A Hoover Institution Essay Hidden Debt, Hidden Deficits: 2017 Edition HOW PENSION PROMISES ARE CONSUMING STATE AND LOCAL BUDGETS Joshua D. Rauh
The unfunded obligations of the pension systems sponsored by state and local governments in the United States continue to grow. In this second annual report on the off-balance-sheet pension promises of state and local governments, we study in detail 649 pension systems around the United States, including all of the main pension systems of the states, the largest U.S. cities, and the largest U.S. counties.
We report on both their own measurements of their costs and obligations, and how these differ from market valuations that are consistent with the principles of financial economics. As of fiscal year 2015, the latest year for which complete accounts are available for all cities and states, governments reported unfunded liabilities of $1.378 trillion under recently implemented governmental accounting standards.
However, we calculate using market valuation techniques that the true unfunded liability owed to workers based on their current service and salaries is $3.846 trillion.
These calculations reflect the fact that accrued pension promises are a form of government debt with strong rights. These unfunded liabilities represent an increase of $434 billion over 2014, as realized asset returns fell far short of their targets.
Governmental accounting standards for pensions underwent some changes in 2014 and 2015 with the implementation of Governmental Accounting Standards Board (GASB) statements 67 and 68, procedures which require state and local governments to report on the assets and liabilities of their systems with a greater degree of harmonization.
However, these standards still preserved the basic flaw in governmental pension accounting: the fallacy that liabilities can be measured by choosing an expected return on plan assets. This procedure uses as inputs the forecasts of investment returns on fundamentally risky assets and ignores the risk necessary to target hoped-for returns.
Specifically, the liability-weighted average expected return chosen by systems in 2015 was 7.6 percent. A 7.6 percent expected return implies that state and city governments are expecting the value of the money they invest today to double approximately every 9.5 years. That means that a typical government would view a promise to make a worker a $100,000 payment in 2026. as “fully funded” even if it had set aside less than $50,000 in assets in 2016; a similar payment in 2036 would be viewed as “fully funded” with less than $25,000 in assets in 2016.
The private sector all but abandoned defined benefit pension plans long ago, but government, public utilities and a few large corporations still have them.
I terminated the pension plan for Electromagnetic Sciences, Inc. in 1993 and replaced it with a defined contribution age-weighted plan to accompany the 401K Plan that had been established. It can be done and it doesn’t hurt and most government entities will have to do the same thing soon.
Norb Leahy, Dunwoody GA Tea Party Leader