PERA obligations still threaten Colorado’s future

PERA obligations still threaten Colorado’s future

Colorado is ranked one of the worst states in the US regarding the ability to pay state pensions. In October 2018, Bloomberg’s Danielle Moran tallied the total liabilities and the funded portion that applies to each state’s public employee pension funds, finding that five states had funded less than 50% of the cost needed to pay for their promised state public employee’s pension benefits: Kentucky (33.9%) New Jersey (35.8%) Illinois (38.4%) Connecticut (43.8%) and Colorado was the fifth-worst in the US (47.1%). The exorbitant real debt of PERA obligations is over twice the size of the entire state budget ($32 billion) when using a discount rate that the private sector has to use in calculating its debt obligations.

According to the Foundation of Economic Education, another way to measure the shortfall is to calculate the amount of money that each individual state resident would have to cough up to fully fund the cost of providing state government employees with the retirement benefits promised to them by state politicians. This analysis shows that the 2018 cost of unfunded state government employee pension liabilities per Colorado resident (man, woman, and child) is $9,722 the fifth-highest in the US.

The PERA funding ratio (assets/liabilities) has been in steady decline since 2009 despite an expanding economy and a booming stock market over the same period of time. This tells us that the PERA model is headed for insolvency. There are insufficient contributions and excessive benefits for government employees, and too many beneficiaries. This funding problem will substantially worsen when Colorado enters a recession, an inevitable occurrence.

Recently, Warren Buffet called the state pension fund problems in the US a “disaster.” In an interview with Seeking Alpha, Dr. Marc Faber said these state pension funds must earn a better return (not likely given they are already taking on too much risk by using hedge funds) increase taxes (not likely because of the TABOR restriction in Colorado) or reduce benefits (not likely due to opposition from the government union, protests, walkouts, etc.)[1] As a result, an economic train wreck awaits us and government union special interests prevents us from avoiding it. Special interests demand that taxpayers foot the bill for government pensions that far exceed their own retirement plans in the private sector. PERA has one of the most generous retirements despite being substantially under funded by their own contributions. A private sector employee pays 6.2% of income (up to $132,900) into Social Security which is matched by the employer with a 6.2% contribution, summing to a total contribution of 12.4%. The PERA employee contributes 8% while the taxpayer contributes over 18% (10.15% plus an actuarially determined cost, ADC, of another 7.98 %.) Clearly, PERA is a much better deal for the employee but a much worse deal for the taxpayer.

PERA’s long term diverging trends regarding insufficient contributions from employees, excessive pension payments to retirees, and an unrealistic expectation to earn 7.25% on the portfolio are unsustainable and will lead to a financial crisis. From 1996-2013, the annual contribution rate to support pension benefits grew 6.1% annually while the benefit amounts grew 9.2%.

This is a recipe for bankruptcy. This is because of irresponsible benefits such as HAS (Highest Annual Salary) calculations that enable beneficiaries to receive a pension based on their five highest years of earnings. They also have “spiking” where employees inflate their pension amounts by higher earnings during the few years immediately preceding retirement. This doesn’t happen with Social Security or in the private sector. The average PERA benefit is over twice the Social Security benefit. The average PERA beneficiary is 58 years old with 23 years of service and receives $38,000 annually while the average Social Security retiree is in their 70’s, has a working service of over 30 years, and receives less than $17,000 annually. You can’t retire on Social Security until age 62 (with a reduced benefit) while PERA beneficiaries could retire at 58 (with a full benefit.) until last year’s reform which boosted the retirement age to 64. The private sector employee is actually preparing state employees, at double the cost, for a better retirement than they have for themselves. The burden is primarily already upon the taxpayer yet taxes will need to increase further in the next PERA bailout.

Social Security will default in 16 years and PERA is in much worse shape. According to the Social Security Trustee’s Report, benefits will have to be reduced 20% in 2035 due to insufficient funding while Colorado legislators have been reluctant to address the PERA economic realities, thereby threatening future beneficiaries, future taxpayer burdens, and Colorado’s fiscal health (credit agencies will lower our credit rating thereby increasing our cost of debt and impair future borrowing.) PERA’s model assumes a discount rate of 7.25% (unusually high compared to private pensions) which grossly underestimates the actual indebtedness of the program.

A new Frontline PBS special (6-10-19) stated “one half of all states in the country don’t have enough money to pay pension obligations.” The investigation showed that bad investments, deteriorating funding ratios, and incompetent financial management have now enticed fund managers to take greater risk through the use of hedge funds to generate higher returns to support pensioners. Hedge funds impose higher costs, higher risks, and lack transparency. However, higher risk doesn’t always pay off and many state pensions are worse off by using hedge funds to boost their returns.

Some states are nervous about using risky hedge funds and look elsewhere to close the funding gap. Oregon, for example, passed a law in 2018 that earmarked taxes on alcohol and marijuana and lottery revenues, among other things, to help bankroll pensions. Last year, New Jersey dedicated all earnings from the state lottery to the public pension fund, a move that will generate $1 billion per year, according to a recent report by the state’s independent pension commission.[2] The coming state pension train wreck will negatively impact the overall state credit rating.

Colorado has a lower credit rating than the states surrounding it due to PERA debt. Ballotpedia depicts New Jersey as having the worst state credit rating determined by Standard and Poor’s with a rating of A-. Grades range from AAA (best) to BBB- (the worst.) Colorado is ranked AA, trailing surrounding states like Nebraska (AAA) Utah (AAA) New Mexico (AA+) Oklahoma (AA+) and Wyoming (AA+)[3] In November of 2017, Standard & Poor’s threatened to lower Colorado’s credit rating if the PERA liability wasn’t funded over the next 30 years.[4] Moody’s downgraded Colorado debt’s outlook to negative in 2016 specifically due to excessive PERA debt.[5] More downgrades will eventuate when Colorado’s terrific economy deteriorates as the recession finally arrives.

Repeated PERA reforms have been unable to solve the problem. There was a major PERA reform effort in 2010 that was supposed to fix the problem. It didn’t. “In 2010, facing growing financial pressures within the Colorado Public Employees’ Retirement Association (PERA), the state legislature passed—and the Governor signed—Senate Bill 1 (SB-1). Using any objective measure, SB-1 has failed to achieve its central objective. PERA’s funded ratio, i.e., the ratio of assets to liabilities, has fallen from 61.3% in 2010 to 56.1% in 2016, and the system’s unfunded actuarial accrued liability (UAAL), has increased from $23.5 billion to $33.8 billion, or $15,400 per Colorado household, over the same period.”[6]

Another major reform passed in May 2018 titled SB-200 which promised to fix the $32 billion pension shortfall problem again. The Stanford Institute for Economic Policy Research published a study in April 2018 saying, “Absent future reforms—enacted quickly and aggressively—PERA’s financial condition is highly likely to worsen, reducing the retirement security of the state’s public employees, increasing required contributions from taxpayers, and costing the state more in the long run.”[7] This reform included a new $225 million annual payment from the general fund to support PERA. It also included reforms for far-in-the-future retirees (new employees) without substantive changes for existing and prospective retirees in the next 20 years. The $225 million from the general fund can be rescinded if Colorado encounters extenuating circumstances, e.g., a recession. A recession is long overdue (it has been over 10 years since the market crawled out of the last one on March 9, 2009.) The first “major” reform of 2010 was followed by another “major” reform in 2018 and we will undoubtedly see another “major” reform necessary in a few years. These reforms basically take the form of more taxes with little emphasis on increasing employee contributions or reducing employee benefits.

The 2018 reform included raising the minimum retirement age for new hires to 64, calculates their earnings from five years of their highest average pay and drops the cost-of-living adjustment only to 1.5 percent. It also allows for limited expansion of the defined-contribution plan to more state workers and municipal employees, but not to school-district employees and requires phased-in increased contributions of 2 percent from workers and 0.25 percent from taxpayers.[8] House Bill 19-1217 passed in the recent legislative session made matters worse by rescinding the 2% employee contribution increase for the local government division of Colorado. This puts more burden on the taxpayer and less on the government employee. House Bill 19-1270 also imposed climate change investment requirements on the portfolio.

Taxes will have to rise for a pension bailout. The Tax Foundation says individual income taxes are a major source of state government revenue, accounting for 37 percent of state tax collections and forty-three states levy individual income taxes.[9] Only nine states have a flat income tax of which Colorado is one.[10] Anti-TABOR advocates (and pro-PERA pensioners) typically want the flat tax changed to a progressive tax so as to fund the state pension shortfall and other pet projects. Pension proponents want taxes increased yet tax increases restrain economic growth and diminish stock market returns in the pension investment portfolio. As states increase taxes, taxpayers will migrate out of tax heavy states to nearby tax friendly states.

The legislature and judiciary in Colorado has eroded TABOR’s power to restrain taxes and Colorado is now a much less tax friendly state than it was when TABOR was first approved by the voters. They have done this by calling taxes fees and by categorizing these fees as “enterprises” which excludes them from TABOR provisions. According to research by Kiplinger, Wyoming is the 2nd most tax friendly state, South Dakota is 3rd, Nevada is 5th, North Dakota is 6th, and Arizona is 8th. If Colorado increases taxes too steeply, taxpayers will flee to other nearby states.[11] Wyoming will become a top destination state for Coloradans fleeing tax oppression. Another study indicates that Colorado is the 40th tax friendly state with an income tax of 4.63%, property tax of 0.54%, state sales tax of 7.52% and a state tax on Social Security. Those who are younger than 65, can shield up to $20,000 while those 65 and older can shield up to $24,000. The income tax rate is lower in Colorado than in more than half of the states. However, the Colorado sales tax is higher than in a majority of the states.[12] A 247wallst.com study showed that Illinois, New Jersey, New York, and Connecticut are the top four states in the US where people are leaving with the primary reason being economics. All four states have a high tax problem. High taxes impede economic growth and stimulate a migration exodus.[13]

The solution is to protect the taxpayer and make PERA pay its own way. The problem is intractable but not insoluble. The way out of this mess is to convert the PERA plan to a cash balance or 401(k) plan which is used in the private sector for tens of millions of people across the US. Unfortunately, special interests want the taxpayer to keep paying more while protecting inflated benefits and insufficient contributions from PERA employees. TABOR is one of the best ways to prevent more taxpayer bailouts of the PERA ticking time bomb. PERA advocates are opposed to having PERA beneficiaries assume more responsibility for the pension plight. Their desire is to “privatize the gain and socialize the loss.” This means they want the taxpayer to absorb the increasing costs of benefits while they enjoy the benefits of retiring earlier with a better pension than the taxpaying public.

Taxpayers contribute over twice what the PERA beneficiary contributes. This doesn’t happen in Social Security or the private sector. The next “major” PERA solution must benchmark fairly

with Social Security and private pensions as well as restoring balance between beneficiaries and taxpayers. The ratio of taxpayer-to-beneficiary has grown from 1:1 (1969) to 2.4:1 (2016) and continues to grow. We need to restore equity between employees and taxpayers and between retirees and the next generation. June 30th marks the release date for the 2018 PERA annual report that will reflect the market losses for 2018. There has been 90 legislative changes to PERA since 1969, however more reforms are coming as the Band-Aids wear out.

[1] https://seekingalpha.com/article/4270106-coming-pension-crisis-subsequent-fallout

[2] https://www.pbs.org/wgbh/frontline/article/how-states-have-tried-to-close-their-pension-funding-gaps/

[3] https://ballotpedia.org/State_credit_ratings

[4] https://www.bizjournals.com/denver/news/2018/05/10/with-less-than-an-hour-to-go-in-the-2018-session.html

[5] https://www.denverpost.com/2017/11/16/colorado-credit-rating-could-tumble-pera/

[6] http://www.securefuturescolorado.org/wp-content/uploads/2018/04/PERA-Update.April032018PSDA.JN_.FINALHS.v2.pdf

[7] Ibid. p. vii

[8] https://www.bizjournals.com/denver/news/2018/05/10/with-less-than-an-hour-to-go-in-the-2018-session.html

[9] https://files.taxfoundation.org/20190320121737/2019-Individual-Income-Tax-Rates-and-Brackets-FF-643.pdf

[10] https://www.thebalance.com/which-states-have-a-flat-income-tax-rate-3193306

[11] https://www.kiplinger.com/slideshow/taxes/T006-S001-10-tax-friendly-states/index.html

[12] https://www.gobankingrates.com/retirement/planning/best-states-for-retirement-taxes/#12

[13] https://247wallst.com/economy/2018/01/03/10-states-where-the-most-people-are-moving-and-leaving/

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