The problem is cities’ overly optimistic assumptions to calculate their liabilities, including unrealistically high rates of return on pension fund investments. As a result, pension liabilities are significantly underestimated leading to chronic underfunding.
The scale of the shortfall is impressive. The report notes that when more conservative, market-based assumptions are applied, unfunded liabilities balloon from the officially reported $1.4 trillion to over $5 trillion. This gap represents a future burden on city budgets, squeezing out funding for essential public services.
No city is unaffected. Even those with relatively better-funded systems are only one economic downturn away from significant distress. Cities like Chicago and Detroit, already struggling with underfunded pension systems, stand as stark warnings of what could happen elsewhere if leaders fail to act.
To make matters worse, Truth In Accounting has pointed out for years that cities and states engage in sleight-of-hand accounting to mask their financial situation by not properly accounting for long-term obligations such as pension commitments. Through cash basis accounting, cities often don’t count those long-term commitments toward their current solvency, allowing mayors and governors to claim their governments are running a surplus!
Like gambling addicts, we’re overestimating our odds of winning while ignoring how deep in debt we actually are.
We need a comprehensive and transparent approach to public pension accounting. Cities must adopt more realistic assumptions about investment returns and fully recognize the extent of their liabilities. This won’t be easy or painless, but it is necessary to prevent a fiscal disaster. We must also consider pension reforms that include adjusting benefits, increasing employee contributions and/or exploring hybrid pension models that combine traditional defined benefit plans with 401(k)-style plans.
It won’t be easy to confront voters with the truth of local finances, especially if they have been told for years that things are rosy. But the sooner we act the less traumatic the process will be, and the quicker we’ll see real and substantive growth.