The paper summarized here is part of the spring 2021 edition of the Brookings Papers on Economic Activity, the leading conference series and journal in economics for timely, cutting-edge research about real-world policy issues. Research findings are presented in a clear and accessible style to maximize their impact on economic understanding and policymaking. The editors are Brookings Nonresident Senior Fellow and Northwestern University Professor of Economics Janice Eberly and Brookings Nonresident Senior Fellow and Harvard University Professor of Economics James Stock. See the spring 2021 BPEA event page to watch paper presentations and read summaries of all the papers from this edition.
What must state and local governments do to make their public employee pension plans sustainable? Less than many analyses conclude, according to a paper discussed at the Brookings Papers on Economic Activity (BPEA) conference on March 25.
The paper—by Jamie Lenney of the Bank of England, Byron Lutz of the Federal Reserve Board, Finn Schüle of Brown University, and Louise Sheiner of the Brookings Institution—suggests that, for the United States as a whole, state and local pension debt can be stabilized with relatively moderate fiscal adjustments. (They offer an important caveat: Plans vary significantly, and some do require very large funding increases.)
Their findings, however, imply that many state and local governments may be able to spend more than assumed on improving their educational systems and economically important infrastructure.
“Given other demands, fully funding their pension plans might not be the right thing for state and local governments,” Sheiner said in an interview with The Brookings Institution. “They should compare the benefits of upping their pension investments with the benefits of investing in their people.”
Most research evaluates state and local pension plans on the assumption they should be fully funded—that is, their assets are sufficient to meet all anticipated obligations to current and future retirees. State and local pension plans, benefiting more than 11 million retirees, hold nearly $5 trillion in assets and, according to a recent estimate cited in the paper, would require an additional $4 trillion to meet all of their obligations.
However, in The sustainability of state and local pensions: A public finance approach, the authors observe that, using the types of calculations that economists recommend, state and local pension plans have never been fully funded—meaning that they have always been implicitly in debt. Furthermore, they show that being able to pay benefits in perpetuity doesn’t require full funding. If plans contribute enough to stabilize their pension debt, that is enough to enable them to make benefit payments over the long run.
Moreover, after projecting the cash flows for a representative sample of 40 state and local pension plans, they conclude that there are generally modest returns, if any, to starting the stabilization process now versus a decade later. Also, because of already implemented reforms, such as future benefit reductions, pension funds’ cash-flow pressures should begin to recede in 20 years. At that point, under their baseline estimate, pension benefits as a percentage of gross domestic product declines sharply through mid-century and gradually after that.
“While achieving fiscal stability will require adjustments, our results suggest there is no imminent ‘crisis’ for most public pension plans,” the authors write.
David Skidmore authored the summary language for this paper. Becca Portman assisted with data visualization.
Lenney, Jamie, Byron Lutz, Finn Schüle, and Louise Sheiner. 2021. “The Sustainability of State and Local Pensions: A Public Finance Approach.” Brookings Papers on Economic Activity, Spring, 1-48.
Lucas, Deborah. 2021. “Comment on ‘The Sustainability of State and Local Pensions: A Public Finance Approach’.” Brookings Papers on Economic Activity, Spring, 49-57.
Rauh, Joshua. 2021. “Comment on ‘The Sustainability of State and Local Pensions: A Public Finance Approach’.” Brookings Papers on Economic Activity, Spring, 57-61.
Conflict of Interest Disclosure
Byron Lutz is a board member of the National Tax Association. The authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this paper. Other than the aforementioned, they are currently not officers, directors, or board members of any organization with an interest in this paper.
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