As states respond to the Covid-19 pandemic, many also face severe revenue shortfalls because of the economic downturn. These gaps between resources and planned spending pose immediate challenges for policymakers, who must balance budgets while addressing increased demand for public health and other essential services. Some states have already tried to cut costs by reducing or delaying contributions to public pension plans, and others may consider doing so if federal aid to states does not materialize.
The pandemic’s effect on state budgets has been significant. Fiscal year 2020 marked the first time that state general fund revenues declined since the Great Recession, with preliminary projections issued since March showing that states expected fiscal 2021 revenues to fall below initial estimates by about 10%, on average. More recent estimates indicate that state revenue shortfalls could total more than $300 billion cumulatively over fiscal years 2020-22.
Policymakers in some states are looking to improve their overall fiscal outlook over the near term by making changes to the funding policies for public employee pension plans. Certain states have already adjusted planned pension payments in response to anticipated budget shortfalls. Among those are:
In contrast to these states, which reduced scheduled pension payments to help address current fiscal pressures, New Jersey is an example of a state increasing pension contributions in fiscal 2021. After postponing a $951 million pension payment due in September to the start of the state’s fiscal year on Oct. 1, New Jersey committed to making a pension contribution of $4.7 billion in fiscal 2021. That represents the largest pension contribution in state history and continues a planned ramp-up of pension funding to overcome decades of underfunding in the state’s public employee retirement system.
In most cases, the cuts made by states affect supplemental payments initially intended to pay down unfunded liabilities, rather than annual contributions. Whether states further reduce or delay pension contributions will depend on several factors, including the length and severity of the pandemic and the corresponding economic downturn. In addition to assessing the pandemic’s effect on key revenue sources, states may also be considering the likelihood of additional federal aid before making deeper cuts to pension contributions or other spending priorities.
State policymakers contemplating temporary changes to pension contributions will need to consider not only near-term budget needs, but the longer-term costs to their plans as well. Despite the recent recovery in investment markets, an analysis by Pew this summer estimated that the 50-state pension funding gap had risen at that point to close to $1.4 trillion, a historic high. If plans are further underfunded because of missed contributions, states will face additional costs in the future. At the same time, potential market shocks could put additional strain on pension systems.
Pension stress tests—which simulate the real-world impact of various economic conditions on plan balance sheets and government budgets—can help policymakers anticipate budgetary pressures and identify the trade-offs and costs of contribution changes. States that had stress test analyses available before the pandemic hit could better anticipate what that would mean for plan funding and state pension costs over both the initial recession and subsequent recovery.
Policymakers using stress tests or similar analyses when evaluating pension contribution changes should examine the long-term cost impact and the potential risk of insolvency or asset depletion. For example, Colorado’s changes, which are anticipated to save $225 million in fiscal 2021, would add $990 million in long-term costs. Likewise, in New Jersey, pension stress tests assessing the pandemic’s effects showed that without a substantial contribution increase, the state’s pension plans risked asset depletion and insolvency. These analyses led the state to pass a fiscal 2021 budget containing a historically large pension payment, rather than postponing or reducing contributions in response to COVID-19.
Changes to pension contributions may be an appropriate tool for states seeking to balance their budgets while maintaining critical services during the pandemic. And in cases where states are cutting back on supplemental payments to their plans above and beyond the minimum actuarial determined contributions, budget relief can occur without causing long-term fiscal distress thanks to sound planning. At the same time, underfunding pension systems ultimately creates future costs that states will need to address. Tools such as stress testing can help policymakers make choices that meet their current fiscal needs while ensuring the long-range health of pension plans that they oversee.
David Draine is a senior officer and Stephanie Connolly is a senior associate with Pew’s public sector retirement systems project.