Should Public Retirement Plans be Fully Funded?

Abstract

Abstract Most state and local retirement plans strive for full funding, at least by actuarial standards. Funding measured at market values fluctuates and often falls short. In a model where most taxpayers hold debt and face intermediation costs, returns on pension assets are less than taxpayers’ costs of borrowing. Hence, zero pension funding is optimal. Also, unfunded pension promises are properly discounted at a rate strictly greater than the government's borrowing rate. Funding can still be in taxpayers’ interests if legal enforcement problems make unfunded pensions risky for employees, but except in special cases, the optimal funding ratio is less than 100%. ‘Neither a borrower nor a lender be’ (Shakespeare)

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