The Corner

Public Pensions: A Growing Drama with No Happy Ending in Sight

Last week’s Economist featured a report on the crisis in U.S. state pensions:

Mr Reed [the Democratic Mayor of San Jose California] estimated that the average cost to his city of employing a police officer or firefighter was $180,000 a year. Not only can such workers retire at 50, but some enjoy annual pension payments greater than their salaries. They are also entitled to cost-of-living increases of 3% a year, health and dental insurance for life and lump-sum payments for unused sick leave that could reach hundreds of thousands of dollars.

The bottom line is that promises like these cost a lot of money and the states don’t have the cash.

The article does a very good job listing the issues behind the problem: unsustainable promises, lack of proper funding by the states, and terrible accounting standards set by the Governmental Accounting Standards Board (GASB).

It also spends some time on the case of New Jersey and the remarkable and thorough study by Eileen Norcross of the Mercatus Center and Andrew Biggs of the American Enterprise Institute. In their work, Norcross and Biggs use the Treasury yield as a discount rate, rather than the unrealistically high discount rate that states are using, to show how New Jersey has run up a pensions deficit of $174 billion, which is the equivalent of 44 percent of the state’s GDP, or more than three times its official debt.

The problems started in 1992 when the then governor, Jim Florio, increased the assumed return on pension assets from 7% to 8.75%. That allowed contributions to be reduced and helped the state balance its budget. Further reforms in 1994 and 1995 eased the accounting assumptions, allowing Mr Florio’s successor, Christie Whitman, both to cut taxes and to balance the budget. In the late 1990s the fund bet heavily on technology stocks, giving a brief boost to asset values. Employees’ contributions were cut from 5% of payroll to 3%. New Jersey also increased benefits, giving pension rights to surviving spouses in 1999 and a boost of 9.1%, in effect, to scheme members in 2001, just as the dotcom bubble was bursting and the fund’s assets were falling in value. The effect of this chronic underfunding on the pension scheme for the police and firefighters is shown in chart 3.

I find this chart stunning. Can you imagine what would happen to you if you behaved that irresponsibly? Unfortunately, taxpayers will again have to pay the price of this irresponsibility.

For more on this issue, you can read the work of Biggs and Norcross here. Also, you can read the work of Joshua Rauh, of the Kellogg School of Management at Northwestern University and Robert Novy-Marx of the University of Rochester, here and here. These guys estimate that the states’ pension shortfall may be as much as $3.4 trillion and that municipalities have a hole of $574 billion. Also, in this study, Rauh estimates that even under the very unrealistic assumptions made by states about rate of return on their investments, seven states will have exhausted their pension assets by 2020 and half will run out of money by 2027.

Also, you can watch Eileen Norcross talk about the pension drama on Washington Journal yesterday, here. Watch, read, and cry.

Veronique de Rugy — Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

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