What Causes Policymakers to Underfund Pensions

Commentary

What Causes Policymakers to Underfund Pensions

The failure of many states properly fund their pension systems has been a well documented reality over the past few years, and unfunded liabilities are estimated to be as high as $4 trillion. However, a little examined question, though, is why policymakers have been so particularly bad at this area of their many responsibilities.

Every year actuaries assess a pension system’s finances and determine how much should be set aside in the coming budget year to save for promised pensions. This is called the annual required contribution, or ARC. It is critical that lawmakers pay the full ARC and thus save enough each year, otherwise pension debt will rise and create compounding costs for taxpayers. Unfortunately, lawmakers don’t have the best track record on fulfilling this duty.

In 2012, actuaries determined that the 50 states should set save $90.4 billion to pay for the pensions they were promising to current workers and to pay down existing pension debt. Instead, the states collectively only saved $69.5 billion.

This is not to say that every state underfunded their pension plans; 19 states paid at least 100% of their actuarially determined ARC. But another 16 states paid less than 70% of their ARC. The rest were in-between.

We wanted to know what caused some states to fund their pensions in full and what caused others to underfund their pension plans. It turns out there are various fiscal, political, and institutional factors at work, and no one-size-fits-all answer.

USC political scientist Michael Thom and I compiled data on the fiscal, political, and institutional behavior of the 50 states over the past decade to examine this question, and our results have been recently released by the journal State and Local Government Review. To read the full article before it comes out in print check out SLGR’s website under their Online First section, or click here.

Anthony Randazzo

Anthony Randazzo is a senior fellow at Reason Foundation, a nonprofit think tank advancing free minds and free markets.