October 21, 2012
The Washington Post rarely tries to conceal its contempt for unions or middle class workers. In keeping with this spirit it ran a column today that was intended to scare readers about the extent to which public sector pensions will impose a burden on taxpayers in the years ahead. The column projects that the unfunded liabilities of public sector pensions will require:
“on average, a tax increase of $1,385 per U.S. household per year would be required, starting immediately and growing with the size of the public sector.”
Now that’s pretty scary, right? It sure looks like we better go after those public sector workers and their generous pensions.
The column, by two finance professors, Robert Novy-Marx of Rochester University and Joshua Rauh from Stanford, uses two simple tricks to generate its scary projections of household liabilities. First is assumes that pensions will receive impossibly low returns on their assets. The piece notes:
“These finding were calculated assuming that states invest somewhat cautiously and achieve annual returns of 2 percent above the rate of inflation. But even if states continue to make massive bets that the stock market will bail them out, and if the market were to perform as well over the next 30 years as it did over the past half-century (an unprecedented bull market), the required per-U.S. household tax increase would still amount to $756 per year.”
Actually, all the stock market has to do to get us to this $756 per year figure is to grow at the same pace as the economy. Using the standard growth projections from the Congressional Budget Office and other official forecasters, if the price to earnings ratio in the stock market remains constant over the next 30 years then we will see the lower liability figure than the pension funds themselves project.
This is hardly a heroic assumption. In fact, unless Novy-Marx and Rauh want to dispute the official growth projections, it is almost impossible to construct scenarios in which stock returns will come in much below the levels assumed by the pension funds.The point is simple, it was absurd to project high returns in the stock market in the late 90s, when the ratio of stock prices to trend earnings was over 30 to 1 or even in the last decade when it was still over 20 to 1. However with a current ratio that is close to the historic average of 15 to 1, real returns of 7 percent are very reasonable. People who understand the stock market and saw the stock bubble could have explained this fact to Post readers, but such views are excluded from the pages of the Post in order to avoid embarrassing its writers, editors, and columnists, all of whom completely missed both the stock and housing bubbles.
The other trick in this this piece is to implicitly compare averages to medians. Undoubtedly many people would look at this $756 per year number and still find it to be a big hit that they have not budgeted for. Let’s put this in a slightly different context. There are a bit less than 120 million households in the country, which means that average income per household is around $120,000 a year. This means that the unfunded liability from public sector pensions will cost an average household a bit more than 0.6 percent of their income. For a family making $60,000 a year, this would be slightly under $400 a year.
Does that still sound like a lot? Let’s make a couple of comparisons. At their peak, the wars in Afghanistan and Iraq were costing an average family about 2 percent of their income or around $2,400 a year in the current economy. In the same vein the patent protection that we give to drug companies costs the average family around $1,800 a year in higher drug prices. The implicit subsidy that the government gives large banks by protecting them against failure costs an average family around $500 a year. This is in effect the money that we are being taxed to help the struggling CEOs and top executives at the major banks.
The other part of this story is that workers did work for these pensions.This was part of their pay package, which is generally comparable or even slightly less than the compensation of private sector workers with the same education. Most public sector pensions are relatively modest, with the median less than $20,000 a year.
The pensions are underfunded in part because policymakers would not take seriously those of us who warned that pensions were making overly optimistic assumptions about stock returns before the market crashed. Returns have been well below expectations in the dozen years since the peak of the stock bubble in 2000.
The other reason is that some politicians, like New Jersey Governor Chris Christie, think it is really cute to not make the state’s required contribution to the pension fund. Not surprisingly, if states get into the habit of not contributing to their pension fund, as has been the case in some states, then pension funds will be underfunded.
However it is more than a bit bizarre that we should therefore ripoff the workers who are counting on these pensions. Suppose state and local governments contract with construction companies for road work or hospitals to treat poor people. If the governments don’t put aside the money to pay these contracts would we then think it makes sense to tell the contractors and hospitals to get lost?
That is the view being pushed at the Post, but that is what readers have come to expect, given the papers hatred of middle class workers.
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