The Miracle of Funding by State and Local Pension Plans

Alicia H. MunnellJean-Pierre Aubry Kelly Haverstick

SLP#5

Introduction

It is generally agreed that each generation of taxpayers should pay the full cost of the public services it receives.  If a public employee’s compensation includes a defined benefit pension, the cost of the benefit earned in that year should be recognized, and funded, at the time the worker performs that service, not when the pension is paid in retirement.  The discipline of making state and local governments pay the annual costs also discourages governments from awarding excessively generous pensions in lieu of current wages.  Many states and localities also have some unfunded pension obligations from the past, either because they did not put away money at the time the benefits were earned or because they provided benefits retroactively to some participants.  The cost of these unfunded liabilities also needs to be distributed in some equitable fashion.

The question of funding has gained increased urgency as baby boomers are about to begin retiring in large numbers.  To the extent that sponsors are paying less than required contributions today, taxpayers tomorrow will face rising benefit costs, in addition to the pay-as-you-go costs of retiree health benefits.  Public sector workers also risk benefit cuts — primarily in discretionary improvements such as post-retirement cost-of-living adjustments.  But the pension benefits earned by state and local government workers generally have strong legal protections.  So most experts see future taxpayers bearing the primary burden resulting from current funding shortfalls…