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The Risky Business of Public Pensions

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State and local governments all around the country have failed to set aside enough money to pay for the pensions they have promised to workers in the public sector. They’re also making unrealistic assumptions about their future investment returns, further risking their budgets and the ability to pay for promised pension benefits. Confronting the true cost of future pension payments would force state and local governments to save more now and prevent budget problems in the future.

Discussion Questions

  1. Why are pensions underfunded?
  2. Can we ensure that local and state governments use tax money responsibly to meet pension commitments?
  3. What motivates local and state governments to make risky investments while knowing the drawbacks?

Additional Resources 

  • Watch the five-part animated video series “Pension Pursuit” based on Josh Rauh’s research on the vast underestimation of public pension liability to gain insight into the hidden debts the next generation will face, available here.
  • In “Hidden Debt, Hidden Deficits: 2017 Edition,” Joshua D. Rauh details the issues surrounding the pension system and the role of governments in increasing liabilities and deficits by means of their pension system. Available here.
  • “The Public Pension Crisis” is an essay excerpted from a new Hoover report by Joshua Rauh, “Hidden Debt, Hidden Deficits: How Pension Promises Are Consuming State and Local Budgets.” The full report may be read here.
  • In “A Tale of Six Cities: Underfunded Retiree Health Care,” Rauh and Pozen analyze the retiree health care systems of six American cities: Boston, Minneapolis, Pittsburgh, San Francisco, San Antonia, and Tampa, Florida. They also outline a broad variety of reasonable measures that cities could adopt to materially reduce their long-term OPEB liabilities. Available here.
View Transcript

State and local governments all around the country have failed to set aside enough money to pay for the pensions they’ve promised to workers in the public sector. 

State and local pension administrators report that they’re over a trillion dollars short of what’s required to fully fund pensions. 

But it’s even worse than they’re reporting because they aren’t investing in a way that completely guarantees all the money will be there for retirees in the future. 

And since the promises they’ve made to future retirees must be paid, 

what they should do instead is plan for investment returns at the risk-free rate to ensure enough money is there in the future. 

When you calculate current unfunded pensions using the risk-free rate, they’re actually underfunded by more than four trillion dollars. 

Pension funds hide the debt they create by assuming that they’ll achieve relatively high investment returns. But the higher the rate of return they assume, the less likely they’ll achieve that goal over the long run. 

State and local governments need to calculate their investments at the risk-free rate to ensure they can deliver on their promise. 

Confronting the true cost of future pension payments would force state and local governments to save more now to prevent tax increases in the future.