Pension Cuts Won't Cover U.S. Taxpayers' $3 Trillion Bill, Professor Says

Friday, August 20, 2010

Taxpayers must cover at least a third of a $3 trillion bill for public employee pensions even if lawmakers eliminate cost-of-living increases and raise the retirement age, according to an academic study.

“Even if states uniformly eliminated generous early retirement deals and raised the retirement age to 74, the unfunded liability for promises already made would still be more than $1 trillion,” Joshua D. Rauh, associate professor of finance at Northwestern University’s Kellogg School of Management in Evanston, Illinois, said in a statement.

He presented the paper yesterday to the National Bureau of Economic Research’s State and Local Pensions conference in Jackson Hole, Wyoming.

The study of 116 U.S. retirement plans for teachers and government workers showed that as of June 30, 2009, they had $1.89 trillion in assets to cover $3.15 trillion in liabilities, Rauh said. The research used the typical fund’s assumption that investments will earn about 8 percent annually. That is a gap of $1.26 trillion -- more than double the shortfall of a year earlier, according to a study by the Pew Center on the States.

Using more conservative investment assumptions, such as the rate of return on U.S. Treasury zero-coupon bonds on June 30, 2009, the liabilities are $5.28 trillion, Rauh calculated.

Cost of Living

Benefit reduction strategies such as cutting annual cost- of-living increases for retirees by 1 percent per year would reduce the total cost to $4.71 trillion, according to the report. Eliminating cost-of-living adjustments altogether would still leave a liability of $3.89 trillion, it said.

“There is no magic bullet as far as policy changes are concerned,” Rauh wrote in the paper. “Ultimately taxpayers will have to come up with sums of this magnitude. If unfunded liabilities continue to grow the bailouts could be even larger.”

The effects of altering the system are limited because most costs arise from benefits promised to workers who are already retired, and wouldn’t be affected by changes to benefits for current employees, Rauh said.

“Assuming states don’t start defaulting on their bonds and other debts, it seems that taxpayers will be footing most of the multitrillion dollar bill for the pension promises that states have already made to workers,” he said.