Report: Taxpayers Face High Costs to Fund Public Pensions

WASHINGTON — Taxpayers will have to contribute an average of $1,398 per household per year over the next 30 years, either through tax hikes or reduced public services, to fulfill public-sector pension obligations, according to a study released Tuesday. 

The report, entitled “The Revenue Demands of Public Employee Pension Promises,” is co-authored by two economists, Joshua Rauh of the Kellogg School at Northwestern University and Robert Novy-Marx of the University of ­Rochester.

Their analysis, stemming from a review of 193 state and local government pensions, comes amid a spike in interest among regulators and lawmakers in the viability of public-sector pensions.

Early next month, the Governmental Accounting Standards Board is expected to release long-anticipated recommendations, dubbed an exposure draft, for pension accounting and financial reporting standards by state and local governments.

“This is really another way of looking at the problem,” Rauh said. “Basically, state and local governments have to choose among the options of raising taxes or reducing expenditures on other things in order to keep the pension systems in place.”

Specifically, the economists found that residents of New Jersey — where its two largest public-sector pensions were the subject of a high-profile securities fraud settlement with the Securities and Exchange Commission last year — would need to contribute $2,475 per household per year from tax increases or spending cuts to fund that state’s future pension obligations.

Residents of four other states — New York, Oregon, Wyoming, and Ohio — would see more than $2,000 per year in tax hikes or service reductions. Eight states, including California, Illinois, Rhode Island, and Pennsylvania, would have to boost taxes or trim spending by between $1,500 and $2,000 per household per year.

Indiana residents would see annual household contributions of $329, the lowest of any state.

In their study, the economists scrutinized information from the comprehensive annual financial reports, or CAFRs, filed by state and local defined-benefit pension plans. They estimated all assets and liabilities as of December 2010.

Rauh cited widespread public-sector accounting methods as a key factor in the funding straits facing public-sector pensions.

“All of the systems are behind because of the accounting standards that systematically lead to the underfunding of state and local pensions,” he said in an interview.

Typically, pension plans use historic rates of return from roughly 7% to 8% to determine their unfunded liabilities.

In their study, Rauh and his colleague used a so-called risk-free rate of return, pegged to a Treasury rate of 3% to 4%.

But a pension expert disputed the report’s methodology, including its use of the risk-free rate, calling the conclusions “dramatic” and “alarming.”

“It produces this outcome that is all driven by a finance theory,” said Keith Brainard, director of research at the National Association of State Retirement Administrators. “But state legislatures don’t operate in a world of finance theory.”

GASB is expected to recommend that pension plans use the historic rate of return only to the extent the plan has assets set aside, in an irrevocable trust for beneficiaries, to pay future benefits. When a plan lacks adequate resources to pay beneficiaries, GASB will propose shifting to the lower risk-free rate.

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