Tax Reform

Unfunded pension liability worse than expected

The issue of state pension sustainability has been a cause of major concern ever since the 2008 recession took a severe toll on pension investment portfolios. State Budget Solutions, a non-partisan group that promotes sustainable budget practices, recently gave more evidence in support of state pension reform. Their study revealed that the average public employee’s pension plan in the United States is only 41 percent funded – bringing total state and local unfunded liabilities to an estimated $4.6 trillion.

The study examines and critiques the use of the Government Accounting Standards Board (GASB) method for evaluating the funding for pension plans. Pension plans are funded through three methods: employee contributions, government (read taxpayer) contributions, and investment returns. Most importantly, however, GASB standards allow for a highly unrealistic 8 percent rate of return on pension fund investments. For example, the California Public Employees’ Retirement System (the country’s largest pension fund), earned a dismal 1 percent return for FY 2012.

GASB’s overly optimistic assumptions have led some estimates astray. Using these assumptions, it has been calculated that the average public employee’s pension plan in the United States is 77 percent funded – significantly higher than State Budget Solutions’ finding of 41 percent. In addition, using GASB’s standards, an estimated total state and local unfunded liabilities is $783 billion, far off from State Budget Solutions’ estimated $4.6 trillion. To address such discrepancies, GASB is slowly moving towards making necessary changes in public fund accounting practices.

Some states, however, have made the decision to directly address unfunded pension liabilities. ALEC member Senator Dan Liljenquist of Utah spearheaded major pension reform in 2010. According to Sen. Liljenquist’s congressional testimony:

“Utah closed its defined-benefit pension plans to new enrollees, creating a new retirement system for new employees hired after July 1, 2011. Under Utah’s new retirement system, public employees will receive a defined employer contribution towards retirement. New public employees will be able to choose between (1) a 401(k) style program, or (2) a hybrid pension program. Utah’s recent pension reforms will, over time, reduce and eliminate Utah’s pension related bankruptcy risk. This is a big win for Utah taxpayers.”

Without these reforms, the Utah retirement fund would have had a 50 percent chance of becoming insolvent by 2028, with a 10 percent chance of insolvency by 2022. Utah’s sustainable budget decisions make it a model for other states looking to reform their pension systems. The state’s first-place ranking in ALEC’s Rich States, Poor States, reflects the host of fiscally responsible policies which have helped it to maintain low tax burdens and high rates of growth.

Ultimately, budget constraints will force states to address their unfunded liabilities. ALEC’s State Budget Reform Toolkit offers recommendations for state legislators attempting to tackle unfunded liabilities by replacing defined benefit plans with defended contribution plans, along with restructuring Other Post Employment Benefit (OPEB) plans.

Public employees deserve the same flexibility and control over their retirement as their private sector counterparts. With the use of a 401(k) style, defined contribution plan, retiree benefits will be protected from faulty accounting practices. The State Budget Solutions’ study exposes the overly optimistic actuarial assumptions used by many states. Once you apply reality to accounting practices like this study does, taxpayers are able to see the severity of unfunded pension liabilities across the 50 states and the necessity of fundamental pension reform.

In Depth: Tax Reform

Mainstream economists, small business owners and taxpayers across the country understand that growth-oriented reforms mean increased opportunity for all. As demonstrated by the annual Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index, sound tax and fiscal policies are critical to economic health, allowing businesses and households to flourish. A…

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