Yesterday I posted about my new paper, “The Revenue Demands of Public Employee Pension Promise,” which finds that state and local pension contributions would need to rise on average by $1,398 per household per year to be on path to full funding. Keith Brainard of the National Association of State Retirement Administrators, has submitted more comments in addition to the ones I already responded to under the original post. Here are his further comments in quotes and my responses.
The Federal Reserve’s projection for long-term GDP growth is 2.5 to 2.8 percent, well above the paper’s assumption of 1.98 percent.
As I already pointed out, the analysis is not very sensitive to GDP growth assumptions. A one percentage point higher growth rate is worth $120 per household. So using the 2.5-2.8% assumption cuts between $63 and $98 per household off of the $1,398 annual increase.
The paper assumes that the entire cost of unfunded pension liabilities will be paid with higher taxes, ignoring the option of higher employee contributions. Indeed, this option already has been effected in many states, including Alabama, Arizona, California, Colorado, Florida, Iowa, Kansas, Maryland, Minnesota, Mississippi, Nebraska, New Hampshire, New Mexico, North Dakota, Vermont, and Wisconsin, and New Jersey appears likely.
The study does not ignore the option of higher employee contributions, and indeed shows in Table 5 how much higher employee contributions would have to be to put the systems on a path to full funding. The mean increase across states would have to be 22% of payroll. For 6 states it is more than 30% of payroll. The actual increases referred to by Mr. Brainard have only amounted to several percentage points of public employee pay.
Due to reporting lags, the latest year for which all contribution data were available was 2009. For those governments that already raised employee contributions effective in 2009, these contribution increases are in the analysis. For the others, we will update our analysis when the new government reports are available.
It’s also worth pointing out that using employee contribution increases to pay for legacy liabilities forces younger employees and especially new hires to subsidize later career workers and retirees.
Also, the paper’s assumption that the full cost of new participation in Social Security will be borne solely by the employer (taxpayer), is unrealistic.
If so, then moving new employees to DC plans plus Social Security will save considerably more money than we calculated in the paper. That is the only place this assumption plays a role.
Roughly 30% of state and local system members are not in Social Security. We assumed that governments wanting to enroll these employees in Social Security could not force them to take what amounts to a 6.2% pay cut. That is, the government would either pay the full 12.4% or would give employees a 6.2% pay raise to cover their portion. Under this assumption, closing DB plans to new workers and enrolling these workers in a DC plan plus Social Security (a “soft freeze”) would save around $175 per household nationally, but would not save money in seven states with relatively low Social Security coverage (see page 4). If instead employees bear the cost of being enrolled into Social Security, then the soft freeze would save considerably more money overall and would reduce required taxpayer contributions in all states.
One-half of that [Social Security] cost is paid by the employee, and there is no sound basis on which to assume that employees will discount the value of their salaries by the amount of the cost of Social Security, particularly given current high rates of unemployment and downward pressure on wages.
Yes. That is why we made the assumption that we did. And that is the only reason in this analysis that moving new employees to DC plans plus Social Security might not save money in the seven states mentioned above.
The paper ignores the changes made in many states to automatic cost-of-living adjustments affecting existing retired members, including in Colorado, Maine, Minnesota, and South Dakota.
Not true. The cost of living adjustment (COLA) changes for Colorado and Minnesota are already incorporated (see footnote 20). The Maine provision passed just last week and does not immediately reduce COLAs but rather limits them to 3%, which will not have a large effect on the analysis.
There is no doubt that actual cuts in COLAs could have a substantial effect on the taxpayer costs. In previous work we calculated that each percentage point of COLA reduction would reduce total liabilities by 10%, and that if COLAs were eliminated nationally (and permanently without option to reinstate), it would reduce the unfunded liability by 50%. These COLAs are valued highly by public employees, as revealed by the lawsuits taking place over the cuts in Colorado, Minnesota, and South Dakota.
In my view, in determining its projections, the paper applies the most pessimistic angle and assumption to every available factor: use of a risk-free rate to calculate liabilities; a rate of economic growth well below what the Federal Reserve expects; rates of real investment return that are well below historic norms; solutions that can be funded only with taxes when other options are available; and taxpayer assumption of employee Social Security costs, when those costs will be borne by employees. Respectfully, your paper would better serve its readers by informing them that the methods and assumptions used to develop its alarming conclusions are based on a highly pessimistic outlook for investment returns and the U.S. economy, and ignores options available to and, in some cases, already implemented by, many state policymakers.
We have no disagreement that reductions in COLAs and increases in employee contribution rates reduce the amount that will have to be raised in taxes or cut out of spending. The study reflects the costs to taxpayers under current policy, and we’ll happily incorporate any new changes in state and local pension policy going forward. That said, the magnitudes involved relative to the size of the changes currently being considered indicate that taxpayers are going to pay for the bulk of this through tax increases or spending cuts.
As for whether we take a “pessimistic angle,” we don’t see any of these assumptions as particularly bearish. One cannot assume that the pension funds will receive with certainty the same returns they earned in the past by betting on the stock market. The fact that most systems are attempting to target 8% returns in an environment where the 10-year bond is yielding 3.0% necessarily means that they are taking on even more substantial investment risk than in the past, exposing taxpayers to an even larger downside since the pensions have to be maintained regardless. (For more, see “Wipe Away Your Debts with State Government Accounting” and“Return Assumptions: It’s All Just Borrowing in Disguise”.)