The Coming Tax Increases
By David Henderson
Remember when critics of the Romney tax plan claimed that under his plan, the middle class would face tax increases of about 2,000 per family? [Here’s just one of many examples.] Well, unless state and local government plans for their employees’ pensions are reined in, households will face state and local tax increases of almost $1,400 per year forever. Here’s what Robert Novy-Marx of the University of Rochester’s Simon Graduate School of Business and Joshua D. Rauh of Stanford University’s Graduate School of Business write in a recent NBER Working Paper:
We calculate increases in contributions required to achieve full funding of state and local pension systems in the U.S. over 30 years. Without policy changes, contributions would have to increase by 2.5 times, reaching 14.1% of the total own-revenue generated by state and local governments. This represents a tax increase of $1,385 per household per year, around half of which goes to pay down legacy liabilities while half funds the cost of new promises. We examine sensitivity to asset return assumptions, wage correlations, the treatment of workers not currently in Social Security, and endogenous geographical shifts in the tax base.
The paper is “The Revenue Demands of Public Employee Pension Promises, Working Paper #18489. [gated]
There is one error. The increase to 14.1% is not an increase of 2.5 times; it’s an increase of 1.5 times. That’s small comfort.
One other highlight:
In twelve states, the necessary immediate increase is more than $1,500 per household per year, and in five states it is at least $2,000 per household per year. A key feature of this analysis is that it accounts for the cost of new DB [defined benefit] accruals, for both current and future workers, not just the cost of unfunded legacy liabilities. Decomposing the results into these two components reveals that 49% of the increased contributions would be required to pay only the present value of new service accruals.
For California, the state I care most about (I live here), the increase would be $1,994 per household per year.
Here’s an ungated version.
UPDATE: Russ Roberts interviewed Joshua Rauh on this issue on Econtalk.