Auditor General Report Presents Novel Ideas for Pa. Pension Reform

Published September 19, 2014

If one mines down into Pennsylvania Auditor General Eugene DePasquale’s recent pension report, one can find some gems hidden among the recommendations that I believe risk the creation of a too-big-to-fail “financial super-fund site.”

However, with a few minor tweaks, DePasquale’s proposal could be turned into a robust model for pension reform. It would rely on outright bribery, but it might be just crazy enough to work. 

In DePasquale’s proposal, the two “lynchpin” recommendations are the creation of a new recovery plan and a limit to the amount of pension costs covered by state aid.

Tweaks and Lynchpins

To participate in the recovery plan, a municipality would be required to eliminate “any benefit increases to current employees” and manage future costs by “establishing a revised benefit structure for new hires.” Additionally, if the municipality has also been funding its pensions appropriately, additional state aid would then be made available to it.

That last provision could be tweaked to cap pension payments at a percent of the “tax base” – 10% is a reasonable, sustainable rate. With this minor change, we have created a program that incentivizes rational, realistic budgeting and provides an outline for how to manage a complex cost structure. And while we are at it, let’s limit the time in the program to five years — that should be enough time to recover from a bout of “Blue City Disease.”

The second “lynchpin” recommendation, limiting the amount of pension costs covered by the state, seems to run contrary to the recovery plan’s main point. However, it is actually the contradiction that makes the two recommendations work so well together.

DePasquale’s recommendation could be tweaked as follows: if a municipality makes an annual payment equal to 10% of prior year tax receipts, the state could offer to pick up the difference between the minimum annual contribution and the municipality’s “capped” pension payment. In practice, this tweak would limit that aid.

Combining these adjusted lynchpin recommendations with a few others from DePasquale’s original list – guidance from the Department of Community & Economic Development, increased reporting requirements, reduced administration and management costs – we now have a roadmap for our trip to solvency that doesn’t rely on yet-to-be-built highways.

“Help Me Help You”

Just consider how this new plan would benefit Scranton, PA, what some have termed DePasquale’s pension “problem child.”

Managing pension costs by removing “spiking items” from the benefit calculation, as DePasquale’s recommendations would reduce Scranton’s $13 million annual contribution to the original $9 million it was before the Supreme Court award. Under the “capped” contribution requirement, Scranton’s tax base, defined as prior year’s receipts of between $55-60 million, would require annual contributions of about $6 million.

For the first 5 years, the state would pick up the $3 million deficit. However, by placing a term limit on the new recovery program, the City would be incentivized to reduce its pension costs. A five-year term also gives the city time to phase in changes to the benefit structure.

We can even throw in some extra incentives – let’s say the fund gets a “bonus” of 100% of the state’s cost. What is the total cash investment by the state for stabilizing a nearly-broke pension fund? About $30 million, over five years.

Under the existing system, Scranton has been receiving about $4 million a year in state “reimbursement”. Because they have been distressed for more than 22 years, and they show no sign of cleaning up their act in the near future, we can safely assume this is basically a perpetuity which – at the state’s current cost of funds of 5% – has a present value of about $80 million, representing more than $50 million in savings for the state.

Gary Lewis ([email protected]) is an independent professional financial advisor, based in Greenwood, Indiana. Lewis serves on the Indiana Pension Management Oversight Commission. Used with permission of the Manhattan Institute Center for State and Local Leadership’s Public Sector Inc.,