HIDDEN DEBT HIDDEN DEFICITS IN STATE AND LOCAL
HIDDEN DEBT, HIDDEN DEFICITS IN STATE AND LOCAL GOVERNMENT BUDGETS Joshua D. Rauh Ormond Family Professor of Finance, Stanford GSB Senior Fellow, Hoover Institution Senior Fellow, Stanford Institute for Economic Policy Research
A BALANCED BUDGET? 2
A BALANCED BUDGET? $43, 071 per year when I retire $19, 000 per year when I retire $88, 101 per year when I retire $100, 000+ per year when I retire 3
ASSETS IN RETIREMENT PLANS $ Trillions in Assets 5. 0 4. 5 4. 0 3. 5 3. 0 2. 5 2. 0 1. 5 1. 0 0. 5 0. 0 Question: Are these assets enough to deliver public employees the pensions they have been promised? State and Local Government DB U. S. Corporate DB U. S. 401(k) DC DB data are from 2016 Q 4 (Fed), DC data are from 2014 Q 4 (DOL) U. S. 403(b) DC
FINANCE 101: ASSETS AND LIABILITIES • Suppose you borrow $100, 000 due in 2027, with zero interest • You then spend $50, 000 on a vacation… $ gone • You invest the remaining $50, 000 in a portfolio of stocks and bonds • A week later, you go to a bank to apply for a mortgage on a house you might like to buy • The bank wants to know your assets and liabilities to calculate your current Net Worth (= Assets – Liabilities)
NET WORTH • Net Worth = Assets – Liabilities • From the loan, you have liabilities of $100, 000 • From your investment in stocks and bonds, you have assets of $50, 000 • If you have no other assets, then your net worth is –$50, 000
WHAT ABOUT YOUR INVESTMENTS? Average Annual Return Compound Annualized Return (a) Common Stocks 12. 0% 10. 0% (b) Long-Term Government Bonds 6. 0% 5. 6% (c) = 60%(a) + 40%(b) 9. 6% 8. 2% All statistics for 1926 - 2016 Source: Stocks, Bond, Bills, and Inflation (Ibbotson 2017) Fact: A diversified portfolio of stocks and bonds has returned over 8% per year over the past 90 years Question: does this fact matter in the previous example?
A FRIEND’S ADVICE? A FRIEND SAYS TO YOU… • “Lets be conservative and assume your investments will only grow at 7. 5% per year. ” • “This means your money will (more than) double every 10 years: (1+7. 5%)10 = 2. 06” • “So your $50, 000 will be worth 2. 06 x $50, 000 = $103, 000 in 2027, when your loan is due. ” • “You might even invest in some hedge funds and private equity, and get even higher returns. ” • “So just ignore this debt if anyone asks you about your finances. You don’t even need to mention it. ”
GOVERMENTAL ACCOUNTING USES THE LOGIC OF YOUR “FRIEND” • For example: when the government borrows $100, 000 from an employee, due in 2027 • • It spends $50, 000 on current activities, like paying for Medicaid • • Would otherwise have had to pay more in current compensation Invests the remaining $50, 000 in a pension fund of stocks and bonds • • e. g. the promise of one year of a pension and private equity and hedge funds The government reports a $3, 000 net asset, not a $50, 000 net liability
State and Local Pensions, Fiscal year 2015 (649 Plans) STATES’ AVERAGE DISCOUNT RATE TREASURY YIELD 7. 36% GOVERNMENTAL ACCOUNTING STANDARDS BOARD (GASB) 67 2. 77%
Your $3. 8 Trillion Hidden Debt to Public Employees (649 Plans) $ AMOUNTS IN TRILLIONS Pension Liability Assets Unfunded Liability Funding Ratio TOTAL STATE AND LOCAL GASB 67 Standards Market Value Standards ($4. 967) = TPL ($7. 435) = ABO $3. 589 ($1. 378) ($3. 846) 72. 3% 48. 3%
STATE PENSION LIABILITIES IN RELATION TO OWN REVENUE SOURCES TOP (WORST) 10 & BOTTOM (BEST) 10
CITY PENSION LIABILITIES IN RELATION TO OWN REVENUE SOURCES TOP (WORST) 10 & BOTTOM (BEST) 10 Chicago: Unfunded debts to public employees equal 19 years of tax revenue
STATE + LOCAL CONTRIBUTIONS – ACTUAL VS. REQUIRED – TOP 10
CITY CONTRIBUTIONS – ACTUAL VS. REQUIRED – BOTTOM 10
CONCLUSIONS • No state or local government that sponsors a DB plan has run a balanced budget in an economic sense in a very long time • Governments are gambling (in hedge funds and private equity) on behalf of citizens • • Citizens bear only the downside Get ready for much higher taxes and much worse public services
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