Municipalities need to get handle on public-employee liabilities

 Doug MacEachern

Saturday, March 29, 2008

For those of us looking under rocks for the nation's Next Great Financial Crisis - failing investment banks and spiraling home-mortgage disasters? Bah! - bankrupt cities suddenly look promising.

Late last month, the city of Vallejo, Calif., came within hours of declaring bankruptcy, largely because it no longer could bear the weight of the salaries and retirement benefits it pays its employees.

As financial-political thrillers go, the near demise of Vallejo was a nail-biter. The city of 120,000 on the East Bay side of San Francisco isn't poor, so few of its residents had reason to see the crisis coming. But until its public-employees unions agreed to wage concessions, the City Council had planned to announce at its next meeting that it simply couldn't pay its bills.

The details proved startling. The city projected a $20 million shortfall in its $80 million budget for the coming year, much of it caused by massive depreciation in property values, which depressed property taxes. On the other side of the ledger, the city faced liabilities for the wages and retirement benefits of its police and firefighters that consumed 80 percent of that annual $80 million budget. The costs were fixed. The property-tax revenue, alas, was not.

All over California, suddenly, municipalities are looking at their public-employee liabilities, and the picture in many cities is ugly. As reported by Steven Moore of the Wall Street Journal, California's public-sector employees' retirement system is carrying $26 billion worth of unfunded liabilities, while the separate teacher's retirement system has a combined exposure of $68 billion for retirement and health-care benefits.

A lot of shortsightedness has gone into making this financial mess on the West Coast. Local politicians anticipated the gravy flowing from ever-higher property values to pay for defined-benefits packages often found in the public sector. And plenty of other states are sitting on financial "time bombs" (as Moore described them) nearly as dire.

But, then again, not all ill winds blow east from California. Believe it or not, Arizona may be suffering from the same real-estate nightmares as is California, but this state seems better prepared to deal with them.

"In defense of the local governments in Arizona, they've not done what other states have done," said Kevin McCarthy of the Arizona Tax Research Association.

"Vallejo underscored how poorly managed they were, and that's not the case in Arizona."

Which is not to say all is well. Nor is it to suggest that tax hawks like McCarthy are not concerned that the burden of defined-benefits programs may push cities and towns to raise taxes to pay for them.

Compared with public-employee retirement systems elsewhere, Arizona's are in decent shape. But their trajectory of currently unfunded liabilities has reflected both stock markets and real-estate values. Not a pleasant sight right now.

The aggregate net employer contribution to the Arizona Public Safety Personnel Retirement System (which handles retirement benefits for most municipal police, fire and other public-safety officials) is at just over 21 percent of payroll, for example. That's stiff, but manageable.

But the system's unfunded liabilities (in other words, the overbearing ratio that is getting so many California towns in trouble) is at its worst level in 30 years. At current, about 69 percent of liabilities are fully funded. By comparison, the system actually was over-funded - at 127 percent of its liabilities - as recently as 2001.

Rep. Marian McClure, R-Tucson, is the Legislature's designated retirement-program hawk.

She took the job of chairwoman of the House Public Institutions and Retirement Committee in 2001, right around the time that (she thought) the job looked pretty cushy. Now, she sees long-term reform as the key to assuring Arizona doesn't teeter California's way.

"Those unfunded liabilities - we are addressing that," said McClure. "And if the trend turns around, that's all I care about."

In the long term, though, McClure - supported by McCarthy, among many others - would like to see defined-benefits retirement packages be "retired" for newly hired public employees.

To stave off the prospect of California's woes coming this way, they would like to see those packages reflect what is happening in the private sector, with far greater reliance on 401(k) accounts and the like.

It won't happen any time soon. McClure does not expect her reform legislation to get out of the House this year, despised as it is by public-sector unions.

Generous retirement benefits and life-long health care have served as attractive inducements for quality public employees for a long time. We rarely pay our cops, firefighters and teachers top-flight salaries, so the knowledge that they might make up the difference on the back end has been a great way to attract good people.

But Vallejo, Calif., (and the towns and cities that likely will follow its path) tell us there are limits to everything. As if we didn't know.