This morning a colleague asked me what I thought of the argument that state pensions are not a big deal because contributions currently account for only 3.8% of state and local spending. Here is what I wrote.
How much is being contributed now has nothing to do with how much needs to be contributed to avoid a crisis. Consider a household with $50,000 per year of annual income. You observe the household paying only $100 per month in total payments to creditors. Does that tell you anything at all about whether their debts are a “big deal”? Obviously not. Household A might make $100 monthly payments having no mortgage and minimal credit card balances that are being paid off every month, that’s no big deal. Household B might have a $500,000 mortgage and $100,000 of credit card balances — that is definitely a big deal, especially if they are only paying $100 per month! So in fact, low payments may be as much a cause for concern as a cause for reassurance.
What about the numbers for state and local pension systems? In our paper Revenue Demands of Public Employee Pension Promises, we present the following. Contributions from state and local governments to pay for public employee retirement benefits, including the employer share of payments into Social Security, currently amount to 5.7% of the total own-revenue generated by these entities (all state and local taxes, fees, and charges). In aggregate, and assuming each state grows at its 10 year average with no Tiebout effects, these contributions must immediately rise to 14.2% of own-revenue to achieve fully funded systems in 30 years. Average contributions would have to rise to 40.7% of payroll to achieve these goals, corresponding to an increase of 24.3% of payroll. This analysis starts from our estimates of December 2010 asset and liability levels for state and local pension funds, and holds employee contributions as a percent of payroll at their current rates.” (page 1)
Note the goal of full funding in 30 years is a what many systems aspire to. If they are aspiring to lower funding goals (e.g. zero funding!) then the number gets smaller. We also show that just to claim that state and local governments are paying the true cost of new benefit promises (not paying down any unfunded liabilities) would require an average 60-70% increase in contributions. Furthermore, these increases would have to be immediate. The more slowly contributions rise, the greater amount by which they will ultimately have to rise.
It’s worth noting that the inclusion of all own-revenue assumes that fees state and local governments charge for services (e.g. university tuition) are a fully available source that could be increased to pay pensions. If one restricts to just tax revenues, contributions need to be 23% and are currently only 9%. I would say that the need to contribute almost one-quarter of total state and local tax revenues across the US to pensions in order to claim that they are being funded does constitute a big deal.