Public Employee Pensions and Benefits
For the third time in two years, a major bond rating agency gave Pennsylvania a downgrade.
The most recent downgrade, courtesy of Moody’s, has real implications for taxpayers. Moody's points to "one-time measures", a "structural impalance", and "large and growing pension liabilities" as reasons for their downgrade.
This has been a long time coming. For seven straight years—dating back to the Rendell administration and reliance on temporary stimulus funds—Pennsylvania has spent more than revenue. The most recent state budget, while avoiding raising taxes and doing well to keep spending under the rate of inflation and population growth, did not fully fix this structural deficit.
In addition, past decision combined with poor investment performance have resulted in a massive, and still growing, unfunded pension liability. This pension liability and lack of meaningful reform was the primary impetus for Moody’s downgrade.
Due to the downgrade, creditors may require higher interest rates for state and local debt, leaving you to pick up the tab. This threatens taxpayers with future tax increases, and makes Pennsylvania a less attractive state for investment or new businesses.
Moreover, neglecting pension reform could result in the commonwealth, not to mention cities that have their own pension problems, facing Detroit-like insolvency. This month, Detroit workers and retirees voted to accept a 4.5 percent cut in their pension benefits. Such a cut—particularly for retirees—used to be unthinkable in the public sector. But today's pension crisis represents a triple threat to state and local governments, taxpayers, and employees.
But Detroit's fate need not be our destiny. By continuing to practice fiscal restraint and addressing long-term cost-drivers via meaningful reform, we can build a Prosperous Pennsylvania.
PolicyBlog readers will be well-familiar with the fact that Pennsyvlania state funding for public schools is at a record high.
So why do government union leaders and some politicians still repeat a lie about multiple-billion dollars being cut from public education? Simply put, in some cases they refuse to count state funding to school districts for teachers' pension costs as part of education funding.
As the chart below shows, state aid to public schools for pensions has increased more than $1 billion since 2010-11 (this includes a $225 million transfer from the Tobacco Settlement Fund, not counted in the General Fund total).
Note that this $1 billion increase in state pension aid only covers about half of school employees' pension costs. School districts have had to match this increase with a billion dollar increase in payments from local property taxes.
It makes it easier to say that "there isn't a pension crisis" when you completely ignore a dramatic increase of more than $2 billion in public school pension costs.
Unfortunately, that pension crisis is only going to get worse. Costs will continue to rise over the next few years. The required increases under Act 120 of 2010 are equal to about $900 per household. The costs increase for school districts for required pension payments would be the equivalent of laying off one out of every three teachers in the state.
The fact is this: We are spending more on public education than ever before (see chart below as a reminder of that), but more and more education dollars are going to pay off pension debt created by past political decisions.
On Friday, CF President Matt Brouillette joined The David Madeira Show to talk about Pennsylvania's looming $50 billion public pension crisis and the biggest obstacles to reform: government union leaders.
Listen to a portion of the show below:
The David Madeira Show airs weekdays from 6-9 a.m. on 94.3 FM in northeast PA and can be streamed live at http://thedavidmadeirashow.com/
Lawmakers may have agreed on a no-new-taxes budget, but the cost drivers behind this year’s budget shortfall and Pennsylvania’s annual budget crisis remain unchanged. Chief among those cost drivers is the state’s ailing pension system, with our pension plans more than $50 billion in debt and warnings from all three bond rating agencies.
With such a serious fiscal crisis why has nothing been done? The answer lies with public sector union CEOs who have for years denied a pension crisis, supported underfunded pensions for teachers and state workers, and lobbied against any reform.
The PSEA, for example, sent over-the-top emails to teachers saying a new pension reform proposal is “a new attack on YOUR retirement security,” and claiming it unfairly targets women, playing off absurd “war on women” demagoguery. The PSEA also sent mail to retirees claiming falsely that proposed reforms take away their pensions.
In contrast to this misinformation campaign, our pension debt is a triple threat to Pennsylvania’s future and could lead to teacher layoffs, fewer government services, and retiree pension benefit cuts.
Increases in school pension costs are equal to the salary of 33,000 teachers, which means one in three teachers could be laid off. That is the equivalent of a family of four facing a tax increase of $900 annually to just to make up the payments for pension debt.
Pension reform is about protecting state employees, taxpayers, and future teachers and state workers. As long as government unions are permitted to campaign against it using taxpayer resources, all Pennsylvanians will suffer.
My latest letter to the editor in the Phoenix Reporter and Item corrects the record, noting that government union leaders have for years denied a pension crisis, supported underfunded pensions for teachers and state workers, and lobbied against any reform.
To the editor:
A recent letter from Jay Galambos (June 3) makes the absurd claim that the Commonwealth Foundation and "right wing lobbyists" created the state pension crisis by supporting reduced payments into pension plans.
Unfortunately, he has his history completely backwards. Public employee union lobbyists — not the Commonwealth Foundation — supported Act 9 of 2001, which increases pension benefits and artificially reduced payments. Those same union lobbyists endorsed Act 40 of 2003 and Act 120 of 2010, which "kicked the can down the road" by continuing to underfund the plans.
In contrast, the Commonwealth Foundation fought all of these proposals and has long touted the need for reform. Yet government union leaders, from both the PSEA and AFSCME, denied there was a crisis coming until it was too late.
That crisis is now here, with tax hikes and teacher layoffs a result of postponing tough decisions. Neither revisionist history nor the continued "do nothing" position of the PSEA will solve that. Rather, lawmakers should look to reform the system with retirement benefits that are affordable for taxpayers and predictable for employees.
Most importantly, such pension reform, similar to a 401(k) plan, couldn’t be deliberately underfunded for short-term political gain, leaving our children to pay the cost.
In 2013, Pennsylvania school districts increased their reserve funds by $445 million—to a total approaching $4 billion as of June 30, 2013—according to the latest data from the Department of Education.
Including charter schools and CTCs, public schools had more than $4.2 billion in total fund balances.
While this increase in reserve funds undermines that narrative that public schools have been "cut to the bone," there are good reasons why school districts have built up massive reserves.
Many school districts have rationally grown their reserve funds to deal with the coming spike in required contributions to teachers' pensions.
However, taxpayers would be better served if public schools invested these funds in the pension system now, got investment returns, and paid off part of our more than $50 billion unfunded pension liability. Unfortunately, there is no incentive for schools to do so—there is no mechanism to reduce their future district pension contributions, and they might not receive the full state match for prepaying.
Legislators should look to develop a formula for schools to "prepay" their pension contributions and get a credit for future costs. This could be done by creating separate accounts within PSERS that are invested, but still owned by public schools in order to pay their pension costs in future years.
Doing this could reduce the unfunded liability by several billion dollars and alleviate the pressure for higher property taxes.
To learn more about additional recommendations to solve Pennsylvania's fiscal crisis, read our policy report, Blueprint for a Prosperous Pennsylvania.
We've mentioned before the big lie of "$1 billion cut from education."
Part of the reason that lie continues is that union executives ignore a big chunk of education spending. For instance, the PSEA doesn't count payments toward teacher pensions as "education spending" when making their allegations.
While it is absurd to suggest payments for teachers' pensions "doesn't go to the classroom," excluding employee benefits from instructional spending means less than half of the $26 billion public schools spend "goes to the classroom." Employee benefits consume 19 percent of public school spending, with construction and debt costs another 13 percent and support services (less employee benefits) 21 percent.
What is more, those categories are among the fastest-growing among school spending.
Here is a shocking statistic: Since 2002-03, school district spending on employees' salaries grew 22 percent, but spending on benefits grew a whopping 108 percent, largely because of pension payments.
It is pretty obvious that employee benefits are consuming more and more of school spending — whether union executives want to count this as "classroom spending" or something else.
So what does the PSEA want to do to fix this runaway growth? Nothing.
Is your family ready to bend their budget to pay for Pennsylvania's pension crisis? State pension costs are set to drive up the average family's taxes by nearly $900 annually, but Senate Democrats claim to have a solution. This week they proposed borrowing $9 billion in pension obligation bonds to invest and drive down more than $47 billion in unfunded liabilities of the two state pension systems (PSERS for teachers and SERS for state workers).
Unfortunately, as the saying goes: If it sounds to good to be true, it probably is. Pension obligation bonds are a risky proposition. Issuing bonds without pension reforms, could put taxpayers on the hook for billions more.
Senator Pat Browne notes in Capitolwire [subscription required], "The history of pension obligations bonds is they represent a tremendous amount of risk. Across the country, when they have been used, there have been very mixed results."
For example, under then-Mayor Rendell, Philadelphia issued $1.29 billion in pension bonds to balance the budget. But underfunding continued and pension liabilities grew higher still.
The experience of Philadelphia shows that pension obligation bonds alone are not the answer to Pennsylvania's pension woes. And it's because they fail remove politics from pensions. To achieve that, any pension reform plan should include a defined contribution feature to avoid future crises.
In a defined contribution plan, funds are deposited into an employee's personal account, and it becomes impossible to increase benefits without paying for it. Underfunding requires telling workers that required deposits aren't being made into their accounts. Such a transparent plan prevents political manipulation and wouldn't take any benefits already earned away from retirees or current workers.
It's commendable to see Senate Democrats acknowledging the pension crisis, but their proposed solution is a risk taxpayers can't afford to take.
Pension reform promises to be on the forefront of the legislative agenda in the new year, and for good reason.
PSERS and SERS, the state’s two pension systems for public school and state employees, owe a combined $47 billion in unfunded liabilities. Not only have pension costs driven a downgrade on Pennsylvania’s bond rating, but they siphon taxes away from other budget priorities.
The consequences of doing nothing are significant: Within four years, state and school district pension contribution increases will cost taxpayers an additional $900 per household per year.
So, what's the solution to the pension crisis?
According to the American Legislative Exchange Council's "Keeping the Promise: State Solutions for Government Pension Reform," the political nature of the current defined-benefit (DB) plans creates a "fiscal time bomb" as legislators increase benefits without the ability to make annual payments. Former Utah State Senator Dan Liljenquist outlines several legislative options and recommends switching to a defined-contribution plan (DC) to make future obligations affordable, predictable, and sustainable.
But some charge that transitioning to a DC plan will cost the state more money. Luckily, Twenty Myths about Public-Sector Pension Plans, compiled by Richard C. Dreyfuss, a Senior Fellow at the Manhattan Institute and the Commonwealth Foundation, provides some much-needed clarity.
He writes that the estimated transition costs fall well below the costs of continuing a DB plan—where unreliable contributions, benefit increases, and unrealistic returns promise to magnify the current crisis. Michigan provides a case study for successful reform. Dreyfuss estimates taxpayer savings of $2.2 to $4.2 billion since switching to a DC plan in 1997.
Now is the time to enact transformative pension reform, keeping in mind the lessons learned from other states. Doing nothing is simply not an option.
"They are going to take away your pension!" is a common scare tactic used by Pennsylvania government union leaders to oppose pension reform (even though private school unions have agreed to pension reform).
Such a scenario is no longer fiction for workers in Detroit. Yesterday a federal bankruptcy court ruled the City of Detroit has the ability to renegotiate pension benefits, like any other contract with the city’s 100,000 plus creditors. The dramatic development has widespread implications across the country—including Pennsylvania, where unfunded local and state pension liabilities surpass $50 billion.
Ironically, union officials' refusal to consider reform has endangered the very pensions they claimed they were protecting.
We've noted before the desperate municipal situations in Scranton, Pittsburgh, Allentown and Harrisburg. Government union leaders' unwillingness to compromise and ignore fiscal reality have put these cities on Detroit’s destructive path—harming taxpayers, residents and government employees.
Only by depoliticizing government pensions with 401(k)-type plans will state and local workers be able to keep their pension and create a system that’s fair to new workers and taxpayers.
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