Pension Tension: State's Public Retirement System in Need of Reform
July 09, 2010Glenn Hamer
Despite assurances from some economists that the U.S. is beginning to emerge from this Great Recession, there's little comfort for state budget officials across the country who are continuing to struggle to balance their budgets and deliver core government services as revenues have failed to tick upward.
Cutbacks are the norm for states now. In fiscal years 2009 and 2010, total spending by states declined, marking the first time in 40 years that state spending declined in consecutive years. According to the National Association of State Budget Officers, proposed state spending for FY 2011 is $52 billion less than FY 2008. The weak recovery is of special concern to Arizona, where the state's GDP has failed to make an upward climb, unlike rest of the country.
During this time of budget cuts, tax increases and questions about the state's overall economic future, Arizona can count on one thing for certain: public employees continue to earn constitutionally guaranteed retirement benefits, and the annual costs associated with financing these obligations continue to rise.
According to a new policy brief by the Arizona Chamber Foundation, Pension Tension: Understanding Arizona's Public Employee Retirement Plans, the state's four major public pension programs enjoyed a cumulative $4.7 billion surplus at the turn of the century. Since that time, however, asset growth has been unable to keep pace with the liability growth caused by a number of factors including an expanding government workforce, rising salaries and legislative action that increased benefit levels. As a result, the $4.7 billion surplus has become a $10.4 billion deficit.
This scenario is not unique to Arizona, as evidenced by a Pew Center on the States report from February that warned of a cumulative $1 trillion public pension gap for plans across the country. In fact, Arizona was recognized as a top performer among the states analyzed by Pew researchers. However, recognizing a state with a $10.4 billion funding shortfall as a top performer underscores the structural challenges facing public pensions nationwide.
These long-term pension funding challenges have significant short-term implications. During fiscal year 2009 - one of the toughest budget years in Arizona history - state and local governments contributed $1.3 billion to the state's retirement plans. Of this contribution, over $400 million was dedicated to closing the funding gap. This was $400 million of additional budget flexibility that would have been available if not for the unfunded liability.
In the absence of pension reform (or another economic bubble that saves the day by inflating investment returns), state and local budget officers should get used to this scenario of paying down pension debt. The Arizona State Retirement System, Arizona's largest pension plan, forecasts rising contribution rates for the remainder of the decade.
Assuming that the magical bull market does not arrive in the near term, Arizona must take steps to improve pension transparency and then reduce the growth of future pension liabilities.
--First, the state should take steps to better communicate the costs and obligations of pension funding with the taxpayers. This should involve presenting a simple line item in state and local budgets that reflects the size of the annual pension contribution. It should also present an alternative calculation of plan funding levels that uses similar investment return assumptions that are required of private sector pension plans.
--Next, Arizona needs to curb the growth of future liabilities. During the most recent session, HB 2389 took steps in the right direction by raising the retirement age, adjusting the average salary calculation and eliminating employer contribution refunds for future ASRS enrollees. Ultimately, the only way to completely eliminate future liability growth is by closing the defined benefit plans to new enrollment and transitioning new employees to a defined contribution plan. A number of states, including Alaska, Michigan, Nebraska, Minnesota, Utah and West Virginia have implemented this type of change for at least some categories of public employees.
Making up the $10.7 billion pension shortfall is an obligation that Arizona cannot excuse itself from. However, the state does have the option to stop the rising liability growth that will continue to place additional upward pressure on state and local budgets by transitioning to a defined contribution plan.
Historically, generous retirement benefits to government employees have been justified by lower compensation levels compared to a comparable private sector position. In light of the growing evidence that public sector employees are now compensated as well or better than those with similar skills and education levels in the private sector, it seems reasonable for them to receive comparable retirement benefits as well.
Cutbacks are the norm for states now. In fiscal years 2009 and 2010, total spending by states declined, marking the first time in 40 years that state spending declined in consecutive years. According to the National Association of State Budget Officers, proposed state spending for FY 2011 is $52 billion less than FY 2008. The weak recovery is of special concern to Arizona, where the state's GDP has failed to make an upward climb, unlike rest of the country.
During this time of budget cuts, tax increases and questions about the state's overall economic future, Arizona can count on one thing for certain: public employees continue to earn constitutionally guaranteed retirement benefits, and the annual costs associated with financing these obligations continue to rise.
According to a new policy brief by the Arizona Chamber Foundation, Pension Tension: Understanding Arizona's Public Employee Retirement Plans, the state's four major public pension programs enjoyed a cumulative $4.7 billion surplus at the turn of the century. Since that time, however, asset growth has been unable to keep pace with the liability growth caused by a number of factors including an expanding government workforce, rising salaries and legislative action that increased benefit levels. As a result, the $4.7 billion surplus has become a $10.4 billion deficit.
This scenario is not unique to Arizona, as evidenced by a Pew Center on the States report from February that warned of a cumulative $1 trillion public pension gap for plans across the country. In fact, Arizona was recognized as a top performer among the states analyzed by Pew researchers. However, recognizing a state with a $10.4 billion funding shortfall as a top performer underscores the structural challenges facing public pensions nationwide.
These long-term pension funding challenges have significant short-term implications. During fiscal year 2009 - one of the toughest budget years in Arizona history - state and local governments contributed $1.3 billion to the state's retirement plans. Of this contribution, over $400 million was dedicated to closing the funding gap. This was $400 million of additional budget flexibility that would have been available if not for the unfunded liability.
In the absence of pension reform (or another economic bubble that saves the day by inflating investment returns), state and local budget officers should get used to this scenario of paying down pension debt. The Arizona State Retirement System, Arizona's largest pension plan, forecasts rising contribution rates for the remainder of the decade.
Assuming that the magical bull market does not arrive in the near term, Arizona must take steps to improve pension transparency and then reduce the growth of future pension liabilities.
--First, the state should take steps to better communicate the costs and obligations of pension funding with the taxpayers. This should involve presenting a simple line item in state and local budgets that reflects the size of the annual pension contribution. It should also present an alternative calculation of plan funding levels that uses similar investment return assumptions that are required of private sector pension plans.
--Next, Arizona needs to curb the growth of future liabilities. During the most recent session, HB 2389 took steps in the right direction by raising the retirement age, adjusting the average salary calculation and eliminating employer contribution refunds for future ASRS enrollees. Ultimately, the only way to completely eliminate future liability growth is by closing the defined benefit plans to new enrollment and transitioning new employees to a defined contribution plan. A number of states, including Alaska, Michigan, Nebraska, Minnesota, Utah and West Virginia have implemented this type of change for at least some categories of public employees.
Making up the $10.7 billion pension shortfall is an obligation that Arizona cannot excuse itself from. However, the state does have the option to stop the rising liability growth that will continue to place additional upward pressure on state and local budgets by transitioning to a defined contribution plan.
Historically, generous retirement benefits to government employees have been justified by lower compensation levels compared to a comparable private sector position. In light of the growing evidence that public sector employees are now compensated as well or better than those with similar skills and education levels in the private sector, it seems reasonable for them to receive comparable retirement benefits as well.
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