Pension reform isn't the high-profile, headline-grabbing kind of initiative that most politicians would stake their re-election on, but Gov. Tom Corbett isn't most politicians.
Gov. Tom Corbett's Budget Secretary Charles Zogby meets with the Patriot-News editorial board to talk about the pension crisis.
Corbett, who came into office promising to right the commonwealth's fiscal ship, is not only making pension reform his signature policy going into re-election, he's betting this year's budget on it.
The political danger is two-fold: Real reform risks the considerable ire of nearly 300,000 current state employees and school teachers as well as the unions that represent them. And the details of pensions, generally, make the average taxpayer's eyes glaze over.
Indeed, the Pennsylvania State Education Association, the union representing public school teachers, is already saying this is going to be "a significant fight."
But the numbers are clear: If something isn't done, the outrage of the past two years over cuts to education, social services, environmental programs, state museums, and transportation will seem like a quiet day in the park.
Corbett's budget secretary, Charles Zogby, admits the last two budgets have "really wrung the cloth - if not dry, really dry."
But mandated payments into the pension systems continue to rise at alarming rates.
Pension payments will increase by more than half a billion next year, with another half a billion increase the following year, and yet another the year after that.
Even if the economy continues its rebound, and state revenues go up, the majority of that additional money will go straight into the maw of the growing pension obligation.
Add to that the costs of other mandated payments - debt service and medical assistance programs - and next year's budget has a $400 million revenue shortfall from the very beginning, not counting contracted increases in expenses for salaries and other benefits.
"If you're going to find money for pensions, there's less for everything else," said Zogby.
"We're at the point now," he said, "If it's not pension reform, it's something in the general fund that's got to be cut."
That means deep cuts to core governmental services.
The teachers' union says that's bunk. They say Zogby is creating a "false choice" between paying the pension debts and funding core services because Corbett has intentionally chosen not to increase corporate taxes.
According to PSEA, "Gov. Corbett made a conscious policy decision to provide more than $800 million in corporate tax breaks." That would be enough to pay next year's pension bill, they say.
Corbett came into office on a pledge not to raise taxes.
But Corbett - despite his miserly reputation - has also decided he's near the end of his budget cutting tether.
Zogby said the reality is "people have reached their maximum pain point on budget cuts," and that includes "a fair segment of the public and maybe the entire capital."
"Nobody's demanding more cuts," said Zogby, "but on the other side, nobody wants to pay more in taxes."
And taxpayers shouldn't have to foot the bill, he said.
"This issue isn't (the taxpayers') fault," said Zogby. "We ought not go back to them and ask for more."
The stock market disaster of 2008 certainly had an impact, but the current crisis is largely the fault of previous legislatures, said Zogby.
On that point, the unions agree.
THE CAUSE
In early 2001, as the deflation of the dot-com stock market bubble was still being optimistically termed a "correction," Pennsylvania legislators were afflicted with a nasty case of pension envy: theirs weren't as big as local district justices'.
Gov. Tom Ridge said he wasn't interested in increasing pension benefits, but put it on the table in order to get some of his other priority policies through the legislature.
The resulting deal, Act 9 of 2001, raised the multiplier - the key formula applied to an employee's years of service and ending salary to determine his pension - to 2.5 percent, the second-highest in the country at the time. It was effectively a 50 percent raise for the legislators, and applied to all the others in both pension systems.
It was a retroactive raise in that it applied to everyone in the system without requiring any retroactive increases in contributions.
What's more, the number of years a person had to work before becoming "vested" in the pension system was lowered from 10 years to five, effectively welcoming in all the "Ridgies" - political appointees of the governor who often leave government service after their patron's 8-year term is over.
At the time, the pension systems were flush: they'd been getting double-digit returns in the market and were more than 100 percent funded.
John Perzel, House Majority Leader at the time, dismissed questions about the long-term wisdom of granting such generous benefits by saying, "Nobody's going to have a tax increase to pay pensions."
Perzel is now serving a 30-month sentence in state prison for corruption.
Within a year of granting themselves - and everyone else - cushy pension increases, lawmakers were scrambling for ways to soften a looming four-fold increase in taxpayer-funded retirement costs.
The Sept. 11 terrorist attacks had further depressed the stock markets. A slew of high-flying companies were spiraling into bankruptcy in the wake of increased financial scrutiny after the collapse of ENRON. Ridge had gone to Washington as the nation's first Secretary of Homeland Security, and Gov. Mark Schweiker was staring at a $250 million budget deficit for the year, the first in a decade.
And Pennsylvania's pension bill was going to be more than 5 percent of total payroll the coming year.
Lawmakers looked at that $230 million bill and saw money they could use elsewhere in a tight budget, so they passed Act 38 of 2002, which arbitrarily capped state payments into the pension systems at just 1 percent.
What's more, they jimmied the system - through "actuarial smoothing" - so that required payments would be lower in future years as well.
When asked to pay the piper, Pennsylvania legislators passed a law that said they didn't have to.
The following year, under Gov. Ed Rendell, the lawmakers went a-tinkering again. This time, they decided that the accounting for pension gains would be treated differently than the accounting for losses. Gains would be amortized over 10 years, whereas losses would be amortized over 30.
The result of all this "actuarial manipulation of gains and losses," said Zogby, was artificially low state payments into the systems.
Between 2004 and 2010, the state shorted the pension systems by nearly $6 billion.
But the bill didn't go away.
It only got worse - $41 billion worse.
The cumulative result of years of legislative under-payment and a stock market crash is the total future retirement benefits to be paid out now exceed the pension systems' total assets by $41 billion.
It's called an "unfunded liability."
"We bought that," said Zogby. "It's obligations owed. We have to pay that back."
Thus, as Corbett prepares to unveil his budget for next year with an eye on re-election, he plans to demand the legislators put on their big boy pants and tackle the pension problem head-on.
They attempted a reform two years ago that staved off rapidly increasing costs by again applying artificial "collars" to how much the state had to pay. The unions also agreed to alter benefits for new employees. But critics of Act 120 of 2010 say it simply "kicked the can down the road" and the changes in benefits had little impact on costs to the system because there are so few new employees.
THE CURE
Corbett's reform is likely to include changing the benefits for current employees going forward.
The benefits that current employees have already accrued will not be touched, Zogby said. Nor will the benefits of people who have already retired.
Everything else is on the table.
That practically guarantees a fight in court if the fight in the legislature is successful, but more of that in a moment.
Corbett's people are not saying exactly what his plan will be, but Zogby outlined some of the things they are considering.
It's a "taxpayer first" approach that would apply more artificial "collars" - or caps - on pension payment increases in the immediate future, with comprehensive reforms that would result in commensurate savings to the system later on.
The challenge is to ease the immediate budget pain but still pay up the unfunded liability through changes to the system that will cost the state less going forward - all without triggering any further ratings downgrades of state finances.
The biggest item is moving current employees from the existing system that guarantees them a set payout to one more akin to the 401K-style "defined contribution" plans most common in the private sector.
Under a "defined contribution" plan, the employer simply guarantees a specific amount will be paid into the plan. What the plan ends up paying depends largely on the stock market.
Zogby said the "concept" of moving to some form of defined contribution plan for current employees is "under active consideration."
The benefits of such a system include removing the taxpayers from any risk from poor market performance, but just as importantly, it would also eliminate the political risk of legislators deciding to grant lavish benefits in good years and deciding not to pay in bad years - precisely what created the current crisis.
But Zogby acknowledged defined contribution plans "were never designed to be a primary retirement vehicle," even though we now live in a world where they are for most people.
People often don't know how much they should save, he said, and more often they just don't save anything at all.
"We're not a nation of savers, generally," said Zogby. "To the extent we do move toward a DC plan, we have to ask, 'How do we buttress it?'"
Zogby noted the state is different from the standard private sector employer in that private sector employers doesn't have to worry about whether or not their employees have adequate savings for retirement, whereas the state does. Retirees with inadequate savings are likely to return on the back end for expensive social service supports.
Zogby said, "I do think there is an obligation to make sure we're helping people plan and save," so the responsibility doesn't ultimately fall again in the lap of the taxpayer.
The options under consideration include:
- Lowering the multiplier for current employees
- Changing the way an employee's final salary is calculated for pension purposes.
- Reconsidering what constitutes a base wage for pension calculations.
- Eliminating lump-sum withdrawals.
Zogby said the specifics would be unveiled during the governor's budget address, possibly sooner.
The proposed budget will be predicated on the reforms passing the legislature.
It could be a messy process.
Zogby said, "If this were easy, it would be done by now. We know this is going to be difficult."
And passage in the legislature could only be the beginning.
Dave Fillman, executive director of Council 13 of the American Federation of State, County and Municipal Employees, noted that any proposal to change the pension benefits of current employees will bump up against a PA Supreme Court ruling on contractual obligations under the state constitution.
"I am sympathetic to the dilemma we're all in at this point," said Fillman, "but the wiggle room to fix it is very limited" because of past court rulings.
He said, "Even if we sat on our hands and watched it go by - which we're not going to do - somebody could individually take action against the governor."
That's a risk Corbett is apparently now willing to take.
"I think we all know it will be decided in the courts," said Zogby. "Whatever we put forward, we will have reasoned arguments to make in support. It won't be predicated on specious or untenable legal concepts, but rather ones we think ultimately be upheld as constitutional."
Zogby said, "Everywhere people are being asked to pay more just to hold on to what they have. There's nothing different here from what you see in other walks of life."
Fillman said AFSCME is "looking forward to siting down with the administration to find out exactly what we can do, just as we did two years ago with Act 120."
The teachers are more bellicose.
None of Corbett's suggestions solve the problem, they say.
"If all pension benefits for all employees were eliminated tomorrow, the Commonwealth would still have this unfunded liability of $41 billion," said PSEA spokesman Wythe Keever.
The union's president, Mike Crossey, said, "To blame Pennsylvania’s budget problems on debts employers owe to the pension systems is to make a scapegoat of working people who have contributed to their pensions – year in and year out."
When asked about a majority of their members withdrawing all those contributions - with interest - the moment they retire, a PSEA spokesman claimed he didn't know anything about that.
Pennsylvania Pension Plan Booklet by