June 15 marked the full implementation of two new Government Accounting Standards Board rules affecting the reporting of pension liabilities. These rules require state and municipal governments to report their pensions in ways more like that of private sector pensions.
The most important issue surrounding GASB’s rule change is the way governments must report the level and type of future payment obligations on pensions.
For a responsible municipal government that has almost fully funded its pensions, the most notable impact will be that the reported pension value will be subject to more pronounced ups and downs with the market.
But few governments have 100 percent of estimated liabilities covered. For a 30-year pension fund that can be balanced by adding assets or cutting pension payments, something like an 80-percent funding level is considered to be in good shape. Still, the new rules will motivate governments to better balance these plans or face higher borrowing costs. This can be done by downsizing benefits or increasing annual payments into the funds.
For governments that have underfunded their pensions, a reckoning is right around the corner. The rules will require these governments to use lower rates of return for the unfunded portion of their plans. The purpose is to reduce the rate of potential tax revenue growth that could be applied to these plans in the future. The result will roughly quadruple the level of unfunded liabilities for most funds.
Governments with very high levels of unfunded liabilities will see their bond ratings drop to levels that will make borrowing impossible. Some places, like Indianapolis or Columbus, Ohio, might have to increase their pension contributions and perhaps make modest changes to retirement plans, such as adding a year or two of work for younger workers.
Places like Chicago or Charleston, W. Va., will be effectively unable to borrow in traditional bond markets. Under the new rules, Chicago’s liability could swell to almost $60 billion, or roughly $21,750 per resident. Retiree health care liabilities add another $3.6 billion, or $1,324 per resident, so that each Chicago household would need to cough up $61,000 to fully fund their promises to city employees. The promise will be broken.
In the meantime, expect that borrowing for infrastructure or other improvements will effectively cease in many places. More than a few Indiana counties will face the music for decades of failed fiscal management. What I love about this is that it isn’t political pressure or overdue common sense derailing this fiscal malfeasance at the municipal level. It is accountants.•
Hicks is director of the Center for Business and Economic Research and a professor of economics at Ball State University. His column appears weekly. He can be reached at email@example.com.