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The Pension Burden on State Budgets
From Nicole Kaeding of Cato.
"Cato’s “Fiscal Policy Report Card on America’s Governors”
focuses on short-term tax and spending decisions made by governors. But
governors and legislatures also make important decisions that will
affect state budgets over the longer term.
As Chris Edwards and I discuss in the Report Card, one area of
particular concern is compensation for state workers, particularly
retirement benefits.
Total wages and benefits for state and local workers was
$1.3 trillion in 2013, which accounted for 53 percent of all state and
local spending. That is a huge cost that could rise substantially in
coming years, particularly in those states that have large funding gaps
in their retirement plans. Governments have promised their workers
generous pension and retirement health benefits, but most states have
not put enough money aside to fund them.
In recent years, many states have modestly trimmed benefits and
increased worker contributions for retirement plans. However, more
reforms are needed, as recent studies have shown. A study by the Center
for Retirement Research (CRR) at Boston College found that the average
funding level—the ratio of assets to liabilities—for public employee
pensions was just 72 percent in 2013 after declining substantially over
the past decade. Based on the usual accounting for these plans, the
unfunded liabilities in state and local pensions total $1.1 trillion,
according to CRR.
Those numbers understate the size of the problem. Most
financial economists think that the discount rate used in official
valuations of government pension liabilities is too high, or too
optimistic. When CRR used a lower discount rate of 4 percent instead of
the average official rate of 7.7 percent, the value of unfunded state
and local pension liabilities skyrocketed to $3.8 trillion. Our Cato
colleague, Jagadeesh Gokhale, argues even that is too conservative as it
only includes currently accrued pension costs. He estimates that the
funding gap for accrued benefits plus future accruals under today’s
generous pension rules is about $10 trillion.
Many states have made modest reforms to pensions in recent years, but
larger reforms are needed. Without reforms, state budgets will be put
under increasing stress and part of the burden of pension benefits will
land on future taxpayers."
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