Friday, November 5, 2010

Public pensions should not be fully funded

Many governments are currently struggling to fund the future liabilities stemming from the retirement benefits of their civil servants. For many of those, the fact that they are significantly falling behind, especially as those funds lost value during the crisis, is seen as a very serious problem that could jeopardize those commitments and/or lead to significant tax hikes. But is this really a problem?

Henning Bohn claims that it is not necessarily so. First, most taxpayers are debtors, thus they would prefer not paying taxes now for future pension payments, as they discount at their borrowing rate, which is higher than the return of the pension funds. The violation of the Ricardian Equivalence thus stems from the intermediation costs. This means that governments should actually not fund at all their future pension liabilities. The only exception may be if they need those funds for collateral, which may be quite important in the case of sovereign debt, as I reported recently.

No comments: