The Origins and Severity of the Public Pension Crisis

February 2011, Dean Baker

There has been considerable attention given in recent months to the shortfalls faced by state and
local pension funds. Using the current methodology of assessing pension obligations, the
shortfalls sum to nearly $1 trillion. Some analysts have argued that by using what they consider to
be a more accurate methodology, the shortfalls could be more than three times this size. Based on
these projections, many political figures have argued the need to drastically reduce the generosity
of public sector pensions, and possibly to default on pension obligations already incurred.

This paper shows:

• Most of the pension shortfall using the current methodology is attributable to the plunge
in the stock market in the years 2007-2009.

• The argument that pension funds should only assume a risk-free rate of return in assessing
pension fund adequacy ignores the distinction between governmental units, which need be
little concerned over the timing of market fluctuations, and individual investors, who must
be very sensitive to market timing.

• The size of the projected state and local government shortfalls measured as a share of
future gross state products appear manageable.

Paper URL: http://www.cepr.net/documents/publications/pensions-2011-02.pdf