Economics, Entitlements

Federal government adopts fair market valuation for state and local pensions

Image Credit: Shutterstock

Image Credit: Shutterstock

There is the long-running debate over how to assess the financing of state and local government employee pension plans, focusing on the interest rate that plans should use to discount their future benefit liabilities. The plans themselves prefer to discount their liabilities using the high returns they expect to receive on their investments, which are heavily weighted toward equities and other risky assets. Using high discount rates lowers the present value of future benefit liabilities and makes the plans appear better funded. Under this approach, public pensions are underfunded by only around three quarters of $1 trillion and have average funding ratios of around 75%.

Economists, on the other hand, argue that since public pension benefits are guaranteed they should be discounted using low interest rates derived from safe investments. I’ve been pretty vocal on this side of the argument. Using “fair market valuation,” pensions are only around 45% funded on average and unfunded liabilities top $4 trillion.

But increasingly, the federal government itself has stepped into the debate. Last year, the CBO opined on the subject, concluding that market valuation provided a more comprehensive view of public pension liabilities. And now, the National Income and Product Accounts, which are the official ledger books of the United States economy, will adopt a market approach for valuing both pension liabilities and the implicit compensation that public employees receive through their pensions. This latter has been an important, and controversial, aspect of my work on public sector pay.

The Bureau of Economic Analysis, which compiles the NIPA, doesn’t go quite as far as I would: they discount public pension liabilities using a corporate bond yield, as private pensions are required to do, even though public pension benefits are “more guaranteed” than private plans. Nevertheless, this is a strong step toward economic reality.

One thought on “Federal government adopts fair market valuation for state and local pensions

  1. Perfect, now taxes can be raised at local and state levels to fully fund our public workers’ retirements. Suggesting: “claw-backs” to nonperforming tax incentives given to businesses in order to promote job creation. Win, win!

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