Over the years, I have written numerous articles on the looming problem of funding public pensions. Many states are facing severe shortfalls and it isn’t due to the economy or the recent recession or the pandemic. The main problem is accounting gimmicks that cities and states regularly do which results in underreporting their pensions. In the private sector, if someone were to underreport a pension, they go to jail for it, but the public sector gets away with it, and the taxpayer is left holding the bag.
Here’s what’s going on. A principle of normal (accrual) accounting is that if you have incurred current expenses, they have to be reported currently. You cannot delay reporting it until a future year, even if it is not paid until a future year. You have to count their costs today. So when you accrue an expense — for instance, a legal fee — you owe that money. Even if the bill arrives after the new year and you pay it that next year, you still owe it for the current year when incurred. It is a payable – that is, a liability – as of the end of the year incurred.. This is accrual basis accounting, and it’s how pensions must be accounted for in the public sector — but they’re not. And therein lies the problem.
When an employee works for a government (or any organization) in a given year, all costs associated with that employment must be recorded as an expense for that year. Naturally, the regular pay iis an expense incurred. That’s an easy enough concept to understand. But there are other things to consider — for instance, a bonus. If you have a bonus that is not paid until the next year, it still has to be recorded in the year it was earned. Now, pensions are not paid out in the year worked or the year after, but they will be years in the future and actuaries can calculate that amount. That amount is not what is booked as an expense. What is booked as an expense is what’s paid. There’s a disconnect between the funding requirement for pensions, and those funding requirements are usually less than the cost incurred.
If that amount is two billion dollars (one billion earned now and one billion in future pension benefits) you are supposed to record two billion dollars. In other words, that liability should be factored in on the balance sheet. But what’s happening instead is that they’re merely recording the one billion earned by the employee as an expense and not accounting for future payouts. There is no measure of a pension’s accrued actuarial liabilities (the current value of earned benefits in the future). The accountants are merely recording the present expenses while underreporting the future ones.
In a given year, you might incur $100 million in future payments for employees who work. So that $100 million is the true cost. Remember that even though the money is not paid for many years, you still need to know what that cost is today, and include that amount in the budget. You cannot say you’ll ignore it and not include it because you won’t pay it for twenty years. But that is what has been happening. Suffice it to say, in the private sector, it’s very onerous. You have to pay in an amount very close to what the cost is so that the company doesn’t go bankrupt and then leave the pensions hanging. That is both right and responsible. But the morons in the public sector think that because the municipality is so powerful, it doesn’t have to do the funding requirement — and therein lies the reason why they are in trouble. They only put the amount that they pay as an expense; they don’t put the whole thing. That is fraud. So now they’re falling further behind. Even if they don’t have to fund it all, they are required to keep a balanced budget, but they don’t.
What’s even more difficult, a lot of municipalities also promised other things like future medical expenses, and those aren’t even booked. They’ll just list it as an expense when it is paid. That’s not right. You can’t promise someone a benefit and have a legal obligation for the future and then not book it on your books. And what’s worst of all is a constitutional amendment in several states that grants pension entitlement to public sector workers. In other words, once a person is working for the government and they have a defined benefit plan, they are entitled to keep it and transfer it, even if the contract runs out. They have defined it to pay the pension — not only for what they’ve earned but also include an obligation to continue that level of funding into new contracts, even those that aren’t signed on yet.
These non-standard, non-accrual forms of accounting for public pensions over the past few decades have resulted in reckless — and dare I say criminal — budgets resulting in billions and trillions of unfunded liabilities that in some places are financially insurmountable. Those that have engaged in such practices should be sued criminally for intentionally filing false sheets on their pensions.