This article was originally published in Real Clear Policy.
As Congress approaches the summer recess, members continue to negotiate the language in the must-pass highway transportation bill. Now Congress faces a June 30th deadline, having only been able to pass a 90-day funding extension at the end of March for the nation's transportation needs. As important as stable transportation spending is to the nation's crumbling infrastructure, this bill is not only about roads and bridges. Private corporations are using it as a vehicle to ask Congress to change how they calculate their annual pension contributions, which could create a huge unfunded liability for the American taxpayer.
Currently, the law requires corporate plans to measure their liabilities, and determine the annual contribution needed to fund them, by using the rate of return on corporate bonds - the discount rate. As historically low bond rates force higher contributions, corporations now want to reduce annual payments to their pension plans by lobbying Congress to change this rate. Not only is this misleading and addictive, but artificially lowering contributions today will add to future pension shortfalls tomorrow-possibly requiring further public bailouts.
The provision in the Senate-passed version of the Transportation bill currently under consideration in the House would allow corporations to use a 25-year average rate as opposed to the current 2-year average, increasing the current discount rate from the 4 percent range to roughly 6 percent. Since liabilities are sensitive to discount rate assumptions, the plan's liability will change roughly 15 percent for every one percentage point change in the discount rate. For example, Boeing reports that a mere quarter of a point increase in the discount rate could cut its pension liability by $1.7 billion. Apply a small discount rate hike across all private plans and it's easy to see why corporations are lobbying Congress for a discount rate boost.
Since 2002, Congress has, on a few occasions, let corporations use a higher discount rate to determine their contributions. Among other companies, American Airlines reduced its annual contribution to employee pension plans by $2.1 billion. Unfortunately, today the airline faces a shortfall in its pension plan, triggered by the growing expense for employee retirement. Its parent company filed for bankruptcy in November.
Corporate pension plans are insured by a federal agency, the Pension Benefit Guaranty Corporation (PBGC). If for some reason corporations are not able to pay out the pension benefits they promised to retirees, the PBGC and taxpayers are on the hook for it.
You might wonder why Congress would go along with a policy that provides short-term relief but much longer-term risk to the public. If corporations put less into their pension plans, the federal government is left with more income to tax. According to the Joint Committee on Taxation, the result of shifting that money from pensions funds to income statement results in $8.8 billion more in taxes over the next 10 years.
Before embracing such a move, Congress might consider another pension problem years in the making. States across the country are facing the consequences of inaccurately accounting for their retirees' pension benefits by keeping their discount rates unrealistically high. State and local pension plans face $4.5 trillion in unfunded employee retirement payments. That's several times larger than the $800 billion unfunded liability that governments currently recognize that is attributable to years of rosy accounting.
Why is there such a difference between what state and local governments recognize and the market value of their pension liabilities? Here's how it works: Let's say you promise to pay your employee $1 million in benefits in a lump-sum, 30 years from today. Assume your investments will return 10 percent annually. If you invest $57,300 today it will grow into $1 million over the next three decades. However, if you only achieve a return of 7 percent, then you would have needed to put in $131,400 today to have the same payout.
That's the basic math. The higher the rate of return assumed, the less money needed to set aside today to grow into the promised payout tomorrow. Conversely, the lower the rate of return assumed, the more money required up front or over time.
For years, state and local pension have avoided the pain of shoring up their underfunded pension plans by assuming a high discount rate, based on expected asset returns, rather than on what's being promised. This is not only bad economics; it guarantees plan underfunding and places the burden of the shortfall on future generations.
Disastrous results have followed. Stockton, California; Central Falls, Rhode Island; Pritchard, Alabama; and Vallejo, California, are just a few municipalities driven to bankruptcy by sudden spikes in pension payments.
Private corporations want Congress to give them the same leeway to engage in a similar balance sheet gimmick for private plans. Given the problems with this accounting maneuver, corporations are setting the PBGC up for failure and future taxpayer bailouts. That's not good funding policy no matter what the short-term fiscal gains are for Congress' coffers.