishing your findings. I have looked at the State of Illinois pension financial statements and have left wondering how an unqualified opinion can be provided given the growing gap between resources and commitments. Do you have any insight into this accounting issue? If the people of the State of Illinois are on the hook and the politicians will not address the gap by modifying pension terms the only two obvious future alternatives are either tax increases (large) or insolvency, bankruptcy and reorganization (difficult but doable.) I thought accountants were supposed to pick up on these matters?
Thanks.
NJKost
Norman, thanks for your thoughts. This is a classic example of what economists call an agency problem. The state itself hires its accountants, actuaries and auditors — if state politicians don’t like the opinions provided, they can hire others. Taxpayers typically don’t monitor the various auditors to see if they are doing a good job, and that inattention will cause us grave problems down the line. Unfortunately, we often only wake up to the problems when the situation gets quite dire.
Josh,
1. Both public and private pensions face the same future returns issue. The Dow returns since 1972 average 6%. With scarce resources, water, energy and land, less available to plunder, even the 6% will not be sustainable.
2. States are barred from deficit spending, yet, year after year states underfund their pension liabilities. How does this happen? At least if they are underfunded the crashes in the market do not impact the fund assets.
[…] of Reckoning is imminent and they aren’t alone. Joshua Rauh calculates when other states can expect to run out of funds to pay pension […]
[…] these unfunded liabilities will come due soon. A series of studies by Joshua Rauh (Northwestern) and Robert Novy-Marx (University of Chicago) find that […]
Thanks to Prof Rauh for doing work on a critical issue in public finance. I’m guessing we will continue to kick this rock down the road as we do with most public policy challenges.
As a cynical member of Gen X, I presume that we will do nothing until all of the baby boomers retire, grandfather them into any changes and stick it to current state employees in the form of lower payouts (most likely by terminating the unsustainable defined benefit pension plans). As much as that is counter to my self-interest, I’m more or less fine with that occuring as I view the status quo as morally bankrupt.
This is more true within soft-money academia where it is the bloody federal government picking up the tab for these insanely generous pension programs. Soft-money academia is probably more corrupt than Wall St. or mortgage lending, as it is helping to destroy higher education in this country….which kinda, sort of matters for LT growth….
I’m pretty unfamiliar with this literature and haven’t read the paper, but it isn’t exactly rocket science to realize that any system that guarantees an absurd rate of return is simply a house of cards. A great example is my state’s pension system which has invested in opulent state office buildings which it “leases” to other state agencies. The shell game here is pretty obvious as you can get any desired return on investment by simply changing rents and increasing costs to the relevant agency, requiring increases in taxes to finance the scheme…
I think our generation needs to eat it for the good of the country and to say “enough is enough” — The boomers got theirs, but I don’t want mine if it means leaving my country in no better shape than I found it.
[…] pension, health care and other benefits and the money they currently had to pay for it all. And some economists say that Pew is too conservative and the problem is two or three times as […]
[…] pension, health care and other benefits and the money they currently had to pay for it all. And some economists say that Pew is too conservative and the problem is two or three times as large Link & […]
[…] Rauh, a professor of finance at the Kellogg School of Business at Northwestern University, took a stab at estimating this recently. Before you click through, keep in mind that crunching these numbers is as much art as […]
As always, people forget the other alternatives to pension instability. People should die sooner. Problem solved.
In Illinois, the State Pension system is a substitute for Social Security – the State does not pay its share of what would be social security taxes (FICA), (like all other employers in the US), but is supposed to pay that amount into the pension fund. Unfortunately, the politicians have refused to do that for many years or found ways around it, despite the fact that it is Constitutionally mandated by the State Constitution!
The workers do pay their share as deductions from their salary (approximately equal to what their FICA taxes would be), and that goes into the pension fund. These workers do not have social security – their state pensions are supposed to be their social security when they retire. What will they do when the fund “runs out?”
[…] pension, health care and other benefits and the money they currently had to pay for it all. And some economists say that Pew is too conservative and the problem is two or three times as […]
These lavish pensions were not a result of the free market, they were the result of political pressure applied by the unions. Studies show government workers are paid a third to a half more than than their private sector counterparts. They are generally grossly overpaid.
I never voted for these ridiculous pensions, so I accept no responsibility for them and will not tolerate my taxes being raised to pay for them. If the states default on their obligations and can’t pay the government parasites their huge pensions, I DON’T CARE!!!
Victor, I do not know what state you are in nor what studies you are referring to but in the states of Illinois and California, with which I have experience, government employees are paid less than the private sector – I have worked in both, and worked with private sector counterparts, all of whom where paid more in similar jobs with similar professional qualifications. In Ca I worked on a forensic program which had private sector in some counties and public sector in other counties – and the private sector where paid more than the public.
And in both Ca and IL pensions where based on employee contributions! And as I mentioned elsewhere, in IL this was a substitute for Social Security, with IL State avoided paying FICA contributions which all other employers have to do because it was supposed to pay into pension funds – but it did not! That is why IL has a shortfall.
[…] They found that popular policy changes such as small cutbacks to annual cost-of-living adjustments would have a relatively small impact on the extent of liabilities taxpayers will likely have to pay (Prof. Rauh has previously estimated that the current gap is around $3 trillion to begin with). […]
[…] of state pension fund money within the next 16 years. New Mexico falls within that range. In fact, the Rauh/Novy-Marx model predicts that by 2023, New Mexico’s state pension plan will go […]
[…] last month’s meetings when one task force member brought up a recent analysis by economists Joshua Rauh and Robert Novy-Marx claiming that pension plans in 31 states are at risk of running out of money within 15 years. New […]
[…] of Reckoning is imminent and they aren’t alone. Joshua Rauh calculates when other states can expect to run out of funds to pay pension benefits. Crossed-Posted from Neighborhood […]
Any thoughts on how this would be any different if states were subject to the same ERISA and tax code funding requirements (and PBGC protections) as are pension plans at private corporations? Its always struck me that the same partneralism that went in to ERISA should have also been (should have been more of?) a motivation for state regulation – particularly because the Federal Government would likely be on the hook for pension failures.
Interesting point. If state and local governments had been subject to those rules, their systems would be in much better shape. The justification for ERISA and the introduction of the PBGC was that the federal government implicitly backstopped failed corporate pensions anyway. As you point out, it seems even more likely that the federal government would be on the hook for failed state systems. I would speculate that there are two reasons why the state issue wasn’t taken on at the same time: 1.) possible state sovereignty issues with federal regulation of state and local pension plans; 2.) an assumption that states would never need the help. Regarding the second point, recall that at the time there had been some high-profile corporate bankruptcies (e.g. Studebaker) in which people had lost their pensions, with no similar cases for state and local employees.
Today I think there is a Catch-22 if Congress decides to take on this issue: any proposal to regulate state and local pension systems contains a whiff of admission that the federal government in fact is backstopping the states. That is not popular in states that have only minor budget problems.
As an employee of the state of Illinois for more than thirty years, I am appalled at the suggestion of cutting benefits for members of the retirement system. As an employee, when I retired, I was making, on average, of more than $1000 a month contribution to my own retirement. An amount that is supposed to be matched by the state. The high contribution amount was due to massive amounts of overtime worked due to the state not hiring, and promoting, staff as vacancies occurred. Retirement system members should not bear the burden of a chronically underfunded system that has a history of having funds borrowed for use in the general fund. Even if borrowed funds are repaid in the future, the interest yield is lost. The retirement benefits that members receive are not gifts, or handouts, they are benefits, that were EARNED. The retirement system is a trustee of monies, amount based on the current salary, each pay period, of the member, that were SUPPOSED to be received and placed in a structured trust to be distributed on a schedule that is clearly outlined. States that have underfunded their retirement systems then complain about the member’s benefits are like a household that writes checks while putting no money in the account and the blaming the bank because the account is empty.
I would prefer to see existing promises honored, with incentives to have a more sustainable system for future promises.
[…] to Northwestern University Professor Josh Rauh, Illinois’s pension system will be among one of the first to run […]
The solution is to cancel state defined benefit pension plans entirely and replace them with 401K plans as the private sector has mostly done. This should be done for all gov’t workers under the age of 55, with the state making a deposit into the plan for accumulated contributions (not benefits) to date.
It is interesting that while “What is good for General Motors is good for America”, the reverse also holds true. The states face the same bankruptcy problem due to pensions that brought down GM, Chrysler, as well as most of the steel companies.
While state workers will scream that they were “promised” gold plated pensions, that is not really accurate. It is more accurate to say their unions stole these pensions from under the taxpayers noses, as the true costs of pensions were never properly explained to the voters. If they had been, they would never have been approved, as the people paying the bills, taxpayers, get far more meager pensions and benefits.
[…] by 2020, just nine years from today, and New Jersey being among them. New Jersey is certainly on professor Josh Rauh’s list but their year is 2018, just seven years from […]
Prof Rauh, your work on this is greatly appreciated. As much as I may view the fulfillment of employment contracts (including deferred compensation) as a moral and legal obligation . . . I fully appreciate the fiscal realities (built up over decades of neglect) and severe political realities going forward. There are a couple of things that public employees (and the organizations that represent us) could do to encourage solutions. First is to promote public awareness (and accuracy of information).
Second would be to take the political high ground (and seize the microphone) by initiating a program of reform. Included in that program would be a proposal to eliminate the tax exemption enjoyed on public pensions (in Illinois and many other states). I would heartily endorse progressive taxtion of Illinois pension benefits as a groundbreaking first step. Has your analysis included any simulations on the effects of such a proposal for Illinois?
Thanks for your comment. The taxation of pension benefits is a very interesting idea. Total benefit payments from the 3 largest IL state retirement systems are now around $7 billion annually, and I would estimate total benefit payments from all public DB pension system in IL at around $10 billion annually. Taxation of that at the flat state income tax rate of 5% would bring in $0.5 billion annually to the state, compared to the $8.75 billion in bonds that Governor Quinn has proposed issuing to close the gap. That said, it is worth keeping in mind that pension payouts are growing rapidly, so this tax revenue would grow as well.
Josh: You are certainly aware of the turmoil occurring in my home state of Wisconsin over the proposed increases in public employees’ contribution to their health insurance premiums and pensions.
Steve Chapman’s 2/24/11 column in the Chicago Tribune reported your estimate that Wisconsin has $45 billion in unfunded pension obligations, and your chart above shows Wisconsin’s plan going broke in 2030.
I’ve always heard that Wisconsin’s state plan is one of the healthiest in the nation. What is the real story? What share of your $45 billion estimate is represented by problems with Wisconsin local municipalities underfunded obligations vs. the Wisconsin Retirement System share of underfunded obligations?
Whatever the answer, it’s so refreshing to have your thoughtful analysis of this issue. What can we do to help the average Joe and and Jane understand the magnitude of this problem? The level of debate in Wisconsin, on both sides of the issue, has degenerated to posturing, name-calling, prank calls to our governor, etc.
Paul, thanks for your message. The fully funded calculation comes from disclosures that a.) smooth the value of the pension fund assets by averaging over 5 years; and b.) use expected returns to discount pension assets. Using the finance methodology, the present value of the already-promised liability from the Wisconsin Retirement System is $114B, so the unfunded liability at June 2010 asset values is $45B. That equals 19% of Wisconsin GDP, 3.1 years of Wisconsin state tax revenue, and 2.2 years of all revenues the state of Wisconsin generates through all activities (i.e. including state university tuition, fees, etc). Something unions and taxpayers should both be concerned about.
[…] reference was to a study by Joshua Rauh of Northwestern and Robert Nowy-Marx of the University of Chicago. New Jersey was […]
[…] budgets doesn’t mean that they aren’t in crisis. Take the case of New Jersey. According to Joshua Rauh, professor of finance at Northwestern University, under the best case scenario, New Jersey’s […]
[…] budgets doesn’t mean that they aren’t in crisis. Take the case of New Jersey. According to Joshua Rauh, professor of finance at Northwestern University, under the best case scenario, New Jersey’s […]
[…] budgets doesn’t mean that they aren’t in crisis. Take the case of New Jersey. According to Joshua Rauh, professor of finance at Northwestern University, under the best case scenario, New Jersey’s […]
[…] how big their actual pension debt is, and then hide the lies off the books. Double deception. Other calculations put assets, on average, at about 50 percent of what is required, and show some states having to […]
[…] checks first, whether the state has any money in the bank to pay them or not. According to one estimate, in less than seven years New Jersey will have to pay almost $11 billion in annual pension benefits […]
[…] discussed their paper in a blog post he wrote in March, with my emphasis in bold. This analysis raises the question of how soon such a […]
[…] is likely to be severely impacted sometime during the next 0 to 9 years (References: Article 1, article 2, article 3). According to the Congressional Budget Office (CBO), even senior healthcare is at risk. […]
Why is the year for North Carolina shown as NA? Does it mean that Nortth Carolina’s system will not run out of funds or that you were unable to calcultate the date due to a lack of information? Thanks.
It means that assets in the North Carolina system are sufficient to pay the already-promised liabilities, i.e. the NC systems will not run out of funds under the assumptions in the analysis.
Karl, almost 2 years ago I commented on your projection of NJ’s Public Employees Pension Fund failure in 2018. As I did then and do now believe any Public Pension Fund will not fail until, depending on the amount of a PEPF assets, the ability over a ten or twenty year period to earn enough income on those assets to pay the Public Employee Pensions for that year and add to the total assets of the PEPF along with employee contributions to that fund.
In early 2010 your statements and projections were based on figure of assets of an earlier year. 2/28/10 NJ’s PEPF assets were $67.9 Billion 23 months later after thousands more retired due to pressure from a bully NJ PEPF assets actually grew a few Billion dollars to $70 Billion. This figure is net of all employee contributions ($1.2 Billion per year) and investment return minus the annual pension payments to 300,000 retired public employees ($5 Billion a year).
According to your March 2010 article and your projections on NJ’s 2018 doomsday, with almost 2 years additional data and with growth of the actual assets of the PEPF would you not have to extend the doomsday for at least a couple of years since we did not lower our assets over this period of time but increased.
You may want to add to the additional thousands who retired prior to a so called public pension reform. Those who retired, their postilions were mostly refilled by promoting employees under them etc. only those at the bottom of the pay scales did not get replaced so the difference in employee contributions was miniscule on a $70 billion pension fund.
If by investment returns and contributions by employee and employers meet or exceed the pay out of benefits then you don’t have a problem. If your Fund does not have sufficient assets to “ride out the economic storm” then your in trouble.
NJ’s PEPF assets in the last 10 years rode a roller coaster from a low of $53 billion in 2003 to $84 billion in 2007 and all during that time with only Employee contributions and very little Employer contributions if any at all the fund paid out the benefits required.
I believe you should take the data 2 years latter and apply that to your formula and see if maybe 2018 is a premature year for NJ’s Public Employee Pension Fund failure to pay retirement benefits.
Assets are higher than they were at the time of the study, but not by that much, and the study did assume 8% annualized returns. To redo the calculations we’d also have to model the effects of the early retirements you mention, which accelerate the payouts. The benefit cuts (COLA suspensions) enacted by the reform also would have an effect, although COLA suspensions tend to have a much greater cash flow effect in the distant future.
[…] actual pension debt is, and then hide the lies off the books. Double deception. Other calculations put assets, on average, at about 50 percent of what is required, and show some states having to […]
[…] checks first, whether the state has any money in the bank to pay them or not. According to one estimate, in less than seven years New Jersey will have to pay almost $11 billion in annual pension benefits […]
Josh:
It would appear to me, a forecast of 8% return on funds is a bit high when the inflation adjusted return from 1950 – 2009 was about 7%. If we look at the 2000 decade, the return was a negative. Why 8% return? Are the contibutions in the fund left in the pension fund or are they redistributed to other state agencies because everyone expects an 8% return.
To me the issue appears to be over forecasting the return on the pension funds. In which case, if the return is less than 8%, your forecasts of deficiency is optimistic at best.
[…] renewed interest in my March 2010 blog post, I should point out that I made some (relatively minor) updates to the calculations during the […]