Analysis of HB 1828 - the so-called Pennsylvania municipal pension reform bill (which includes a Philadelphia sales tax increase) facing the PA General Assembly - by Commonwealth Foundation senior fellow Rick Dreyfuss
CF Analysis of HB 1828
Yesterday the Senate approved HB 1828, a long and complicated bill full of so-called pension reforms and potential local tax increases. Here's a basic summary of the provisions following Senate amendments:
- Level I (70-80% funded ratio): Reduced contributions for 2 years and authorization to impose a new municipal tax if unable to make minimum pension payments.
- Level II (50-69%): Reduced contributions for 4 years, aggregation of trust funds, submission of a improvement plan, and prohibition on increasing benefits in most cases.
- Level III ( less than 50%): Takeover by Pennsylvania Municipal Retirement Board, make reduced pension payments, revised benefit plan for new employees, another tax to defray pension costs, transfers assets to PA Municipal Retirement System, and establishes a statewide Cooperative Municipal Pension Program for new hires in an effort to decrease administrative costs.
Pennsylvania legislators are drawing nearer to implementing a bailout bill for Philadelphia and a state takeover for insolvent municipal pension funds in cities like Pittsburgh. While pension reforms are sorely needed, House Bill 1828 encourages imprudent fiscal management and then tacks on additional pension regulations making a bad bill a little less bad.
Rep. Thomas Caltagirone said it best, "Who do you think will bail them out? The Commonwealth of Pennsylvania. We're not going to let them fail." Sen. Jay Costa admitted “Whether consolidation is the best approach for municipal pension plans 'is a discussion for another day,' Costa said. Now, he says, 'we have a responsibility to help those that are not funded properly. We have to work to make sure retirees receive their benefits.' Costa said."
So how are politicians planning to rescue local governments who can't do their jobs?
First, they would allow Philly to raise its sales tax from 7% to 8% for five years - rewarding an inefficient and bloated bureaucracy while simultaneously discouraging economic growth.
An amendment by Senate Finance chair Pat Browne would also bar elected officials from participating in plans that allow employees eligible to retire to pick a retirement date 4 years in the future, and then amass pension payments at a 4.5% interest while continuing to work and collect their salaries via the city's Deferred Retirement Option Program.
Secondly, the bill establishes pension reforms- again shaped by Browne’s amendment. Any municipality pension plan with less than 50% of funding will be taken over by the Pennsylvania Municipal Retirement Board; Pittsburgh’s city pension is funded at 28%. The amendment also requires distressed funds to:
The Pennsylvania House yesterday passed a bill that would allow Philadelphia to raise its sales tax another percentage point and to defer it pension payments for city employees further into the future (HT GrassrootsPA).
Unfortunately, these are both poor policies. Philadelphia's budget crisis is the result years of reckless spending and tax hikes by Philadelphia’s elected officials.
Philadelphia already has the highest sales tax in the state, and an increase to 8% will give the city a rate one-third higher than the rest of the state. This rate increase will make Philadelphia less competitive than its suburban neighbors, in Pennsylvania, as well as in bordering New Jersey and Delaware (the latter which has no sales tax).
Philadelphia already has the 2nd highest local tax burden among U.S. cities, and is one of only six large cities with a wage tax. Thus it is not surprising that Philadelphia has continued to lose jobs and residents.
And Mayor Nutter’s proposal to suspend payments to the city’s pension plan is no solution at all. Instead of reforming the city’s bloated and unaffordable pension system, the mayor would just pass that cost on (with interest) to future generations of taxpayers.
Reason's Out of Control blog notes a new report detailing that states cumulatively face $558 billion in unfunded retiree health care benefits. Pennsylvania doesn't seem to be in as bad as shape as some other states, but that's faint praise. PA has $8.66 billion in unfunded liabilities as of 2008. This represents 220% of the state payroll, or annual payments (which the state is not required to make, and can continue the "pay as you go" approach) of $720 million (or 18.6% of payroll). That's a lot of money.
Note that this unfunded liability is in additional to the looming pension crisis. And it would not only affect state government, buy also counties, municipalities, transit agencies, and school districts.
Among the proposal of Pennsylvania Auditor General Jack Wagner to help balance the state budget without a tax increase.
But Commonwealth Foundation Senior Fellow Rick Dreyfuss suggests this is likely to cost the state more money, rather than provide savings. As evidence, he points to the experience of New Jersey:
Over the past 20 years, New Jersey has on at least four other occasions granted generous early retirement benefits, and in each case, experts say, the plans cost the state more than they saved.
Last year, a review by The New York Times of New Jersey pension records and government and legislative reports relating to the state’s 2002 early retirement plan revealed a multitude of problems.
More than 5,500 workers — more than twice as many as the state had anticipated — received early retirement packages, which added thousands of dollars to many workers’ annual pensions. The larger number of retirements has meant higher-than-projected long-term costs to the pension and retiree health care systems.
In addition, many of those vacancies were filled immediately.
State Senator Leonard Lance, the leading Republican on the budget committee, said he was surprised that Mr. Corzine was considering the idea, since “in the past, he has said accurately that it’s counterproductive and it costs too much money.”
The Patriot News has a series of "Big Ideas for Pennsylvania", including a couple we have championed - privatizing the state-owned liquor stores and reforming the state pension systems. Another idea is tolling interstates, an idea we might support, if such toll roads were privately operated, rather than the debacle of the Turnpike Commission and the proposed tolling of I-80.
Resources on Liquor Stores Privatization:
The Post-Gazette has a story of another reform to municipal pension plans. The plan would be to put all new municipal employees into a statewide, defined benefit pension system. So far as I can tell, the plan does nothing to address the unfunded liability for current employees, and admittedly the proposal would require some municipalities to pay more to cover an enhanced benefit plan.
More importantly, the proposal would ensure we perpetuate our public pension problems by maintaining a defined-benefit plan rather than moving to a defined contribution plan. And creating another state-wide pension system will only exacerbate the problems - created by politically-motivated manipulation of the plans - of the current state run systems.
Yesterday, the PA House passed an amendment making it illegal for public employees to request lump-sum pension payments after they have been convicted of a crime related to their duties.
The policy is a response to former Judge Mark A. Ciavarella Jr.’s request of nearly $234,000. Ciavarella is eligible for a monthly pension payment of at least $5,150 until sentencing, but a pension payment is protected from forfeiture.
Revoking Ciavarella's pension will do little to address the billions of dollars taxpayers are expected to shoulder in unfunded retirement benefits. Then again, given Pennsylvania's record of convicting civil servants, perhaps the law would make an impact.
But if lawmakers are seriously concerned about criminals hosing taxpayers they should reform SERS and PSERS by moving to a defined contribution plan instead of current defined benefit plans.
A number of Pennsylvania House Republicans are proposing using a portion of the federal stimulus money to pay into PSERS, the retirement fund for school employees. The $435 million payment would be only a drop in the bucket of the unfunded pension liabilities - expected PSERS pension contributions are expected to increase by roughly $3 billion per year in 2012 (and contrary to the metaphor of a "spike", for several years thereafter) - and this proposal certainly does not eschew the need for reforming the pension system.
That said, this is one of the best ideas for using the stimulus money. Rather than create a new program, or increase spending on existing programs - which will require state taxpayers to pick up the tab once the temporary stimulus funding ends in two years - paying off some of our obligations, and reducing the need for future tax increase is a better deal for taxpayers.
The Allegheny Institute has a new policy report examining the pension plans of the 10 largest Pennsylvania cities. They find these plans have a combined unfunded liability of $4.5 billion at the end of 2007 (this would have increased given recent market declines). Pension plans for Scranton, Philadelphia, and Pittsburgh were in much worse shape than the other big cities - all below 60% funded.
They also found that pension plans from all other local governments in PA (representing about 40% of the total membership, vs. 60% from the ten largest cities) were much better funded at that time - 96% of overall liabilities, vs. only 57% for the big cities. They conclude that consolidating the pension plans would be a bad move for most of the state.
From a national perspective, USA Today has an excellent piece on the outstanding liabilities of state and local governments to retired employees for health benefits (the previously unknown "third leg" of the stool):
Nebraska is the only state in the country that owes nothing for the medical care of retired government workers [because they don't provide any]. The other 49 states have an unfunded obligation of $445 billion, according to a USA TODAY survey. ...
The USA has 89,437 branches of local government, according to the Census Bureau. A USA TODAY survey of 25 midsize to large governments found a retiree medical obligation of $126 billion.
A couple of editorials on the crisis in Pennsylvania's public pension crisis from the Daily Review and the Courier Express. Both called for depoliticizing the plans by moving to a defined contribution retirement plan.
One note, the Daily Review remarks, "local school districts will face a whopping 29 percent contribution increase in 2012." In fact, the employer contribution rate will be 28-29% of payroll - this represents an increase of over 500%.
Based on SERS and PSERS estimated employer contribution rates for 2012-13, and their payroll estimates from the most recent valuation reports, this increase translates to an increase of over $400 per Pennsylvania resident, or $1,600 per family of four.
Mark Scolforo summarizes the reports from Pennsylvania two statewide pension funds SERS (for state workers) and PSERS (for school district employees):
The percentage losses on investments were similar. The value of State Employees' Retirement System investments dropped 28.6 percent in 2008, while Public School Employees' Retirement System investments fell 29.7 percent. ...
The state employees' pension fund said the losses mean employer contributions could approach 29 percent of payroll by 2012, far higher than had been expected after its investments had generated impressive returns in recent years. For most people enrolled in the State Employees' Retirement System, the government is their employer.
The teachers' pension fund said it projects the spike could exceed 28 percent for the 2012-13 year. If that occurs, the pain will be felt most acutely by people who pay property taxes to fund school districts.That represents an increase of about 6 times what taxpayers were paying this year, as the total taxpayer contributions for these pension plans will rise (by my quick estimates) from a little over $1 billion to about $6 billion.
Although it is often referred to as a spike, the higher rates in 2012 will more closely resemble the start of a higher plateau and are expected to usher in a lengthy period of much higher payments from taxpayers.
Philadelphia Mayor Michael Nutter is proposing addressing the city's unfunded pension liability by, essentially, not paying as much as the city should (HT GrassrootsPA).
Like Pennsylvania's state pension plans, many local government pensions (Philadelphia among them) are facing major problems, due to historical underfunding, recent investment losses, and politicizing of the pension system. But the mayor's proposal to pay off the liability over 40 years, instead of 30, is simply more politicizing - passing the higher cost on to future generations (and future mayors).
However, Philadelphia (along with other local governments and the state) would benefit a reform like the "Unified Contribution Pension Plan".
The Courier Expess expresses support for moving Pennsylvania state and school district employees to a 401(k) model defined contribution retirement plan.
Specifically, they mention the proposal put forth by Sen. Pat Browne (and Rep. Scott Boyd in the House) This is the type of reform we have advocated for some time.
The Pennsylvania Public School Employees Retirement System (PSERS) at their meeting today certified a small increase in the employers' (re: taxpayers) contribution rate - from the current 4.76% to 4.78% of payroll effective July 1, 2009. This represents about a $22 million increase in employer contributions. They also updated the projections of the pension plateau beginning in 2012-13 - from the prior estimate of 11.23% of payroll to a projected employers rate of 16.40% of payroll (see story in the Patriot News).
Th estimated FY 2012-13 employer contribution of about $2.3 billion annually is almost four times the current level ($595 million). These contributions are split between the state and the school districts, meaning there will be a great deal of pressure to increase both state taxes and local property taxes. The complete spreadsheet of future contributions is here.
These numbers are based on the returns through June 2008 - the more recent market losses are not yet reflected. Therefore, it is likely these projections will be revised upwards. This means unless the fund returns 8.5% or more this year (July 2008-June 2009), the projected payments in 2012 and beyond will rise.
For some policy alternatives, check out Rick Dreyfuss's commentary on getting out of the pension dilemma.
Cross Posted at Capitol Domes
The stock market's steep decline is a source of angst for all those whose retirement account balances have taken a nosedive.
The financial discomfort of private-sector workers is compounded by their having to bolster the pension funds (SERS and PSERS) from which retirement benefits are paid to state and public-school employees.
Whereas most private-sector employees are enrolled in a "defined contribution" (DC) pension plan -- the retirement benefit of which rises and falls with the stock market -- government employees participate in "defined benefit" (DB) plans that guarantee a formulaic retirement benefit based on years of employment and average salary.
The retirement benefits of state employees' DB plans are not affected by the Dow Jones. They are funded with employee and taxpayer contributions, which are invested in the stock market. But if the SERS and PSERS portfolios underperform, more tax revenue is simply collected to straighten out the balance sheet.
The SERS and PSERS funds are facing losses of 30-40 percent for the calendar year. In order for these funds to have enough money to pay out the promised retirement benefits for state workers, taxpayers will have to chip in a good bit more.
Well before the recent slide in the Dow, the Commonwealth Foundation reported on the forecasted financial problems for SERS and PSERS.
Rep. Scott Boyd has introduced legislation that would place new state hires into DC plans. It wouldn't impact current DB plan enrollees and beneficiaries, but it would make future taxpayer contributions to SERS and PSERS more affordable and predictable.
Moreover, DC plans provide a long-term retirement benefit comparable to DB plans -- even with market fluctuations -- while not being subject to the politics inherent in the current DB plan paradigm (i.e., state unions and retiree associations constantly lobbying for a higher multiplier in the formula).
It is time state government follow the cue of the private sector and transition from DB retirement plans to DC plans.
The Wall Street Journal has an article on Pennsylvania's state employee's pension fund, and its market losses. Noting that "Pennsylvania invested more in hedge funds than any other state pension fund" and that taxpayers will make up any investment losses (actually, any returns less than 8.5% increase the cost to taxpayers).
With the pension fund down about 14% in the first nine months of 2008, it is possible that the state will have to quadruple its annual contribution to roughly $1 billion in 2012, according to people familiar with the situation.What the article does not mention is that the pension fund for Pennsylvania school employees, PSERS, is also a state-wide fund (funded jointly by the state and by local school districts) in similar circumstances -- in fact, prior to recent losses, PSERS was in worse shape in terms of forthcoming increases in taxpayer contributions -- and that Pennsylvania taxpayers were already expecting a dramatic increase in pension contributions in 2012.
Deb Erdley has a story in the Pittsburgh Tribune-Review on pension funds for public school employees and state workers, in light of a PSBA plan for reform, recent losses in investment funds, and the looming jump in required taxpayer contributions.
Our own Rick Dreyfuss explains why the PSBA plan isn't much of an improvement, and why the "defined contribution" plan introduced by Pat Browne and Jane Orie in the Pennsylvania Senate and Scott Boyd in the House is a better long-term solution.
Steven Malanga of the Manhattan Institute has an excellent editorial in the Wall Street Journal covering all the major topics of why states overspend - creating or expanding costly programs in good times, failing to deal with state pension and benefit liabilities, failing to seek innovative solutions to problems, and the like.
States of course argue today, as they have countless times in the past, that they need federal aid to avoid cutting essential programs that hurt their most vulnerable citizens. But the blunt fact is that the money will only encourage them to keep doing business the same old way rather than seek innovative solutions.The Tax Foundation made similar comments a few days ago, noting a USA Today article on how state and local governments increased spending and payrolls over the past year.
For instance, many state officials want the federal government to boost infrastructure aid as part of a federal spending package, so that states can build more roads, bridges and mass transit. This is typically unimaginative: Around the world sits hundreds of billions of dollars of private capital looking to go to work financing infrastructure, which our states are largely ignoring.
Countries as different as France, Spain, China and Russia have tapped this money. In the U.S., only a few governments have even tried. Indiana Gov. Mitch Daniels privatized the state's major toll road for an upfront payment of $3.8 billion in 2006. He put the money in the state's transportation trust fund and increased investments in infrastructure. Other governors, like Mr. Rendell in Pennsylvania, have tried similar maneuvers. But they've been blocked by state legislators who want to keep these assets -- and the public-sector jobs that usually are dedicated to running them -- in government hands.
