Tags: US | pension | funding | tax | hikes

Study: Tax Hikes Needed to Fund Public Pensions

Wednesday, 22 Jun 2011 04:56 PM


NEW YORK — U.S. state and local governments will need to raise taxes by $1,398 per household every year for the next 30 years to be able to fund their pension systems, a study released on Wednesday said.

The study, co-authored by Joshua Rauh of Northwestern University and Robert Novy-Marx of the University of Rochester, both of whom are finance professors, argues that states will have to cut services or raise taxes to make up funding gaps if promises made to municipal employees are to be honored.

But Keith Brainard, research director at the National Association of State Retirement Administrators, questioned the methods and assumptions used in the study as "improbable and unrealistic."

Brainard said the data was, in part, based on a 10-year period of the average growth rate of state economic output. And yet, the last decade saw one of the worst economic climates in 60 years, Brainard said.

"(Rauh) is extrapolating future economic growth to be consistent with what the nation experienced during the last decade, which was anomalous and paltry," Brainard said.

Pension funding in U.S. cities and states deteriorated in the wake of the 2007-2009 recession as investment earnings dropped, and some states, such as New Jersey and Illinois, skipped or reduced required payments.

The issue has sparked heated debates, from the streets of Wisconsin's capital, Madison, where thousands demonstrated over public employees' rights to bargain, to New Jersey, where lawmakers are expected to give final approval this week to a plan that will scale back benefits for public sector workers.

Wall Street rating agencies and investors in the $2.9 trillion U.S. municipal bond market are increasingly focusing on unfunded pension liabilities as they weigh the credit-worthiness of state and local government debt.

Rauh and Novy-Marx previously stirred up the debate over state pension obligations, including issuing the dire prediction that existing pension liabilities total around $3 trillion, if expected returns on investments are not counted.

Other studies have estimated the shortfall as far less. In March, the Pew Center on the States, for example, found the pension shortfall for states could be $1.8 trillion, or as much as $2.4 trillion based on a 30-year Treasury bond's rate.

The study issued on Wednesday said required contributions from states will far exceed projections for state revenue.

"To achieve fully funded pension systems within 30 years, contributions would have to rise today to the levels we calculate, and then continue to grow along with the economy," said Rauh.

New Jersey will need to increase its revenue by the largest margin, requiring $2,475 more from each household per year, according to the study.

The contribution requirements may be higher for states that already have a significant amount of debt on their books and "cannot tap municipal bond markets as easily for large contributions," the report said.

Illinois, for example, which has the lowest funded ratio of any state pension system, sold billions of dollars of pension bonds over the last two years to make its pension payments.

© 2015 Thomson/Reuters. All rights reserved.

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