Q&A: Funding of State Pension Funds

Question:  When you say the prior to the 1980’s, public pensions were funded in a traditional way, do you mean that the state governments simply put most of the funding in a fund as they went along, but then they started to put more and more of it into Wall St., so that after the meltdown (when all of the go-it-alone, self-reliant Republicans gladly took their government handouts), the reduced returns caused what can be viewed as temporary concerns that needed to be addressed so as to get them over the “speedbump,” the temporary squeeze???

Answer:  Pensions used to be funded entirely on pay-as-you-go bases, referred to as PAYGO by many policy analysts.  Employers and active employees made contributions out of which retirees were paid pensions. In most cases the contributions went into pension trust funds that were separate from general operating funds; in other cases there was no separation.  Social Security today continues to be on a pay-as-you-go basis with there being a Social Security Trust Fund that is separate from the operating funds of the federal government.

Once prefunding became a goal, the funds attempted to build up reserves out of which all claims (liabilities) for current and retired workers could be paid in case contributions stopped. That’s the origin of “unfunded liabilities.”  To increase those reserves, they began investing the funds in the stock market.  As we know, stock market returns go up and down.  So, you are right, the 2008 stock market crash has temporarily impacted the reserves of pension trust funds.  But, and this is very important as you indicate, that has not caused an imminent crisis since the funds remain quite solvent and able to pay their current liabilities as well as those into the foreseeable future.

There are two types of state contributions: those that are for the normal operating expenses of the pension system and those that are used to build up the reserves enough so that they are fully funded.  When states such as New Jersey do not pay even the normal contribution, that of course will aggravate the fiscal health of the system.  No pension system can survive if no contributions are made to its trust fund.

James W. Russell

One Response to Q&A: Funding of State Pension Funds

  1. Francis Carragher says:

    Thank you.

    I do understand more about public pensions as a result of participating in the blog — and more about current public policy.

    I did take out from the library and read the (Robert) Reich book, Aftershock. Of course, he doesn’t focus on pensions, but he does help readers to connect the dots in the bigger picture of what’s been happening, generally, to the economy in the last few decades; to wit, wealth has been increasingly sent upward to the higher income earners (and unearned income earners) from the lower income earners. And, at the same time (as I mentioned before), this increased wealth is put into investments, financial speculation, mainly into developing countries and emerging markets such as China and India. So, while income, as a proportion of what average people earn, is increasing for the wealthy and decreasing for the non-wealthy, becomes extra cash (investments) to pump into places like China, it also becomes a means to take high-paying manufacturing jobs out of the US and put them into places like China. And let me point out that a lot of those jobs used to provide not only high wages and good benefits, but also a good tax base. Now they are gone or soon to be gone. And wealth (and political power) becomes more concentrated at the top. This explains why “free trade” has become so important to the financial elite. It goes directly to their bottom line. Yet America became an economic powerhouse with very high tariffs. But that was another time and place, and, I guess, that’s another story. But it is connected to current policies.

    One statistic (from the Reich book) best puts it all into perspective for me: In 1980 about 10% of the wealth of the US was in the hands of the top 1% of income holders, now it is about 25%. And the highest tax bracket used to be 70%, now it is about 30 — but most of the really wealthy pay much less than that as they can show that a lot of their income is from capital gains, which, I believe, is now taxable at a 15% rate (also reduced from higher rates).

    So that’s what’s happening. And it is within that context that public pension funding has become a “crisis.”

    So the blog helps me connect the dots and put it all together as I try to understand it all and fashion my own approach to public policy.

    Thanks again.

    And again, as you can see, I view all of this in a general way. I do think that, going forward, maybe pensions do need adjusting and budgets might need cutting; but right now, it’s another power play by the moneyed interests — because taxes do need to be increased and the trend of wealth upward does need to be curbed — and they know it.

    FRAN

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