(updated with correction)
A new study of public pension plans by finance professors Joshua Rauh and Robert Novy-Marx warns that states and municipalities will have to raise taxes each year for the next 30 years to address funding problems.
Pension experts counter that the key assumption of the analysis by Mr. Rauh of Northwestern University and Mr. Novy-Marx at the University of Rochester exaggerates the cost of the pension benefits by removing expected rates of return from the equation.
Messrs. Rauh and Novy-Marx predict that existing pension liabilities are roughly $3 trillion, not allowing for projected growth based on rate-of-return assumptions. To get state and local plans to full funding within the next 30 years, states will have to raise taxes by an average of $1,398 each year per household until then, with five states need to raise them by more than $2,000 per year.
“It is one possible outcome for one possible set of assumptions, but we believe that significantly exaggerates the cost of those benefits,” Keith Brainard, research director for the National Association of State Retirement Administrators, said in an interview. “Unlike corporate plans, public pension plans are allowed to discount their liabilities when setting the rate of return. We believe the arguments are well documented for that.”
Mr. Rauh in an interview counters that “liabilities need to be measured by the fact that they are solemn promises even if the stock market performs poorly.” Ignoring those liabilities “is inconsistent with the entire fiscal economics. Even if they earn 8% return, the systems still face major challenges,” he said.
NASRA released its own study earlier this month that found that along with strong investment returns, and growth in both assets and funding levels, public pension funds were making operational changes that included lower assumed rates of return and increased employee contributions, which are improving funding levels. “A lot of changes in public plans have taken place since 2010,” said Mr. Brainard in the interview.