The Truth About the State Pension Crisis: Separating economic myth from economic fact By Veronique de Rugy

Myth 1: Unfunded state pensions do not represent an immediate threat and are therefore not in crisis. Fact 1: In the best case scenario, some state pension funds will run out as soon as 2017. And the longer the states wait to fully fund their pensions, the more drastic the financial consequences will be. The fact that state pensions only represent a small share of state budgets doesn’t mean that they aren’t in crisis. Take the case of New Jersey. According to Joshua Rauh, professor of finance at Northwestern University, under the best case scenario, New Jersey’s pension funds (there are 5 of them) are scheduled to run out as soon as 2017. Once those state pension plans run out of money, pension payments will have to come out of the state’s general fund revenues—that is, out of the pockets of state taxpayers. Furthermore, there is reason to believe these estimates are too conservative. When private-sector accounting methods are used to show the true market value of state pension liabilities, the situation becomes even more critical than it initially appears.

According to Andrew Biggs of the American Enterprise Institute and my Mercatus Center colleague Eileen Norcross, the state of New Jersey reports that its pension systems are underfunded by $44.7 billion. Yet when those pension plan liabilities are calculated in a manner consistent with private-sector accounting requirements—methods that economists almost universally agree to be more appropriate— New Jersey’s unfunded benefit obligation rises to $173.9 billion. In other words, New Jersey has made a $173 billion promise without any idea of how it will pay for it. I would say that’s a crisis. Plus, this is serious money. As Biggs and Norcross note,
This amount is equivalent to 44 percent of the state’s current GDP and 328 percent of its current explicit government debt. This calculation applies a discount rate of 3.5 percent (the yield on Treasury bonds with a maturity of 15 years) to reflect the nearly risk‐free nature of accrued benefits for workers. It is estimated if state pension assets average a return of 8 percent, New Jersey will run out of funds to meet its pension obligations in 2019. If asset returns are lower than 8 percent, they will run out of funds sooner.

This has real implications. State actuaries estimate that under certain assumptions, New Jersey’s pension plans will run out of enough assets to make benefit payments beginning in 2013. The irony is that New Jersey, like other states, has put itself in a financial binder even before the pension crisis really hits. That says a lot about the state’s future ability to address the problem.

. The official estimated value of its unfunded pension liabilities is $48. have added Connecticut’s unfunded liability to the state’s debt. changing their compensation won’t make a difference. And while all of that money wouldn’t be paid out at once. the state’s reported debt is roughly $23 billion.2 billion in underestimated liabilities due to poor accounting standards. Would the federal government really have the ability to bail out 50 states whose individual debt often exceeds $100 billion? That would cost roughly $5 trillion. Northwestern’s Joshua Rauh and Robert Novy-Marx. Now you have a total state debt of almost $100 billion. Connecticut also owes to its pensions and retiree health care funds. which are not clearly disclosed. Take the case of Ohio. an assistant professor of finance at the University of Rochester. it is still unrealistic for the states to count on a federal bailout. And state default is not a concern because the federal government will bail the states out before they reach that point.Myth 2: State debt accurately reflects state liabilities. so most states and cities underestimate their actual debt. the total compensation package for state workers does tend to exceed that of their private-sector counterparts.4 billion. Myth 3: State and local workers are not overpaid. Fact 2: Many government pension liabilities are kept off the books. Consider Connecticut.4 billion. As you can see in the chart above. and which will cost even more in the long run. And even if they are. Bonds are only a small part of its total debt. That’s $71. Fact 3: While this is a complex issue. On top of that amount we should add another $28. Like many other states.

compensation costs for state and local employees begins at a higher level than that of their private-sector counterparts and continues to diverge throughout the employees’ careers. where almost one new public-sector job was added to the economy for each private-sector job from 1990 to 2010. for 26 careers in state and local government paying around the median wage rate. The data shows that in the Buckeye state. realigning state worker compensation packages to match those of their private-sector peers would save taxpayers over $2. Ohio has an on-the-book $8 billion budget gap. This chart from The New York Times shows that there are 12 percent more white-collar workers in local government than there are in private employment and 19 percent more white-collar workers at the state .The Buckeye Institute for Policy Solutions has an interesting report out called “The Grand Bargain is Dead. government employees were consistently and significantly paid above the corresponding private-sector wage rate.1 billion in the next two years (or 28 percent of this year’s $8 billion deficit). It is true that comparing compensation is a tricky business.” As we see in this example from Ohio. According to the Buckeye Institute. it is not great enough to explain the difference in wages between comparable public and private employees. While taking a closer look at the differences between public and private-sector employees explains some of the compensation differential.

co. The problem started long before the recession. illustrates this point. http://www. By 2008. meaning out of the pockets of taxpayers. A good first step would be to switch to accounting methods that show the true market value of their liabilities. Many states had already failed to cover the cost of promised benefits even before they felt the full weight of the Great Recession. By 2006.co. A 2010 Pew study called “The Trillion Dollar Gap. Once the pension plans run out of money. that number had shrunk to six states.uk/news/business-your-money-12150443 http://www.bbc. they must push through reforms as soon as possible. The pension age for women will also rise to 66 by 2020 under Tory proposals something the party says is needed to help reduce the UK's national debt.bbc.eight years earlier than planned. but all the diplomas in the world can’t explain the 221 percent difference in lifetime employment costs witnessed by workers in Ohio. We can even debate what the true meaning of being broke. which caused a depreciation of pension assets. taken from the Pew study. New York. Myth 4: The financial crisis.uk/news/business-11910642 The squeeze on pensions The Conservative Party has outlined plans to raise the state pension age for men to 66 from 2016 . is the real culprit behind pension underfunding. The chart above. or what the true value of the unfunded liabilities is. the problem of pension underfunding dates back to the early 2000s.co. Some argue that this is the reason for the difference in compensation. Here’s the bottom line: We can argue endlessly over when the pension plans will run out of cash. The Labour government has already committed to raising the pension age for men . If the states want to avoid this. Once those methods are in place.bbc. the payments will have to come out of general funds. It’s the diplomas stupid! Maybe. Washington and Wisconsin—could make that claim.uk/news/business-12349155 http://www.level. only four states—Florida.” found that in 2000. But there is one issue where there is no room for debate. slightly more than half of the states had fully funded pension systems. lawmakers should consider moving away from defined benefit pensions. Fact 4: While the recession dealt a severe blow to state pensions.

but also as the UK population ages. So why do the two parties want the pension age to go up? Currently.gradually from 65 to 68 between 2024 to 2046. For women it will rise from 60 to 65 over ten years from 2010. However. there are more than 12m pensioners in the UK . the UK is not alone. putting increased pressure on government resources. The world's population is also growing older and many other countries are facing similar problems. The move by politicians to raise the state pension age comes not only amid difficult financial conditions.with many more women than men in retirement. .

will be reduced. the government's Actuary Department calculated there were 3. In 2001.44 people of working age for every one state pensioner. By 2060. it says the ratio will have fallen to 2. there will be fewer working people contributing towards the system that finances the state pension. This means the amount of time spent in retirement. In other words.The ageing UK population means there will be many more pensioners to support. taking into account people's longer lives. as well as government expenditure. Both the Conservatives and Labour have proposed raising the state pension age. .32 people of working age to support every state pensioner.

the value of state pensions has declined since the link with average earnings was cut by Margaret Thatcher's Conservative government in 1980. You can find out more about pension credit on the Directgov site. Labour has legislated to bring back the link with average earnings by 2015 at the latest .co.stm .uk/2/hi/business/8294251. http://news. Although a top-up benefit or pension credit has been introduced to ensure no pensioner has to live on less than £130 a week.Meanwhile.bbc.a plan supported by the Tories.

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