Will NH Households Pay $1,010 Tax Hike to Solve Public Pension Crisis?

NHCEP has found previously that New Hampshire’s official public pension burden is much lower than the real public pension burden (pdf).  Now, Joshua D. Rauh just announced on his blog about a new study that he just released, with Robert Novy-Marx, that estimates state and local pension contributions need to increase by a factor of 2.5 to reach solvency in 30 years.  For the average American household, that amounts to a tax increase of $1,398 per household, per year!

The study is titled “The Revenue Demands of Public Employee Pension Promises.” (pdf)  Here is the abstract:

We calculate the increases in state and local revenues required to achieve full funding of state and local pension systems in the U.S. over the next 30 years. Without policy changes, contributions to these systems would have to immediately increase by a factor of 2.5, reaching 14.2% of the total own-revenue generated by state and local governments (taxes, fees and charges). This represents a tax increase of $1,398 per U.S. household per year, above and beyond revenue generated by expected economic growth. In thirteen states the necessary increases are more than $1,500 per household per year, and in five states they are more than $2,000 per household per year. Shifting all new employees onto defined contribution plans and Social Security still leaves required increases at an average of $1,223 per household. Even with a hard freeze of all benefits at today’s levels, contributions still have to rise by more than $800 per U.S. household to achieve full funding in 30 years. Accounting for endogenous shifts in the tax base in response to tax increases or spending cuts increases the dispersion in required incremental contributions among states.

The chart below is taken from Table 5 of their study on page 40 which ranks the states (from highest to lowest) in terms of the size of the necessary tax hike, per year, to achieve solvency of the state’s public pension system.  As you can see, New Jersey ranks top in the country at $2,475 while Indiana comes in last at $329.

The good news is that, relative to the rest of the country, New Hampshire’s taxpayers are better off coming in as the 31st highest tax increase in the country.  The bad news is that New Hampshire’s taxpayers must still face a tax hike of $1,010 per household, per year!  In terms of the budget, the annual pension contribution would more than double under their analysis from $400 million to $900 million.  Instead of a tax hike, New Hampshire needs pension reform (pdf).

New Hampshire’s Pension Burden

According to a recent report by the Pew Center on the States, in 2008, New Hampshire’s unfunded pension liability was $2.5 billion. Put simply, this means that the pension obligations owed ($7.8 billion) exceed the assets set aside ($5.3 billion) to pay them by $2.5 billion.  To pay for these obligations, New Hampshire’s state government was required to pay $252 million but only managed to contribute $189 million.  Not meeting these minimum payments only worsens the situation.

However, economists Robert Novy-Marx and Joshua Rauh have found that official pension and liabilities are being dramatically underestimated based on current actuarial methods. The problem revolves around the “discount rate” or “interest rate” used.  For example, a 5 percent interest rate means that a $100 today grows to $105 a year from now ($100 time 5 percent) while a 5 percent discount rate means that $105 a year from now is worth $100 today.  In effect, the discount rate is the opposite of the interest rate.

As shown in the table below, they found that New Hampshire’s $7.8billion unfunded pension liability increases to somewhere in the range of $9 billion to $14.2 billion.   More disturbingly, the maximum pension liability ($14.2 billion) is 24.6 percent of Gross Domestic Product ($57.8 billion).  Not that this offers much comfort, but at least that level of liability is only the 46th highest percentage in the country.  In number 1 ranked Ohio, pension liabilities exceed 71 percent of GDP!

As bad as that news is to policy-makers, new information paints an even more disturbing picture.  Since the reported pension liabilities are being dramatically understated, the current payments to the pension system are insufficient to fully-fund the pension system.  Not paying their full contribution (as the state did in 2008) only compounds that problem.  As a result, the pension system will at some have to start cashing-in the pension’s assets in order to pay benefits.

According to their calculations (pdf), New Hampshire’s pension system will run out of money in 2022—only twelve years from today. This is the 8th earliest (tied with Colorado, Kansas and Kentucky) date for insolvency in the country.  The earliest date is held by Illinois when they are projected to run out of money by 2018.

As we near the end of campaigning for this election cycle, the next Legislature and Governor will have to spend time reforming New Hampshire’s pension system.  If they do not, New Hampshire’s credit rating will begin to suffer and the cost of all debt will rise–and taxes along with it.