The Political Economy of Underfunded Municipal Pension Plans
This paper analyzes the determinants of underfunding of local government's pension funds using a politico-economic overlapping generations model. We show that a binding downpayment constraint in the housing market dampens capitalization of future taxes into current land prices. Thus, a local government's pension funding policy matters for land prices and the utility of young households. Underfunding arises in equilibrium if the pension funding policy is set by the old generation. Young households instead favor a policy of full funding. Empirical results based on cross-city comparisons in the magnitude of unfunded liabilities are consistent with the predictions of the model.
The views expressed here are those of the authors and do not necessarily represent the views of the Federal Reserve Bank of Philadelphia or the Federal Reserve System. Thanks to David Albouy, Dan Bernhardt, Steve Coate, Victor Rios-Rull, and seminar participants at various institutions and conferences for helpful comments. Sieg acknowledges financial support from the National Science Foundation (SES-0958705). The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.