Underfunded Public Pensions Put Future Taxpayers on the Hook


One of the most well-known and enduring lessons of public choice economics is the dynamic of concentrated benefits and diffuse costs. Well-organized groups have both the incentive and ability to lobby government for benefits for themselves, paid for by taxpayers at large, who lack organization and whose individual payouts toward said benefits aren’t large enough to prompt them to expend much effort opposing this arrangement.

This has gone on as long as there have been governments. That’s bad enough, but this rent-seeking scenario doesn’t just transfer wealth from the general populace to organized interest groups; it also works across time.

This often occurs with the funding of public employee pensions, as a recent Cato Institute research brief by UCLA economist Christian Dippel highlights.

Pension underfunding is, at its core, a political-economy problem: while voters may fail to account for the Ricardian equivalence of public debt more generally, this failure is more severe in the case of unfunded pension benefit increases because these are treated as if they were budget neutral. This misleading budget neutrality creates, in the words of James Buchanan and Richard Wagner, a “fiscal illusion” that makes pension benefit increases an attractive substitute to wage increases in politicians’ eyes. This is illustrated by an interview with the former mayor of Houston, Lee P. Brown. During a tight reelection campaign that he narrowly won with 51.7 percent of votes, he was instrumental in a large increase in municipal employees’ pension benefits. He later justified his decision to increase pension benefits by the fact that it was budget neutral, and that he did not “have the funds to give municipal employees the raises they deserved.”

Put another way, politicians’ limited time in office creates a strong temptation to put off addressing some difficult problems, since it’s much easier to pass those on to successors for them to deal with. This temptation is made stronger by voters’ rational ignorance—people’s rational tendency to devote time and effort to matters for which those efforts are likely to bear fruit; public policy rarely qualifies.

In the case of public pensions, the motivated interest groups are government employee unions, whose support politicians seek. And as Dippel points out, their influence is strongest in close elections. Meanwhile, the people paying aren’t just current taxpayers, but future ones as well.

For more on public sector unions, see here.