Special Report

The Unsustainable Cost of Local Pensions

Wisconsin and New Jersey are just the starting point in the escalating war to clean up this mess.

By 9.1.11

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You wouldn't think that Erie County, Pa., epitomizes the least visible yet most insidious aspect of the nation's pension crisis. With just 280,566 residents, the county is better known for its once-grand status as being the hub between the Rust Belt metropolises of Pittsburgh, Cleveland, and Buffalo, for the sandy Presque Island State Park, and for being the site of one of the few battles won by the Americans in the War of 1812. But these days, Erie County taxpayers are learning plenty about the high cost of pension and retiree healthcare deals struck over the past five decades by politicians and public sector unions.

In the county seat of Erie, taxpayers have seen the city's pension deficit increase by a 12-fold between 2003 and 2007 to $22 million. Given that the most recent audit by Pennsylvania's state auditor only accounts for pension costs from four years ago -- and doesn't account for the last decade's financial meltdown, the current economic malaise, or new deals such as a new contract with the city's firefighters' union that forces it to hire 20 more hook-and-ladder men -- the cost to taxpayers is probably even higher.

Residents in nearby Millcreek Township -- where police officers and other civil servants get free healthcare -- must cover $5.4 million in pension deficits; residents in the city of Corry struggle with a $2 million tab.

While Erie County residents must struggle with a $30 million pension tab for its municipalities, they also face even bigger costs from the county government. The county's pension is underfunded to the tune of $23 million, while the county has set no funds to cover its $69 million in unfunded retiree healthcare costs. And those costs are increasing rapidly. This year, taxpayers will shell out $5 million to cover immediate pension costs -- a 41 percent increase over the costs paid out three years ago.

Erie County residents aren't alone. The $3 trillion tab faced by American taxpayers for state civil servant and teachers' pensions has captured much of the public attention -- and has been the driving force behind heated battles in states such as Wisconsin, Ohio and New Jersey between school reform activists and public-sector unions. But taxpayers must also worry about the nation's 2,329 local pension systems and retiree healthcare benefits, whose deficits are growing thanks to generous public employee deals, feckless fiscal management, and overly optimistic investment assumptions.

Taxpayers in Central Falls, R.I. -- which is now using bankruptcy to deal with $80 million in pension deficits -- have seen the consequences of fiscal incompetence. So have residents in dusty Vallejo, Calif. (which is emerging from its own bankruptcy) and Benton Harbor, Mich., whose government is now under the control of a state-appointed emergency manager. (The American Spectator discusses more about Benton Harbor's fate and that of other Michigan towns in its September issue.) And even more taxpayers are finding their cities heading toward similarly dire straits.

Residents in rugged Baltimore find themselves on the hock for at least $940 million in deficits for its three pension plans; the real tab may be as much as $3.7 billion, according to estimates by University of Rochester professor Robert Novy-Marx and Joshua Rauh of Northwestern University in a study on municipal pensions released earlier this year. With pension costs increasing by 23 percent between 2008 and 2010 -- and facing a $155 million budget shortfall last year -- Baltimore officials enacted a series of modest reforms, including increasing the number of years police officers must work before they can retire from 20 to 25. But the city's public-sector unions, looking to keep the generous benefits (including annuities equal to 60 percent of final salary), are suing to overturn the moves. And the cuts only forestall the inevitable.

Facing even tougher odds is San Diego, which is still struggling with a decade-long pension scandal involving the city's move to divert its share of pension contributions to finance a stadium for its Major League Baseball franchise. The combination of overly generous benefits -- some 487 city employees collect annuities of more than $100,000 a year -- and investments losses have nearly doubled the pension deficit to $2.7 billion. The city paid $229 million in annuity costs this past fiscal year, marking a 48 percent increase over 2009-2010. Those costs accounted for 8.3 percent of the city's budget versus 5.2 in the 2004-2005 fiscal year. San Diego officials are now pushing for a ballot initiative next year to close the pensions to new employees -- and finding themselves in a fierce battle with the city's public sector unions.

Meanwhile in Chicago, deficits for the city's five pensions have increased by 30 percent between 2005 and 2009; the teachers' pension deficit increased by 48 percent during that period alone. New mayor (and President Barack Obama's former chief of staff) Rahm Emanuel now has to wrangle with $15 billion in pension deficits that his predecessor, Richard M. Daley, ignored for nearly all of his two decades in office, all the while battling the city's public-sector union leaders. Those leaders have already won such sweet deals as the ability to buy service credits that they can use to boost their annuity payouts; six union officials now stand to earn an additional $12 million in annuities during their retirement after putting down just $1 million for the privilege.

Municipal pensions are likely underfunded to the tune of $574 billion, according to Novy-Marx and Rauh; this includes a whopping $53 billion pension deficit for both the city and the county of Los Angeles, and an even bigger $122 billion for New York City. Given that the current assets aren't enough to cover all the future costs, cities will eventually have to dip further into their budgets to cover payouts, crowding out spending on public safety, parks, and other activities. Novy-Marx and Rauh estimate that Boston would have to devote 27 percent of projected revenues to covering pension benefits once assets are depleted in 2019; for Philadelphia, whose assets could likely run out in the next four years, it would be 19 percent.

But those numbers are only half the story. Cities, suburbs and school districts are just finally starting to account for billions more in retiree healthcare costs and "Other Postemployment Benefits," for which they usually have no reserves. In Rhode Island, municipal governments have $2 billion in unfunded retiree benefits obligations, according to a state senate report released earlier this year. Taxpayers in Pittsburgh face a $489 million retirement tab (which doesn't include their share of the $906 million in retiree burdens for Allegheny County and its transit authority).

The very same feckless dealmaking between politicians, school districts and public sector unions that have led to the massive state pension insolvencies are also driving the fiscal crises at the local level. Starting in the 1980s, municipalities sweetened payouts through the creation of so-called deferred retirement option programs, or DROPs, in which a government employee forgoes raises and incremental pension contributions in his final years of employment in exchange for a lump-sum payment upon retirement. This resulted in curious situations in which city workers could collect multimillion dollar checks upon retirement -- and still collect six-figure sums. Practices such as "double-dipping," or allowing teachers and other public sector employees to collect annuities and still work for school districts and local governments, have also contributed to the problem. In Chicago, 54 police officers are collecting $2.5 million in annuities and picking up another $2 million in full-time salaries.

Meanwhile, state and local government assessments of their stocks and other investments have been overly optimistic given the historic volatility of the stock market. Local governments took advantage of those inflated assumptions to help boost payments to civil servants while still avoiding paying out those costs directly from budgets. But financial meltdown, along with current economic malaise in which even Fortune 500 companies are socking away cash in low-interest savings accounts, is now forcing municipal governments to admit that the promises weren't even worth the paper on which they were written.

The costs of this Ponzi-scheming aren't borne by local taxpayers alone. State governments, reckoning with their own pension bungling, have to step in to help. Pennsylvania taxpayers shelled out $200 million in local pension relief in 2009 alone; last year, they doled out $5.7 million just to offset Erie County's local pension deficits. Michigan's own state government is taking more direct action. It has seized control of five local governments (including Detroit's stupendously failing school district) over the past two years and could take over 107 more.

States are also bearing local costs through their teachers' pension systems. And this is where things often get worse, because it allows for two of the biggest players in state politics, the NEA and the American Federation of Teachers, to protect the deals that have made teaching the most lucrative profession in the public sector.

In California, school districts have helped boost annuity payouts to teachers and administrators through the practice of spiking, or offering double-digit pay raises. This is one reason why the state's Teachers Retirement System faces a $56 billion deficit. But fixing this problem has proven to be difficult. A proposal to end such pay raises was approved by the state senate but the NEA's Golden State affiliate, along with CalSTRS, has stalled passage of the law in the assembly.

It will take some fierce battles -- like the kinds we saw earlier this year in statehouses in New Jersey and Wisconsin -- just to begin solving this fiscal mess.

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About the Author

RiShawn Biddle the editor of Dropout Nation , is co-author of A Byte at the Apple: Rethinking Education Data for the Post-NCLB EraHe can be followed at Twitter.com/dropoutnation.