The Cost of a Broken Promise

Published May 2103 Voice

Now with 11 years in the classroom, “Joe’’ has settled into his chosen profession as a teacher.

Certainly, things have gotten difficult in recent years with historic state funding cuts to public education. Class sizes are inflated, making individual instruction more difficult. The tutoring programs to which he once directed struggling students have been eliminated. Fewer instructional resources in general are available to him and his colleagues.

But he loves teaching and he loves being around kids, and he has been fortunate to avoid the furloughs that have ensnarled 20,000 other public school educators since Gov. Tom Corbett took office two years ago.

As the end of another school year nears, Joe is helping to plan parties for some senior teachers who are retiring. It has made him realize the years will pass quickly – just look at how his first 11 years as a teacher have flown! – and the time will come when others will be planning his retirement party.

When it does, financial security will be important – security that has to be built work year by work year through a contract between employee and employer. He thought the 7.5 percent of his salary he contributes to the pension benefits promised to him by the state would give him that security, and the peace of mind that goes with it.

But promises and commitment – to students or educators – don’t mean anything with this governor.

Corbett is proposing so-called pension “reform’’ that would reduce Joe’s future annual pension benefit by $16,166 a year, or 26 percent.

That’s how much the average member of the Public School Employees’ Retirement System – represented by Joe with 11 years of service and a current annual salary of $50,000 – stands to lose under the governor’s proposal, based on an assumed 35-year working career.

“Sally,’’ a paraprofessional who came to Joe’s school when he did 11 years ago, is looking at a $2,531, or 24.7 percent reduction, in her annual pension benefit.

“Jane,’’ who has been serving meals to kids for 21 years as a cafeteria worker, stands to lose $1,190, or 14 percent, annually in retirement. The calculations for the two ESPs are based on  minimum-wage-level salaries and 35 years of service. 

Joe, Sally, and Jane aren’t real people. But their jobs and salaries are reflective of many PSEA members. And the potential losses to their retirement portfolios – 26 percent, or $16,166 for the average PSERS’ member – are very real indeed.

A proven, losing strategy
There’s more to the governor’s plan: He also wants to create a 401(k)-style defined contribution plan for new employees.

What is confounding is there would be no benefit to the state as the employer, or to taxpayers either since switching current and future employees to a defined benefit plan does nothing – NOTHING – to reduce the $41 billion unfunded liability facing the Public School Employees’ Retirement System, and the State Employees’ Retirement System.

Officials in several states can attest to that.  West Virginia and Nebraska both switched to defined benefit plans after trying 401(k)-style systems. Alaska found that after switching new hires to a defined contribution plan – part of Corbett’s package in Pennsylvania – employer payroll costs still required for employees in the defined benefit plan skyrocketed (see “What not to do’’ section below).

“It’s lose-lose,’’ said PSEA President Michael J. Crossey. “The governor would punish the very people – public employees – who did nothing to create the unfunded liability, and who actually made pension concessions just two years ago. And in the long-run it actually makes the situation worse for taxpayers.’’

But real costs to real human beings haven’t been high on the governor’s list of priorities during his first two years in office.

He purposely created a public education funding crisis by throwing out funding formulas based on the 2007 “Costing Out Study’’ – one that was producing significant gains in student achievement – and slashing nearly $1 billion in basic education funding the past two budget years.

“For some bonehead reason, they keep coming up with cuts that are in programs which are investments,’’ state Treasurer Rob McCord told Capitolwire (www.capitolwire.com).

Now, Corbett is contending that the best way out of the public education funding quagmire he created is to switch current employees and new hires to a new 401(k)-type retirement plan with vastly inferior benefits.

In so doing, the governor shows a stunning coldness to the fact that public school employees continued to pay an average of 7.5 percent of their salaries toward their pensions during a period in the 2000s when the state gave itself a “pension holiday’’ and didn’t have to contribute. Some employees are now paying 10.3 percent to earn higher benefits.

The governor does, however, show considerable compassion for corporations and wealthy individuals who lined his campaign coffers during his 2010 gubernatorial campaign, and who can be expected to do so for his 2014 re-election campaign (see story page 13).

“The governor hasn’t seen a corporate tax loophole, or tax break he doesn’t like,’’ Crossey said. “This blatant attack on pensions is in line with everything he has done to this point: Allowing stubborn political ideology and political cronyism to trump research, experience, reason, and good faith.’’

Political ploy; not a solution
If there is one thing the governor and critics of his pension proposals agree on it is that employees didn’t cause the problem.

That is the result of a nearly decade-long “pension holiday’’ the state gave itself and school employers starting in the early 2000s. Although public school employees, for example, steadfastly contributed 7.5 percent on average of their salaries during that period, the state gambled instead on then heady investment returns more than making up for the lack of employer contributions.

Well, the bursting of the housing bubble and with it a free-fall on Wall Street and the worst recession since the Great Depression blew up that strategy.

Amazingly, if you look behind the governor’s plan – or at least at those details he has shared – he really is proposing “a second pension holiday,’’ according to McCord.

McCord joined the Harrisburg-based Keystone Research Center at a press conference recently to say the governor’s proposed defined contribution system for new public employees  will do nothing to address the $41 billion unfunded liability, and in fact will make it worse.

McCord, a highly successful private businessman before becoming treasurer in 2009, said the governor’s proposal might provide some relief to employer and taxpayer contributions in the near term, but by 2019 PSERS and SERS would be $5 billion deeper in debt – money that will have to be paid off in subsequent years.

“Let’s look at what happens in five years if the governor wins re-election (in 2014),’’ McCord said. “The governor will be leaving office.’’

Corbett’s approach, McCord added, is sort of like: “OK, we have a $41 billion problem and to make my life easier let’s increase that problem by 10 percent … it’s a tax hike on anybody living in 2019 and beyond.’’

What to do
The irony to the governor’s pension attack is that a law in which reasonable consensus was formed and concessions made by public employees took effect the year he came into office in 2011.

Corbett is ignoring the Pension Reform  Law of 2010 (Act 120), in which public school employees agreed to concessions – reduced multipliers, higher contributions for new hires, and increased years of service to name just three.  Over the next three decades, the 2010 reforms affecting new public school hires will result in $24.6 billion in savings for Pennsylvania taxpayers.

“Instead of allowing these reforms to work, Mr. Corbett has set up the false choice between the retirement benefit of teachers and basic education funding for children,’’ Nina Esposito-Visgitis, president of the Pittsburgh Federation of Teachers, wrote in an op-ed in The Pittsburgh Post-Gazette. “(Act 120) is a long-term solution for state pensions that was agreed to and will place the Public School Employees’ Retirement System on the right course.

“Gov. Corbett’s pension reform proposals are not solutions. They are mechanisms to support his anti-public-school philosophy and to continue corporate tax breaks.’’

Both state Treasurer McCord and Stephen Herzenberg of the Keystone Research Center feel the 2010 law will significantly reduce employer pension costs over time, which it was designed to do in the first place.

Herzenberg noted that new employees under the Pension Reform Law are costing less since they have reduced benefit multipliers, and each new employee in the future will also cost less.

Furthermore, leaders of both PSERS and SERS have noted that improved investment returns since the 2008 recession, and a continued return to pre-recession form will aid both funds. For example, the Dow Jones Industrial Average has topped the 14,000 level for the first time since 2007.

In addition to giving the Pension Reform Law of 2010 more time to work, McCord has also raised the possibility of states asking the federal government to allow tax-free bond issues as a way to raise revenue.

He said the state has to recognize there is a bill that has to be paid, adding “you have to go back to the budget office and find revenue.’’

What not to do
The governor and his budget secretary, Charles Zogby, should consult counterparts in other states about their view of 401(k)-style pensions as a public policy mecca.

A short pilgrimage through the Allegheny Mountains and into the hills and hollows of West Virginia, for one, would be insightful. And if not convinced there, they could venture further west into the plains of Nebraska.

Both states have gone to defined benefit pension plans after finding 401(k)-type defined contribution plans cost more to administer, and turned out poorer results for employees – the same employees who as retirees will be important consumers to the states’ economies, and whose buying decisions and confidence will be based heavily on their financial security.

But really all Corbett and Zogby would have to do is venture across Third Street from their Capitol offices and visit the Keystone Research Center. There they would find data showing that more than a dozen states, including California, Minnesota, and Texas, took a long look at pension proposals similar to Corbett’s and concluded it was the wrong way to go.

One major reason is that switching new hires to defined contribution plans and/or switching current employees to 401(k)s doesn’t make the unfunded liability in the defined benefit plan go away –  something Zogby has acknowledged in the news media.  It also lowers the investment pool of earnings, and drives employer contributions to the plan higher.

Alaska, for example, found that the employer contribution rate has skyrocketed from 16 to 39 percent of payroll due to transition costs associated with putting new hires in a defined contribution system in 2006.

Both McCord and Steven R. Nickol, PSEA’s assistant director of retirement benefits and a former Republican legislator from York County, noted that under the Pension Reform Law of 2010 the employer cost going forward for the defined benefit plan is 2.2 percent of a worker’s salary. Under Corbett’s proposal to put new hires and current employees into a defined contribution plan, the employer (a.k.a. taxpayer) contribution would be 4 percent.

“Think about that for a moment,’’ Nickol said. “The governor wants the taxpayer to pay more – for an inferior benefit to public workers.’’

Nickol said it’s wrong to think that the current $41 billion unfunded liability is unsustainable. That’s because the unfunded liability is not the result of the cost of workers’ benefits going forward; it’s the result of 12 years of bad policy decisions that allowed employers to underfund the system.

“It would be nice if the mistakes of the past 12 years could be erased without having to pay the debt, but it must be paid,’’ Nickol said. “The Pension Reform Act of 2010 sets up a responsible payment plan to do that. It’s a fiscal challenge for the Commonwealth, without question.

“But it can be done, and more importantly it must be done – even if all benefits to workers were eliminated tomorrow, the unfunded liability would be there, and would have to be paid.’’

There is also one other reason trumping actuarial formulas that dictate the state must remain committed to the contractual arrangement it has entered into with public employees: the Pennsylvania Constitution, whose impairment of contract clause has been found in several court cases to apply to public pensions.

“Breaking a contract  with public school employees – in effect a broken promise that will seriously erode their future financial security – is not only immoral, it’s illegal,’’ said PSEA’s Crossey. “We will vigorously defend the rights of these employees – first before the Legislature, and if necessary, later in a court of law.’’  

 

 



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