The National Center for Policy Analysis recognizes “growing pension costs are an increasing problem for local government. Public pensions require fundamental reform, but defenders of the current system have advanced arguments that do not reflect sound economic thinking. Yet these public pension fallacies endure in political debates, even as finance economists have roundly rejected them.”
In an article entitled, “Nine Fallacies Used to Defend Public-Sector Pensions” Jason Richwine, a senior policy analyst at the Heritage Foundation, addresses common fallacies used by public employee unions and other defenders of the status quo.
Notably, Richwine’s discussion regarding investment returns (Fallacy #5) is relevant to Contra Costa County, whose retirement board is scheduled next month to adopt investment earnings rates through 2017. These investment assumptions will drive pension costs for 17 public employers in Contra Costa, including the county fire districts and the Central Contra Costa Sanitary District. As pension costs increase, these agencies adjust through service cuts (such as closing fire stations), increasing utility rates and raising taxes.
Richwine has this to say about the accounting methods used by government pensions:
“A central problem with pension accounting in the public sector is the rate-of-return assumption on plan investments. When calculating the year-to-year cost of new benefits accrued by workers, plan administrators assume that their investments will achieve the ‘expected’ (or target) rate of return, usually in the 7.5 percent to 8 percent range. [Note: CCCERA’s rate is currently 7.75%.]
”Much to the chagrin of finance economists, this cost calculation ignores the risk associated with plan investments. Pension funds might achieve 8 percent average returns, but they must pay their promised pension benefits regardless.
“This guarantee – that benefits will be paid even if the plan’s investments do not generate the predicted returns – is not free. It must be incorporated into the calculated cost of public-pension plans. Finance economists do this by discounting (reducing the value of) future pension liabilities using a risk-adjusted rate of return (usually around 3 percent to 5 percent) rather than the expected rate of return (around 8 percent). Such an approach is implicit in how private-sector pensions calculate their liabilities, as well as how public-employee plans in other countries do so.”
Read Richwine’s full report here.
The list of nine common fallacies follows:
Fallacy #1: “The average pension payment is a good indicator of the generosity of the plan’s benefits.”
Fallacy #2: “The cost of a public pension plan is equal to whatever the government contributes to the pension fund each year.”
Fallacy #3: “Public pension plans can ‘assume away’ risk because governments are long-lived.”
Fallacy #4: “Advocates of risk-adjusted discounting are merely a niche group of contrarian economists.”
Fallacy #5: “Critics of public pension accounting assumptions are projecting low rates of return.”
Fallacy #6: “The investment returns earned by a pension fund pay for most pension benefits, so taxpayers are actually charged very little.”
Fallacy #7: “Public pensions are not overly generous because they are simply deferred compensation.”
Fallacy #8: “Generous pensions are necessary because some government employees do not participate in Social Security.”
Fallacy #9: “Closing a public pension carries major transition costs.”
This article cross-posted at WatchDogWire.com.