Editor’s Note: Reason columnist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.
Myth 1: Unfunded state pensions do not represent an immediate threat and are therefore not in crisis.
Fact 1: In the best case scenario, some state pension funds will run out as soon as 2017. And the longer the states wait to fully fund their pensions, the more drastic the financial consequences will be.
The fact that state pensions only represent a small share of state budgets doesn’t mean that they aren’t in crisis. Take the case of New Jersey. According to Joshua Rauh, professor of finance at Northwestern University, under the best case scenario, New Jersey’s pension funds (there are 5 of them) are scheduled to run out as soon as 2017. Once those state pension plans run out of money, pension payments will have to come out of the state’s general fund revenues—that is, out of the pockets of state taxpayers.
Furthermore, there is reason to believe these estimates are too conservative. When private-sector accounting methods are used to show the true market value of state pension liabilities, the situation becomes even more critical than it initially appears.
According to Andrew Biggs of the American Enterprise Institute and my Mercatus Center colleague Eileen Norcross, the state of New Jersey reports that its pension systems are underfunded by $44.7 billion. Yet when those pension plan liabilities are calculated in a manner consistent with private-sector accounting requirements—methods that economists almost universally agree to be more appropriate—New Jersey's unfunded benefit obligation rises to $173.9 billion.
In other words, New Jersey has made a $173 billion promise without any idea of how it will pay for it. I would say that’s a crisis.
Plus, this is serious money. As Biggs and Norcross note,
This amount is equivalent to 44 percent of the state's current GDP and 328 percent of its current explicit government debt. This calculation applies a discount rate of 3.5 percent (the yield on Treasury bonds with a maturity of 15 years) to reflect the nearly risk‐free nature of accrued benefits for workers. It is estimated if state pension assets average a return of 8 percent, New Jersey will run out of funds to meet its pension obligations in 2019. If asset returns are lower than 8 percent, they will run out of funds sooner.
This has real implications. State actuaries estimate that under certain assumptions, New Jersey’s pension plans will run out of enough assets to make benefit payments beginning in 2013.
The irony is that New Jersey, like other states, has put itself in a financial binder even before the pension crisis really hits. That says a lot about the state’s future ability to address the problem.
Myth 2: State debt accurately reflects state liabilities. And state default is not a concern because the federal government will bail the states out before they reach that point.
Fact 2: Many government pension liabilities are kept off the books, so most states and cities underestimate their actual debt.