Real Clear Markets

Are Pensions Busting Local Government Budgets?

As Stockton, California inches toward the largest municipal bankruptcy since the Great Depression, many accusing fingers are pointing at public employee pensions. One finger belongs to New York City Mayor Michael R. Bloomberg. In Albany recently to lobby for more pension flexibility, he argued:

“We really are up against it… Towns and counties across the state are starting to have to make the real choices — fewer cops, fewer firefighters, slower ambulance response, less teachers in front of the classroom.”
But how big of a problem are local pensions really? Unfortunately, readily available data don’t tell us. The U.S. Census Bureau tracks all state and local employee retirement funds, but it only recently started reporting liabilities and then only for state administered plans (222 out of 3,418 total). It also does not collect information on retiree health care or other post employment benefits (OPEBs).

More promising are surveys conducted by Boston College’s Center for Retirement Research. They suggest that local pensions are as well funded as statewide plans (with assets covering 77 percent of liabilities as of 2010). However, these ratios are based on current government accounting standards, which allow for discounting future liabilities based on average past investment returns.

At a more conservative rate used by corporations and favored by many economists, liabilities expand significantly. According to Northwestern’s Joshua Rauh and the University of Rochester’s Robert Novy-Marx, the nation’s largest municipal plans (those with more than $1 billion in assets) have collective unfunded liabilities of $383 billion. Assuming plans shut their doors tomorrow (but assets continued to earn 8 percent), Philadelphia would exhaust its pension funds in 2015, with Boston and Chicago not far behind in 2019.

But we still don’t know how well these large plans represent municipalities throughout the nation. Perhaps the largest pensions are in the most trouble. Nor do we know what paying off unfunded liabilities will cost on a yearly basis relative to other spending priorities or as a share of local taxes.

What is to be done? First, it’s important not to paint with a broad brush. Variety is the name of the game in local government. As I see it, there are three types of jurisdictions facing pension troubles:

  1. Places that have been losing people and jobs for years, such as Detroit, Michigan, where average employee retirement benefits are only $28,000 per year but the city includes twice as many retirees as active workers. Also in this category is Prichard, Alabama, a city that lost 40 percent of its population in the 1970s and simply stopped sending pension checks in September 2009. It filed for bankruptcy a month later – its second time in a decade. Here, pensions may be a symptom of larger distress or dysfunction. (The SEC is also investigating Detroit’s management of pension funds.)
     
  2. Places that rode the housing boom and bust. This category includes fast growing California towns such as Lincoln and Hercules as well as Stockton, where according to an outside consulting firm: “Compensation packages exceeded sustainable levels and the city assumed a significant liability for improved retiree health coverage without sufficient recurring revenues to cover growing costs.”
     
  3. Relatively affluent places, such as New York’s Suffolk or Nassau County, unable to make the tough spending cuts outlined by Mayor Bloomberg or raise taxes because of political gridlock. Instead, many of these places have essentially “doubled down,” borrowing from the state to cover their annual required pension contributions and hoping for the best in stock market returns.
Also worth remembering is that only two recent municipal bankruptcies (Vallejo, California and Central Falls, Rhode Island) stemmed from public pensions and employee compensation pressures together with falling revenues. Other high profile cases – such as Jefferson County, Alabama; Harrisburg, Pennsylvania; and Boise County, Idaho – were triggered by bad investments or adverse court rulings.

Finally, there are several intermediate steps before default or bankruptcy. In the wake of the Great Recession, many states have stepped up their efforts to monitor local fiscal conditions and intercede if necessary. Also, cities such as Atlanta, San Francisco, and New York have taken steps to limit pension growth, often with cooperation from local public employee unions. Central Falls managed to extract concessions from active police officers and fire fighters as well as current retirees, but even this previously unheard of step was insufficient to stop the slide toward bankruptcy.

In sum, pensions are not behind recent municipal bankruptcies but will put pressure on local government budgets in the future. Raising taxes or cutting services in these places could be a tough sell, especially if homeowners and businesses feel they are paying for yesterday’s teachers, firefighters, and cops. Taxpayers may pick up and leave, or demand lower home prices to move in to a burdened city. Then again, if the local pension problem is pervasive, where will they go?