US public pension system facing $3T funding gap: report

The nation's public pension system is facing a $3.4 trillion funding hole that may force cities and states to either cut spending or raise taxes to cover future shortfalls. 

The deficit in pension funds is three times more than official figures and is growing, and without an overhaul could weigh on state and local budgets and lead to Detroit-like bankruptcies, according to research reported by the Financial Times. 

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Joshua Rauh, a senior fellow at the Hoover Institution who put together the report, told the FT that "the pension problems are threatening to consume state and local budgets in the absence of some major changes."

“It is quite likely that over a 5- to 10-year horizon we are going to see more bankruptcies of cities where the unfunded pension liabilities will play a large role."

The main concern is that the unfunded liabilities will drive cities and states into insolvency, like in Detroit and San Bernardino, Calif.

Illinois, Arizona, Ohio and Nevada, along with the cities of Chicago, Dallas, Houston and El Paso, have the largest pension gaps compared with their own revenues, according to the Stanford study.

Facing large funding shortfalls, many cities and states will have to raise taxes or cut spending on vital services.

Rep. Devin Nunes (R-Calif.) has introduced a measure that would revamp how the plans report their holdings. 

“It has been clear for years that many cities and states are critically underfunding their pension programs and hiding the fiscal holes with accounting tricks," he told the Financial Times. 

“When these pension funds go insolvent, they will create problems so disastrous that the fund officials assume the federal government will have to bail them out," Nunes said.

The Stanford research said that cities and states will have to raise their pension contributions to an average of 17.5 percent, more than double the current 7.3 percent rate, to plug the hole.

California, Illinois, New Jersey, Chicago and Austin would need to boost revenue contributions to 20 percent to stem the increase in their deficits. Nevada would have to contribute about 40 percent, the research said. 

Rauh’s study argues that the funding problems have been mostly hidden behind how costs and liabilities are calculated and are based on the expectation that the plans reach 7–8 percent in returns each year. 

Instead, Rauh figures that the actual rate, which he based on Treasury bond yields, is a much lower 2–3 percent a year. 

Yet despite the growing concern, Hank Kim, executive director at the National Conference on Public Employee Retirement Systems, said the study skews the math and that pension plans are doing fine and their health is actually improving. 

Kim argued that the estimated rate of return at upward of 8 percent is realistic because pension plans have historically been able to hit that mark. 

“Over a long-term trend, that 7.5 percent return rate is absolutely feasible,” he said.