NCPA - National Center for Policy Analysis

States' Accounting Practices Unsustainable

March 11, 2011

Nearly every state offers defined-benefit pension plans for public employees.  Financed through a mix of employee and employer contributions along with the investment returns on pension funds, a defined-benefit plan represents a contractual obligation to dole out a set amount in annual payments for as long as the recipient lives, regardless of whether there are sufficient assets in the fund at the time of the employee's retirement.  One would think this obligation to pay no matter what would have led states to invest conservatively and plan ahead.  Instead, they have been following accounting rules that pretty much guarantee the funds will be unsustainable, says Veronique de Rugy, a senior research fellow at the Mercatus Center.

  • First, by law, states are not required to pony up regular contributions to pension systems. Many states have deferred pension payments and used their share of the contribution to increase spending in other areas.
  • Second, government accounting standards systematically underestimate fund liabilities, which in turn encourages pension deferrals. States calculate the value of pension liabilities based on the returns they expect from investing pension assets; onaverage, the states assume an unrealistically high 8 percent annual return on pension investments.

Once the pension plans run out of money, the payments will have to come out of general funds, meaning taxpayers' pockets.  If states want to avert that, they need to push through reforms as soon as possible.  A first step would be to switch to accounting methods that show the true market value of their liabilities, says de Rugy.

Source: Veronique de Rugy, "The State Pension Time Bomb," Reason Magazine, April 2011.

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