Preventing Tax Rate Increases in Pennsylvania

In a growing economy with taxes levied on sales, income, and the value of real property, not to mention special levies such as business privilege taxes and fees for government services, tax revenues will normally rise with the tax rates that are in place.  Of course, confiscatory rates, evasion, loop holes and inability to pay might offset some of the expected revenue gains.  Indeed, lowering some tax rates such as capital gains tax rates can boost revenue by creating more realization of gains through selling. Or lowering U.S. corporate net income rates could lead to repatriation of overseas profits. Granted, those two are mostly national level considerations. Then too, regulatory costs and restraints can impact business and economic growth.

 

Pennsylvania has been shown to rank poorly in several areas of taxation on business by the Tax Foundation and that undoubtedly exerts a drag on the Commonwealth compared to lower tax rate states.  Certainly, the state should not be looking to make doing business and earning after tax profits more difficult through regulations and higher taxes.  But that seems to be the Governor’s office’s preferred way of going after more revenue.

 

The problem in Harrisburg, as in many state capitals, is the refusal of some to understand the need to curb and even reduce spending.  In Pennsylvania and in many other states,  public sector pensions, especially the school retirement and the state employees retirement that are heavily funded by state tax dollars, are gobbling up tax revenues at a horrendous pace and taking money that could be used for other state functions, including education expenses other than pensions.  As a result of making overly generous promises to future retirees over fifteen years ago through an increase in the payout formula and failing to adequately fund them for several years, the state is in a crisis. A crisis the Governor and his allies refuse to address in any meaningful way thereby allowing the devouring of revenue growth by the pension system’s insatiable appetite.  There will be no significant progress on the state’s budget dilemma until the pension issue is dealt with seriously.

 

Nor is there any significant effort in Harrisburg to address some other underlying drivers of exorbitant and unnecessary expenditures.  The state and other levels of government could save hundreds of millions if not billions of dollars each year by getting rid of the prevailing wage law that artificially drives up the cost of public construction in Pennsylvania. And it is grossly anticompetitive by preventing non-union contractors from bringing their cost advantages to bear.  Why not implement a staged phase out of the prevailing wage requirement over the next three or four years, lowering the gap between the prevailing  wage and market wage each year, eliminating the prevailing wage altogether in year four?

 

Next, the government should put an end to the right of teachers and transit workers to strike and then revise the law governing arbitration in police and fire labor contracts to be more in line with what other states use and along the lines spelled out in the legislation that created the Intergovernmental Cooperation Authority in Pittsburgh.  Teacher strikes are allowed in very few states and Pennsylvania has for decades led the nation in the number of strikes. The strikes disrupt education and create hardships for parents.  Worst of all they are used to ratchet up compensation and benefits as well as more favorable work rules. A union in one district gets a very generous contract by striking or threatening to strike and that contract is then used by unions in other districts as bargaining leverage.

 

Well-off districts with large tax bases that can comfortably afford rich compensation packages in labor contracts at relatively low tax rates become the standard that unions in less well-off districts can hold up as what fair pay should be.  This also leads to cries of unfairness by the education lobbies and groups who continually point to disparities in per student spending across the state.  The use of these disparities generates needless pressure for more state spending that can never eliminate the disparities as long as wealthy districts have enormous tax bases—or until the state eliminates local taxing authority for schools and funds all expenditures out of Harrisburg, an unlikely event to say the least.

 

Transit strikes allow unions to use threats to the economy as well as to public welfare to browbeat transit managers into capitulating to demands, or getting the state to toss in more money—a pattern used successfully over and over again by PAT workers.

 

Or perhaps Pennsylvania might follow the lead of Michigan and enact a right-to-work law.  Michigan enacted right-to-work for all employees other than police and fire in December 2012.  After years of languishing, private employment growth in Michigan since the bill was signed into law has more than doubled the rate in Pennsylvania. For example, from August 2012 to August 2015, Michigan jobs grew 7.6 percent, in Pennsylvania during the same period the employment count rose 3.3 percent. From August 2013 to August 2015 jobs were up 4.9 percent in Michigan compared to 2.5 percent in Pennsylvania.

 

Granted, factors other than right-to-work might be at play contributing to Michigan’s employment gains but bear in mind too that Pennsylvania’s economy was benefitting from the Marcellus Shale boom over the last three years: Michigan had no such natural resource driven economic boost. It is certainly time for Pennsylvania to begin moving toward right-to-work.

 

In sum, there are many alternatives to looking for tax rate increases and new items to tax to improve the state’s fiscal situation and its growth prospects—alternatives that are used in many other states. All it takes is a willingness to refocus the government toward cost effectiveness and respect for the taxpayers and businesses that make an economy prosper so that government can be funded. Of course, this will require reining in the power of special interest groups, especially the outsized influence of employees of government and government entities exercised on policy makers—the long running and seemingly intractable problem the Commonwealth faces.

 

Barring the enactment of the major cost savings and free market enhancements mentioned above it is incumbent on those who want a more prosperous Pennsylvania to fight any increase in taxes or new taxes unless there are; (1) true offsetting tax reductions that are broad based, (2) there is substantial pension reform and, (3) the state gets serious about working out a solution to the angst created by a school funding system that allows and/or requires local taxes in some districts to provide the lion’s share of school funds.

Pennsylvania Credit Rating Takes Another Hit

Citing the unwillingness of political officials to make difficult decisions, Fitch bond rating agency has lowered Pennsylvania’s credit rating. This follows Moody’s downgrade last year. Fitch also says that unfunded pension obligations now represent the dominant share the state’s long term obligations.

The failure to address the problem this year compounds the issue and inevitably makes the eventual coming to grips more difficult. There are reasonable proposals on the table including those made by the Governor earlier this year. Fear of offending the powerful unions has hamstrung the Legislature who apparently cannot put the well-being of the state ahead of their fear of being opposed heavily by unions in the next election.

But no one should be surprised. This is the same Legislature that refuses to deal with the money wasting prevailing wage law, public ownership of liquor stores, teacher strikes, transit strikes or any other issue that unions defend with all their considerable power.

While they might congratulate themselves on maintaining their privileged positions, they must be made to understand that in the long run, their opposition to solving any problems they create will make it harder for Pennsylvania to compete. The boost the state has received from Marcellus Shale will not be enough to overcome the obstacles represented by the free market killing behavior of so much of the body politic.

More downgrades can be expected. How many will it take to get Harrisburg’s attention?

Super Predicts Pension Calamity

In discussing the financial picture of the Pittsburgh Public Schools-the director of budget, management, and operations reiterated his position that the District will be insolvent by 2015, a statement he made in November of last year-the Superintendent handicapped the Governor’s pension proposal that would affect the District as it pays into PSERS, the state retirement system covering public school employees. That proposal, which we recently wrote about, would affect future earnings of current employees and would put new hires into a defined contribution type plan on a certain date if enacted.

Noting there would be "a lot of pushback", which is not surprising since the state teachers’ union has already stated its position, the Superintendent opined that "Even if it were to go through, it would result in a rush to the exit in 2015 like this state has never seen" and then possibly causing a teacher shortage, especially in certain subject areas, and "That would be a real statewide human resources issue".

Lots of governments, state and local, have made changes to retirement benefits that have affected new hires or close the window on existing benefits but allow those that retire before the changes go into effect to leave with their benefits intact. That’s happened locally with the Port Authority and Pittsburgh police and fire. Existing teachers that could retire before changes to current benefits might; it also happens with early retirement incentives. Those seeking to enter the teaching profession now might be put off by the thought of being employed in Pennsylvania if they had to be in a 401k type defined contribution system. If so, the latest data from the National Conference of State Legislatures shows that 40 states (including Pennsylvania, as no changes have occurred) offer only a defined benefit plan to elementary and secondary teachers. Only Alaska has a mandatory defined contribution plan; Indiana, Oregon, Rhode Island and Washington have mandatory defined benefit/defined contribution hybrids; Virginia and Kansas are moving to db/dc and cash balance plans in the next few years; Florida, Utah, and Michigan allow employees to choose the type of plan.

While the PPS is certainly on hard times and has been for a while, Census data on local government employment and payroll shows that full time equivalent employment in elementary and secondary education (instruction and other) rose by about 50,000 from 1993 to 2011. Teachers, on a per 10,000 person basis, rose from 121.7 to 142.2 over the nearly two decades shown by the Census. Note that all other local government employees-police, fire, librarians, water workers, welfare employees, parks, etc. fell slightly from 131.8 to 129.5 per 10,000 people.

And what of a state like Alaska, where in 2006 the switch was made for teachers by enrolling new hires in a defined contribution plan? In 1993 there were 8,386 teachers, or about 140.2 per 10,000 people. In 2011, five years after the pension change, the Census count of teachers is 11,233, or about 155.1 per 10,000 people. Sure, many of those are still likely working under the old pension plan, but has there been a problem attracting new teachers to the point there is a shortage?

Some Pension Funding Proposals You May Not Have Heard Of

With the Governor’s budget address coming up next week and the expectation that there will be something said about pensions-what with a presentation by the Budget Secretary on pension reform and the reaction by employee groups and the release of a pension report by the Public Employee Retirement Commission which comes on the heels of another pension report released earlier by the Governor’s office-how much outside of the box thinking might there be?

We have written about options over the years: switching new hires to defined contribution plans (this does not erase built up liabilities), selling off an asset and putting that into pensions, and of course there have been mentions of pension bonds (a la Pittsburgh in the mid and late 1990s), tax increases (the new report spells out what would be needed for income and/or sales hikes, no mention of local property tax increases for school pensions) but here are two mentioned in the PERC report that are quite interesting.

One is to examine what state and local governments in PA are putting toward retiree health care coverage and shifting that to pensions. The report points out that retiree health care (as part of an overall group of benefits known as other post-employment benefits or OPEB) does not enjoy the same judicial and Constitutional treatment that pensions do (that they fall into the language preventing the impairment of contracts and that pension benefits are "future compensation for present services") and that "revenue saved by modifying the active employee health care plan, or by reducing or eliminating retiree health care, could be applied to pay for pension obligations". Note that Pittsburgh, which ended retiree health care for police and fire personnel hired after 2005 (and was the subject of a Commonwealth Court case cited by the report’s section) still has to pay for its OPEB liability that was built up, but it is not taking on more costs for this benefit.

Another is to gradually wean local governments off of state pension aid (it comes from a tax on insurance premiums) and dedicate that money to SERS and PSERS. "Such a major reallocation would shift the burden from state to local resources requiring those local governments to compensate for the funding lost from the state aid program".

If Pensions Be Pac-Man…

Then does that make the various methods of reform the ghosts? The video game reference, made by the Governor and noted in a new report on pensions from the state Budget office, arises from the state’s pension contributions in which money put toward pensions devours dollars that would otherwise go to the fundamental areas of state policy such as public safety, infrastructure, education, and health.

The report deals with the two pension plans administered directly by the state-one for state employees (SERS) and one for public school employees (PSERS)-and no mention is made of dealing with the pension plans that exist at the county, municipal, or authority level. There are about 2,000 of those in Pennsylvania, but diagnosis of the problem (the report looks at the dozen years or so of legislative enhancements and corrections to pension funding) and exploration of solutions deals with the two big statewide plans. Believe it or not, the funding ratio for both hover around 68%, making them "moderately distressed", which is where the beleaguered City of Pittsburgh’s plans are as of now.

The report lays out a framework for how to achieve changes, including looking at other states for guidance. Interestingly, with data from the National Conference of State Legislatures there has been a fair amount of reforms that have affected new and current employees as opposed to just singling out employees that have yet to be hired. Increasing employee contributions, a reduction in increases to post-retirement benefits, and restrictions on return to employment tended to hit current and new employees in recent years. If there were changes to age and service requirements, changes to average final salary calculations, or vesting changes they tended to fall on new hires predominantly or exclusively. Pennsylvania’s Act 120 of 2010 made changes that mostly affected new hires.

No Silver Bullet

A newspaper article recently wrote of the efforts in many states to move from a defined benefit type pension to a defined contribution type plan. Our most recent report points out the differences in these two models and shows that statewide, as well as in Allegheny County, defined benefit plans are far more predominant in the public sector.

Most places that have switched or are contemplating a switch often target it to new employees, and that’s due to language in many state constitutions that prevent abrogating contracts like pensions where people are vested. A 2009 report by the National Conference of State Legislatures showed that three states and the District of Columbia had closed down defined benefit plans and offered defined contribution plans as the primary option while six other states had a defined contribution plan as an option.

An analyst with one of the major bond rating agencies said in the piece "It is no doubt the proper thing over the long term to…consider reforming the level of benefits…[however] it’s not to be forgotten that these existing benefits don’t just go away."

A micro-level example is the retiree health care benefit in the City of Pittsburgh that was closed to new entrants hired on or after January 1, 2005. The 2009 Controller’s report shows an unfunded liability of $359 million as of January 1, 2008. The next CAFR will have an updated number but the City contributes around $20 million a year on a pay-as-you-go basis for its retiree health care liability.

Getting Serious About Public Sector Pensions

A Tribune Review article of November 8 reminds once again just how desperate the unfunded pension plan situation is for many Pennsylvania communities, including the two largest cities as well as several midsized cities. With assets to liabilities ratios below 50 percent in Pittsburgh, Philadelphia and Scranton and others below 65 percent, there can be little doubt that a crisis is at hand.

Legislators are saying it is time to get serious. But if the plans being contemplated are not more forceful than the municipal legislation passed in 2009 or the legislation dealing with the state’s own pension difficulties already drafted, we can expect little correction of the underlying problems and no lasting improvement in the underfunding situation.

Drastic steps need to be taken and very soon.

Dealing with the pension difficulties will require legislators to face up to the real problem. Simply put, public sector pension plans are too generous. Municipalities, the Commonwealth, and school districts are saddled with long term obligations to retired and current employees that cannot be met without: (1) diverting large amounts of revenues from fundamental, core functions of those governing bodies or (2) raising taxes to such a punitive level that the affected economies and tax bases stagnate or shrink and populations decline.

Attempts to fix this legacy cost problem by having the state assume more of the responsibility to fund municipal pensions as well as its own will choke off any efforts to reduce the size of state spending and to lower the business tax burden that has been so detrimental to the Commonwealth’s ability to grow economically.

Search for effective and meaningful answers must address the size and growth in pension liabilities-what is owed to retirees and eligible employees. Several proposals have been discussed such as having new employees put in 401 (k) or similar defined contribution plans. Clearly, that is a major initial step but unfortunately will not make a significant dent in the problem for many years.

It is time to tackle the issue head on. Pennsylvania needs to make two fundamental legislative and constitutional changes. First, the legislature must make it easier for municipalities to enter into Chapter 9 bankruptcy to deal specifically with massive unfunded pension obligations for which there is no solution other than ruinous tax hikes or crippling service cuts. Second, the state needs to amend the Constitution to remove the requirement that public sector employees must receive all money they have been granted contractually for any municipality that has entered into bankruptcy because of its legacy cost difficulties. Private sector employees enjoy no such guarantee. If their employer fails and cannot maintain contractual benefits to current or retired employees, adjustments can be made through bankruptcy.

Obviously, legislative language must be very careful to avoid permitting capricious misuse of the bankruptcy provisions. Employees and retirees deserve to be and must be protected to the greatest extent possible consistent with the level of financial distress of a community filing for bankruptcy. At the same time there must be recognition of responsibility. Cities that have made overly generous commitments and now cannot meet their obligations cannot reasonably expect taxpayers in other municipalities who have been more prudent to provide the funds necessary to solve the legacy cost problems of irresponsible communities. Retirees enjoying handsome pension and other benefits in a city that cannot provide for current basic services have no ethical or moral claim on taxpayers in other communities.

Obviously, many hearings and debates will be necessary before these dramatic proposals can move toward legislative language and bill enactment. Still, the very process of entertaining the possibility of forceful steps could engender some meaningful, voluntary compromise that would help ease the crisis substantially.

At the very least, bankruptcy should offer an opportunity to renegotiate the terms of pension plans for future retirees so as to increase the number of years needed to be eligible for full benefits; limitations on the use of overtime or other non-standard pay in the calculation of retirement benefits; and reductions in the percentage of pay received for each year of service.

When dire situations such as the pension crisis arrive, it is necessary to confront the real causes of the problem and not kick the problem down the road for someone else to deal with when it will surely be much worse. Adequate provision of core government services without wrecking the economy with higher taxes must not be held hostage to decisions made by previous governing bodies to be excessively generous to public employees.

Privatization Makes for Strange Bedfellows

Are we to believe our own eyes? The head of the City’s firefighters union and a Councilman who has championed living and prevailing wage mandates are now leading proponents of the Mayor’s parking lease plan.

These longtime anti-privatization zealots are now falling all overthemselves to help the Mayor get the lease done. Why? Becauseit is a way to raise the enormous amounts of money needed to savetheir jobs by sticking it to folks who park in the City. Call it abackdoor tax increase. It could not be for any other reason. When a municipal pension reform plan emerged in the state legislature this time last year, the union head was quick to oppose it saying "we’re opposing this, guys, we’re shutting it down". The legislation contained provisions, such as opening the door to 401k type plans for new hires, which were unpalatable to the unions.

Privatization is supposed to save money by providing more efficientdelivery of government services. If Pittsburgh was not under the gun to come up with a fix for its pensions and had the time to deliberate whether or not it should even be in the parking business, the current proponents would most assuredly be dead set against it.

But since this is about saving the jobs of unionized City employees the plan is being heralded as the only solution. And now it will be used to hammer the employees and customersof Pittsburgh’s businesses.