On January 10, 2012, Senator Orrin Hatch (R-Utah) released a report on state and local government defined benefit pension plans in which he detailed the risks associated with the nation’s $4.4 trillion public pension debt, calling the defined benefit pensions structure “inherently flawed in the state and local government setting.” This massive liability is dangerous for taxpayers and could mean future cuts in services, reductions in benefits, higher taxes, or a combination of these less-than-desirable options.

One good indicator of a sound government pension plan is whether the funding ratio of pension assets to liabilities is at least 80 percent. According to the Government Accountability Office, 40 percent of state and local government pension plans had already dropped below the 80 percent funding level before the 2008 recession began. Post-recession data now shows that 62 percent have dropped below the 80 percent funding level threshold and that 11 states are projected to exhaust all of their pension assets by 2020. These unfunded state and local pension liabilities are also damaging to the federal government’s credit rating, as a federal bailout becomes increasingly inevitable.

Defined benefits lie at the heart of the issue. While 40 legislatures enacted 48 separate pension reform laws in 2010 and 2011, most left the basic defined benefit structure in place. According to the National Conference of State Legislatures, only two states –Alaska and Michigan – and Washington D.C. have required all new hires to participate solely in a defined contribution plan. Georgia, Indiana, Oregon and Rhode Island (as of July 2012) have introduced mandatory “hybrid” plans for new employees, under which employees are required to participate in both a defined benefit and a defined contribution plan. In some cases, these pension requirements do not apply to public school teachers as their powerful union lobby has managed to receive special carve-outs. For example, even though Michigan state employees are placed in defined contribution plans, their teachers are placed into hybrid plans.

Despite the best efforts to increase the level of employee contributions paid toward pensions, raise the retirement age, or modify the annual cost of living adjustment, failure to make a complete switch from the traditional defined benefit plans to more stable defined contribution models guarantees that underfunded pensions will continue to be a growing problem for state and local governments.

State and local governments’ diminishing coffers should not be ignored, nor should they become dependent on federal bailouts to ensure the fiscal soundness of their pension plans. Thankfully, some forward-thinking lawmakers on Capitol Hill have already begun to highlight this massive problem, proposing legislation that would publicize state and local pension fund balance sheets and encourage lawmakers to act in a fiscally responsible manner.

In 2011, Rep. Devin Nunes (R-Calif.) and Sen. Richard Burr (R-N.C.) introduced the Public Employee Pension Transparency Act (H.R. 567 and S. 347). This bill would require state and local government pension plans to disclose the true nature of their liabilities with the Secretary of the Treasury and make their financial statements available to the public through a searchable website.

Government accounting standards show states’ unfunded pension liabilities to be much lower than estimates that rely on more accurate market-based discount rates. The undervaluation is due to the fact that government accounting standards require state and local governments to base their estimates on unrealistically high rates of return on their assets.

These faulty accounting practices are misleading and dangerous. While the rate of return on pension assets fluctuates, the fiscal promises made to state and local employees do not. Moreover, taxpayers, who foot the bill for pension funds, do not have a clear picture of how indebted they are to state and local governments. Increasing pension fund transparency will make lawmakers more accountable to taxpayers and compel elected officials to deal with the reality of their fiscal crisis.

In his report, Senator Hatch outlines four goals of public pension reform that he plans to address in the near future by offering a comprehensive legislative solution:

1. Make public pension plans affordable to public employers and taxpayers and make their costs transparent.
2. Structure plans so that taxpayers will not be liable in the future for past years of employee service.
3. Ensure that public plans provide retirement income security for employees.
4. Avoid a federal bailout of the states at all costs.

With a growing $15.3 trillion debt, the federal government and taxpayers cannot and should not be responsible for fiscally irresponsible states. Nor is it fair to punish taxpayers in those states which have properly managed their budgets. Efforts like those of Sens. Hatch and Burr, and Rep. Nunes to call attention to the pension liability issue, increase transparency, and preemptively quash any expectations of a federal bailout, will force states and localities to confront their problems and consider real reforms that could save taxpayers billions.

State and local governments can no longer defer remedial action on their pension liabilities, quietly hoping for a federal rescue package later. States and local officials must grasp the urgency of the situation and change course before they are faced with filing bankruptcy, or worse, forcing their financial problems beyond their borders onto the American people.

-- Erica Gordon