In October, staff from the Japan Local Government Center attended a forum on the fiscal problem facing many if not all local government employee pension systems in the United States. The forum lasted all morning, with two discussion panels of experts on the subject and two keynote speeches. The first panel discussed what the fiscal problem was and the second panel talked about how to fix these fiscal problems.
In the first panel, discussion focused on how the local government public pension system is affecting local government fiscal solvency. We all talk about public pensions becoming a major burden on local government finances but the real issue is the fact that public pension expenditures rob the local government of money they can otherwise spend on core services to their residents. This loss of the ability to spend money on services is what is called ‘crowd-out’.
The first panelist talked about what the cost to the resident would be to fund the public pension system properly. Generally, local governments rely on the property tax to fund most of their expenditures. So, property taxes in Chicago, as an example, would have to double by 2015. Local governments, however, have been able to hide the potentially unsustainable cost to their budgets of all these public pension promises. Even with the attempt by the Governmental Accounting Standards Board (GASB), a non-profit organisation that makes recommendations to the States on governmental accounting principles, to force local governments to report their fiscal conditions more transparently, it is still almost impossible to determine what a local government’s future public pension and other retirement liabilities are.
Another panelist pointed out that by not pre-funding these liabilities (and they include what are called ‘other post-employment benefits (OPEB)) local governments face even more difficulties in the future. Even if public pension payments are made in anticipation of a liability, other benefits, particularly health-care benefits, are not pre-paid. The OPEB liabilities are expanding at an alarming rate and will have a dramatic effect on the ability to provide basic services to residents. This ‘crowd-out’ effect is particularly so because OPEB liabilities are to retired employees mainly. In New York, for example, it has been estimated that the total value (now) of OPEB (health) costs is approximately $250 million. These costs, moreover, are on a pay-as-you-go basis, so the debt is shifted to future taxpayers. In many cities facing fiscal distress, OPEB benefits are the first to be reduced since they do not have the same protection as public pensions themselves. This negotiated reduction can only happen though when a local government is facing a severe fiscal problem. Detroit, for instance, is openly hoping to shift all of its retirees to the Affordable Care Act in its bankruptcy negotiations. Such a move will inevitably lead to litigation.
The key to understanding ‘crowd-out’ is that the more money has to be spent on personnel – salaries, benefits, pension contributions, retirees, etc. – the less that can be spent on services to the residents of that local government. There are limits to the amount of money that can be raised by taxation, particularly since the recession of 2007-9 has reduced what is called ‘tax capacity’. Tax capacity is the amount of available money from which governments can raise revenues.
The mayor of the City of San Jose in California addressed this whole question of crowd-out in his luncheon speech. As he put it, many local governments in California are facing the pension liability explosion problem, especially since the courts have interpreted the California Constitution to mean that no reduction in future promises for pensions can be made once the employee starts his job. So, the mayor explained that he and several other mayors have combined together to place an initiative on the statewide ballot for November 2014 election to allow cities the explicit authority to change the terms of future unearned benefits of current employees. This way, he hopes, it should be possible to get a better handle on the anticipated costs of future liabilities. Only when there is some certainty as to what those liabilities are can local governments allocate their expenditures more efficiently.
All in all, it was a very stimulating forum. Should you wish to see and hear the discussion go to the Manhattan Institute’s web-site at: http://www.publicsectorinc.org/2013/10/saveourcities/.
Senior Researcher
Seth Benjamin