Commentary

State and Local Government Pensions: Problems and a Solution

A new study from the Mercatus Center at George Mason University examines the trends and differences between public and private pension plans, the financial condition surrounding state and local plans, and the legal impediments to reform.

The study starts by noting that while defined benefit plans’ popularity has declined significantly in the private sector, they remain prominent in the public sector. When pensions and other benefits are taken into account, government workers enjoy higher compensation than their private counterparts with similar skill levels. In addition, public pensions follow accounting standards that are much looser than those governing private defined benefit plans.

The financial conditions of public pensions are not promising. Under a fair market valuation approach, 21 states had funded ratios below 40 percent in 2009. On average, state and local governments would need to contribute 14 percent of annual revenue to fully fund their pension plans. Roughly a third of state pension plans are expected to run out of money within the next two decades.

This bleak financial picture however is not easy to deal with, thanks to rigid legal protections granted to pension benefits. This means pension reforms will have to rely on voluntary choice by plan participants. The study’s reform proposal focuses on two features:

  • Requiring governments to disclose the financials of their pension plans to beneficiaries in plain language, using standardized conservative accounting assumptions
  • Allowing governments to offer beneficiaries a choice to receive a lump-sum buyout of their pension benefits, adjusted by the funded ratio.

To read the full study, go here.

Truong Bui is a policy analyst at Reason Foundation, where he works on the Pension Integrity Project.