Situation is dire, but options are available

By Daniel M. Rothschild

A panel of leading academic experts and policy makers issued a warning to states last week: your unfunded pension liabilities are larger than you think, and they must be addressed now.

The Mercatus Center at George Mason University hosted a panel of pension experts and reform advocates to discuss policy solutions for state pensions that are underfunded by between $1 and $3 trillion according to recent estimates.

“You’ve got some tough choices,” said panelist Scott Pattison, the director of the National Association of State Budget Officers (NASBO) and former budget officer for the Commonwealth of Virginia. “It’s no secret we’ve hit bottom.”

Andrew Biggs of the American Enterprise Institute cited four factors as contributing to the states’ pension crisis: misstatement of liabilities, exorbitant benefit pensions, underfunding, and excessive risk. Biggs stressed that these causes demonstrate policy makers’ disregard for basic economic principles.

“It’s hard to overstate the degree to which public pension accounting methods clash with accepted principles of economics,” said Biggs. “If you apply private sector accounting standards to public sector pensions, there is not a single public sector plan in the country” that is fully funded.

Biggs described the states as effectively exercising “put options” on their pension plans, forcing future taxpayers to bear the risk of markets that do not perform as expected.

Mercatus Center researcher Eileen Norcross, who coauthored a recent paper on New Jersey’s unfunded pension liabilities with Biggs, also discussed the role of lax accounting standards in allowing the crisis to unfold. Specifically, she cited the Governmental Accounting Standards Board (GASB) for allowing states to assume rates of return on investments that exceed realistic assumptions.

Norcross argued that this risk has led to states speculating in high-risk investments in an attempt to “double down” on a bad bet. She used Illinois’ foray into credit default swaps as a particularly egregious example.

Discussing New Jersey, Norcross addressed the difficulties in implementing many reforms that affect current workers. Norcross praised Governor Chris Christie for his recent proposals that would solve many of the state’s pension system flaws.

“They’re very reluctant to apply reforms to current workers, and the reason is they could end up in court,” said Norcross.

NASBO’s Pattison suggested the future of state pensions is particularly complicated because of other programs competing for scarce state resources including K-12 and higher education programs, corrections, and health care services. Pattison predicts that many states will see sharp increases in their health care tabs in coming years.

However, Pattison is hopeful about the future, citing the 20 states that have made reforms to their pensions in the previous years.

“We’re certainly moving in the right direction,” said Pattison.

Utah Senator Dan Liljenquist discussed his state’s recent reforms to their pension system. Lilijenquist recommended that policy makers in other states seeking to evaluate their own states’ pension liabilities begin by collecting data about the current state of pensions and modeling what the state’s liabilities would be given different market scenarios.

“Having that ability – to show the data – that won the battle,” said Lilijenquist.

“When there are no other tools available but reality, you figure out some pretty interesting things to do.”

Click here for an online video of the the panel.

Daniel Rothschild is a Visiting Adjunct Scholar with the Pelican Institute for Public Policy and the Managing Director of the Mercatus Center’s State and Local Policy Project at George Mason University