Public Employee Pensions and Benefits
Pennsylvania may soon be unable to meet its pension obligations. Without additional contributions, Pennsylvania’s Public School Employees’ Retirement System (PSERS) will have only a 31% chance of sufficient funding by 2030 and the State Employees’ Retirement System (SERS) will have only a 16% chance.
Meanwhile, the Independent Fiscal Office estimates that pension payments in 2019-20 will represent 9.4% of the state General Fund budget or $3.3 billion. That’s more than double the share of pension payments in the 2011-12 budget—crowding out funding for other services.
The political landscape has experienced a seismic shift, and it isn't centered in Washington DC. This past weekend Kyle Peterson of the Wall Street Journal highlighted Pennsylvania and six other states poised to transform their state and, in turn, our nation.
"The dynamic has shifted considerably," CF president & CEO Charles Mitchell says in Peterson's article, The Spoils of the Republican State Conquest.
Charles notes issues like meaningful pension reform are not only possible in the upcoming legislative session but probable. And paycheck protection—while once "laughed out of the room"—may land on the governor's desk.
Four of the seven states briefly profiled focus on labor reform as a necessary component of restoring economic opportunity. Any labor reform that prevents union executives from imposing their will on workers is essential to putting Pennsylvania back on the path to prosperity.
Tax reform was also a recurring theme in the article. In Pennsylvania, pension reform is, in many ways, a tax reform issue. After all, surging pension costs are a key driver of rising property taxes and yearly budget shortfalls that lead to tax hikes. So any effort to reform the tax code will likely require spending restraint.
Overall, the WSJ's highlight of CF as a frontline fighter for free-markets is an incredible endorsement of our mission and a compliment to every lawmaker working to pass the reforms that will improve the lives of all Pennsylvanians.
News reports today indicate SEPTA (the public transit agency serving the Philadelphia region) came to an agreement with the Transportation Workers Union Local 234—ending a six-day strike just before election day.
The agreement terms are not available, but SEPTA Chairman Pat Deon says:
It provides for wage increases, pension improvements, and maintains health care coverage levels while addressing rising costs.
Who will pay for this?
Currently, 49 percent of SEPTA’s operating budget comes from state taxpayers—almost double the average among transit systems nationally. In addition, 60 percent of SEPTA’s capital budget (i.e., funding for infrastructure improvement and new trains and buses) comes from the state.
What most people may not realize is most of this funding doesn’t come directly from taxes—though both the sales tax and lottery revenue subsidize transit systems. Rather, more than $925 million in driver charges, including Turnpike tolls and vehicle fees, are diverted to transit agencies, primarily SEPTA.
The Philadelphia Inquirer reports SEPTA will pay for the additional costs of the new agreement “out of its budget.”
Deon, who credited Evans with helping resolve the impasse, said SEPTA had the money in its budget to pay for the deal, and no new funds were needed.
So, we can expect SEPTA won’t ask for an increased state subsidy? Or maybe will even refund some of the excess revenue to state taxpayers and motorists? Right?
Three critical bills stalled last week amidst a flurry of last minute legislative activity. Failure to reform pensions, repeal the e-cigarette tax, and prohibit ghost teaching were missed opportunities that will compound challenges facing lawmakers in 2017.
A compromise proposal to place newly-hired state workers into a hybrid pension plan fell three votes short of passage in the House. The bill provided a 401(k) component paired with a smaller defined benefit component. Employees could also choose to opt-in to an entirely 401(k)-style plan, providing ultimate portability and retirement control. Although the legislation provided little in immediate cost savings, it shifted future financial risk away from taxpayers and provided a predictable system for measuring costs.
Union leaders and lobbyists campaigned hard against the bill, and it was narrowly defeated without seeing a vote.
Reducing the E-Cigarette Tax
Revising the punitive e-cigarette / vape tax from a 40% retroactive wholesale tax to a 5 cents per milliliter tax failed to advance in the House. Meanwhile, the Senate was reluctant to add any session days to send the bill to Gov. Wolf. This inaction will eliminate thousands of jobs and bring in far less revenue than the $13 million originally projected.
Vape businesses are already beginning to close.
Expelling Ghost Teachers
Lawmakers were unable to prohibit release time provisions that enable unions to pluck teachers from the classroom to perform union work on school time. These ghost teachers continue earn salaries, rack up pension benefits, and accrue seniority while working for the union. Worse, the union may not be formally required to reimburse school districts for these costs. In other words, resources are being diverted from the classroom to line the pockets of a private organization. Strictly limiting the practice of ghost teaching, as would HB 2125, would have saved taxpayers millions and corrected an obvious injustice.
HB 2125 will be reintroduced next session.
Pension reform talks are in full swing as state lawmakers finish up their fall session. The latest pension proposal offers a side-by-side hybrid system for new employees, including new lawmakers and judges, beginning January 2018. The hybrid consists of a defined benefit component (at half the benefit of current employees) and a defined contribution component, like a 401k.
Alternatively, new employees could choose a defined contribution only option.
This represents a significant improvement over Governor Wolf's proposed stacked hybrid plan. And it's an improvement on the side-by-side hybrid approved by the State Senate in December, which was linked to a $1.8 billion tax increase.
Here's a rough breakdown of the major components:
|Component||Proposed Side-by-Side Hybrid||December Proposed Side-by-Side Hybrid|
|DB Employee Contribution||4.5% or 5.5%||4% or 5%||4%||3%|
|Benefit Accrual Rate||1% or 1.25% of final salary||1% or 1.25% of final salary||1% of final salary||1% of final salary|
|DC Employee Contribution||3%||3.5%||3.5%||3.25%|
|DC Employer Contribution||2%||2%||2.5%||2.5%|
|Optional DC Only Employee Contribution||7.5%||7.5%|
|Optional DC Only Employer Contribution||2%||3.5%|
The proposal also closes loopholes that inflate pensions. Those reforms include altering the final average salary calculation to prevent the use of excessive overtime at the end of one's career to increase pension payments and ensuring the lump sum payment option is revenue neutral. The latter reform applies to current and future employees.
This doesn't get pensions out of politics, but any reform that reduces the influence of politics on the pension system—while creating a model for further improvement—represents a step in the right direction.
The next step is tackling the monstrous $60-plus billion pension liability driving tax hikes.
A majority of Pennsylvanians want pension reform. In a poll conducted from October 4th to 9th, 54 percent of voters supported placing new state employees in a 401(k)-style retirement plan. Pension reform isn't a partisan issue: 67 percent of Republicans, 51 percent of Independents and a plurality of Democrats are in favor.
Lawmakers appear to be obliging voters. According to Capitolwire (subscription), legislative leaders are considering a side-by-side hybrid plan for new employees. The proposal is similar to the plan defeated in December, which was linked to a major tax hike.
As we've noted before, this type of pension reform fails to fully remove politics from pensions, but takes an important step in the right direction. Under a hybrid system, new employees enroll in a defined contribution plan and a defined benefit plan. Only the defined benefit component would be subject to political manipulation.
The details of the plan are still murky, but pension reform that moves towards a defined contribution, or 401(k)-style plan, is an improvement upon the status quo.
In the past six years, Pennsylvania taxpayers’ unfunded pension liability has more than doubled from less than $30 billion to $63 billion.
While the legislative debate over reform continues, Pennsylvania taxpayers and state workers are sinking deeper into the pension crisis. A recent Moody’s report on state pension liabilities concludes states with large gaps, like Pennsylvania, will be forced to direct more money toward their pension systems just to keep unfunded liabilities from growing. That means fewer dollars for schools, roads, and other basic services.
A big reason for the growing funding gap is lower than expected investment returns.
The State Employee Retirement System (SERS) assumes a 7.5 percent rate of return for investments, but the actual rate of return was only 0.4 percent in 2015. In the first half of 2016, SERS reported a 2 percent investment return.
The much larger Pennsylvania State Education Retirement System (PSERS) isn’t fairing much better. The fund earned just 1.29 percent for the fiscal year, ending June 30th. Recognizing the reality of today’s economy, the system reduced their assumed rate of return from 7.5 percent to 7.25 percent starting July 2016.
Unfortunately, Governor Wolf vetoed reform back in June 2015 which included a defined contribution, alongside a “cash-balance plan”, for new employees only. This legislation was itself a compromise from a straight 401k-style plan that would provide adequate retirement benefits while being, by definition, fully funded.
By December, the Senate crafted a side-by-side hybrid pension model. The hybrid model allowed new employees have both a (smaller) defined benefit pension and a defined contribution plan from dollar one. While less than ideal, the plan would significantly reduce taxpayer risk, a step in the right direction.
In June, a different reform proposal passed the state house. This stacked-hybrid plan includes a defined benefit plan for workers until they reach $50,000 in salary (or 25 years of service), followed by a defined contribution plan. However, the $50,000 threshold would increase by 3 percent annually--greatly limits the number and extent of employees participating in the defined contribution plan.
There’s no question pension reform is urgent. Lawmakers must prioritize proposals with a stronger defined contribution component while preventing political manipulation of pension payments. Anything less will keep government budgets squeezed and taxpayers exposed to tremendous risk.
Pennsylvania’s state budget is three months old and showing signs of a major budget deficit.
Actual revenue collections are already behind $218.5 million through the first quarter, according to the Pennsylvania Department of Revenue. In July, the legislature passed and Gov. Wolf signed a $1.3 billion revenue package, which includes $650 million in higher taxes, to help pay for a $1.6 billion increase in government spending.
The revenue assumptions built into the billion dollar package are now proving optimistic. The chart below shows revenue collections lagging official estimates in each of the first three months.
In August, the Independent Fiscal Office identified problems with certain revenue projections used to balance the budget—at least on paper. Here are their major assumptions:
- The IFO deducts $95 million to pay for the expenses of the Commonwealth Financing Authority (CFA) from sales tax revenue. The legislature moved this line-item out of the General Fund Budget and created a new fund via the fiscal code. Legislative leaders have expressed an interest in passing gambling expansion to generate $100 million to cover CFA spending, but no enabling legislation exists.
- IFO assumes Act 39 (wine modernization) will raise $73 million in 2016-17. The legislature predicts an increase of $149 million—a $76 million difference.
- IFO projections of tobacco tax revenue (includes taxes on cigarettes, e-cigarettes, loose & roll-your-own tobacco) are approximately $38 million less than the official projections.
- $75 million from the Philadelphia casino is not included in the IFO’s official revenue estimate. They do not expect it will generate revenue for the current fiscal year.
Moreover, the budget was unbalanced from the start. The budget counts on $260 million in one-time revenue and transfers from other funds, and a $200 million loan from the Pennsylvania Professional Liability Joint Underwriting Association.
Borrowing money to pay our bills is the very definition of unbalanced.
If current revenue trends continue, lawmakers and the governor will need to focus on reducing government spending to balance the budget. Such as,
- Cutting back on $800 million in arbitrary corporate welfare,
- Immediately imposing a (real) hiring freeze and travel ban, and
- Reviewing funds outside the General Fund budget for savings.
As the fiscal year progresses, and more revenue collections are announced, we will continue to update our Deficit Watch.
APSCUF—the union representing faculty at state-owned universities—has begun a vote to authorize a strike.
One of APSCUF's complaints with the proposed contract is higher health care expenses. In a recent email to faculty members, APSCUF touted the fact that employees would now have a deductible with their health insurance plans--$250 for singles and $500 for families. That is, their current contract offers a ZERO deductible.
In contrast, the average deductible nationwide for employer-provided coverage is more than $1,300 for single coverage and more than $2,000 for family coverage, according to the Kaiser Family Foundation.
Likewise, APSCUF is complaining about out-of-pocket limits on health care since employees currently pay $0 out-of-pocket. The proposed contract would limit out-of-pocket expenses to $1,000 for single coverage and $2,000 for family coverage.
Nationwide, 83 percent of employee-sponsored individual plans have an out of pocket maximum of more than $2,000, according to the Kaiser Family Foundation.
If students and parents wonder why tuition costs so much, they should look to faculty health care benefits that are out of whack compared to the private sector.
Pennsylvania's pension debt stands at $63 billion or more than $4,900 per resident. It's a big number to be sure, but what does it mean for the average Pennsylvanian? What does it mean for lawmakers struggling to close budget gaps?
We've broken down the pension debt by state agency to show how many tax dollars are being diverted from services and taxpayers to personnel costs.
For instance, the share of pension debt for corrections officers is $3.3 billion—about $1 billion more than this year's entire corrections budget. Human services personnel account for about $2.3 billion in pension liabilities. Likewise, the state currently has a $1.7 billion obligation to transportation workers.
These obligations will command a large portion of future tax dollars, which means state government will be providing fewer services at a higher cost to taxpayers. Any system that charges taxpayers more to provide people with less is broken.
State workers deserve a decent retirement, but many may not see one unless the current unsustainable system is reformed. If pension reform isn't taken up soon, pension payments will be reduced again and eventually deteriorating finances will cause retirees and current workers will lose benefits.
Pension reform that protects benefits from politics isn't just fiscally prudent; it's about making our government work for all Pennsylvanians.
The 2016-17 budget is in the books with a $650 million tax increase. That's a significant increase—but it could pale in comparison to future tax hikes if pension reform continues to fall by the wayside.
Meanwhile, there's a notion gaining traction that we don't need pension reform because our public pension crisis is at a climax. After all, the yearly spikes in pension contributions will moderate beginning in fiscal year 2018.
Nothing could be further from the truth.
Recent reports from the state's two pension systems (PSERS & SERS) show the crisis is far from over. In April, SERS reported an approximately $350 million jump in the system's unfunded liability, swelling to $18.79 billion in 2015. But according to their actuary, the unfunded liability is closer to $19.45 billion—a roughly $1 billion jump.
SERS assumes a 7.5 percent rate of return for investments, but the actual rate of return was only 0.4 percent in 2015. This year isn't looking any better. SERS reported a 0.7 percent investment return for the first quarter of 2016.
In June, PSERS reduced their assumed rate of return from 7.5 percent to 7.25 percent starting in fiscal year 2017. These changes will add to the unfunded liability by about $2 billion.
In the past 3 months alone, we've added at least $3 billion to the already enormous $63 billion pension liability. Now imagine the impact of a recession or another reduction in assumed investment returns.
It's clear our pension system's liabilities are still growing at a rapid pace with no protection for taxpayers. The only way to truly end the pension crisis is to change the fundamental structure of these plans from the antiquated defined benefit plan to a modern defined contribution plan.
Like the budget, small adjustments may ease tensions in the short-term, but systematic reforms are required to change our future. Right now all signs point to higher taxes for Pennsylvanians.
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