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Should Public Retirement Plans be Fully Funded?


  • Bohn, Henning


Most 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.

Suggested Citation

  • 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.
  • Handle: RePEc:cdl:ucsbec:qt1cw6c8qg

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    References listed on IDEAS

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    7. Robert Novy-Marx & Joshua D. Rauh, 2009. "The Liabilities and Risks of State-Sponsored Pension Plans," Journal of Economic Perspectives, American Economic Association, vol. 23(4), pages 191-210, Fall.
    8. Dennis Epple & Katherine Schipper, 1981. "Municipal pension funding: A theory and some evidence," Public Choice, Springer, vol. 37(1), pages 141-178, January.
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    11. Friedberg, Leora, 2011. "Labor market aspects of state and local retirement plans: a review of evidence and a blueprint for future research," Journal of Pension Economics and Finance, Cambridge University Press, vol. 10(02), pages 337-361, April.
    12. Barro, Robert J. & Ursúa, José F., 2017. "Stock-market crashes and depressions," Research in Economics, Elsevier, vol. 71(3), pages 384-398.
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    Cited by:

    1. Holger Sieg & Daniele Coen-Pirani & Jeffrey Brinkman, 2015. "The Political Economy of Underfunded Municipal Pension Plans," 2015 Meeting Papers 345, Society for Economic Dynamics.
    2. Meijdam, A.C. & Ponds, E.H.M., 2013. "On the Optimal Degree Of Funding Of Public Sector Pension Plans," Discussion Paper 2013-011, Tilburg University, Center for Economic Research.
    3. Robert Novy-Marx & Joshua D. Rauh, 2012. "Fiscal Imbalances and Borrowing Costs: Evidence from State Investment Losses," American Economic Journal: Economic Policy, American Economic Association, vol. 4(2), pages 182-213, May.
    4. Triest, Robert K. & Zhao, Bo, 2013. "The role of economic, fiscal, and financial shocks in the evolution of public sector pension funding," Working Papers 13-26, Federal Reserve Bank of Boston.
    5. Constantin Anghelache & Alexandru MANOLE & Marius POPOVICI & Emilia STANCIU, 2016. "Statistical analysis of the pensioners condition," Romanian Statistical Review Supplement, Romanian Statistical Review, vol. 64(12), pages 180-186, December.
    6. Ponds, E.H.M. & Severinson, C. & Yermo, J., 2012. "Implicit debt in public sector plans : An international comparison," Other publications TiSEM 8263bb65-8b50-4890-9252-0, Tilburg University, School of Economics and Management.
    7. Börsch-Supan, A. & Härtl, K. & Leite, D.N., 2016. "Social Security and Public Insurance," Handbook of the Economics of Population Aging, Elsevier.
    8. Dashle Kelley, 2014. "The political economy of unfunded public pension liabilities," Public Choice, Springer, vol. 158(1), pages 21-38, January.
    9. Robert Novy-Marx & Joshua D. Rauh, 2012. "The Revenue Demands of Public Employee Pension Promises," NBER Working Papers 18489, National Bureau of Economic Research, Inc.

    More about this item


    Public pensions; pension funding; Social and Behavioral Sciences;

    JEL classification:

    • 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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