Unfunded pension liabilities are already the largest source of debt for state and local governments—and the problem could be much worse than many politicians are willing to admit. Governments estimate the total state and local pension debt to be about $1.9 trillion, based on the assumption that they will earn annual investment returns of between 7 and 8 percent. However, it is likely that the debt is larger than governments claim, as minor fluctuations in realized returns translate into sizable differences in pension costs.
For example, if unfunded liabilities were calculated using a 7 percent rate of return, the debt would jump to $2.3 trillion. When assumptions are lowered to 6 percent—a reasonable expectation for future returns—the debt increases dramatically to $3.2 trillion. Not only does this mean that governments likely owe workers more than estimated, it means that they are probably not contributing enough to their pension funds to fully cover their retirement promises, which will cause serious problems down the road. Think of your mortgage or credit card bill. If you pay less now, it will cost you more to pay down your debt over time. Likewise, if cities and states contribute less to their pension funds now, it means that taxpayers and workers will end up paying more in the future.