State and Local Finance and The Future Part I: Pensions

The quality of life, the extent and quality of state and local government public services, and the level of state and local taxation are not determined solely, or even primarily, by policy decisions made in a given year. They are also determined, in large part, by decisions made in the past that provide current and future residents of a community with assets, or stick them with liabilities. This post, and the two spreadsheets attached to it, use data from the Governments division of the U.S. Census Bureau to evaluate how residents of New York City, the Rest of New York State and New Jersey have fared by this measure, compared with other places and the national average.

One spreadsheet contains data on state and local debts, pensions, and capital construction expenditures for FY1972 and all years (excluding those for which none was collected due to budget cuts) from FY1977 to FY2008, for New York City, the rest of New York State, the U.S. total, New Jersey, California and Illinois, presented in a series of ten line graphs (Charts 1 to 10). The second presents similar data, in a table set to print on two pages, for all 50 states plus the District of Columbia for FY 2007 alone, and ranks these states (plus NYC and the Rest of the State if they had been separate states) according to a single “sold future rank.” I suggest downloading the spreadsheets, and printing out charts 1 to 10 and the table, to follow along as you read the rest of this post and the one following.

Throughout the United States, those who have been in charge of our public and private institutions in recent decades have been members of what I call Generation Greed. It is a generation that has been less willing to pay taxes to invest in the future via public infrastructure, and more willing to impose debts on future taxpayers, than those that preceded it, and has felt entitled to more years in “retirement” than it has been willing to pay for. Inadequate infrastructure maintenance and upgrading, promises of rich benefits for today’s seniors, and public debts are a triple whammy for the future of younger generations of Americans.

But the legacy those generations have and will receive goes beyond the conditions discussed in this post, beyond state and local government policy. That legacy includes federal debts and benefits, the distribution of the tax burden between the retired and non-retired, the unaddressed problems of U.S. energy dependency, the balance of payments deficit, our status of the world’s leading debtor, and the global environmental challenges. To bring up a “conservative” issue, one might also include the home life many those born after 1955 or so were given in childhood – wonderful beyond anything in history for many, but damaged by divorce and single parenthood for a higher share than ever before. While some were unwilling to sacrifice in government taxes and spending, leading to government debts and unfunded retirement obligations (which only seem to be obligations for those now at or over age 55), others were unwilling to sacrifice in their own life choices to benefit family members.

Most members of those younger generations, beginning with the second half of the baby boom, have also been paid less at work, adjusted for inflation, than those who came before. This situation was covered over first by having two parents in the labor force, allowing average household income to continue to increase – an increase substantially offset by higher taxes, a second automobile, and child care and prepared food costs. Then by giving up deferred pay (pensions, 401K matches) to maintain current spending power, deferred pay that will be sorely missed when younger generations reach old age without it. And finally by borrowing to maintain a standard of living that the typical American income could no longer support, an adaptation that recently collapsed.

To be fair there have been countervailing factors. One reason after tax cash income has been going down is because more U.S. resources have been shifted to health care. While the value of this additional spending may be debated, life expectancy has gone up (although I would not be surprised if it begins to go down when those born after 1955 reach old age). Information technology has provided a host of advantages today’s retired did not have when they were younger. While global environmental problems threaten catastrophe, the local environment is much cleaner, almost everywhere in the United States, then it was in the 1950s. And there is the tendency for younger people to expect to immediately replicate the lifestyle their parents took decades to achieve, rather than that of their parents when those parents were just starting out themselves.

But overall, most reasonable people now understand, polls say, that younger generations of Americans are and will be less well off than those who came before. It is less apparent in New York City because many of the better off among the young are moving here, whereas life in the city’s recent past was less than rosy. But in general the perception, helped along by the Great Recession, has begun to match the data. So what does the data show about state and local government finance?

Chart 1 shows the finances of the New York State pension system, which also provides pension benefits to employees of local governments in the part of the state outside New York City. Chart 2 shows the same data for the New York City pension system. The data includes benefit payments out, contributions to the pension system by active public employees, and contributions to the pension system by taxpayers, all adjusted for inflation.

The first thing that stands out is the upward march of pension benefit payments. In the NY state system pension benefit payments increased from less than $2 billion (in 2008 dollars) in FY 1972 to nearly $12 billion in FY 2008. For the New York City pension system the increase was from less than $3 billion to nearly $9 billion. The increase was not steady, but rather shows several significant shifts.

Pension benefit payments leveled off and even fell in the late 1970s and early 1980s. A prior generation of public employees, the first to form public employee unions, had cut a deal for rich pensions with early retirement in the 1960s, but those pensions did not include an inflation adjustment. While the effect of the soaring pension burden was initially devastating for New York City and (to a lesser extent) the rest of the state, the high inflation of the period subsequently reduced the real cost of those pensions (and the real benefit to the pensioners). This reduction of a fixed burden through inflation, which also reduced the burden of New York City and State debts at the time, is an unacknowledged factor in the city’s recovery from the horrific 1970s fiscal crisis.

New York City’s pension benefit payments soared in the early 1990s, as employees hired before the 1970s fiscal crisis retired en masse, emptying the city’s schools of qualified teachers. As another fiscal crisis was taking place at the time, it is likely that “pension incentives” were used to defer taxpayer costs to the future – getting older workers off the payroll by granting them early retirement but not initially paying more into the pension funds to adjust for the massive increase in pension costs (let alone the added cost of retiree health care).

Another big leap in pension benefit payments, for both the New York City and New York State systems, took place in 2000. That year public employees – including those already retired – were granted a partial cost of living increase, a benefit described as “free” to taxpayers and public service recipients. There was another big leap in pension expenditures in the early 2000s, with more pension “incentives” allowing public employees to retire earlier on more favorable terms, also described as “free.”

For those who retired and moved away, or have their taxes exempted from state and local income taxes (ie. retired public employees), these pension benefit increases and incentives did turn out to be free. Because the cost was not paid for.

For the New York State pension system, taxpayer contributions to the pension funds were slashed in FY 1991, during that early 1990s fiscal crisis. In a pattern that will be repeated for debts, New York State’s leadership at the time presumably decided that a fiscal emergency justified shifting some burdens to future state residents. That leadership, however, was replaced by the Pataki, Bruno, Silver triumvirate after 1994, and despite the boom of the late 1990s (and the mid-2000s), the practice of deferring costs to the future never ended.

In the case of the New York State pension system, taxpayer contributions did not rise to something like their level of the Carey Administration and most of the (Mario) Cuomo Administration until the last few years of Governor Pataki. And even then, a large share of the increase was by the state government, which New York City taxpayers are forced to fund part of, rather than local governments in the rest of the state.

From 1982 to 2003 New York City’s taxpayer contributions to its own pension funds also fell, but not to the same extent as the state system, except for two years: FY 2000 and FY 2001. Then, in a move that is similar to one that has led to lawsuits and fraud investigations in places like San Diego, former Mayor Giuliani and the public employee unions agreed to allow the public employees to cut their contributions to the city pension funds permanently, in exchange for the city cutting its own contributions for two years. This gave Giuliani money to spread around while running for his next job – the U.S. Senate.

At the same time the state, in deal pushed by then-Comptroller Carl McCall who was seeking union support to run for Governor, was increasing the city’s pension benefit costs at the same time – with the justification that the state system had plenty of money. In 2000, however, pension benefit payments equaled 4.5% of assets for the state system, but were sucking out 6.8% of assets for the New York City system. Even so New York City public employees got the same pension enrichments as local government employees in the rest of the state. So the deal was more pension benefits out, fewer taxpayer contributions in, and fewer employee contributions in, even as a stock market bubble was ready to burst.

Both in the New York State pension system and the New York City pension system, contributions by public employees themselves are low, but one does find spikes in employee contributions to the NYC pension system. They generally take place about the same time pension benefit payments are soaring.

The spikes in both pension contributions and benefits are a result of pension incentives. In most of them, public employees were required to “buy back” extra years of retirement, albeit by contributing what turned out to be a small fraction of the real cost of those additional years of retirement. For example, in Giuliani’s mid-1990s deal new public employees in general categories (not police, fire, sanitation, and others who get better deals) were allowed to retire at 57 instead of 62 but were also required to contribute 5.85% of their salary to the pension plans rather than 3.0%. Existing public employees were permitted to “buy back” they years when they would have been contributing more, and then retire early.

In the 2000 deal the employee contribution was reduced to 5.85% for the first ten years of work and 2.85% afterward. While New York City’s taxpayer pension contributions were not as low for as long as in the New York State system, they have soared much higher much faster in recent years. Even as taxpayer contributions soar, however, the city’s public employees are contributing less to their own pensions.

The next few charts compare the New York State pension system, the New York City pension system, the U.S. average and three states know to be in big trouble as a result of pension underfunding – New Jersey, California and Illinois.

Chart 3 shows how much public employees themselves have contributed to their pensions, as a percent of their wages and salaries, in these places over the years. New York State public employees, and public employees of local governments outside New York City, have contributed almost nothing to their own pensions, as the data show, with New York City employees contributing little more. Employees covered by the New York State pension system typically contribute 1 to 2 percent of their own pay to their pensions. Aside from years when pension buy-backs are going on as part of retroactive enhancements, New York City public employees typically contribute less than 3 percent. Moreover, under a deal dating back decades much the “employee” share of the city’s police and fire pensions is paid by taxpayers as well, yet may be counted as an employee contribution in this data

The average state and local government worker in the U.S. has contributed 4 to 5 percent of their wages to their pensions over the years. The figures for California, New Jersey and Illinois have consistently been much higher. Consider that as pension funding crises in those states lead to benefit cuts for both existing and future public employees. (For all future hires in Illinois the retirement age has already been raised to 67). You can watch those disasters unfold on the Pension Tsunami site.

Shifting to the table, one finds that in FY 2007 the 1.0% of wages paid into the New York State pension system by public employees was less than state and local government average in all but five states; the 2.5% of wages contributed by New York City’s public employees to their own pensions was less than in all but 12 states. In Massachusetts and Ohio, state and local government employees contributed an average of 9.3% of their pay to their own pensions. In Ohio, press reports indicate, that figure is going up.

Chart 4 shows taxpayer contributions to public employee pensions, as a percent of public employee wages. The data shows one reason why New York City’s public services collapsed in the 1970s – more of the taxes were going to ex-public employees in Florida rather than those still on the job in New York. The city’s taxpayer contributions to its pension system soared from 12.1% of wages in FY 1972 to 23.8% in FY77, before peaking at 28.6% in FY82. This disaster for the city’s public services can be traced directly back to the rich Tier I pensions awarded by former Mayor Lindsey in exchange for political support. As those workers were finally paid off the city’s pension costs, as a percent of the wages of active employees, gradually fell toward the level required to fund the less generous Tier IV pensions for those subsequently hired. Aside from those two years under the 2000 Giuliani for Senate deal, however, New York City’s taxpayers have contributed as much or more than the national average to its pension funds, an average that is typically around 10.0%.

The same cannot be said for the New York State pension system, or that of New Jersey. Taxpayer costs rose for the New York State system in the 1970s and early 1980s, though not as much as for New York City, and then fell back to more reasonable levels by 1990. New Jersey’s taxpayer pension contributions tended to be at or slightly below the U.S. average through 1990 as well.

Taxpayer contributions were slashed for both systems in the early 1990s and never restored. (The massive contributions by New Jersey taxpayers in 1997 and Illinois taxpayers in 2005 were funded by pension bonds not taxes, bonds that future taxpayers will have to pay back with interest.) In contrast taxpayers in Illinois and California have regularly contributed to their public employee pension funds at just above or just below the U.S. average according to this data, a few years excepted. Despite this, and despite above average contributions by the employees themselves in those states, their pension systems are in big trouble.

The retroactive pension enhancements and incentives passed from 1995 right up to the present have had the effect of re-Lindseying the burden of New York City pensions on New York City taxpayers. In effect Tier IV didn’t mean that later groups of public employees received less generous pensions than Tier I, only that the pension system was only funded at a Tier IV level with Tier I benefits retroactively granted to those fortunate enough to be in on the deals. The burden was shifted to the future, particularly during the Giuliani Administration.

By FY 2008 that burden had reached 23.0% of the wages of active employees, it has almost certainly soared since, and it will almost certainly soar more as public services are cut and cut to pay for it. The city’s FY 2007 burden of taxpayer contributions at 20.8% of the wages of active employees was far above any state, let alone the U.S. average of 9.5%. In contrast taxpayer contributions to the New York State system were below average that year. The same was true in New Jersey, although in a few years of the Corzine Administration at least something was contributed. Residents of New Jersey and the part of New York State outside New York City have yet to face the higher taxes and diminished services as a result of early employee retirement that New York City residents have already faced for years.

Now consider Chart 5, which shows pension benefit payments as a percent of the wages and salaries of those still working. The New York City pension system paid out more than 30 cents for every dollar the city paid to its active employees in recent years, far more than in the past. Rising benefits for the retired, compared with the wages of those still working, are also a trend in the rest of the state, the U.S. as a whole, and NJ/CA/IL, as the chart shows. And pension benefit payments have always been higher in New York City, compared with the wages of active employees, than in all those places going back to the early 1970s. Much higher. At 33.7% of wages, the NYC figure was higher than in any state in FY 2007 according to the table. The 22.9% for the State of New York pension system, and the 23.2% for New Jersey, were just slightly above the U.S. average of 22.9%.

But in theory today’s taxpayers and public service recipients are unaffected by the level of pension benefit payments by the pension funds, because they are paid from the assets of those funds, and enough money was supposed to have been accumulated by the funds when the retirees were working to pay for their benefits when they were retired. Is that so, or was that burden shifted forward, with not enough assets available?

Retirement planners advising people managing their own 401Ks typically recommend that no more than 5 percent of accumulated assets be spent in each year of retirement. That is, no more than 5 percent for the retired, but pension funds also have to have enough assents for other workers who have piled up pension rights that are coming due soon as they approach retirement. Across the country pension systems are in crisis in what is increasingly acknowledged as a national disaster. As shown in Chart 6, however, pension benefit payments equaled an average of 4.9% of pension assets in FY 2007, less than in the past. In California, and for the New York State pension system, that ratio was even lower. But all this was before the financial crisis revealed that those assets were actually worth far less than had been believed. No doubt pension benefits are a much higher percent of pension assets today.

Even in FY 2007 and FY 2008, however, pension benefit payments were draining the pension funds much faster in New Jersey, Illinois and New York City, according to the data. Pension benefit payments drained 6.7% of the assets of New York City’s pension funds in FY2007, higher than everywhere but Rhode Island (a small state in desperate trouble that is getting little attention), Connecticut, Illinois, Kentucky, New Jersey, and Louisiana, a rogue’s gallery of fiscal irresponsibility. One wonders how high the NYC figure is right now. In New Jersey, the politicians now say, ten years and its pension funds will be out of money. And New York City’s pension funds, which no one seems to talk about perhaps because they figure that public services can always be eliminated to pay for the retired in New York City because that’s what city residents are used to/deserve, are in nearly as bad shape as New Jersey.

As this post is already more than 3,000 words long, so we’ll move on to the second half of my state and local government and the future analysis – state and local debts and capital investment -- in the next one.

NY Debt Pension Capital 1972 to 2008.xls332.5 KB
Debt Capital Pension AllState.xls83 KB