Pension debt punt could cost Phoenix taxpayers $2.3 billion

The Arizona Republic
Thursday, June 15, 2017
Dustin Gardiner

Soaring pension costs are strangling Phoenix’s city budget, but city officials are weighing a plan to ease the near-term misery: Punt on paying pension debt, and spend big later.

The maneuver could cost the city up to an additional $2.3 billion in police and fire pension costs over the next 30 years — and possibly much more if investments don’t perform as assumed.

But it would lower the city’s annual pension payments to the state-run pension system for police officers and firefighters immediately, and help the city avert a steep budget deficit in 2018.

Phoenix’s public-safety pension costs have ballooned from $56 million in its general fund in 2007 to about $207 million in the upcoming fiscal year that starts July 1. That’s an increase of 270 percent.

Skyrocketing costs make it hard for the city to balance its budget and maintain basic services. The city faces the prospect of a $43 million to $64 million deficit in 2018, which could require cuts to popular services like libraries, senior centers and swimming pools.

City Manager Ed Zuercher is proposing the city relieve the pressure by taking more time to pay off pension debt — a move the Arizona Legislature and Gov. Doug Ducey authorized this year to help localities with their pension costs.

He likened the maneuver to a homeowner picking between a 15- or 30-year mortgage: The longer loan requires a homeowner to pay more in interest, but a family might not afford the higher monthly payments of a 15-year loan.

As the analogy goes, Zuercher contends Phoenix can’t cover higher pension payments and still pay for services residents need and expect today.

“It’s about having flexibility so that we can make sure the police officers and firefighters have the pensions that were promised to them,” Zuercher said. “But our kids can go to libraries and swimming pools, too.”

The City Council is expected to vote on the proposal at its meeting on June 21, but the move faces vocal opposition from some council members and financial experts concerned about the long-term costs.

Councilman Sal DiCiccio has called the maneuver “insane” and "the most fiscally irresponsible move ever by the city of Phoenix."

Similarly, two government-watchdog groups contacted by The Arizona Republic criticized the prospect, saying the city should not drastically inflate its pension debt for future generations to relieve a budget problem today.

“I think it’s a particularly bad idea,” said Kevin McCarthy, president of the Arizona Tax Research Association. “Trying to get out from underneath the reality of what we are facing ... it’s the last thing that we ought to do.”

Zuercher wants the city to switch from a 20-year plan to pay off its pension debt — which has accrued over decades due to economic downturns and other issues — to a 30-year plan.

Phoenix's pension debt, also called its unfunded liability, reflects pension benefits the city owes to retirees and active employees over their lifetimes but doesn't have money in the plan to cover. Today, that unfunded liability is $2.1 billion.

The city's payments to the state public-safety pension system have dramatically increased as the system aims to pay off those long-term unfunded costs.

The switch would essentially allow the city to put off some principal payments on what it owes for the retirement benefits of police officers and firefighters. In exchange for an additional decade to pay the debt, the city would pay more in interest.

If the city takes the full 30 years, it would spend an estimated $2.3 billion more.

“The truth of the matter is I don't see a better plan ... given the circumstances we are at.”
Councilman Daniel Valenzuela
While the city would be officially locked into the 30-year payment plan, it could pay the debt sooner. Zuercher wants the city to pay it off in 25 years, to keep costs lower. Under the 25-year scenario, the city's interest would be about $1.1 billion more.

But lower annual payments from the city’s budget would take effect immediately. The city’s payment would drop by about $10 to $25 million in the next fiscal year, which starts July 1.

Zuercher wants to put that money in a “Pension Reserve Fund” so the city has a rainy-day account to deal with future increases in pension costs. That could help offset the city’s projected budget deficit in 2018.

And lower annual pension payments to the state would carry forward. Starting in 2018, the city expects it would save $10 to $15 million every year.

A few council members have already voiced support for Zuercher’s plan, dubbed the “Hybrid Option,” because they say it gives the city leeway to pay less if it faces potential budget crises in the future while avoiding steep budget cuts in 2018.

“The truth of the matter is I don’t see a better plan ... given the circumstances we are at,” Councilman Daniel Valenzuela said Tuesday, when the council first debated the issue.

The city’s police and firefighter unions also support the hybrid plan.

Ken Crane, president of the Phoenix Law Enforcement Association, said the move could free up money for the city to hire officers or at least prevent the city from slowing hiring or trying to cut pay and benefits if it has a deficit.

“From where we sit, it’s worth it,” he told The Republic. “It’s going to give the city some needed breathing room.”

Erasing the city’s projected $43 million to $64 million deficit in 2018 could require tough choices, and punting on some pension payments is likely only a partial solution.

Three years ago, Phoenix erased a roughly $38 million deficit by creating a water-bill tax and slashing employee compensation. Last year, the city avoided a deficit and service cuts by raising property taxes.

Harmful or wise maneuver?

Phoenix has a short deadline to act. If the council agrees with Zuercher’s plan, the decision must also get approval from state Public Safety Personnel Retirement System Board of Trustees at a June 28 meeting.

“It's essentially trying to refinance a credit card.”
Leonard Gilroy, Pension Integrity Project
City officials who support the maneuver stressed the city can always pay the debt off faster than 30 years, as Zuercher has suggested, to lower interest costs.

But critics question if the city will do that once it moves to the longer payment schedule.

Leonard Gilroy, director of the Pension Integrity Project at the libertarian Reason Foundation, said he’s not sure there’s any way to “hammer into stone” that the city will pay its pension liability down more quickly.

Gilroy said the move concerns him because the city is extending the financial risk its pension debt poses to taxpayers, possibly setting the stage for more budget crises down the road. He said costs could swell if the pension system doesn’t hit its investment-return assumptions.

“It’s essentially trying to refinance a credit card,” Gilroy said, adding that the city is “basically stretching out debt for short-term budgetary gain.”

“Why leave yourself without an option? I think there's going to be some serious buyer's remorse later if they don't do this.”
Robert Klausner, attorney
Voters have approved reforms aimed at slowing pension costs. The challenge: Those changes won't stop the bleeding in the short term — at least on the public-safety side of the ledger.

Cost increases for the city’s civilian pension system have slowed, however.

Robert Klausner, an attorney who specializes in representing public-pension systems, said he would advise city leaders to go with Zuercher’s hybrid option.

Klausner said switching to a longer payment period is a one-time opportunity that gives the city flexibility in case of another economic downturn. He said creating a pension reserve fund with the savings will also show the city is disciplined about paying off its debt.

“Why leave yourself without an option?” Klausner asked. “I think there’s going to be some serious buyer’s remorse later if they don’t do this.”