Growing Pressure to Push State Pension Funding to Local Level

Published November 13, 2012

Economist Jonathan Williams says one way to solve state pension funding problems is to give local governments more control over and responsibility for their employees’ pensions.

Many states that are responsible for contributing to local employee pensions haven’t done so—and this has spawned a national government pension crisis, said Williams, director of tax and fiscal policy for the American Legislative Exchange Council.

Because municipalities and school districts have less fiscal leeway, they are more likely to be financially responsible, he said.

“At the state level, you can just ignore the annual employee contribution. Many states have done it for a decade or two,” he said. “If you don’t make changes in pensions at the local level, it tends to eat up a big part of the local budget.”

Part of the problem, Williams said, is inherent in the political system.

“Let’s say we make a long-term promise. I might be out of office by the time the bills come due. It’s easy to make a promise and pass the bills down to future legislatures and future taxpayers. The bigger the promise, the bigger the liability problems,” he said.

State Law for Texas Cities

In Texas’s seven major cities, local pensions are funded by the local municipality but codified in state law, leaving City Councils unable to reform their pensions.

“We’re advocating for returning that authority back to the local legislative body. They have to pay the bills,” said Talmadge Heflin, director of the Center for Fiscal Policy at the Texas Public Policy Foundation.

Currently, reducing retirement benefits, even for a cash-strapped city, would mean first changing state law.

Expansive Benefits

Many municipalities are finding they cannot afford their employees’ generous retirement benefits.

“It becomes a costly proposition to the pension system when you have a lot of people retiring at a younger age with rich benefits and living much longer, as they do today. That exacerbates the unfunded liability,” Heflin said.

A defined contribution system like the 401(k) many private sector workers have would give municipalities more control over future pension liabilities, Heflin and Williams said.

Illinois Tour

In Illinois, pension liability is “basically crushing the state,” said Kristina Rasmussen, executive vice president at the Illinois Policy Institute (IPI). The institute recently held a “Local Pension Accountability Tour,” a series of debates at eight locations across the state.

“At each event … we really focus on making sure that people debating the issues aren’t singing from the same hymnal. It’s important to get different perspectives,” she said.

The tour served to educate voters and policymakers, giving them “more informed opinions.”

“It’s been great to hear people express their concerns, how it would affect them locally, what it means for teachers, parents, taxpayers, students,” she said.

School Pension Reform

IPI backs legislation to reform how teacher pensions are funded, among other changes in school finance regulations. In particular, IPI argues local districts, not the state, should make the employer contribution to the pensions.

Most citizens don’t need to worry about local taxes increasing if school districts begin covering it, Rasmussen said.

“A little-known secret is that many districts over time have decided to pick up and pay for the teacher portion” of the pension contribution, she said. “If you move the employer cost back to the district and the employee cost to the teacher, it could be a wash for many districts.”

Also, some districts “spike” teachers’ salaries during the last few years of employment to increase their pension benefits, Rasmussen said. Responsibility for funding those spiked pensions likely would deter that practice, she said.

In addition, she said, the state should let up on some operational regulations and allow the districts more freedom in spending their own money.

“If they’re going to relocate the costs, you should give the entity that’s absorbing the costs some flexibility so they can better absorb the cost,” she said.

Fudging Numbers

The unfunded pension liability problem may be bigger than policymakers realize—or are willing to admit, Williams said.

“Sixth-grade math tells you that when you lose 30 percent and gain 30 percent [of the remainder] back, you aren’t where you started. That’s the problem. The pension problems have taken such a big hit from the 2008 crash that it’s going to take them a long time to get back.”

Previously, investors could count on an 8 percent annual return, but now 5 or 6 percent is the norm, Williams said, yet policymakers are still relying on the old 8 percent figure to make budget predictions.

“The problems are much bigger than people see on paper every day,” he said. “When you change that expectation down to 6 or 5 percent, as actuaries have said we need to do, that absolutely explodes the unfunded liability. It’s just not sustainable to say we’re going to earn 8 percent. Now, for a decade, we’ve not been earning 8 percent.”

Williams said “it could be quite some time” before the economy fully recovers from the financial crisis of 2008.

“That means, absent reform, there’s going to be a serious cash-flow problem” to cover pension liabilities, he said.