A Pension for Insolvency

 

The federal government’s solution to a negatively imbalanced budget is to increase “M-1” money supply (the equivalent of “printing money”) and/or sell government treasury bonds. As long as the dollar is king and taxpayers don’t mind paying a larger share of the budget simply for interest charges, it works. At state level, not so much. The driving force behind so many state and municipal governmental financial strains is almost always the cost of pensions for their workers. 

The private sector has pretty much dispensed with so-called “defined benefit retirement plans” – where there is a clear hard-dollar monthly payout (often inflation indexed) based on your final years’ wages and the number of years worked. Instead, the private sector has elected to move to “defined contribution retirement plans” – where what you get at retirement (either as a lump sum or a payout over time) is simply the amount money paid into that retirement account plus any earnings generated by investing that money over time.

The problem with the defined benefit plan is that it mandates a payout regardless of how much money is actually in the pension fund charged with writing those retiree checks. Over the years, if insufficient funds have been deposited into the fund to cover the expected payout (or if the earnings fall short) – often the case with cash-strapped state and local governments kicking the can down the road – money is being paid out to retirees at a vastly more rapid pace than money is coming in to support the retirement checks being written. Ideally, the plans should be funded at the same time as the employee is working and earning money… so that the employee’s retirement is covered by the time retirement rolls around... rather than from folks working now using current contributions to pay for folks now retired. 

Ideally almost never happens, and because most state and local pensions are defined benefit plans – that perk that theoretically makes lower paying government jobs so attractive (not so low anymore, however) – very few state and municipal governments are actually able to use the contributions made while an employee was working to fund that employee’s retirement when it happens. What happens is a shortfall. Sometimes new pension contributions for currently-working employees are directed instead to pay the old and accrued obligations for people who have already retired. The bucket empties faster than it fills. Even worse, the state/local government reaches out to find shortfall funding from the general fund, by floating bonds that accrue interest and have to be paid back… or simply by declaring insolvency. 

Under federal bankruptcy law, there is no provision for state or territorial bankruptcy – Congress has to act separately if at all; Chapter 9 is “municipal” bankruptcy (a “municipality” is a non-federal agency that is less than a state). A water district, a school district, a city or a town can declare Chapter 9 bankruptcy, with dire consequences, but they can. Some states provide for their own relief for municipal insolvency. But what really pushes states and municipalities towards insolvency are under- or unfunded pension obligations for their retired workers. With public unions wielding massive political power, plus big checkbooks that make politicians on both sides of the aisle drool, it’s not difficult to see how we got into this mess.

The above chart, to be sure, shows lots of shortfalls, but this is about states. When it comes down to municipalities, the numbers can get a whole lot worse. Chicago for example. There city pensions are 26% funded with far more retirees than active workers. Every recent mayor of that city has struggled with this seemingly unsolvable problem. Across the nation, the shortfall is staggering.

“Public pension systems currently face a shortfall of more than a $1 trillion. They’ve helped put two cities — Stockton, California and Detroit — into bankruptcy.” Politico.com, 12/31/14. Simply put, there are too many state and local pension plans that can never ever pay for the obligations they have incurred… but when they ask for voter or legislative relief, even when they get the votes, they face a huge hurdle: courts usually see these pension benefits as fully-vested property rights that cannot be reduced or discharged by a vote. Even when there is insufficient money to pay all of a municipality’s obligations, which could be to provide police and fire protection, fix infrastructure, fund the local judicial system, local jails, etc, the pension obligations are often a priority to be honored even if the rest of government grinds to a halt.

Today, new government workers are often hired at a fraction of the pension benefits accorded to older employees. Public unions are learning how to live with that… most public unions anyway. The problem remains that there are so many current and already-retired government workers who have rich defined benefit plans that just waiting until they all die off is untenable; the pension funding will run out of money a long time before that. It is becoming an impossible choice, and legislatures have found taxpayer-sensitive voters by pushing austerity agendas and cutting taxes. 

For example, a school district in such conundrum facing inadequate funding appropriations and swollen pension obligations has only some very drastic solutions: cutting back the number of teachers (producing unteachable overcrowded classrooms), refusing to increase teacher pay, deferring maintenance on crumbling old buildings, not replacing ripped and torn out-of-date textbooks and failing to provide modern teaching tools (like laboratories, modern and adequate numbers of computers and tablets). The long-term damage to society from such inferior schools is incalculable… Simply, there goes our future!

Slowly, however, reality is seeping into courts, even in bright blue states with powerful public worker unions: the current government pension landscape is unsustainable. So, when a court can assault aspects of a public pension program that do not decimate the core pension benefit, increasingly they do. Even in California! “The California Supreme Court made it clear Monday [3/4] that state and local governments may reduce pension costs by repealing certain benefits without running afoul of constitutional protections for public pensions.

“In a unanimous decision written by Chief Justice Tani-Cantil Sakauye, the court upheld California’s 2012 repeal of an ‘air time’ benefit that allowed state workers to buy credits toward retirement service…  In ruling for the state Monday [3/4], the high court distinguished core pension benefits from the retirement credits at issue.

“Pensions are a form of deferred compensation protected by contract law, but the opportunity to buy retirement credits was simply an optional benefit, the court said… It likened the option to the opportunity to choose from various healthcare plans, to purchase disability insurance coverage or create a flexible spending account to pay for health and child care costs with pretax dollars… ‘Unlike core pension rights,’ the court said, the opportunity to purchase retirement credits was ‘not granted to public employees as deferred compensation for their work.’…

“A similar case before the court involves ‘pension spiking.’ A three-judge Court of Appeal panel decided in 2016 that Marin County had the right to bar workers from spiking their pensions… Pension spiking occurs when an employee’s pay is inflated during the period on which retirement is based — usually at the end of a worker’s career.

“This can be done by cashing in years of accumulated vacation or sick pay or volunteering for extra duties just before retirement… In some cases, spiking has created pensions higher than the workers’ salaries… The Court of Appeal in that case ruled that public retirement plans were not ‘immutable’ and could be reduced. The law merely requires government to provide a ‘reasonable’ pension, the intermediate court said.” Los Angeles Times, March 5^th. 

Careless regulation over governmental worker vacation benefits can slam taxpayers in another way, especially at the time of retirement. Once again, California provides the nasty example: “In a trend that stems from lax enforcement of the state’s cap on vacation accrual, more and more state workers are able to retire with massive payouts for unused vacation and other leave. That could become a budget breaker for California as an aging workforce heads into retirement. During the next recession, California will be obligated to continue the payouts, forcing lawmakers to cut programs to balance the state budget…

“For some, vacation payouts can surpass annual salaries. And since state labor code requires employers to compensate workers for unused days off based on final pay rate — not what they were earning when the time was accrued — the actual cost of each vacation hour increases over time.

“The top 20 employees with the largest payouts in 2018 took home a combined $5.9 million, with all but three receiving raises in the year before they left state service. The raises increased the employees’ leave payouts by an average of $7,500 apiece, The Times’ analysis found.

“‘That’s in line with pension spiking,’ said Jon Coupal, president of the Howard Jarvis Taxpayers Assn. — likening it to boosting retirement pay with last-minute salary increases, a practice banned in many cases under a 2012 reform law. ‘It’s an abuse and it should be corrected with legislation,’ Coupal said.” LA Times, March 7^th. Really? And we could get less to run the state because we’re paying for folks who have successfully gamed the system?

Is the handwriting on the wall? Will courts find a way to claw back at the heart of these governmental worker pensions themselves? Unused fringe benefits? Or will they allow governmental units to hit insolvency, with all the nastiness that entails, as the ultimate and possibly the only solution?

I’m Peter Dekom, and the one true thing about unsustainability of anything: eventually it ends.