We provide evidence that the accounting rules prescribed by the Governmental Accounting Standards Board (GASB) and the choices states make when implementing these rules allow states to understate pension funding gaps, especially during times of fiscal stress. We also find that the funding gap understatement is negatively associated with states’ decisions to increase taxes and cut spending, and that these understatements are associated with higher future labor costs. Importantly, we find that the positive association between the funding gap understatement and future labor costs is attributable to the inherent methodology in the GASB rules, which systematically understate the funding gap, and not to opportunistic reporting by state governments. Therefore, it is not only the case that the GASB pension accounting rules pose intergenerational fairness issues (by not requiring sufficient pension contributions), but also that they are associated with policy choices (such as increased labor expenditures) that have the potential to exacerbate future fiscal problems.
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