The Impact of Governmental Accounting Standards on Public-Sector Pension Funding

Abstract

The funding policy for defined benefit pension plans covering government employees represents an important decision for government entities sponsoring those plans. In recent years, many state and local governments have experienced extreme funding shortfalls (e.g., New Jersey, Illinois, and Detroit), raising concerns about whether government entities are contributing enough to their pensions. Governmental Accounting Standards Board Statements Number 67/68 (hereafter, “GASB 67/68”) fundamentally alter the financial reporting of pension liabilities, by (i) requiring pension liabilities to be estimated using a potentially lower discount rate (which increases estimated liabilities and any funding deficits), and (ii) mandating recognition of funding deficits (surpluses), previously only disclosed in footnotes, as a liability (asset) on governmental balance sheets. Although GASB 67/68 only changes financial reporting requirements and acknowledges specifically that funding decisions are outside its scope, we find, for a sample of 100 large state-administered plans, that governments increase pension contributions significantly upon applying GASB 67/68. This funding response is stronger from governments likely to face more severe political consequences once pension deficits are made prominent by GASB 67/68. While benefit cuts are also more likely post-GASB 67/68, plans that respond with increased funding are less likely to cut benefits – suggesting that these responses substitute for each other, and that pension funding is more of a fiscal priority in some states than in others. Overall, these responses suggest that governmental entities are willing to take actions with cash flow consequences to avoid recognizing large liabilities on-balance sheet; purely accounting changes, therefore, can have “real” effects on governmental pension policy.

Keywords: Public sector pensions, valuation of pension liabilities, Governmental Accounting Standards Board

JEL Classification: M41, M48