What taxpayers and public employees don’t know about public pension transparency can and does harm them. Economists are beginning to sound the alarm that public-sector pension debt is untenable.
At issue is a public-sector accounting rule making it appear that public pensions are fully funded when in fact most face serious shortfalls. State and local governments are relying on unrealistically high assumptions for the expected rate that pension investments will return, many analysts say. As a result, states are not providing enough pension funding today to cover the plans’ future liabilities.
Unfunded liability is the gap between promised pension benefits and the cost of paying those benefits to retired, current, and future public employees. If government officials were forced to apply the same uniform accounting methods that private pension plan administrators must use to calculate liabilities, experts say the funding shortfall would be five times greater than the amount being reported by state and local governments.
A 2009 study by Robert Novy-Marx and Joshua Rauh for the National Bureau of Economic Research put the unfunded liability of all U.S. public pensions at $3.23 trillion. This collective pension debt, the authors warn, “dwarfs the states’ publicly traded debt,” making total state debt actually closer to 4.5 times the value of outstanding state bonds if pension liabilities are included.
Using a 2008 U.S. population of 304 million, Novy-Marx and Rauh calculate the per capita burden of this pension debt at $10,625 for every man, woman, and child in the United States.
Novy-Marx and Rauh say current accounting rules make it impossible for the current generation of taxpayers to know how much money must be “set aside for their children to pay off this debt.”
U.S. Reps. Devin Nunes, R-Calif., Paul Ryan, R-Wisc., and Darrell Issa, R-Calif., introduced a bill Dec. 2 that would require state and local governments to use accurate and honest accounting in their financial reporting. According to the release announcing H.R. 6484, “Public Employee Pension Transparency Act,” plans would have to report liabilities using “realistic rates of return and tie assets to more reasonable fair market valuations.”
The bill also would suspend the ability of any jurisdiction failing to comply with the new accounting rules to issue tax-exempt bonds.
Public pensions in North Carolina
The North Carolina Retirement Systems is the 10th-largest public pension fund nationally, providing retirement benefits for more than 820,000 North Carolinians. The state uses an expected investment return rate of 7.25 percent, which is more conservative than the average 8 percent rate that many other state and local governments use.
Jeremy Gold, a New York-based actuarial consultant and co-author of a 2008 study of public pension plans, advocates marking public pension plan liabilities to market; that is, using market value for liabilities like private pension plans do. Gold considers the 30-year Treasury bond the best measure of market valuation.
Using existing public-pension accounting rules, the report by Novy-Marx and Rauh showed the North Carolina Retirement Systems in 2008 with pension assets of $59.1 and reported liabilities of $68.7 billion. If liabilities were reported using the Treasury rate, the figure would be $117.0 billion, leaving an unfunded gap of $57.9 billion rather than $9.6 billion.
So while North Carolina’s plan is among the best funded public pensions he’s studied, Gold tells Carolina Journal that doesn’t mean the state’s retirement system is fiscally healthy or sustainable.
As CJ reported earlier this year, the General Assembly decided not to make the full annual required contribution to the pension fund for the first time in the fund’s history. The reported unfunded shortfall was $310 million.
Joe Coletti, director of fiscal and health policy studies at the John Locke Foundation and a member of a retirement study commission created by Gov. Bev Perdue to make recommendations for pension reform, estimates that an additional $300 million will be needed to fund the pension in fiscal year 2011-12.
Among recommendations released by the commission Dec. 2 are that the state offer all current and future employees a choice between a defined-benefit pension plan (like the current public pension system) and a defined-contribution program (similar to the 401(k)s offered by private employers). The commission would also automatically enroll all public employees hired in the future in a supplemental defined-contribution plan.
The recommendations do not address the lack of transparency in the current retirement system or the accounting flaws that distort the true cost that the public pays for a government worker.
Why defined contribution?
Eileen Norcross, a research fellow with George Mason University’s Mercatus Center, says governments like to use a higher discount rate to calculate plan liabilities because it lowers the annual contribution needed to fund the plan. Norcross also says the actuarial method encourages fund managers to ignore market risk in managing pension assets, tempting them to invest in higher risk, higher volatility portfolios to target unrealistic rates of return. Greater investment risk heightens the possibility that pensions will be underfunded.
If pension are unable to pay retirees fully, governments may default on their pension debt or be forced to raise taxes to cover employee retirements. Active employees may end up with fewer benefits as they’re forced to contribute more to provide benefits to current retirees whose payouts are guaranteed. Norcross says these and other problems could be alleviated or eliminated if governments shifted to defined-contribution plans the way the private sector has.
Gold does not support Norcross’ view and says pensions simply should be smaller, more affordable, and fully paid so that their liabilities are not passed on to future generations of taxpayers.
In North Carolina’s congressional delegation, Rep. Sue Myrick, R-9th, is an original co-sponsor of H.R. 6484. While the lame-duck session of Congress may not have time to take up the bill, Myrick spokeswoman Taylor Stanford told CJ that the bill probably will be reintroduced in the 112th Congress.
Ken Willis, spokesman for 1st District Democratic Rep. G.K Butterfield, says Butterfield is concerned that the “bill seeks to expand federal oversight and intervention in areas that have been historically regulated by state, county, and local governments.” According to Willis, Butterfield also believes the bill would lead to “increased costs resulting from a new, unfunded federal mandate including costs associated with state, county, and local governments having to move to a new accounting and reporting system and standard and the costs associated with undermining the state and municipal bond markets.”
Karen McMahan is a contributor to Carolina Journal.