Tax Analysts Blog

It’s Time to Talk About State and Local Pension Debt

Posted on Sep 27, 2016

My colleague Maria Koklanaris recently wrote an excellent article on the pension debt held by state and local governments. It’s worth a read. Those in state and local government should be well aware of the level to which pension plans are underfunded. According to Koklanaris’s article, which was published in State Tax Today on September 20, there “isn’t a pension fund in America that can earn its way out of its liabilities.”

Most state and local governments provide some form of retirement income for their employees. Often, governments provide defined benefit plans, in which employees are guaranteed a specific pension payment upon retirement. Defined benefit plans are funded through dedicated trust funds, which are funded to cover future pension liabilities. Payments into those trust funds come from employers (the state or local government) and employees, and the amounts in the funds are invested.

The level of underfunding in state and local government pensions is significant.

When I first wrote about this in 2012, it was estimated that state and local government pensions were underfunded by approximately $1 trillion. And the picture was even worse if liabilities are valued using "low-risk" discount rates. Under that approach, state and local pension plans were estimated to be underfunded by $3 trillion. According to new numbers from the U.S. Pension Tracker at Stanford University, state and local government pensions are now underfunded by closer to $5 trillion. It’s a staggering figure, and it hasn’t improved in the last four  years.

Many state and local governments also provide healthcare benefits to retired state and local government workers, as well as life insurance and other smaller benefits. Those programs often receive little funding because they are funded on a pay-as-you-go basis. The situation could be made worse if the federal government increases the eligibility age for Medicare. Liabilities for those programs would increase because state and local government healthcare benefits often provide coverage during the transition period between retirement from government service and eligibility for Medicare.

States must begin planning for the future. This is not a can to be kicked down the road. Given consistently tight budgets year after year, the always present potential for a decrease in federal funding (even if for programs that are not directly related to state pensions or healthcare), the existing underfunded programs, and the fact that most states must balance their budget each year (and must stop shifting funds to achieve a balanced budget), states have no ability to put off planning for the future. They must plan for more than one year at a time.

What does that mean? It means state and local officials will have difficult decisions to make. Do they raise taxes or lower expenses or both? The debts are coming due, so as much as politicians like to avoid being the one who raised taxes or reduced services, they will have to be honest with voters about the choices that were made and what it will take to eliminate the underfunding.

As Stanford University professor David Crane said in Koklanaris’s article, “When you’re in a hole, stop digging.”

Follow me on Twitter @TaxCaraGriffith for more tax talk.

Editor's Note: On September 30, this article was corrected to show that the U.S. Pension Tracker estimates pension underfunding to be close to $5 trillion, not the Actuarial Standards Board. The author regrets the error. 

Read Comments (5)

Mike55Sep 27, 2016

I would support a tax increase to shore up the pension system in my state, despite generally being a "no tax increases!" type. The money clearly needs to be spent at some point, not paying isn't an option and, at this specific point in time at least, I feel as though my State does an OK job of not overspending. There's some waste and graft to be sure, but this is inherent in any massive organization where cost efficiency is not a primary goal.

One important precondition though: a 100% pension freeze needs to happen BEFORE any sort of tax increase or other austerity measure. It doesn't have to necessarily be a "hard freeze"* across the board, so long as it's definitive and covers all state employees. To borrow your analogy, politicians need to stop digging the hole deeper before asking taxpayers to tighten their belts.

*A "hard freeze" means the pension plan basically stops on the freeze date, so employees are only entitled to the benefits earned up to that date. In contrast, a "soft freeze" means existing employees get to keep their pension plans unchanged, but new hires do not receive any pension benefits.

Edmund DantesSep 28, 2016

After some initial resistance in the private sector, the passage of ERISA in 1974 was seen as a good thing, a positive for the retirement industry. What had previously been "best practices" were converted into minimum standards, with the force of law behind them. Good for employers, employees, shareholders.

As I recall, a companion statute was then drafted in the late 70s, the Public Employee Retirement Income Security Act. The feds would have imposed the same funding standards on state and local government as private industry was then meeting. The resistance from the states was furious, so the effort was dropped.

Contrary to your headline, Ms. Griffin, *that* was the best time to face the public pension crisis, the late 70s, before the stock market boom of the 1980s. The opportunity was squandered by our very short-sighted politicians.

Don't know what state Mike55 is in, but I'm in CT. We have dramatic overspending at every level of government here. We are shedding population, particularly the affluent, and we are shedding businesses (GE most notoriously, but plenty of others), and yet the number of government employees goes up and up every year. According to NPR, the pension hole for the City of Hartford is so deep that if they ended all city services, and dedicated all tax receipts only to the pensions of their retirees, it still wouldn't be enough. (There may have been some hyperbole in that claim, but not much.) CT's per capita underfunding of pensions is in the top 5 in the country, and still we won't stop digging.

So I would not accept a tax increase to pay for pensions for government workers. I would need Mike's hard pension freeze coupled with a drastic reduction in state spending--on the order of 25% or more. These are not even on the table in CT, they are not being discussed.

This is going to get very ugly.

Mike55Sep 30, 2016

"I would need Mike's hard pension freeze coupled with a drastic reduction in state spending--on the order of 25% or more."

Given where CT is at financially,* I wouldn't call a mandatory hard freeze coupled with dramatic spending cuts an unreasonable "trade" in order to achieve a tax increase. The more dire the fiscal and economic woes of the State, the more austerity required.

Mike55Sep 30, 2016

My "*" footnote got chopped..... the point I was going to make is that CT is sort of unique in that it is towards the bottom of every state "fiscal health" ranking you can find online. For most other states it seems to depend more on who is doing the ranking. For example, some rankings show South Carolina as a financial catastrophe waiting to happen, while others have it as being middle of the pack. But pretty much everyone seems to be in agreement that CT is in big trouble by any logical measure.

Brian StrahleSep 29, 2016

This is definitely an issue that needs talked about at some level. There needs to be a solution to stop the bleeding or the 'hole from getting deeper." However, I have one simple question - who else in America has a pension plan? No one. So why do government employees still have a pension program? If the 'pay-as-you-go' approach isn't working, why does it continue? Doing the same thing year after year and expecting a different result is the definition of stupidity (this seems to be what governments do in general). Taxpayers should pay to bail out government mismanagement? I don't think so. Maybe I'm missing something. Just thinking out loud.

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