Paul Feiner, The Supervisor of the Town of Greenburgh, sent out an email last week alerting the community that the ‘prolonged recession’ had finally hit local government. He pointed to a cumulative $3.4 million of revenue shortfalls and mandatory spending increases that had to be offset in order to balance the budget. $3.4 million represents about 4.5% of the budget of unincorporated Greenburgh. Sales tax receipts have dropped 10% or $600,000 as consumers have reduced spending and started saving. Mortgage tax receipts have dropped $1 million as the housing market has locked up. Pension benefits skyrocketed by $1.222 million, reflecting a 26% drop in the value of the New York State Pension Fund in 2008. All-the-while, health care costs continue their steady climb and have added another $603,000 to the problem.
It will be difficult to take 4.5% out of the budget at this late hour. Expect a freeze on hiring, no backfill of attrition and the elimination of all discretionary spending.
Building an operating budget based on volatile receipts like sales and mortgage taxes, though common practice, is risky in a bubble-based economy. But the real problem lies in the pension and health care costs. It is time for taxpayers to stand and take notice.
The New York State pension system is funded based on an average 8% portfolio return. As shown in the attached chart, when returns exceed 8%, taxpayer pension contributions are reduced – with a one year lag – and when returns underperform, taxpayer contributions jump.
This system of making up the shortfall or enjoying the excess in a single year is different from the way pension work under ERISA – the Federal law that governs private pension funds. In a private defined contribution plan, unrealized gains and losses are amortized over fifteen years to smooth out their short-term impact. Why New York State does not adopt such a reasonable approach escapes this author.
Recognizing the catastrophic impact of a 26% pension shortfall on local government finances, the New York Legislature quickly passed a law in June 2009 to spread the pain over 5 years. This law caps pension funding levels for the Employee Retirement System (ERS) at 7.5% of salary in 2010 increasing to 14.5% in 2015-16. For our uniformed heroes who fall under the Police and Firemen’s Retirement System (PFRS) funding caps are set at 15.1% in 2010 increasing to a whopping 22.5% of salary in 2015-16. Note that the Teachers Retirement System (TRS) is not part of the legislation, because the teachers union is way too powerful to be controlled by some transitory body of elected officials.
This bill will increase pension contribution deferrals that the State government will plug by borrowing from the capital markets.
The obvious solution to New York State’s perennial pension funding increases is a switch to a defined contribution plan wherein the local governments contribute 5% of salary each year and the government employee contributions 3% of salary. That equals an 8% funding level throughout the employees career; vesting could be waived. This would shift the market risk from the local government to the employee and, over the long-term, cause the employee to support public policy that would dampen the cycles of bubble and bust.
Giving the employee a stake in the financial performance of his or her pension goes a long way to fixing irresponsible public policy. In the 1970’s many private and government defined pension plans offered inflation protection for retirees. When the German courts decided in a landmark case that inflation risk should be split 50/50 between the company and the retiree, inflation rates around the world started to fall as retirees started to elect anti-inflation governments.
Under the assumption that a defined contribution plan is politically unattainable, Governor Paterson brokered some pension reforms in June 2009 that could be passed into law if our elected officials can stand up to the special interests. These ‘reforms’ aim to take the State pension rules for NEW HIRES back to where they were in the early 1970’s – but only for civil service employees, the uniformed services and teachers have opted out of the reform. Today, new hires fall under something called Tier 4 – Tier 1,2, and 3 pertained to long dated employees – and going forward new hires would fall under Tier 5.
History is littered with regimes that have crumbled under the weight of government/military pensions — the Spanish, Chinese, Ottoman and Russian Empires, for example. Is the Empire State following in their footsteps?