Fiscal condition, institutional constraints, and public pension contribution: are pension contribution shortfalls fiscal illusion?

Abstract

One important aspect of public finance is understanding expenditure allocations among competing purposes. Applying the public choice paradigm and fiscal illusion framework, this study explores the interplay between current state expenditures and financial needs, and long‐term financial responsibility to pension funds. Using state finance and pension data during 2004–2018, we found actuarially determined employer contributions paid by a state are inversely related to budgetary fund balances, total reserve fund balances, and state expenditures. Especially when governments are fiscally stressed, state officials appear to delay pension contributions while prioritizing operational spending. Interestingly, more stringent TELs and technical BBRs are effective at promoting prudent pension fund management. The study contributes to the public finance literature by providing empirical evidence to advance the argument that government's financing choices can affect the level of public expenditure while demonstrating the mechanism of the relationship between fiscal illusion and government budgetary decisions.

Public Pension Reform and Credit Quality of State Governments

“…Second, to fully capture the dynamics of the reform process and credit rating and whether the impacts of pension reforms on credit ratings accelerated, stabilized, or reverted, we applied empirical strategies similar to those used by Autor (2003) and Stevenson and Wolfers (2006) to estimate the main model augmented with leads and lags of the reform adoption, where the sums allow for the m lags ( δ − 1 , 0.25em δ − 2 , … , 0.25em δ − m false) , 0.25em 0.25emor post-treatment effects and the q leads ( δ + 1 , 0.25em δ + 2 , … , 0.25em δ + q false) , 0.25em 0.25emor anticipatory effects as follows: Third, the dichotomous reform specification is based on the DID assumption of a homogeneous intervention of the event. For this study, this assumption entails that having one pension reform has the same effect on credit rating as having multiple pension reforms.…”

“…Previous studies contend that unfunded pension liabilities are akin to GO debt in that they will be serviced from general revenues, and as such, changes in pension funding level can prompt reactions from credit rating agencies and the bond market (Epple and Schipper 1981;Martell, Kioko, and Moldogaziev 2013;Marks and Raman 1988;Rauh 2017;Triest and Zhao 2013). Some scholars further asserted that unfunded pension liabilities are even more concerning than GO debt because the former often face less scrutiny and fewer restrictions (Bifulco et al 2012;Hoang and Maher 2022;Martell, Kioko, and Moldogaziev 2013). Applying the same logic, previous studies provide empirical evidence to support the connection between the governments' pension funding status and the municipal bond market's response.…”

Navigating the Public Pension Landscape: An Examination of Asset Allocations

“…Such a move towards imprudent portfolio allocations reflects the lack of cautious actions and oversight from pension governance and plan sponsors (Weller & Wenger 2009). For example, facing a dire funding situation, government officials who want to avoid the political pressures of increasing contributions or cutting back pension benefits (Inman, 1981;Splinter, 2017;Hoang & Maher, 2022) might be more willing to take on additional risks for higher expected returns. In a similar vein, a decline in investment return in previous years can cause an unexpected need to increase employer contribution to maintain the plan's funding levels.…”