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Dire outcomes predicted for municipal pension systems

Associate Professor Joshua Rauh estimates that cities and counties add $574 billion to the $3 trillion in unfunded liabilities from the states


10/12/2010 - Prior research by the Kellogg School of Management has found $3 trillion in unfunded legacy liabilities from state-sponsored pension plans. However, new research finds additional liabilities from municipalities that magnify the growing public pension crisis.

Municipal Pensions
click to see full-size chart
In a new report issued today by the Kellogg School, economists estimate an additional $574 billion in unfunded liabilities from pension plans at the city and county levels.

The paper, “The Crisis in Local Government Pensions in the United States,” is co-authored by Joshua Rauh of the Kellogg School and Robert Novy-Marx of the University of Rochester. In this latest study, Rauh and Novy-Marx calculate the aggregate unfunded liabilities and forecast the number of years assets will last for 77 defined pension plans sponsored by 50 major U.S. cities and counties. The sample represented all non-state municipal entities with more than $1 billion in pension assets, covering 2.04 million local public employees and retirees. Rauh will present the paper at the Brookings Institution on Oct. 15 in Washington, D.C.

“This new paper calculates the present value of local government employee pension liabilities for about two-thirds of total local government employees, and estimates the unfunded obligation for the remaining one-third of workers covered by municipal plans not in our sample,” said Rauh, associate professor of finance at the Kellogg School. “In total, we estimate that municipal plans in the U.S. are carrying $574 billion in off-balance-sheet debt in the form of unfunded pension obligations.”

In many cities, these unfunded promises will be a long-standing and substantial burden for municipal revenues. For example, even if all other spending was shut down, the city of Chicago would need to allocate about eight years of dedicated tax revenues to cover pension promises it has already made.

Six major cities have current pension assets that can only pay for promised benefits through 2020: Philadelphia, Boston, Chicago, Cincinnati, Jacksonville and St. Paul. An additional 18 cities and counties, including New York City, Detroit, Cook County in Illinois and Orange County in California would be solvent through 2020 but not past 2025.

“Philadelphia has the most immediate cause for concern, as the city can pay existing promises with existing assets only through 2015 — less than five years from now,” Rauh said.

Rauh and Novy-Marx estimate that each household already owes an average of $14,165 to current and former municipal public employees in the 50 cities and counties they studied, only including the unfunded portion of benefits that have already been promised based on work performed. In New York City, San Francisco, and Boston, the total is more than $30,000 per household. In Chicago, the total is more than $40,000 per household.

“The situation is especially dire for taxpayers in these areas,” Rauh said. “In addition to being exposed to the prospect of severe local government tax increases and spending cuts, they also will be called upon to pay for their share of the $3 trillion unfunded liabilities at the state level.”

According to Rauh, it is clear that state and local governments in the U.S. are not far from the point where these pension promises will impact their ability to operate. Once the funds themselves are liquidated, the extent to which promised pension payments are competing with other local resources will skyrocket, eroding a large portion of many municipal budgets.

“The fact that there is such a large burden of public employee pensions concentrated in urban metropolitan areas threatens the long-run economic viability of these cities, as residents can potentially move elsewhere to escape the situation,” he explained.

“What is yet to be seen is how this burden will be distributed between state and local governments, and whether the federal government will be called upon for bailouts. If these issues are left unresolved, fiscal crises on the state and local levels may translate into significant losses for municipal bondholders,” he concluded.

MORE INFORMATION: To arrange an interview with Professor Rauh or to request a copy of “The Crisis in Local Government Pensions in the United States,” contact Aaron Mays. Professor Rauh can be followed on Twitter via @joshrauh.