The financial soundness of pension systems for state and local government workers has been a topic of much debate. In recent work, Robert Novy-Marx and I have argued that the use of GASB rules to discount future benefit payments results in present value measures of liabilities that are too low to reflect the true economic liability faced by state taxpayers. At the same time, a number of states have enacted changes designed to reduce the liabilities associated with their pension systems. Most of these changes affect new employees only, and hence have no impact on standard liability measures, which do not consider future employees. However, some changes, such as the reductions in the cost of living adjustments (COLAs) passed by Colorado and Minnesota this year, do affect existing plan members and hence do affect the economic present value of current state pension liabilities.
Today, Novy-Marx and I have released a draft of a new paper, “Policy Options for State Pension Systems and Their Impact on Plan Liabilities.” In this paper, we examine the present value of state pension liabilities under existing policies and separately under several sets of hypothetical policy steps. In particular, we consider changes to COLAs, full retirement ages, early retirement ages, and buyout rates for early retirement.
We find that even relatively dramatic policy changes, such as the elimination of COLAs or the implementation of Social Security retirement age parameters, would leave liabilities around $1.5 trillion more than plan assets under Treasury discounting. This suggests that taxpayers will bear the lion’s share of the costs associated with the legacy liabilities of state DB pension plans.
Click on the image below to access the complete study:
Your analysis is correct on underfunding, but just leaving it to the taxpayers is not the answer. The solution is to terminate defined benefit pensions as the private sector has largely done and replace them with deifined contribution plans, which will not be under-funded by definition. It is time to face reality that the pensions promised to government empluyees are excessive, unsustainable and morally wrong, when the taxpayers paying for them do not get similar pensions. Moreover such pension reform is needed so that taxpayers understand the full costs of public employees, which are largely hidden under the current system (and allow teachers, policemen, etc. to falsely claim they are “underpaid”).
We are certainly not saying that leaving the problem to taxpayers is the answer. We are pointing out that taxpayers are unlikely to succeed at reducing the unfunded liability by more than half (from $3 trillion to $1.5 trillion).
Our headline numbers assume no future growth of unfunded liabilities. That means you could “hard-freeze” all DB plans across the country, put all future work on 401k-type plans, implement a 67 retirement age, AND eliminate generous early retirement deals. Taxpayers would STILL be left with around $1.5 trillion in unfunded pension liabilities. (A “hard-freeze” of liabilities is like what the companies have done — DB accruals are stopped and all future work goes under a 401k plan.)
If taxpayers don’t want to pay the remaining $1.5 trillion, states will have to go much further at cutting already-earned benefits. We don’t see that as politically likely.
Personally, I have been calling for states to put all new workers onto defined contribution plans. We should also start discussing whether hard-freezes are feasible for states employees. There is often an assumption that a 401k type arrangement would be worse for all public employees, but I don’t think that is true. Right now, early-career public employees are heavily subsidizing an unsustainable system. They are paying for current retirees in systems that will be broke long before they retire.
What most taxpayers don’t realize (and most articles on the topic don’t explain) is that public employees pension plans are in lieu of social security which for all its shortcomings is effectively a DB plan. Public employees are not entitled to social security benefits.
And at least in Colorado, the contribution rates for both employer & employee are higher than for social security with no caps. Thus, blanket conclusions that public pension plans are too generous may be rather hasty.
While I’m not sure which state’s participate in Social Security, Texas does. As a retired bureaucrat (10 years), my nominal income (retirement + early social security) is now higher than when I worked and I was a well paid bureaucrat. W/ the anticipated deflation, I’m looking forward to an increase in real income. 🙂
Wow. 10 whole years. Can I get on that plan please? I was aghast when I heard that my retired school teacher aunt didn’t get SS until I found out the system was more than making up for the difference.
d Paulsen
I’d love to see a side by side comparision of SS to public employee pension plans. While it is true that a lot (not all) of public employees don’t get SS, their pension plans are much more generous that SS is. If I could opt out of SS I would.
Compare the COLAs, amount contributed, amounts received, and age you are eligible to recieve benefits.
In Illinois for example, teachers contribute 8.5% towards retirement, the state makes up the rest, can retire at 55 with 75% of pay, and get 3% COLA. SS contributes 6.2% from the worker, 6.2% from the company, retire at 67, with a max benefit less than $30K per year, and COLA tied to the CPI (0 this year). Which one would you take?