Thomas Donlan devotes a major portion of his latest Barron’s editorial commentary to long-term fiscal challenges related to state pension funds.
Beyond the unfortunate short-term dependence of many states on money that falls from the federal heavens, there are the unfortunate longer-term policies of their own that have put many states in fiscal trouble. Chief among these is the growing crisis in state and municipal pension funds.
Importantly, the condition of state and local pensions is worse than officially reported. Pension boards, their advisors, and their actuaries have been using unrealistic estimates of their investment returns that are left over from the years of higher inflation that ended in the 1990s.
The National Association of State Retirement Administrators surveyed 132 big government pension plans last year and found the average estimate of future annual investment returns—the discount rate—to be 7.6%. Hard-nosed reformers say they should be using a Treasury rate around 3%, but only seven of the funds in the survey were using discount rates below 7%.
The difference is powerful: The funds pretend their investments are strong and that they are a mere $1 trillion short of what they will need to pay benefits that workers have already earned. Cutting the 7.6% investment estimate back to 3% turns the $1 trillion deficit into a $3 trillion hole.
Officials around the country are loath to acknowledge the mismatch, and government plans aren’t covered by federal pension law that would make them fess up. Pension officials can use whatever discount rate suits their needs. Excuses abound: Governments don’t go out of business; they have taxing power; they can hold on for a long time before wolves chew their way through the door.
