The Origins and Severity of the Public Pension Crisis Presentation to EARN Dean Baker Co-Director Center for Economic and Policy Research September 13, 2011

Key Points on Public Pensions 1)The main cause of the shortfall was the economic collapse. 2)The shortfalls are manageable (use percents, not dollars). 3) The return assumptions are reasonable.

The Crisis Caused the Shortfall

1)The plunge in the stock market cost pension funds almost $860 billion, compared with a situation where they earned the risk free rate of return. 2)If state and local governments had continued to contribute to funds at the rate in , they would have gotten another $77 billion contributions. 3)The total impact of the downturn was more than $930 billion, more than many estimates of the pension shortfall. The Crisis Caused the Shortfall

Putting the Shortfall in Context 1)Trillions of dollars are not informative, but they are scary. 2)Pension shortfall is equal to about 0.2% of GDP over the next 30 years (differences by state). 3)The shortfall is equal to about 1.5% of state budgets and a bit more than 2% of tax revenue.

The return assumptions are reasonable 1)Should pensions assume risk-free rates of return (4.5%) or expected rates of return on assets (8%)? 2)Return assumption is reasonable – it depends on current price to earnings ratios and projected growth.

Source: BEA, Federal Reserve Board, and author’s calculations.

Source: CBO, Federal Reserve Board, and author’s calculations.

Implications of assuming risk free rates 1)Investing in equities would give volatility – but not gains – in projected returns. 2)Increased near-term funding = less funding in the future. (This is like pre-funding schools or fire departments.) 3)Managers would have to make up shortfalls in periods of down markets just as they do now. 4)There will be pressure to not invest in equities: a)Would raise the cost of pensions to taxpayers, b)An incentive to drop DB pensions, c)Then workers would have to invest individually in stock market.

Longer-term picture 1)Private sector workers have lost DB pensions. 2)Private sector workers need pensions. CEPR plan: A Voluntary Default Savings Plan: An Effective Supplement to Social Security ( savings-plan)

Conclusion Public sector pension plans are an important part of employee compensation. They are affordable. The problem is that the private sector workers don’t have pensions, not that the public sector workers do.