A new study finds that current Government Accounting Standards Board (GASB) rules used by state and local governments to estimate pension plan funding significantly underestimate costs, and, as a result, potentially encourages excessive hiring at the local level. The study was written by the University of Rochester’s Robert Novy-Marx and Northwestern University’s Professor Joshua D. Rauh.
“A significant finding of our analysis is that the GASB rules significantly undervalues the
cost of providing DB (i.e. pension) plans to state workers,” noted Novy-Marx and Rauh in the report.
Without policy changes, state and local governments will need to more than double the amount of money they put into their pension plans over the next 30 years – specifically, 2.4 times the current amount allotted — to fully fund them.
“These distortions can generate conflicting interests between state and local governments. For example, in states where the state government is responsible for paying the unfunded liability for plans covering local workers, such as teachers, GASB accounting forces states to subsidize local government employees. In these situations, the state effectively must bear the expense of the extra 12 to 14 percent of payroll that the plans actually cost, potentially encouraging excessive hiring at the local level.”
Under GASB rules, state and local governments’ “plan actuaries typically assume that the expected return on their portfolios will be about eight percent,” underestimating actual plan costs by 12 to 14 percent, said Novy-Marx and Rauh.
Without policy changes, state and local governments will need to more than double the amount of money they put into their pension plans over the next 30 years – specifically, 2.4 times the current amount allotted — to fully fund them.
Currently 5.7 percent of state and local government revenues go towards employee Social Security payments. Addressing the shortfall would mean setting aside 14.2 percent of their revenues annually over the next 30 years – equating to an average of 40.7 percent of their employee payroll costs, an increase of 24.3 percent.
To address the gap, governments would need to increase taxes by an average of $1,398 per household annually, with five states — New Jersey, New York, Oregon, Wyoming and Ohio — needing to increase taxes by more than $2,000 per year. Such tax increases could lead to a mass exodus by residents of states with the highest increases, thereby compounding the situation. Cities and counties may be even more exposed to tax flight than states, noted the authors.
Even with a “hard freeze” – stopping all benefit accruals, including for existing workers – governments would still need to increase taxes by more than $800 per household to meet their obligations, noted the study.
Not everyone agrees with the assumptions behind the study.
Keith Brainard, research director for the National Association of State Retirement Administrators (NASRA), believes the report “significantly exaggerates the costs of those benefits,” reported Pensions & Investments in a June 24 article.
“Unlike corporate plans, public pension plans are allowed to discount their liabilities when setting the rate of return.” Additionally, governments have been making changes to their pension plans including increased employee contributions and lower assumed rates of return, he said. NASRA released its own study on pension plans last month.
Additionally, republicans in several state legislatures, including Indiana, Ohio and Wisconsin, are trying to break up government employee unions and reduce benefits, including pensions, to reduce deficits. Should those efforts succeed pension plan costs would be reduced accordingly.
The following chart shows a breakdown by state of current contributions and required increases for full funding, assuming no policy changes:
| Govt Contributions | Required Contribution Increase | |||||||
| Current ($Bil) | Total Required ($Bil) | % of Payroll | % of Tax Revenue | % of Total Own Revenue | % of GSP | per household | ||
| New Jersey | $3.6 | $11.9 | 30.9% | 17.4% | 12.7% | 1.7% | $2,475 | |
| New York | $13.1 | $30.0 | 25.7% | 12.3% | 8.6% | 1.5% | $2,250 | |
| Oregon | $1.3 | $4.4 | 36.1% | 24.7% | 13.2% | 1.9% | $2,140 | |
| Wyoming | $0.2 | $0.6 | 23.7% | 10.3% | 6.5% | 1.2% | $2,080 | |
| Ohio | $3.1 | $12.2 | 33.2% | 21.3% | 13.4% | 1.9% | $2,051 | |
| California | $19.5 | $47.8 | 26.2% | 17.7% | 10.8% | 1.5% | $1,994 | |
| Minnesota | $1.7 | $5.6 | 28.9% | 16.9% | 11.0% | 1.5% | $1,928 | |
| Illinois | $6.0 | $15.5 | 32.3% | 17.8% | 12.3% | 1.5% | $1,907 | |
| New Mexico | $0.9 | $2.3 | 29.1% | 20.4% | 11.4% | 1.8% | $1,756 | |
| Colorado | $0.9 | $4.3 | 42.5% | 19.0% | 10.6% | 1.3% | $1,739 | |
| Rhode Island | $0.6 | $1.3 | 27.0% | 14.0% | 9.4% | 1.3% | $1,576 | |
| Pennsylvania | $2.8 | $10.3 | 34.9% | 14.8% | 9.7% | 1.4% | $1,550 | |
| Wisconsin | $1.4 | $4.7 | 27.0% | 14.2% | 9.3% | 1.4% | $1,522 | |
| Connecticut | $1.6 | $3.6 | 22.1% | 9.6% | 7.5% | 0.9% | $1,459 | |
| Michigan | $3.0 | $8.3 | 31.7% | 15.4% | 9.3% | 1.4% | $1,386 | |
| Washington | $2.5 | $6.0 | 20.8% | 13.5% | 7.4% | 1.0% | $1,371 | |
| Alaska | $0.3 | $0.7 | 15.9% | 6.4% | 3.4% | 0.8% | $1,356 | |
| Hawaii | $0.7 | $1.4 | 17.2% | 10.4% | 6.9% | 1.0% | $1,288 | |
| Texas | $5.0 | $17.1 | 22.1% | 15.4% | 9.4% | 1.1% | $1,271 | |
| Missouri | $1.8 | $4.7 | 26.9% | 15.5% | 9.7% | 1.2% | $1,264 | |
| Kentucky | $1.1 | $3.2 | 26.4% | 15.2% | 9.4% | 1.3% | $1,260 | |
| Delaware | $0.3 | $0.7 | 19.5% | 11.6% | 6.1% | 0.7% | $1,210 | |
| Kansas | $0.9 | $2.2 | 19.2% | 11.7% | 7.1% | 1.0% | $1,197 | |
| South Carolina | $1.5 | $3.6 | 23.5% | 17.7% | 7.9% | 1.3% | $1,186 | |
| Vermont | $0.2 | $0.4 | 23.2% | 9.6% | 6.5% | 1.1% | $1,163 | |
| Mississippi | $1.1 | $2.4 | 21.8% | 14.5% | 8.2% | 1.3% | $1,127 | |
| Louisiana | $1.5 | $3.5 | 21.9% | 11.8% | 7.3% | 0.9% | $1,118 | |
| Virginia | $4.2 | $7.4 | 18.5% | 11.1% | 6.8% | 0.8% | $1,066 | |
| Massachusetts | $2.2 | $4.9 | 19.9% | 8.8% | 5.7% | 0.7% | $1,057 | |
| North Dakota | $0.2 | $0.4 | 21.3% | 7.8% | 5.0% | 0.8% | $1,042 | |
| New Hampshire | $0.4 | $0.9 | 20.6% | 11.0% | 6.8% | 0.9% | $1,010 | |
| Nevada | $1.2 | $2.1 | 17.2% | 9.3% | 5.9% | 0.7% | $884 | |
| Nebraska | $0.4 | $1.0 | 24.3% | 8.6% | 4.2% | 0.7% | $881 | |
| Montana | $0.3 | $0.6 | 19.4% | 9.7% | 5.8% | 0.9% | $872 | |
| Alabama | $1.9 | $3.5 | 15.4% | 12.2% | 6.1% | 0.9% | $868 | |
| Iowa | $0.9 | $1.9 | 15.4% | 8.5% | 5.0% | 0.7% | $861 | |
| Oklahoma | $1.4 | $2.7 | 19.3% | 10.0% | 5.9% | 0.8% | $850 | |
| Tennessee | $1.6 | $3.7 | 20.8% | 11.8% | 5.8% | 0.8% | $837 | |
| Maryland | $2.2 | $4.0 | 15.6% | 6.7% | 4.9% | 0.6% | $818 | |
| Florida | $5.5 | $11.3 | 20.3% | 8.9% | 5.3% | 0.8% | $813 | |
| Georgia | $2.5 | $5.6 | 20.4% | 10.1% | 6.1% | 0.8% | $803 | |
| North Carolina | $1.8 | $4.6 | 15.1% | 9.5% | 5.7% | 0.7% | $784 | |
| South Dakota | $0.2 | $0.4 | 15.9% | 9.6% | 5.7% | 0.6% | $776 | |
| Maine | $0.3 | $0.7 | 18.7% | 7.1% | 4.9% | 0.8% | $761 | |
| Idaho | $0.5 | $0.9 | 16.5% | 10.2% | 6.0% | 0.8% | $737 | |
| Arizona | $2.0 | $3.6 | 11.6% | 7.8% | 4.7% | 0.6% | $608 | |
| West Virginia | $0.7 | $1.1 | 14.7% | 6.7% | 4.1% | 0.7% | $600 | |
| Utah | $0.9 | $1.5 | 13.2% | 6.9% | 3.6% | 0.5% | $538 | |
| Arkansas | $0.8 | $1.4 | 15.2% | 6.4% | 4.1% | 0.6% | $534 | |
| Indiana | $2.2 | $3.0 | 7.5% | 3.6% | 2.2% | 0.3% | $329 | |