Today’s New York Times report that state and local government tax-funded pension contributions in New York may triple over the next five years should come as no surprise to anyone who has made an effort to understand the current system and its pitfalls.

As noted in this 2006 Empire Center report:

In the past … officials of the state and city retirement systems have sought to minimize the impact of pension cost increases by adjusting contribution schedules, “smoothing” investment return assumptions over longer periods, and allowing government units to “amortize” their increased contributions over a number of years.

This kind of tinkering merely pushes costs into the future and will not prevent future gyrations in pension contributions for government employers. Because the New York State Constitution does not allow pension benefits to be “diminished or impaired” for current public employees, nothing can be done to reverse the recent run-up in pension costs. But this system, which contributed to a previous budgetary meltdown in the Empire State, will remain a ticking fiscal time bomb if it remains unchanged.

So now the timer is ticking down to the inevitable explosion.  How did we get into this fix?  What, if anything, are elected officials proposing to do about it?  What policy options are they overlooking?

How the bomb was assembled

New York, like almost every other state, provides public employees with defined-benefit (DB) pensions — which provide a guaranteed post-retirement income stream based on peak salaries and career longevity. By private-sector standards, benefit levels are extraordinary: Our state and local government employees (and employees of public authorities) can retire earlier, with larger pensions, than the vast majority of those who pay their salaries.  Government workers in the Employee Retirement System (ERS) and the separate Teachers Retirement System (TRS) can retire as early as age 55 with pensions equal to 60 percent or more of their final average salaries.  Most members of the state Police and Fire Retirement System (PFRS) can retire at half pay (including overtime) after 20 years, with no minimum retirement age.  (For more details, see our report.)

The pensions are paid out of gigantic pooled retirement funds, to which government employers contribute varying amounts, depending on actuarial assumptions and market fluctuations.   The funding assumption is that the retirement fund investments will earn a “target” rate of return averaging 8 percent a year.   When returns exceed the target rate, as they did during the stock market boom of the 1990s, the employer contribution is reduced.   When returns fall below the target rate, taxpayers must make up the difference.

Assuming the good times would roll on forever, then-Governor George Pataki, then-Comptroller Carl McCall and the Legislature agreed in the late 1990s to further sweeten public pensions—just in time for the bursting of the tech bubble in 2000, which sent the markets tumbling.  Over the past decade, as illustrated in the chart below, the state retirement system’s rate of return has been extremely volatile—and has averaged well below 8 percent, including last year’s record loss of 26 percent.

pension-returns-6577903

Even when the stock market is not sinking, loose government accounting standards ensure that public pension systems are systematically under-funded, hiding the extent of their true financial liabilities, as explained here.

The Governor’s “Pension Reform”

Public pension contributions by every level of government in New York State have already increased tenfold in this decade, from $991 million in 2000 to $10.1 billion in 2009.  In response to the threatened run-up in pension costs resulting from the most recent market downturn, Governor David Paterson has proposed what his office calls “the most significant reform of the state’s pension system in more than a quarter century.”

Unfortunately, the governor’s “Tier 5” proposal doesn’t live up to that billing.  As shown in the comparative table below, the major elements of the governor’s plan for non-uniformed employees would merely restore the original Tier 4 benefit structure of the early 1980s, which was subsequently sweetened under a series of bills enacted between 1985 and 1999.

paterson-tiers1-1593845

The governor says his bill will save the state and local governments, including school districts, a total $30 billion, over the next 30 years.  However, this figure needs to be kept in context.  If the pension contribution hits nearly 33 percent of salary for non-uniformed employees, as the comptroller’s analysis reportedly predicts, pension contributions for members of Paterson’s proposed Tier 5 will be just 2.5 percent lower, based on his own estimates.  This is not much of a savings, obviously.

The governor’s proposed change in the current “20 and out” pension plan for police and firefighters offers larger savings, but still falls well short of addressing the fundamental problem with the traditional DB pension: these are constitutionally guaranteed benefits—absolutely risk-free to the recipient, yet backed by volatile returns on a fairly risky bundle of investments backed up by taxes.

Groping in the dark

On June 22, the final day of its session, the Assembly passed a bill that would allow the state and local government employers to “amortize” a potentially large portion of their pension contributions for six consecutive years, starting in 2011.   Contributions for ERS members, which have been set at 7.4 percent for fiscal 2010, would be capped at 9.5 percent of payroll in 2010-11, growing to 14.5 percent in 2015-16.  Contributions for PFRS members, now 15.1 percent, would be capped at 17.5 percent in 2010-11, growing to 22.5 percent in 2015-16.

Amounts exceeding the caps would essentially be paid for through what would amount to a series of 10-year loans from the pension system, pushing pension obligations for the first half of the next decade all the way out to 2026.   This is similar to an approach originally recommended by Comptroller Thomas DiNapoli, although DiNapoli did not suggest any time limit on the number of years for which “excess” contributions could be amortized.

The bill, which also passed the Senate during its rump “session” on June 30, was introduced with a message of necessity from the governor on the same day as the Assembly vote, apparently after secret negotiations involving Paterson’s office as well as the comptroller.

So here we have a measure that would effectively authorize billions of dollars in new state and local borrowing over the next decade, which both houses of the Legislature have approved in a snap vote, without debate or a public hearing, and which the governor apparently is poised to sign as soon as he can.

What’s the rush?   While the 2010-11 pension contribution rate is set by the state comptroller in September, the contribution won’t be payable until early 2011.   Assuming the June 30 Senate vote was not actually valid, financially responsible lawmakers should slam on the brakes on this runaway train before it’s too late.

The only way to responsibly finance a transparent retirement plan for government workers is to move to a defined-contribution (DC) system, under which the employer’s responsibility would make a fixed annual contribution to individual retirement accounts. The option outlined in our 2006 report would cap expenses for non-uniformed ERS members at 7 percent of salaries while assuring employees of the ability to save 12 percent of their salaries annually.  This would obviously represent a significant cost reduction compared to the current system’s projected spike in costs and the state retirement system’s projected “long-term” average cost of 11 percent of salary (12 percent in the teachers’ system).

However, even if such a change is made, the legacy cost of active and retired members in the traditional DB system will remain a headache for taxpayers for decades to come.  As pension bills rise, these are the choices that will soon confront state and local officials:

  • dramatically increase state and local taxes; or
  • slash services to the bone; or
  • shift today’s costs to future taxpayers—adding to current debts at the risk of compounding the pension burden in the future;  or
  • nip the problem in the bud by shutting the DB system to new entrants, shifting to a defined-contribution plan for new hires, and exploring statutory and constitutional options for altering pension benefits for current employees.

It’s about time someone in the State Capitol started honestly facing up to those questions.   And instead of complaining only when contributions rise, it would help if local government officials formed a united chorus in support of real reform.

About the Author

E.J. McMahon

Edmund J. McMahon is Empire Center's founder and a senior fellow.

Read more by E.J. McMahon

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