June 22, 2011 / 5:00 PM / 8 years ago

UPDATE 3-Tax hikes needed for US pension funding-study

(Adds details about NCPERS and Pew reports)

By Edith Honan

NEW YORK, June 22 (Reuters) - U.S. state and local governments will need to raise taxes by $1,398 per household every year for the next 30 years if they are to fully fund their pension systems, a study released on Wednesday said.

The findings clash strongly with a June report by the National Conference on Public Employee Retirement Systems as well as a March report by the Pew Center on the States.

The study, co-authored by Joshua Rauh of Northwestern University and Robert Novy-Marx of the University of Rochester, both of whom are finance professors, argues that states will have to cut services or raise taxes to make up funding gaps if promises made to municipal employees are to be honored.

“To achieve fully funded pension systems within 30 years, contributions would have to rise today to the levels we calculate, and then continue to grow along with the economy,” said Rauh.

The disagreement partly stems from the varying assumptions about investment returns and the rate of economic growth.

The National Conference survey of 215 pension funds found an average funding level of 76.1 percent with a 13.5 percent one-year return.

“Public pensions are experiencing a robust recovery from the Great Recession and are reporting strong investment returns, growing assets and funding levels on track to meet their obligations,” Hank Kim, the groups’s executive director, said at the time.

Pension funding in U.S. cities and states deteriorated in the wake of the 2007-2009 recession as investment earnings dropped, and some cash-poor states, such as New Jersey and Illinois, skipped or reduced required payments.

Efforts to curb public-sector benefits this year have sparked heated debates from Wisconsin to New Jersey.

Wall Street rating agencies and investors in the $2.9 trillion U.S. municipal bond market are increasingly focusing on unfunded pension liabilities as they weigh the credit-worthiness of state and local government debt.

Rauh and Novy-Marx previously stirred up the debate over state pension obligations, including issuing the dire prediction that existing pension liabilities total around $3 trillion, if expected returns on investments are not counted.

Other studies have estimated the shortfall as far less. In March, the Pew Center, for example, found the pension shortfall for states could be $1.8 trillion, or as much as $2.4 trillion based on a 30-year Treasury bond’s rate.

The study issued on Wednesday said required contributions from states will far exceed projections for state revenue.

New Jersey will need to increase its revenue by the largest margin, requiring $2,475 more from each household per year, according to the study. For more state data, see [ID:nN1E75L0SJ].

The contribution requirements may be higher for states that already have a significant amount of debt on their books and “cannot tap municipal bond markets as easily for large contributions,” the report said.

Keith Brainard, at the National Association of State Retirement Administrators, questioned the methods and assumptions used in the study as “improbable and unrealistic.”

Brainard said the data was, in part, based on a 10-year period of the average growth rate of state economic output. And yet, the last decade saw one of the worst economic climates in 60 years, Brainard said.

“(Rauh) is extrapolating future economic growth to be consistent with what the nation experienced during the last decade, which was anomalous and paltry,” Brainard said. (Additional reporting by Joan Gralla in New York and Lisa Lambert in Washington; Editing by Andrew Hay)

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