As Josh Barro wrote this summer,
Pensions are complicated, and when they are not causing huge problems, they are boring . . . . Consequently, it has been easy for lawmakers to ignore the long-term risks to which they have been exposing taxpayers; it has not been hard for public-employee unions to talk these lawmakers into providing ever more generous benefits.”
A September paper from Robert Novy-Marx and Joshua Rauh (via Freakonomics) puts a dollar amount on the impact to each household of fully funding these promises. Novy-Marx and Rauh estimate that in order to fully fund state and local public pension systems over 30 years,
contributions would have to increase by 2.5 times, reaching 14.1% of the total own-revenue generated by state and local governments. This represents a tax increase of $1,385 per household per year, around half of which goes to pay down legacy liabilities while half funds the cost of new promises.
The paper also considers the effects of “policy changes that would reduce future benefit accruals” — including moving all new hires to defined contribution plans and stopping all future benefit accruals for new and existing workers (they assume a defined contribution plan would apply for future work). The first option would reduce the required $1,385 per household to $1,210; the second would reduce it to $800.
To fully fund public pensions in Washington in 30 years, $3.5 billion a year would be required. That’s 20.8 percent of payroll, 13.5 percent of tax revenue, 7.4 percent of own revenuce (all state and local taxes, fees, and charges), 1.0 percent of gross state product, or $1,371 per household per year. Washington’s per household number is the 15th highest among the states. New York’s is highest, at $2,250, and Oregon’s is second, at $2,140. Indiana’s per household number is the lowest, at $329.
According to the paper, “the total required contribution equals the required contribution to pay new service accruals plus the required contribution to pay down the unfunded liability over 30 years.” When you look at how much is required to fully fund just service costs (the “present value of newly accrued benefits, which is the cost of the increase in pension benefits plan participants earn by working one more year”), Washington would have to pay $2.4 billion, or $919 per household (7th highest).
The “results are computed under an asset return assumption in which the pension fund assets earn a real risk-free rate of return.” This is unlike Governmental Accounting Standards Board (GASB) rules, under which liabilities are discounted using expected returns on assets. (For more on why this is an issue, see here and here.) Indeed,
A significant finding of our analysis is that the GASB rules significantly undervalue the cost of providing DB [defined benefit] plans to state workers, as the true present value of new benefit accruals averages 12-14 percent of payroll more than the costs recognized under GASB.
Back to that Josh Barro paper I quoted above, “How Congress Can Help State Pension Reform.” He notes that 43 states have enacted pension reforms over the last several years, but they
have not achieved either of the two goals essential to successful pension reform: first, reducing the overall costs of public pensions, and second, reducing the fiscal risks borne by taxpayers.
Barro argues that states need to move from defined benefit to defined contribution models.
Earlier this year, the Washington legislature enacted some public pension reforms, including changing alternate early retirement for new employees and reducing the investment rate of return assumption. (See this policy brief for more information.)
Washington Research Council 