Should Public Retirement Plans be Fully Funded?

Henning Bohn

University of California at Santa Barbara, Economics Working Paper Series from Department of Economics, UC Santa Barbara

Abstract: 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.

Keywords: Public pensions; pension funding; Social and Behavioral Sciences (search for similar items in EconPapers)
Date: 2010-09-01
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Citations: View citations in EconPapers (2)

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Related works:
Journal Article: Should public retirement plans be fully funded? (2011)
Chapter: Should Public Retirement Plans be Fully Funded? (2010)
Working Paper: Should Public Retirement Plans be Fully Funded? (2010)
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