The Next Crisis

by on December 2, 2008 at 7:02 am in Economics | Permalink

It’s not just Social Security and Medicare which are underfunded.  State governments have vastly underfunded public pensions.  Here is the abstract to a new NBER paper, The Intergenerational Transfer of Public Pension Promises by Novy-Marx and Rauh. 

The value of pension promises already made by US state governments will
grow to approximately $7.9 trillion in 15 years. We study investment
strategies of state pension plans and estimate the distribution of
future funding outcomes. We conservatively predict a 50% chance of
aggregate underfunding greater than $750 billion and a 25% chance of at
least $1.75 trillion (in 2005 dollars). Adjusting for risk, the true
intergenerational transfer is substantially larger. Insuring both
taxpayers against funding deficits and plan participants against
benefit reductions would cost almost $2 trillion today, even though
governments portray state pensions as almost fully funded
.

1 fusion December 2, 2008 at 7:43 am

If Social Security and Medicare are underfunded, what about the Defense Department?

2 8 December 2, 2008 at 11:49 am

Does anyone believe that the government won’t lower the benefits to match the funding? This will be a non-event, except for the workers who will feel betrayed.

3 Barkley Rosserr December 2, 2008 at 12:57 pm

This is not being proposed, but one of the biggest problesms for state governments is Medicaid,
which the federal government made them share in the funding of. This was never a good idea, and
now, with some regions of the country being hit harder, with thus more people eligible as revenues
fall for those state governments, we can see how idiotic this was.

Just as medicare is fully run by the federal government, so should be medicaid. Now would be a good
time to make that change, although I am sure many here would disapprove, indeed wish that both
programs would be shut down.

4 Thomas December 2, 2008 at 7:30 pm

A far more sensible strategy would be to encourage (=require) higher retirement age. At 65 the average US resident can expect almot 19 more years of life. If the retirement age were raised to 75 the average time in retirement would be only 13 years with ten more years to contribute. this would help a lot with Medicair funding, too.

5 Jim December 3, 2008 at 12:40 am

//Does anyone believe that the government won’t lower the benefits to match the funding?//

It is my understanding that unlike Social Security and Medicare, state and local government pension obligations are contractual. (That is not true of health care obligations, but it would appear that those obligations are not included in the NBER estimates noted by Alex.) If they are contractual, the SLGs do not have the flexibility to unilaterally reduce them without either the agreement of the employees affected or filing bankruptcy. It would need to be credible that the government entity would seek bankruptcy before the retired employees would agree to reductions, no? And even then, how would you get all of the employees to agree?

6 torris187 December 3, 2008 at 11:19 am

Social security is not underfunded at this present time. Actually Social Security has ran a surplus for awhile. The problem is that the surplus is borrowed against by the federal government.

The social security “bank” does not invest this surplus in the capital markets, it instead has a paper IOU from the federal government. If for some reason, the social security department needs this money quickly, the Federal Government may have some difficulty paying this IOU back. That is where the problem mainly is.

(Side note, this IOU from the Federal Government issued to the social security “bank” is not calculated in the deficit.)

7 Jacqueline December 3, 2008 at 4:58 pm

The problem with social security is that people are now using it as a retirement program instead of as an old age insurance program. The age at which benefits kick in should be automatically adjusted to the average life expectancy. If we’re going to have a government social security program, it should be insurance against outliving your expected lifespan. Individuals should be responsible for saving up their own money if they want to quit working, instead of expecting everyone else to pay for them to loaf around for a couple decades.

8 PAUL December 5, 2008 at 8:25 am

One thing about pensions that everyone who gets upset about them existing fails to recognize is that they arent some “gift” of the employer or state, but part of the benefit of working for the employer. Part of your salary and benefits is a guaranteed pension. Which means the pension isnt someone elses money being given to you, but your money being given to you. People who call for pensions to be cut would never be happy if after working a hard month at their job their paycheck was given them only to find their salary had been cut i half with the excuse being that it was taxing the company to pay you what both you and they originally agreed upon.

9 Dennis Doubleday December 5, 2008 at 9:24 am

Raising the retirement age even higher is a terrible idea. Not everyone works at a desk job, and even for those who do, 40% of them will be dead by 75. I don’t want a society where people are expected to work up until the day they drop.

A better idea is to change state pension plans so they better align with the rest of us. I personally know two people who retired in their early 50s because the state pension plan allowed them to retire on full pension after 30 years of service. I remember wondering at the time how state governments could afford that–turns out they can’t.

10 aion kina March 18, 2009 at 5:15 am

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