Retirement

State And Local Bailout-Aid With Pension Reform Strings Attached? LaHood’s Plan Is Promising But Risky

In the news today:

“Congressman Darin LaHood (R-IL) today introduced the Taxpayer Protection Act of 2020, which would establish the Taxpayer Protection Program in the U.S. Department of Treasury, to provide forgivable loans to State, territory, Tribal, and local governments to support budget shortfalls caused by the COVID-19 pandemic, while protecting taxpayers from fiscal mismanagement engaged in by state like Illinois. States, metropolitan cities, and larger counties must have sound pension funds to receive forgiveness and must also have truly balanced budgets and enough rainy-day funds by June 30, 2022, to receive forgiveness.

Loans which are not forgiven must be repaid in quarterly payments beginning on June 30, 2022. Interest rates shall be set by the Secretary of the Treasury based on the credit strength of the recipient, using the same pricing as the Municipal Lending Facility of the Federal Reserve. Loans will be automatically forgiven for local governments with populations of less than 250,000 and counties with populations of less than 500,000.”

That’s from the press release from LaHood’s office. Separately, LaHood published a commentary in the Chicago Tribune promoting the proposal, and the Illinois Policy Institute provided further details and context. (Of note, LaHood is a Republican in a state in which Democrats hold not just the governorship but a supermajority in both the State House and the State Senate; his own Congressional district is a safe Republican seat due to gerrymandering.)

Is his proposal a promising path forward?

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To begin with, LaHood would allocate the funds purely based on population (with a modest flat per-state amount) rather than on any state or town’s deemed severity of need; given that any given state or city’s financial crisis depends as much on their willingness (or lack thereof) to cut spending up to now, this is probably as reasonable as you can get.

At the same time, the total amount is still fairly small, only $186 billion, a small fraction of the $875 billion in HEROES Act from the spring, and, it turns out, not that much more than what New York ($59 billion) and Illinois ($42 billion) alone requested for their states. But the true amount of need, apart from wishlists and partisan wrangling, is not clear.

How would the proposal work? The forgivable-loan design would provide states with nearly two years to meet the conditions of the program (which surely would be enough time for economic recovery as well as the necessary legislative reforms), and, should they be unable to comply, the reforms are not particularly punitive, with interest rates at a level no higher than would otherwise be the case. One might like to see a partial forgiveness for partial compliance, however.

The specifics of the requirements, however, are not straightforward.

A state is required to have “rainy-day fund protections,” which means that the state must have legislation defining a target for a rainy-day fund of reserves between 5 – 10% of annual general revenues, and under which “amounts are automatically deposited in the fund in order to meet such target,” or, alternatively, the state must have had a rainy-day fund of at least 5% on January 1, 2020. Of course, this provision would appear to be easy to game without further specifics.

A state is also required to have a “truly balanced budget,” that is, a requirement that “operating budgets achieve end of year balance.” This is a key provision; while nearly all states have balanced budget requirements (46 as of a 2015 Urban Institute report or 49 as of an undated National Conference of State Legislatures summary), in many such instances (8 in the Urban Institute tally, including Illinois), only the beginning of the year budget must be balanced; if the state ends the year in the red, it may simply carry over the deficit rather than find additional revenues or make budget cuts to achieve balance.

And, finally, all states as well as counties of over 500,000 and cities of over 250,000 must have “sound pension funds.” These are not defined based on their existing funded status but on a requirement that, using generally accepted actuarial principles, plans be able to reach 100% funding of their pensions in 25 years. In addition, plans may not increase their contribution schedule above that in place as of July 1, 2020, the implication being that, if the contribution schedule wasn’t already targeting full funding at this point, employers must cut benefits rather than increase contributions.

As a final incidental bit, states are prohibited from using a “fixed cost of living adjustment with respect to any pension system administered by the State.”

Now, as it happens, 12 states with underfunded pensions are locked into these benefits, for current employees for all past and future accrual, due their state’s adoption of the “California rule,” in which the California Supreme Court declared that the state was so obliged; Illinois and New York are the only two with explicit provisions in their state constitutions, but in Illinois, at any rate, pension reformers have emphasized that Contracts Clause protections of state pensions are limited and can be curtailed if necessary for “a significant and legitimate public purpose.” And LaHood’s legislation aims to address this with the “sense of Congress” finding that “It is the sense of the Congress that if and to the extent a State’s legislature determines that performance of its supreme obligation is impaired by funding otherwise required under any health, welfare, retirement, or other benefit plan offered to its employees, then that State’s legislature, with its Governor’s consent, may change the terms of any such benefit plan to the extent it was not contemporaneously funded in any manner it determines to be necessary and proper, notwithstanding the terms of any State law or constitution to the contrary.”

Is the required “100% in 25 years” the right funding target for underfunded state and local plans? In Illinois, the state systems currently have a contribution schedule targeting 90% funded status in 2045, so it’s plain that the state would have to find ways to cut benefits so as to reach 100% funding in that timeframe instead. (As a reminder, at least with respect to the teachers’ pension, the state cannot simply cut benefits for future teachers as these are already lower than the contributions the employees pay in, according to the current actuarial assumptions, and subsidize the longer-service teachers and retirees.) In Chicago, the Municipal Employees’ pension’s funding schedule is based on achieving 90% in 2058, helped considerably by the shift, at that point, to Tier 2 pensions, and the cumulative impact of the less-than-inflation growth of the Tier 2 pay cap; as of 2045, their current contribution schedule suffices only to reach 34% funding. To reach 90%, 13 years earlier, annual contributions would need to increase by 20%. To reach 100%, by as much as 30%. On the other hand, New Jersey’s pension contributions are set to reach 100% funding in 2049, and Connecticut’s in 2047. How much of a benefit cut (and how much, for future service, for future employees, or for past accruals) would be required to achieve an earlier full funding level without increasing contributions is not clear.

But what then? Would the various states which would be required to reform pensions, take this obligation seriously, or would they make adjustments for future accruals or even for future employees only, with the intention to restore these as soon as the forgiveness has been achieved? Quite cynically, I can even imagine legislation that claims to eliminate pension benefits for employees hired in 2023 or later, to be repealed on July 1, 2022.

Perhaps I am indeed too cynical. Perhaps the legislation would be modified to claw back any forgiveness if states deviate from their funding targets, and other fine-tuners of draft legislation would ensure there are no loopholes after all. Perhaps state legislators would genuinely meet these targets in good faith. But, after all, in Illinois, just earlier this week, the governor’s press secretary, Jordan Abudayyeh, responded to a Wirepoints pension reform proposal by calling the report-writers “carnival barkers” and “right wing ideologues.” As long as the party in power in a state continues to categorically deny any need for reform, I am doubtful that a proposal such as this can have the desired effect.

As always, you’re invited to comment at JaneTheActuary.com!

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