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Who’s afraid of good governance? State fiscal crises, public pension underfunding, and the resistance to governance reform

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  • Thomas J. Fitzpatrick
  • Amy B. Monahan

Abstract

Much attention has been paid to the significant underfunding of many state and local employee pension plans, as well as efforts by states and cities to alleviate that underfunding by modifying the benefits provided to workers. Yet relatively little attention has been paid to the systemic causes of such financial distress—such as chronic underfunding that shifts financial burdens to future taxpayers, and governance rules that may reduce the likelihood that a plan’s trustees will make optimal investment decisions. This article presents the results of a qualitative study of the funding and governance provisions of twelve public pension plans that are a mix of state and local plans of various funding levels. We find that none of the plans in our study satisfy the best practices that have been established by expert panels, but also that the strength of a plan’s governance provisions does not appear correlated with a plan’s financial health. Our most important finding is that, regardless of the content of a plan’s governance provisions, such provisions are almost never effectively enforced. This lack of enforcement, we theorize, has a significant, detrimental impact on plan funding and governance. If neither plan participants nor state taxpayers are able to effectively monitor and challenge a state’s inadequate funding or improper investment decisions, public plans are very likely to remain underfunded. We conclude by offering several possible reform options to address the monitoring and enforcement problems made clear by our study: automatic benefi t haircuts, automatic tax increases, a low-risk investment requirement, and market monitoring through the use of modified pension obligation bonds.

Suggested Citation

  • Thomas J. Fitzpatrick & Amy B. Monahan, 2012. "Who’s afraid of good governance? State fiscal crises, public pension underfunding, and the resistance to governance reform," Working Papers (Old Series) 1223, Federal Reserve Bank of Cleveland.
  • Handle: RePEc:fip:fedcwp:1223
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    Cited by:

    1. Don H. Chamberlain & L. Murphy Smith & Randall B. Bunker, 2016. "An examination of US state pensions by total state expenditures, state budget deficit and red v. blue state," International Journal of Economics and Accounting, Inderscience Enterprises Ltd, vol. 7(1), pages 27-44.

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    Keywords

    State finance ; Social security ; Public policy;

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