Today I am speaking at a conference in Washington hosted by the University of California Retirement Security Institute. I am unveiling a plan called “What the Federal Government 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 much sooner than you think. Unless action is taken soon, the federal government will face intense pressure to bail out the affected states, at a price tag of $1 trillion or more.
The outline of the plan is that the federal government should cut a deal with states. They should allow a state to issue tax-subsidized bonds for the purpose of pension funding for the next 15 years — if and only if the state government agrees to take three specific measures to stop the growth of unfunded liabilities:
- The state must close its defined benefit plans to new employees under a “soft freeze” and agree not to start any new defined benefit plans for at least 30 years.
- The state must annually make exactly its actuarially required contribution (ARC) left over from the existing underfunded plans; only the amount of that ARC will be subsidized.
- The state must include its new workers Social Security, and provide them with an adequate defined contribution plan, again for at least 30 years. To this end, the federal government should start a Thrift Savings Program for state workers and operate it alongside the existing Thrift Savings Program for federal workers.
The tax subsidies for these new Pension Security Bonds would work like Build America Bonds, with the federal government paying 35% of all coupon payments directly to the state. The cost of this subsidy will be in large part offset by the gains to the Social Security system of bringing in new state workers.
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Kellogg School of Management at Northwestern University