When it matters to keep promises: Funding of retiree benefit and government borrowing cost

Abstract

While funding of retiree benefits has become a critical challenge to the fiscal sustainability of U.S. local governments, little is known about the consequences of public expenditures on OPEBs and pensions. This study examines whether and when annual contributions to other post-employment benefits (OPEBs) plans affect government borrowing costs. By reducing unfunded liabilities, OPEB contributions may decrease borrowing costs. As two parts of deferred employee compensation, expenditure tradeoffs may exist between OPEBs and pension contributions. Fiscal capacity can further moderate these expenditure tradeoffs. Results show that, as U.S. city and county governments make more contributions to OPEB plans, they pay lower borrowing costs when the pension contribution is low and when fiscal capacity is low. They pay higher borrowing costs when the pension contribution is high and when fiscal capacity is low. These findings suggest that the savings of borrowing costs from OPEB contributions depend on the tradeoffs between OPEB and pension expenditures and the availability of fiscal resources.