BUDGET 2013: Legal fireworks could threaten Corbett's pension system proposal
When it comes to Pennsylvania's public-sector pension systems, the reality has been quite clear: It's only going to get worse before it gets better.
The two state-level pension systems have an unfunded liability of more than $44 billion.
That is projected to climb to a peak of $65 billion by the end of the decade, while general fund contributions are on course to more than double in the next few years and peak near $6 billion in a little more than two decades.
That's if nothing changes.
Lawmakers have to answer two questions this legislative session: What should reform look like? And is it even needed?
Gov. Tom Corbett made it clear last week in his 2013-14 budget proposal that he's in favor of a multilayered approach that could generate some short-term state and local savings, plus ease the long-term debt obligations.
"The surest way to guarantee the solvency of our pensions is to make certain that our pension systems can deliver what they promise," Corbett said in his address.
The Republican governor is calling on lawmakers to once again tackle a change for new employees, moving them into a 401(k)-style defined-contribution system that brings the state in line with much of the private sector.
That change would take effect in 2015 for both the State Employees' Retirement System and Public School Employees' Retirement System.
Most state employees would be required to contribute at least 6.25 percent of their salary to their plan, while school employees would need to chip in 7.5 percent.
Corbett also wants to change the formula for future benefits for current employees' plans.
Beginning in 2015, he has proposed reducing the multiplier used to determine future benefits by 0.5 percent.
Final salary under the Corbett model would be based on a five-year average rather than the current three. Pensionable compensation would be capped at 110 percent of the average salary of the previous four years, while the ceiling on pension income would be set at the Social Security wage base, which is $113,700 for 2013.
Meanwhile, the 2013-14 budget would reduce the annual increase in the employer contribution limit to the pension funds to 2.25 percent, instead of the 4.5 percent increase scheduled to take effect.
That amount would increase by 0.5 percent per year until it reaches 4.5 percent again.
This "tapering of the collars" would save the state $175 million in the upcoming budget year and about $2 billion over the next five years, according to projections from the Office of the Budget.
School districts and local education agencies are projected to save more than $1 billion over five years and nearly $140 million in 2013-14, according to projections.
"Balancing the budget on the backs of our middle class and working Pennsylvanians is obviously the wrong approach," AFSCME Council 13 Executive Director David Fillman said in a statement criticizing the proposal.
The pension plan was called a "step backwards" by Stephen Herzenberg, executive director of the liberal-leaning Keystone Research Center.
He said he believes this plan will increase the state's pension debt.
Herzenberg and other critics of recent reform talk bring up Act 120 of 2010. That reform act helped address an anticipated spike in pension costs by "smoothing" the increases over a long period of time. That law also reduced benefits for new hires.
"Short-term political decisions led to a failure to contribute money that was needed," he said, referring to benefit enhancements and deferral techniques last decade that heightened the liability problem, along with down investment markets.
Corbett is repeating that behavior with the collar tapering, Herzenberg said.
Legal challenges are almost a certainty when it comes to the future benefits of current employees, he added.
"He's gone ahead and made proposals that do lower pensions of current employees, which the courts are likely to decide is unconstitutional," he said.
A lack of appropriate contributions and the potential that investment returns do not yield at least the assumed rate of 7.5 percent annually will mean higher unfunded liabilities, Herzenberg said.
A move away from the defined-benefit plan in favor of the defined-contribution plan for new hires is the way to design a plan best, said Nathan Benefield, director of policy analysis for the conservative-leaning Commonwealth Foundation for Public Policy Alternatives.
"It means affordable and predictable costs for taxpayers," he said.
There is concern about the legal challenge over current employees' future benefits, Benefield said.
"(The administration is) banking on those savings. They need a contingency plan," he said of the projected savings achieved through the reforms.
Absent the reforms, Budget Secretary Charles Zogby said, $175 million in general fund spending cuts would likely be needed.
The steep annual contributions for pensions will eventually come back around, Benefield said. He said he would expect some discussion on pension obligation bonds.
"There is still some pain involved," Zogby said the day of the address, highlighting presentation slides that show how contributions and the unfunded liability change with the different reforms. That presentation is available online at www.budget.state.pa.us.
The Commonwealth Foundation also has concerns about growth in Medicaid and welfare spending, which would continue to limit the amount of revenue available to cover rising pension costs.
"Act 120 will cost less than any 401(k) plan and put an end to 10 years of underfunding these plans," Fillman said. "In other words: no more kicking the can down the road."
If these reforms are not enacted, pension liabilities are going to "eat the general fund," said David Patti, president and CEO of the Pennsylvania Business Council.
"There is always a potential legal challenge," he said. "Let's go do it and see if someone wants to litigate it."
With or without reform
Even with the proposed reforms, the unfunded liability will continue to grow this decade, peaking around $62 billion.
With just lower contribution rates through collar tapering, that number could peak at $70 billion, according to the Office of the Budget.
Budget Secretary Charles Zogby called the governor's proposal a "shared-pain approach" and one that should produce long-term savings that outweigh the near-term costs of collar tapering.