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The Next Crisis
It's not just Social Security and Medicare which are underfunded. State governments have vastly underfunded public pensions. Here is the abstract to a new NBER paper, The Intergenerational Transfer of Public Pension Promises by Novy-Marx and Rauh.
The value of pension promises already made by US state governments will grow to approximately $7.9 trillion in 15 years. We study investment strategies of state pension plans and estimate the distribution of future funding outcomes. We conservatively predict a 50% chance of aggregate underfunding greater than $750 billion and a 25% chance of at least $1.75 trillion (in 2005 dollars). Adjusting for risk, the true intergenerational transfer is substantially larger. Insuring both taxpayers against funding deficits and plan participants against benefit reductions would cost almost $2 trillion today, even though governments portray state pensions as almost fully funded.
Posted by Alex Tabarrok on December 2, 2008 at 07:02 AM in Economics | Permalink
Comments
If Social Security and Medicare are underfunded, what about the Defense Department?
Posted by: fusion at Dec 2, 2008 7:43:08 AM
State governments have vastly underfunded public pensions.
Absolutely, and there’s a reason.
When the Employee Retirement and Income Security Act of 1974 was passed, state and local government (SLG) pensions were exempted from its provisions and those employees have only state trust and fiduciary laws to protect them. This was partially done because of the presumption that SLG plan sponsors will not become bankrupt as private employers might.
The other aspect of pension regulation is the qualified plan rules of the Internal Revenue Code, even there SLG pensions have inordinate leeway-not subject to “nondiscrimination” testing, legislatures frequently establish special provisions for themselves that the “rank and file” employees do not receive.
Worse, the underfunding has occurred despite the fact that there is often mandatory employee pre-tax contributions (So called IRC Sec. 414(h) “pick up” contributions) which are disallowed in the private sector for the ever shrinking number of defined benefit pension plans
Posted by: Superheater at Dec 2, 2008 8:54:36 AM
Does anyone believe that the government won't lower the benefits to match the funding? This will be a non-event, except for the workers who will feel betrayed.
Posted by: 8 at Dec 2, 2008 11:49:47 AM
//Does anyone believe that the government won't lower the benefits to match the funding?//
*raises hand*
I do. They won't lower the benefits; they'll raise the taxes, and cut 'non-essential' functions like parks, libraries, and infrastructure maintenance. Thanks, unions!
Posted by: Howl at Dec 2, 2008 12:48:12 PM
This is not being proposed, but one of the biggest problesms for state governments is Medicaid,
which the federal government made them share in the funding of. This was never a good idea, and
now, with some regions of the country being hit harder, with thus more people eligible as revenues
fall for those state governments, we can see how idiotic this was.
Just as medicare is fully run by the federal government, so should be medicaid. Now would be a good
time to make that change, although I am sure many here would disapprove, indeed wish that both
programs would be shut down.
Posted by: Barkley Rosserr at Dec 2, 2008 12:57:54 PM
To the extent that it's pension funds (who else could it be?) that are eagerly buying up 30-year Treasuries (at 3.19% (!) as I write this), they are in even more trouble than anyone realizes.
The amount of wealth lost when the Treasury bubble pops will almost certainly be in the multiple trillions, perhaps exceeding everything we've seen so far.
When the dust settles, the usual suspects will bleat about "liability driven investment strategies" and protest that the mathematical models seemed like a good idea at the time. But would anyone buy 30-year Treasuries for their personal portfolios? Anyone at all? If not, how can buying them for pension funds be anything other than greater-fool theory?
Posted by: at Dec 2, 2008 3:12:40 PM
A far more sensible strategy would be to encourage (=require) higher retirement age. At 65 the average US resident can expect almot 19 more years of life. If the retirement age were raised to 75 the average time in retirement would be only 13 years with ten more years to contribute. this would help a lot with Medicair funding, too.
Posted by: Thomas at Dec 2, 2008 7:30:50 PM
//Does anyone believe that the government won't lower the benefits to match the funding?//
It is my understanding that unlike Social Security and Medicare, state and local government pension obligations are contractual. (That is not true of health care obligations, but it would appear that those obligations are not included in the NBER estimates noted by Alex.) If they are contractual, the SLGs do not have the flexibility to unilaterally reduce them without either the agreement of the employees affected or filing bankruptcy. It would need to be credible that the government entity would seek bankruptcy before the retired employees would agree to reductions, no? And even then, how would you get all of the employees to agree?
Posted by: Jim at Dec 3, 2008 12:40:04 AM
//Does anyone believe that the government won't lower the benefits to match the funding?//
It is my understanding that unlike Social Security and Medicare, state and local government pension obligations are contractual. (That is not true of health care obligations, but it would appear that those obligations are not included in the NBER estimates noted by Alex.) If they are contractual, the SLGs do not have the flexibility to unilaterally reduce them without either the agreement of the employees affected or filing bankruptcy. It would need to be credible that the government entity would seek bankruptcy before the retired employees would agree to reductions, no? And even then, how would you get all of the employees to agree?
Posted by: Jim at Dec 3, 2008 12:40:37 AM
At this point, I'm beginning to believe that the primary purpose of local government can best be summarized as the provision of generous pensions for its employees. I do think a rash of bankruptcies under Chapter 9 (the section for government entities) is inevitable.
There is a site, Pension Tsunami, that has been providing ongoing coverage on this issue for a long time at http://www.pensiontsunami.com. They ran an article entitled "Land a State Job and Become an Instant Millionaire" at http://pensiontsunami.com/blog/?p=68 that has "public choice theory" written all over it. Don't read it while holding any sharp objects in your hand.
Posted by: Less Antman at Dec 3, 2008 5:45:20 AM
Social security is not underfunded at this present time. Actually Social Security has ran a surplus for awhile. The problem is that the surplus is borrowed against by the federal government.
The social security "bank" does not invest this surplus in the capital markets, it instead has a paper IOU from the federal government. If for some reason, the social security department needs this money quickly, the Federal Government may have some difficulty paying this IOU back. That is where the problem mainly is.
(Side note, this IOU from the Federal Government issued to the social security "bank" is not calculated in the deficit.)
Posted by: torris187 at Dec 3, 2008 11:19:58 AM
I have to agree with Howl. One has only to behold the vise grip with which the teachers' and prison guards' unions squeeze the testicles of the California Legislature to realize fully just how screwed we poor taxpayers are.
The public-sector union thugs will happily shut down every other single function of government, even to the point of forcing defaults on bonds, before a single one of their hogs takes his snout out of the trough.
Posted by: John Skookum at Dec 3, 2008 3:55:02 PM
The problem with social security is that people are now using it as a retirement program instead of as an old age insurance program. The age at which benefits kick in should be automatically adjusted to the average life expectancy. If we're going to have a government social security program, it should be insurance against outliving your expected lifespan. Individuals should be responsible for saving up their own money if they want to quit working, instead of expecting everyone else to pay for them to loaf around for a couple decades.
Posted by: Jacqueline at Dec 3, 2008 4:58:27 PM
Now that there are plenty of true cynics or pessimists (or realists) who assert the
only way for the US to get our of its predicament is by engaging in a (world) war,
I assume this means they'll also be wars between the States.
Posted by: glenn at Dec 4, 2008 3:33:56 AM
One thing about pensions that everyone who gets upset about them existing fails to recognize is that they arent some "gift" of the employer or state, but part of the benefit of working for the employer. Part of your salary and benefits is a guaranteed pension. Which means the pension isnt someone elses money being given to you, but your money being given to you. People who call for pensions to be cut would never be happy if after working a hard month at their job their paycheck was given them only to find their salary had been cut i half with the excuse being that it was taxing the company to pay you what both you and they originally agreed upon.
Posted by: PAUL at Dec 5, 2008 8:25:22 AM
Paul is correct. The problem with pensions is that they have been raided to pay for other things in the government. They have also been handled poorly by government officials who have invested them in risky ways. This money is PART OF PEOPLE'S SALARIES that has been put in trust for them.
Posted by: Sheila at Dec 5, 2008 9:00:16 AM
Raising the retirement age even higher is a terrible idea. Not everyone works at a desk job, and even for those who do, 40% of them will be dead by 75. I don't want a society where people are expected to work up until the day they drop.
A better idea is to change state pension plans so they better align with the rest of us. I personally know two people who retired in their early 50s because the state pension plan allowed them to retire on full pension after 30 years of service. I remember wondering at the time how state governments could afford that--turns out they can't.
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