New Estimate Shows Public Pension Shortfall Ballooning to $4.4 Trillion

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Creative Commons License photo credit: emsphotonut41

Joshua Rauh just blogged on “Everything Finance” a new estimate of the current unfunded public pension liability for both state and local governments:

Using June 2009 data, Robert Novy-Marx and I measured a $3.1 trillion gap in state and local pension systems, arising from $2.3 trillion in assets and $5.4 trillion in liabilities.

Since then, the situation has evolved in several ways. First of all, the stock market continued to recover from the financial crisis . . .

More importantly, the true financial value of the liabilities that have been promised have grown substantially due to much lower bond yields . . .

the total unfunded liability is $4.4 trillion.

And folks are wondering why consumers aren’t spending?! Until policymakers come up with definitive solutions to these massive unfunded liabilities (that don’t involve raising taxes), then the uncertainty it creates will force consumers to pay down their own debt (or save) and restrain consumption.

These are structural issues that can not be fixed by monetary policy actions from the Federal Reserve. Ironically, as pointed out by Rauh, loose monetary policy is worsening the situation by keeping interest rates low and ballooning these unfunded liabilities. The Fed needs to stop babying politicians with cheap money and let them take their Castor Oil (via higher interest rates).

Taxpayers on the Hook for Unfunded Public Pensions Liabilities

Joshua D. Rauh just announced on his blog about a new study that he just released, with Robert Novy-Marx, that estimates state and local pension contributions need to increase by a factor of 2.5 to reach solvency in 30 years.  That amounts to a tax increase of $1,398 per household, per year!

The study is titled “The Revenue Demands of Public Employee Pension Promises.” (pdf)  Here is the abstract:

We calculate the increases in state and local revenues required to achieve full funding of state and local pension systems in the U.S. over the next 30 years. Without policy changes, contributions to these systems would have to immediately increase by a factor of 2.5, reaching 14.2% of the total own-revenue generated by state and local governments (taxes, fees and charges). This represents a tax increase of $1,398 per U.S. household per year, above and beyond revenue generated by expected economic growth. In thirteen states the necessary increases are more than $1,500 per household per year, and in five states they are more than $2,000 per household per year. Shifting all new employees onto defined contribution plans and Social Security still leaves required increases at an average of $1,223 per household. Even with a hard freeze of all benefits at today’s levels, contributions still have to rise by more than $800 per U.S. household to achieve full funding in 30 years. Accounting for endogenous shifts in the tax base in response to tax increases or spending cuts increases the dispersion in required incremental contributions among states.

The chart below is taken from Table 5 of their study on page 40 which ranks the states (from highest to lowest) in terms of the size of the necessary tax hike, per year, to achieve solvency of the state’s public pension system.  As you can see, New Jersey ranks top in the country at $2,475 while Indiana comes in last at $329.

Estimated Annual Tax Increase Required to Bring State and Local Pensions into Solvency by State_Wealth Alchemy

States and Cities Face Great Fiscal Problems

One of the most destructive tools of Wealth Alchemist is the ability create doubly negative productivity shocks on the economy.  For example, they take from the productive through taxes and then send that money to the nonproductive.  Social Security is the classic example.  Current workers (the productive) pay payroll taxes on wages and salaries and payments are sent to the retired (nonproductive).  Another such scheme is the retirement system for government workers.  The end result is that the productive work less and the nonproductive, well, still don’t work at all.

The bigger these schemes become, then the more they eat away at the productive sectors of the economyNobel Laureate Gary Becker recently took a look at state and local pensions and retiree healthcare systems.  He concludes on a rather downbeat note:

One way or another, cities and all states with the most serious unfunded liability problems would eventually be forced to either lower their spending or raise their taxes. Either way that would reduce their competitiveness against other states. It is hard to come away with much optimism for the economic futures of the states and cities with the greatest fiscal problems.