2The condition of state and local government defined benefit (DB) pension systems in theU.S. has received national attention in debates over government budgets. The academic literatureconsidering this issue has primarily focused on three main questions. First, analyses of thestrength of the legal claims of public pension beneficiaries have informed studies of themeasurement of liabilities under appropriate discount rates (see Gold (2002), Novy-Marx andRauh (2008, 2009, 2011a, 2011b), Brown and Wilcox (2009)). Second, a number of papers haveconsidered the optimal level of funding for public employee pension plans (D’Arcy et al (1999),Bohn (2011)) in light of the political economy of public sector debt decisions (Persson andTabellini (2000), Alesina and Perotti, (1995)). Third, an extensive literature has considered thequestion of optimal asset allocation (Black (1989), Bodie (1990), Lucas and Zeldes (2006,2009)), Pennacchi and Rastad (2011)).
Missing in the discussion has been an analysis of the revenue demands of the pension promises to public employees. If states and local governments are going to pay pensions under current policies, how much more revenue will need to be devoted to these systems? This paper attempts to fill that gap. It provides calculations of the increases in contributions that would berequired to achieve fully funded pension systems. These contribution increases are calculatedrelative to a base of Gross State Product (GSP) growth applied to today’s contributions. Resultsare presented under a variety of possible assumptions about the level and cross-sectionalvariation of growth rates of state and local governments, the treatment of future work by currentemployees, and the sensitivity of state and local GSP growth to policy changes. We loosely callthe latter effects “Tiebout effects” after Tiebout (1956).
Contributions from state and local governments to pay for public employee retirement benefits, including the employer share of payments into Social Security, currently amount to5.7% of the total own-revenue generated by these entities (all state and local taxes, fees, andcharges). In aggregate, and assuming each state grows at its 10 year average with no Tiebouteffects, government contributions to state and local pension systems must rise to 14.2% of own-revenue to achieve fully funded systems in 30 years. Average contributions would have to rise to
Other papers have surveyed various labor market, behavioral, and political economy aspects of public pensions(Friedberg (2011), Beshears et al (2011), and Schieber (2011)). Shoag (2011) considers macroeconomic impacts of pension contributions. Fitzpatrick (2011) measures the valuation placed by a group of Illinois public employees ontheir pension benefits based on their choices to buy into additional retirement benefits.
To be precise, the effect we consider is limited to taxpayers’ “voting with their feet,” not the equilibrium provisionof local public goods.