Taxpayers Don't Need $2.9 Trillion Pension Overhaul: Joe Mysak

By Joe Mysak
(c) 2010 Bloomberg News
Tuesday, July 13, 2010; 12:00 AM

The trouble is the assumptions that state and local pension plans make for their investment returns are too high.

Arizona's Public Safety Personnel Retirement System expects to make 8.25 percent on its investments this year.

Colorado's Public Employees' Retirement Association will make 8 percent. And the Virginia Retirement System anticipates 7 percent returns.

Eileen Norcross of the Mercatus Center at George Mason University in Arlington, Virginia, and Andrew Biggs of the American Enterprise Institute say such assumptions are optimistic, and should be much lower, in the 3 percent range.

In a June report on New Jersey's pension system, they also advocate the adoption of corporate accounting rules, and converting public pensions from defined benefit to the defined contribution plans now common in business.

Government pension plans across the nation assume they will make between 7 percent and 8.50 percent, with the median for 126 plans surveyed being 8 percent, according to the National Association of State Retirement Administrators. Moving to the lower investment assumptions of corporate accounting would force taxpayers to come up with $2.9 trillion to bridge the gap between assets and liabilities.

The Governmental Accounting Standards Board, which sets guidelines for state and local governments, in June rejected a corporate makeover in publishing "preliminary views" on pension accounting and financial reporting. That won't make the argument go away.

Governments and public labor unions are going to resist this idea to reform the system, and I don't blame them.

This latest battle in the public pension wars pits those who call themselves "financial economists" against practitioners of "actuarial accounting."

The economists' argument was summed up by Donald Kohn, former vice chairman of the Federal Reserve Board, quoted in the Norcross/Biggs report on New Jersey: "The only appropriate way to calculate the present value of a very low-risk-liability is to use a very low-risk discount rate."

In other words, if you want to figure out how much you will need to pay your retirees -- a low-risk liability, meaning, states and localities always pay -- you must put your money in very safe, low-risk assets. When New Jersey discounts its liabilities at 8.25 percent, the state reports that its pension systems are underfunded by $44.7 billion. If New Jersey discounts the liability at 3.5 percent, the rate you can get on U.S. Treasury securities, its unfunded obligation is $173.9 billion.

"The suggestion that public funds should discount their liabilities at a so-called risk-free rate is terribly misguided," Keith Brainard, research director of the Washington-based National Association of State Retirement Administrators, said in an e-mail. "That standard is partly responsible for the demise of corporate pensions, as it makes the required costs of the plan highly volatile and uncertain."

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