While much of the budget goes to schools and public safety, liability for the city's pension system also consumes significant resources each year. Unfortunately, the citizens of Salem continue to pay a premium for the city's undersized pension fund, even though a more cost-effective alternative lies within easy reach.

Salem's pension fund is in bad shape - it's only 56 percent funded, meaning that it has enough assets to cover just slightly more than half its liabilities. The difference will have to be made up by taxpayers.

State law requires public pension systems to pay off their unfunded liability by 2028, which means Salem must make annual payments into the pension fund much like a homeowner pays off a mortgage. These payments have an immediate impact on the city's budget. According to the latest available schedule, paying off the unfunded liability will cost the city $5.9 million in 2006; and the payment will rise yearly until it reaches $11.7 million in 2024.

Salem's unfunded pension liability could be reduced if the pension fund earned better investment returns. Unfortunately, my recent research for the Pioneer Institute demonstrated that the performance of Salem's fund has lagged the state's primary pension fund (the Pension Reserve Investment Trust or "PRIT") by 1.6 percent annually over the last ten years. Salem's fund returned 10 percent, while PRIT earned 11.6 percent. In 2003 and 2004 alone, Salem's pension fund returned 4.6 percent and 7.6 percent less than PRIT.

These differences may appear small. But if the Salem fund had earned the same returns as PRIT since 1995, the fund would have more than $11 million in additional assets and be 64 percent funded instead of the current 56 percent. This lost opportunity translates into taxpayers paying an additional $1.2 million annually until 2028.

The frustrating fact for Salem taxpayers is that their pension fund has access to these higher returns and chooses not to take advantage of them. PRIT allows local systems, like Salem, to pool their assets into its larger fund.

PRIT's size ($35 billion in assets compared to Salem's $78.5 million) provides access to top investment managers and investment opportunities. Local funds are often not large enough to invest in hedge funds and other vehicles open only to the largest investors, or to obtain the superior management that is available to PRIT. These additional investment options can not only increase returns, but also increase diversification. Salem's fund is concentrated in just five asset classes and 16 investment managers, while PRIT invests across 11 asset classes and over a hundred managers.

PRIT's size also allows it to take advantage of economies of scale when it comes to administrative costs. Smaller funds like Salem's must use a greater percentage of their assets to cover these costs - which has a direct, negative impact on overall fund performance. Seemingly small differences in expenses can compound over years to reduce returns. For a $10 million fund, an extra 0.25 percent in costs each year results in a loss of $2 million over 20 years.

These clear advantages explain why PRIT has a demonstrated 10- and 20-year track record of returns that are superior to Salem's as well as almost every other local fund in the state.

This spring, budget pressures forced the Salem schools to eliminate more than two dozen positions in the middle of the school year. Faced with these grim choices, the city must take advantage of every opportunity to realize savings.

Failing to maximize investment returns is tantamount to squandering public money. Folding Salem's pension fund assets into PRIT would be easy to do. Based on past performance, it offers the potential to increase returns and reduce the pension liability burden for taxpayers.

Ken Ardon is an assistant professor of economics at Salem State College and the author of "Leaving Money on the Table: The 106 Pension Systems of Massachusetts", a Pioneer Institute White Paper.