In “How The Past Can Devour The Future,” David Crane, President of Govern for California,
(Fox & Hounds, July 22, 2014), shows why public pension liabilities are increasing despite the strong economy and record stock market growth. Crane says Thomas Piketty’s Capital in the 21st Century, “explains that capital is wealth derived from past activities (e.g., your savings represent wealth you accumulated over the past) that combines with labor to produce, and split the benefits from, economic growth. Everything works fine so long as returns promised to capital are lower than economic growth rates. But when returns promised to capital are higher than economic growth rates, Piketty says the past ‘devours the future.’”
Crane says, “That’s what’s happening with public pension costs. When elected officials promise pensions to public employees they create capital (assets for employees, liabilities for governments) requiring a high rate of return that forces governments to divert spending from current activities. Public pension funds must earn the expected return or governments have to divert money from other activities to cover the deficiency. Historically, according to Piketty, capital tends to expect a return of 4.5-5% per annum. That’s tough enough when GDP growth doesn’t reach those levels, but governments like California base upfront contributions on an even higher rate of return, usually 7.5-8% per annum. That’s why public pension costs are rising.”
Crane says, “Another consequence is that, once public pension assets fall behind pension liabilities, it’s virtually impossible to catch up if a high expected rate of return was employed to set upfront contributions. Even though the stock market is up more than 100% since 2009 and CalPERS has averaged extraordinary annual returns of 14% since then, the unfunded pension liability (i.e., the deficit when pension liabilities exceed pension assets) owed by California governments has improved (declined) only 30%. Even now, five years into a great bull market, CalPERS needs to earn double-digit annual returns just to keep the unfunded liability from growing.” He claims achieving returns at 7.5% would require the stock market to be over 30,000.
Crane and others saw that “governments were way behind on their pension promises even before the Great Recession. With the market just now reaching a record 17,000, the difference must come from governments. That means more cuts to services, higher taxes or both (emphasis added). Unless political leaders and labor unions work together to fix the problem, “meeting that rate of return will continue devouring the future. Citizens must plan accordingly.”