Should Public Retirement Plans be Fully Funded?
AbstractMost state and local retirement plans strive for full funding, at least by actuarial standards. Funding measured at market values fluctuates and often falls short. A common argument for full funding is that pensions are a form of deferred compensation that does not justify a debt. The paper examines public finance, political economy, and financial market issues that bear on optimal funding, broadly and in a series of models. In a model where most taxpayers hold debt and face intermediation costs, returns on pension assets are less than taxpayers’ cost of borrowing. Pension funding is costly and hence zero funding is optimal. The model also implies that unfunded pension promises are properly discounted at a rate strictly greater than the government’s borrowing rate. If pension funds serve as collateral, funding can be warranted despite the cost. This is shown in a model with legal ambiguity and default risk. Except in special cases, the optimal funding ratio is less than full funding.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16409.
Date of creation: Sep 2010
Date of revision:
Publication status: published as Henning Bohn. "Should Public Retirement Plans be Fully Funded?," in Jeffrey R. Brown and Robert L. Clark, organizers, "The Economics of State and Local Pensions" Journal of Pension Economics and Finance, volume 10, issue 2, (Cambridge University Press) (2011)
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Other versions of this item:
- Bohn, Henning, 2010. "Should Public Retirement Plans be Fully Funded?," University of California at Santa Barbara, Economics Working Paper Series qt1cw6c8qg, Department of Economics, UC Santa Barbara.
- G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
- H7 - Public Economics - - State and Local Government; Intergovernmental Relations
- H72 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Budget and Expenditures
- H74 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Borrowing
- H83 - Public Economics - - Miscellaneous Issues - - - Public Administration
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