Public Employee Pensions and Benefits
Pennsylvania's $50 billion public pension problem isn't going to solve itself. Reform is a must, which is why Senate Majority Leader Jake Corman has rightly called for structural changes to the public pension systems before considering higher taxes.
A reform being considered now would put new state and school employees into a defined-contribution (DC) plan. Transitioning to a DC plan for new hires—a necessary move to extract politics from pensions—is an important first step on the road to real pension reform.
But not everyone is convinced.
A common assertion put forth by critics of this approach is that such a switch would increase "transition costs," forcing taxpayers to foot the bill. The argument is as follows: Transferring new state and school district employees to a DC plan will increase costs for taxpayers as the pool of employees paying into the current DB plan shrinks, requiring more conservative investments and higher contributions.
Still awake? Good.
This argument against switching to DC plans is flawed. Eileen Norcross, program director and research fellow at the Mercatus Center explained why in her testimony last week:
Closing a defined benefit plan does not add liabilities to the plan. Rather, it changes how the plan’s liabilities are accounted for and changes the investment strategy for the plan’s assets. It reveals the economic value of the plan and makes the funding of the plan’s benefits more sound. Closing a defined benefit plan doesn’t add new costs; it makes the costs transparent, and it makes it easier to ensure that the benefits for retirees are fully funded.
But what about the specific contention that closing a DB plan requires moving to more conservative investments, leading to an increase in costs? Norcross refutes this myth:
The investment-based transition costs argument is a casualty of the flawed accounting standards that have created large, unfunded pension liabilities that states must now address. The use of GASB 27 over the years created an accounting and funding illusion that allowed public plans to ignore investment risk and undercontribute annual plan payments. It is why plans experienced such large and unanticipated losses during the 2008 market crash and why plans suffer from large unfunded liabilities today.
To summarize, unrealistic assumptions about future investment returns can increase costs—not a transition to a DC plan. In fact, unrealistic assumptions create dramatic risks for taxpayers that may be alleviated by moving new hires to a DC plan:
…the probability of Pennsylvania meeting its pension obligations by the year 2030 without additional contributions is not even 50 percent, but significantly lower: 31 percent for the Public School Employees Retirement System (PSERS) plan and 16 percent for the State Employees’ Retirement System (SERS). The need to make up this shortfall is the reason for saying that closing a defined benefit plan generates investment-based transition costs. But these costs lessen the risk of pension underfunding and may even eliminate the risk.
While Gov. Wolf seems to think borrowing money will solve the pension crisis, the commonsense approach to getting out of our $53 billion pension hole is to “stop digging”–i.e., stop piling more people into the current, failing system.
Defined contribution plans offer an alternate solution to the current pension system that would benefit both state employees and taxpayers and are always “fully-funded” (meaning they can’t pile up public debt).
Without much-needed legislative reform, public pensions will bankrupt cities like York—which has a quarter of its budget dedicated to pension funds—and continue to dig the commonwealth into a deeper financial hole.
Listen below to hear some of Nate’s interview with WSBA’s Gary Sutton and to learn more about pension reform.
The Gary Sutton Show airs daily on WSBA 910AM in the York area.
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My colleague Katrina has an op-ed in The Patriot-News today explaining the gravity of the state pension crisis and why action needs to happen now.
As Katrina points out, pension costs are the primary cause of property tax increases. Under Act 1, school districts must seek voter referendum to increase taxes above an index tied to inflation—unless they get an exemption from the state Department of Education. Those exemptions are limited, but over the past five years, 98 percent of school districts that received exemptions for tax increases cited pension costs.
|Act 1 Property Tax Increase Exemptions|
|Total School Districts with exemptions granted||133||228||197||171||164|
|Total with exemptions for pension contributions||128||221||194||169||163|
|Source: PA Department of Education|
Why are pension costs driving up school property taxes?
Pennsylvania's two pension systems have a combined $50 billion unfunded liability, or debt ($32 billion for the pension system covering school employees). This debt was created by a combination of factors: increasing benefits in 2001; delaying payments in 2001, 2003 and again in 2010; and stock market losses.
Under Act 120, lawmakers voted to delay (by phasing in) higher pension contributions. As a result, school districts have already seen a massive increase in costs, and the problem will continue to get worse.
School districts' pension contributions rose from $515 million in 2008-09 to an estimated $2.4 billion this school year, a $1.9 billion increase. To put that in perspective, the increase comes to more than $600 per homeowner in Pennsylvania. Or put another way, the increase represents the salary (using the state average of $63,000) of more than 30,000 teachers.
In the next five years, the projected increase will be just as painful. School districts will have to pay an additional $1.7 billion annually to pay off our pension debt. That increase is another $550 per homeowner, or the salaries of 27,000 teachers.
And that is merely the impact on school districts. Meanwhile, pension costs for state workers are going up by almost the same rate, and local governments face their own pension crises.
Those costs will be borne by some combination of higher taxes, cuts in other programs, and layoffs. But it is hard to understate just how significant this crisis is to homeowners, teachers, students, and taxpayers.
Short answer: Yes!
But some—like government union leaders—deny that anything needs to be done or that there’s a crisis at all.
The truth is, the consequences of inaction on public pension reform are felt by students in schools which are paying ever-higher portions of their budgets on legacy costs and by property owners whose taxes seem to rise year in and year out.
Not to mention that a child born today will be paying off our pension debt until the age of 30!
Katrina Anderson discusses the pension crisis and solutions on WSBA’s The Gary Sutton Show. Listen here or below:
The Gary Sutton Show airs daily on WSBA 910AM in the York area.
Follow Commonwealth Foundation’s SoundCloud stream for more of our audio content.
Most workers are shortchanged by Pennsylvania’s public employee pension programs, according to two recent studies.
The Urban Institute gives Pennsylvania's State Employees' Retirement System (SERS) an "F" grade, ranking it third worst in the nation—better than only Massachusetts and New Jersey.
The September 2014 report says:.
The plan scores poorly because it is inadequately funded, it penalizes work at older ages by reducing lifetime benefits for older employees, and it provides few retirement benefits to short-term employees"...
One in five employees with at least five years of completed service lose money by participating in the plan because pensions they earn are worth less than their required plan contributions.
SERS gives 76 percent of the benefits to 25 percent of employees, according to the Urban Institute.
A similar disparity is found in a Bellweather Education Partners study of the nation’s pension funds for public school teachers, including the state’s Public School Employees' Retirement System (PSERS).
Generous benefits for long-term teachers are partly paid at the expense of those who leave teaching earlier or move from place to place within the profession, according to the study, Friends without Benefits: How States Systematically Shortchange Teachers’ Retirement and Threaten Their Retirement Security.
Less than 25 percent of Pennsylvania’s teachers ever become vested in the pension system, compared to a national median of approximately 45 percent, says Bellweather.
In contrast, defined contribution plans like the 401(k), offer many features better for younger workers. In addition to portability and better benefits for short-term employees, our recent pension study outlines several reason why transitioning to a defined contribution retirement system is an improvement for many employees.
- Ownership. Workers with higher risk preferences can pursue their own investment strategies without restrictions.
- Potentially higher returns. A growing body of evidence suggests that a lifetime of defined contribution retirement investments produce higher returns than individuals cashing out of a defined benefit program.
- Security. By definition, defined contribution plans are fully funded. All of the funds promised to an employee are paid up front and become the employee’s property. There is no risk of reduced benefits from municipal bankruptcy as in the case of Detroit.
The primary obstacle to a more equitable retirement system are teacher unions notes the Bellweather study, saying “the teachers who remain in the system long enough to maximize their benefits—an ever shrinking group—are the most organized politically, via teachers unions and other stakeholder groups."
Unfortunately, government unions' refusal to acknowledge the need for pension reform will hurt workers for years to come. Pension reform is essential to not only protecting taxpayers from enormous debt and rising property taxes, but to give workers a higher quality retirement system where benefits are better distributed.
Here is the full version:
Ed Rendell appears more interested in defending his tenure as governor than actually discussing the facts about Philadelphia. The Commonwealth Foundation’s analysis of school spending, enrollment, and staffing trends spanned several administrations. We present the facts—most notably that spending has dramatically increased—regardless of who resides in the governor’s mansion.
Despite that increased investment—more than $1 billion since 2002—Philadelphia public schools continue to leave children unprepared. Four in five students failed to meet proficiency in reading and math in 2013, according to the Nation’s Report Card.
These results shouldn’t be surprising, however. A study conducted by the 21st Century Partnership for STEM Education found “either no or very weak association between levels of education expenditures and student achievement” in Pennsylvania.
Rendell goes on to blame Republicans for slashing state education funding. This claim is false. The loss of funding was due to the expiration of temporary federal stimulus money Rendell used to balance the state budget. Today, state education funding in Pennsylvania is at a record high.
The reality facing Philadelphia, though, is that pension costs are consuming more and more of the increase in spending—the result of legislation signed by Rendell and backed by teachers’ union lobbyists to underfund pensions and delay those cost increases until after he left office.
In Philadelphia alone, contributions to the Public School Employees Retirement System (PSERS) increased by $133 million over the last 5 years, which is equivalent to the salary of 2,000 school teachers.
The pension crisis is real, and its impact is handcuffing Philadelphia and school districts across the state.
Repeating the same lie over and over does not make it magically come true. Yet this hasn’t stopped the Pennsylvania State Education Association (PSEA) leadership from an endless campaign of deception regarding education funding in the commonwealth.
A recent release from the PSEA claims that state funding cuts are causing disproportionately poor test scores for low-income students.
Unfortunately for the “research division” of the PSEA, the truth is state education spending has increased since 2010-2011 and is currently at a record high. What’s more, there is considerable evidence that increased spending has no relationship with improved academic performance.
When calculating education spending, the PSEA refuses to acknowledge rising pension costs, which are an enormous cost driver for districts across the state. You can’t have an honest discussion about education policy without talking about pension reform—unless you’ve buried your head in the sand. In fact, every governor since Milton Shapp in the early 1970s has included pension costs as funding for public schools.
Growing pension costs are directly responsible for layoffs and program cuts. By standing in the way of responsible pension reform, the PSEA holds much of the blame for the current pension crisis.
Since 2009, the state has seen a $1.9 billion increase in Public School Employees Retirement System (PSERS) payments. To put that increase in perspective: $1.9 billion is equivalent to the salary of 33,400 public school teachers.
The PSEA claims that Pennsylvania should “just let Act 120 work”—referring to legislation passed in 2010 that slightly reduced benefits for new employees and relied on unrealistic projections of future investment returns. But letting Act 120 "work" will result in pension costs continuing to skyrocket in coming years. School districts will thus have less money to spend in the classroom, and property taxes will sharply increase to keep pace with pensions.
Of course, higher property taxes are a desirable outcome for PSEA leaders. “Let Act 120 work” essentially means “let higher property taxes fund our retirement.” Between 2012-13 and 2016-17, the average Pennsylvania household will pay nearly $900 in new taxes as a result of pension obligations.
The PSEA doubles down on faulty arguments by pointing the finger at imaginary spending cuts for low scores on the Pennsylvania System of School Assessment (PSSA). A study conducted by The 21st Century Partnership for STEM Education, however, found “either no or very weak association between levels of education expenditures and student achievement.”
This is just another piece of the growing evidence that throwing more money at struggling schools will not improve student performance, but it will hurt property owners—particularly seniors on fixed incomes.
The PSEA is entitled to its own opinions, but not its own facts. Government union bosses should stop deliberately confusing Pennsylvanians with false and misleading claims.
Yet another common refrain—even among those who admit state spending has increased, which it certainly has—is that new expenditures are not "showing up in the classroom." In other words, school districts are hamstrung by pension costs and have to make cuts in other areas.
This point does indeed carry water.
Take a look at how Public School Employees' Retirement System (PSERS) contributions have skyrocketed over the last five years in Philadelphia and Pittsburgh, the state's two largest districts. We can also project the coming costs for 2013-14 and 2014-15 using the mandated contribution rates for those respective years.
In Pittsburgh, pension payments rose from $11 million in 2008-09 to $26 million in 2012-13, and an estimated $45 million in 2014-15. In Philadelphia, payments rose from $42 million to more than $101 million, and will reach $175 million this coming school year.
The statewide retirement contribution trend tells the same story. From 2008-09 to 2012-13—a span of just five years—statewide PSERS costs nearly tripled. Estimated payments for this year are about 5 times what they were in 2008-09.
With contribution rates continuing to rise, the fiscal outlook only grows more ominous in the years ahead.
To put this in perspective, consider how these costs compare to teachers' salaries. Pension costs from all public schools will have risen by approximately $1.9 billion from 2008-09 to 2014-15. Given that the average teacher salary is $63,500, that increase in pension payments equals the salary of 30,400 public school teachers.
The bottom line is that Pennsylvania faces a genuine pension crisis. School districts are simply running out of options. Even increased education revenue will not be able to offset the growing retirement costs.
Responsible pension reform is the best way to ensure that future education funding truly finds its way into the classroom.
Despite the rhetoric of "billions of dollars" in cuts from education, school districts across Pennsylvania have been able to increase their reserve funds. School districts had a combined reserve fund balance of nearly $4 billion as of July 2013, a $445 million increase from the prior year.
Jan Murphy of the Patriot-News reports that several districts have fund balances equaling almost a third of their annual budgets. One district—Valley Grove School District—even has a fund reserve of more than 99 percent of its total budget.
As part of the story, the Patriot-News created a database for readers to look up school districts' annual budget and reserve fund balances.
One school superintendent suggested that school fund balances be considered as a factor in state funding—that is, school districts with excessive reserve funds would receive fewer state dollars.
At the Commonwealth Foundation, we've pointed to the growth in school funding reserves, but also outlined a commonsense way to put those funds to use immediately.
Many school districts have built up funding reserves in anticipation of the coming pension crisis—and yes, there is a crisis, and it is getting worse for school districts. Putting money aside for future pension costs makes a lot of sense.
But it would be better to pay off pension obligations now and earn investment income on those fund reserves. If a school district turned their reserves over to the pension system now, however, it would simply be pooled with other funds, and that district would still have to pay the same contribution rate as other districts next year.
To help alleviate our looming pension crisis, lawmakers should look to change state law to allow districts to use reserves to prepay their pension obligations and receive a credit for doing so.
Readers of PolicyBlog already know that Pennsylvania education spending is at a record high, that state funding to school districts for pension costs is skyrocketing, and that school district spending, revenues and reserve funds are at all-time highs.
That should be enough to stop government union leaders from repeating the $1 billion cut lie...but they're still at it. In fact, a new lie to defend the original lie has emerged.
Talking to Capitolwire (paywall), PSEA spokesman Wythe Keever claims, "No previous administration cited pension funding in order to boost their claims about K-12 funding."
It is preposterous to think that the cost of teachers' pensions isn't part of the cost of education, or that state aid to school districts for pension costs isn't part of state aid to school districts.
Of course, this is far from the first lie Wythe Keever has been caught in.
As we recently wrote, Mr. Keever has denied that union dues are used for any sort of political activity—even as his employer, the PSEA, told its members (as required by law) that 12 percent of their dues go to politics.
Wythe Keever also once denied to a reporter that the PSEA was behind mysterious ads claiming school choice would require a tax hike. We later uncovered that the PSEA spent $575,000 from union dues to fund those ads.
That a spokeman for PSEA consistently resorts to outright, provable lies is a telling commentary on how far government union executives are willing to go to advance their policy agenda.
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