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Pension Liabilities: Fear Tactics and Serious Policy

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  • David Rosnick
  • Dean Baker

Abstract

There is major national debate over the funding status of state and local pension funds. Many economists have argued that pension funds are being overly optimistic in assuming that pensions will be able to get 8 percent nominal returns on their invested funds. This calculation is based on the historic average of the mix of assets that are held by these funds. They have argued that funds should instead that their assets will get the risk-free rate of return on US Treasury bonds and build up their funds accordingly. This paper applies a funding rule projects returns based on current price to earnings ratios in the stock market. It runs a number of simulations based on the pattern of stock returns since the beginning of the last century. It shows that in all cases this funding rule would imply a more even flow of payments to the pension fund than a funding rule that assume a risk-free rate of return. The implication of this analysis is that if state and local governments want to maintain a relatively even flow to their pensions and not burden taxpayers at certain points in time with excess burdens, pensions should adopt a funding rule like the one described in this paper.

Suggested Citation

  • David Rosnick & Dean Baker, 2012. "Pension Liabilities: Fear Tactics and Serious Policy," World Economic Review, World Economics Association, vol. 2012(1), pages 1-57, September.
    • Handle: RePEc:wea:worler:v:2012:y:2012:i:1:p:57
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    References listed on IDEAS

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    1. Alan J. Auerbach & Jagadeesh Gokhale & Laurence J. Kotlikoff, 1991. "Generational Accounts: A Meaningful Alternative to Deficit Accounting," NBER Chapters, in: Tax Policy and the Economy, Volume 5, pages 55-110, National Bureau of Economic Research, Inc.
    2. Robert Novy‐Marx & Joshua Rauh, 2011. "Public Pension Promises: How Big Are They and What Are They Worth?," Journal of Finance, American Finance Association, vol. 66(4), pages 1211-1249, August.
    3. Jagadeesh Gokhale & Kent Smetters, 2003. "Fiscal and generational imbalances: new budget measures for new budget priorities," Policy Discussion Papers, Federal Reserve Bank of Cleveland, issue Dec.
    4. Robert Novy-Marx & Joshua D. Rauh, 2009. "The Liabilities and Risks of State-Sponsored Pension Plans," Journal of Economic Perspectives, American Economic Association, vol. 23(4), pages 191-210, Fall.
    5. Kent Smetters & Jagadeesh Gokhale, 2003. "Fiscal and Generational Imbalances: New Budget Measures for New Budget Priorities," Books, American Enterprise Institute, number 52628, September.
    6. Christian Weller & Dean Baker, 2005. "Smoothing the waves of pension funding: Could changes in funding rules help avoid cyclical under‐funding?," Journal of Economic Policy Reform, Taylor & Francis Journals, vol. 8(2), pages 131-151.
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    Cited by:

    1. Dean Baker & Nick Buffie, 2015. "Pension Funding and the Economy: Would “Proper” Funding Cost Jobs?," CEPR Reports and Issue Briefs 2015-22, Center for Economic and Policy Research (CEPR).

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    More about this item

    JEL classification:

    • G - Financial Economics
    • G2 - Financial Economics - - Financial Institutions and Services
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • J - Labor and Demographic Economics
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs
    • J32 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Nonwage Labor Costs and Benefits; Retirement Plans; Private Pensions

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