This month marked the full implementation of two new Government Accounting Standards Board rules affecting the reporting of pension liabilities. These rules, or, as known in the bland vernacular of accountancy, Statements 67 and 68, require state and municipal governments to report their pensions in ways more like that of private-sector pensions.
The most important issue surrounding rule change is the way governments must report the level and type of future payment obligations on pensions.
For most governments these rules don’t matter much. For a responsible municipal government that has almost fully funded its pensions, the most notable impact will be that the value of the reported pension value will be subject to more pronounced ups and downs with the market.
Investment managers and agencies that provide grades for each local government’s ability to issue bonds will be able to figure this out just fine.
I say “almost fully” because 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 incentivize 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 all these years, 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 of this 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.
One result of this is that 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, may 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, West Virginia, will be effectively unable to borrow in traditional bond markets. Pension funds in Chicago alone are underfunded by almost $15 billion.
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 will 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 wasn’t political pressure or overdue common sense that will derail this fiscal malfeasance at the municipal level. It was accountants.
Michael J. Hicks is the director of the Center for Business and Economic Research and an associate professor of economics in the Miller College of Business at Ball State University. Send comments to firstname.lastname@example.org.