The Pension Crisis

Mark J. Magyar | August 16, 2010 | Budget
Given the state's multibillion dollar deficit, will Gov. Christie try to use pensions and benefits to help make up the shortfall?

Four summers ago, when a special legislative committee met to reform New Jersey’s deficit-ridden public employee pension system, the panel was given legal opinions by the non-partisan Office of Legislative Services and the Attorney General’s office that it could not legally reduce any benefits promised to current or retired government workers.

That legal guarantee could be about to change.

Speaking about upcoming pension reforms, Governor Chris Christie told a cheering crowd in Ocean County on the six-month anniversary of his inauguration, “You ain’t seen nothing yet.”

Most likely, Christie’s “nothing” will include more than just pension reform. The state government workers’ contract is coming up for renewal in 2011. It includes a no-layoff clause that has already earned the governor’s enmity. Meanwhile, Christie is facing new contracts that must be negotiated. Given New Jersey’s deep budget deficit, the governor has every reason to be a very tough bargainer.

Still, the most significant challenge that Christie faces will likely be over pension reform.

Cutting Cost-of-Living Increases

Colorado, Minnesota and South Dakota have already taken the unprecedented step of reducing promised cost-of-living increases for their government retirees. In New Jersey State Treasurer Andrew Sidamon-Eristoff recently said that changes in pension or medical benefits for retired state workers could be included in the recommendations he is making to Christie.

Any decision by Christie and the Democratic-controlled legislature to reduce pension benefits, cost-of-living adjustments or retiree medical benefits would certainly end up in court, as the Colorado, Minnesota and South Dakota cases have.

But the sheer magnitude of the nation’s public employee pension shortfall — which the Pew Center on the States recently estimated at $1 trillion — has state governments crying “actuarial necessity” and “fiscal emergency” as they weigh benefit cuts that run counter to decades of court decisions establishing pension promises as irrevocable property rights.

Third-Largest Shortfall in the Nation

New Jersey’s estimated pension shortfall, which grew from $34.3 billion in 2008 to $45.6 billion in last year’s actuarial reports, is the third-largest in the country, ranking behind only California and Illinois in the Pew Center report.

Fulfilling projected pension obligations for the estimated 550,000 teachers, police, firefighters and state, county and local government employees active in the pension system, along with 250,000 retirees, would require New Jersey taxpayers to put $3.5 billion a year into the pension funds for the next 20 years — after more than 15 years in which the state rarely made any payment at all.

With the state already facing a very real multibillion dollar deficit heading into next year’s budget, that $3.5 billion estimate by David Rosen, budget and finance director for the non-partisan Office of Legislative Services, gave the Assembly Budget Committee a severe case of sticker shock during his testimony last Thursday.

Rosen’s estimate represented a marked increase over the $2.5 billion a year he projected last summer, and it is a number that will continue to grow by at least $250 million a year every year that the state fails to make the required contribution, he warned.

Paying Into the Plan

As the state’s union leaders rightly point out, union members pay 5.5 percent to 8.5 percent of their pay into the pension system. It is the failure of governors and legislatures over the past fifteen years to make the state share of payments into the pension fund that is the principal cause of the current pension deficit. Other factors include a 9 percent increase in pension benefits approved by Republican Governor Donald DiFrancesco and a GOP-controlled legislature on the eve of the 2001 election; the failure of the state’s pension fund managers to meet overly optimistic investment return projections; a 20-and-out law that allows police personnel to retire in their mid-40s; and a demographic shift caused by medical advances that has most retirees living not into their 70s, but into their 80s and even 90s.

Nevertheless, public opinion is clearly on Christie’s side, especially as New Jersey’s poor economy drags into its third year. Private sector workers who have lost jobs, pay or hours, and whose home equity value and 401K portfolio have melted away, find it hard to sympathize with state troopers retiring at 50 with $63,000 average pensions; or police personnel retiring at 53 with $47,000 pensions; or teachers retiring at 61 with $46,000 pensions, usually with free health care for life.

To put New Jersey’s outstanding pension obligation in perspective, the most recent $45.6 billion estimated shortfall represents an average personal debt of $5,200 for each New Jersey resident, or $20,800 for a family of four. With New Jersey already facing a large projected budget deficit next year, raising an additional $3.5 billion a year in revenue to fully cover pension costs would require a 30 percent increase in the state income tax or a hike in the state sales tax from 8 percent to 11 percent.

A Five-Letter Word

Raising taxes to cover public employee pension costs or to fill any other gap in the structural budget deficit is not only anathema to Christie, who campaigned on a no-new-taxes pledge, but even to Democratic legislators from safe urban districts in the current anti-tax, anti-public employee political climate. “Most members of my party categorically reject any consideration of new broad-based taxes,” said Assemblyman Gary Schaer (D-Passaic). “Taxes is a five-letter word that is not in our vocabulary,” Assemblywoman Joan Quigley (D-Hudson) added.

While some private sector actuaries have suggested that the pension system is essentially bankrupt, Assembly Budget Committee Chairman Louis Greenwald (D-Camden) and Assemblyman Joseph Malone (R-Burlington), the ranking Republican on the budget panel, agreed that the pension system was not beyond repair. “The system, while broken, is not irreparably broken,” Greenwald insisted.

Greenwald expressed frustration that “the pension reform measures we enacted in March were supposed to start to address the pension problem, then we failed to make any contribution into the pension system again, and all of the gains we thought we had made were wiped out.”

Missing a Payment

Consequently, Greenwald said he would insist that any future reforms passed by the Democratic-controlled legislature would be linked to the state making at least some payment into the pension system. “If the state fails to make the payment, then the reforms should no longer be valid,” Greenwald said. “Unless the state makes a contribution, there’s not enough reform and there’s not a strong enough rebound in the economy that will solve this problem.”

Ironically, Greenwald’s suggestion that the state be required to start making pension payments is already law. The March pension reform law, which affected only new hires into the pension system, requires the state to make at least one-seventh of its estimated payment in the next budget year and to increase that amount over the next seven years until it is fully paying its way — a graduated payment schedule that would probably require a $4.5 billion to $5 billion annual payment by the time FY18 rolls around.

But laws are not always followed. Christie’s treasurer, Sidamon-Eristoff, said he expected the state would include the scheduled $512 million required payment in the FY12 budget Christie submits to the legislature next spring. But Christie contradicted his own cabinet officer, saying “the treasurer got a little ahead on that.” He added: “We’ll move forward and make that contribution if the state is in the position to make that contribution. Laws change all the time. That’s our current intention, but that could change.”

Rolling Back Benefits

With neither political party willing to consider raising taxes to put in the additional $3.5 billion a year needed to pay for the promised pension benefits and the governor unwilling to make even a smaller graduated payment a top priority, the only way left to reduce the gigantic shortfall is to reduce benefits.

Sidamon-Eristoff has been having ongoing discussions about a wide range of options with Christie, who will make the final decision on what course to follow, said Treasury spokesman Andy Pratt. “Everything is on the table right now,” Pratt emphasized, “but that does not mean that anything has been determined yet.”

Still, it is hard to imagine a governor who has campaigned so hard against “greedy” teachers unions and state workers passing up the opportunity to roll back pension benefits he has repeatedly said that taxpayers cannot afford to pay. This is particularly the case when he has vowed not to raise any state tax for any purpose and when states like Colorado, Minnesota and South Dakota — states with a reputation for good government –have already taken the first step.

The battle over the pensions is just one of three major confrontations looming between Christie and the public employee unions, most notably the state government workforce.

A No-Layoff Pledge

State workers, who had agreed to a four-year contract from July 1, 2007 to July 1, 2011 with no raises in the first two years and 4 percent raises in the third and fourth year, renegotiated their contract with Corzine to save the state more than $300 million by agreeing to push off the third-year raise for 18 months and accept 10 furlough days in exchange for a no-layoff promise. That binding no-layoff pledge, which Christie attacked when he realized it barred him from making any layoffs for a year, expires Jan. 1, 2011, and Christie already is facing a $200 million shortfall in the current budget because of a reduction of expected federal Medicaid funding.

Both the pension issue and the layoff deadline come in the middle of a year in which Christie and the various state government unions also will be negotiating new contracts to replace the ones that expire next July 1. Any changes that affect the budget — whether they cost or save the state money – will need to be agreed to in time for inclusion in the budget for fiscal year 2012, which has the same July 1, 2011, deadline.

Changes in pensions or benefits, the threat of layoffs and hard bargaining over the new contract will be intertwined in the upcoming year, but it seems likely that the pension battle will come first sometime in the fall because a resolution of the pension crisis is critical not only for the state’s long-term fiscal stability but also for decision-making in the next budget.

Legal Challenges in Other States

Understandably, New Jersey state government officials and unions are paying close attention to the legal challenges to the Colorado, Minnesota and South Dakota cuts in cost-of-living increases for public employee pensioners in those states.

Colorado and Minnesota, whose pension systems are in worse fiscal shape than South Dakota’s — but far better than New Jersey’s — argue that their decisions to cut cost-of-living increases are justified because their pension funds are headed toward bankruptcy and that cuts in benefits must be made to preserve the financial stability of the system.

These arguments echo those made last February by Christie when he declared a “fiscal state of emergency” to justify assuming unprecedented executive powers in order to unilaterally cut $550 million in aid to school districts, colleges and hospitals as part of his plan to fill a $1.3 billion midyear budget cut that he said put the state on “the edge of bankruptcy.”

Nine states, including New York, Illinois, Michigan and Texas, explicitly protect public employee pension benefits from being reduced. Colorado, Minnesota and South Dakota do not, which makes their case easier in court. Nor does New Jersey, but even if these first three states win their cases, Christie may face tougher going in the New Jersey courts.

Testifying before the Joint Legislative Committee on Public Employee Benefits Reform on August 23, 2006, Peter J. Kelly, principal counsel for the non-partisan Office of Legislative Services, noted that the New Jersey Legislature established a clear record of legislative intent that pension benefits should not be reduced.

As part of Republican Governor Christine Todd Whitman’s administration’s negotiations with the unions on a controversial 1997 pension refinancing plan, the state’s public employee unions persuaded Whitman and the Republican-controlled legislature to agree to a new law that “confers on a public employee a non-forfeitable right to pension benefits established by law after the employee has served for five years.”

Benefits as a Contractual Right

Through that 1997 law, the New Jersey legislature made it clear that it intended to establish pension benefits as contractual rights. Thus, the provisions in the United States and New Jersey Constitutions prohibiting the impairment of a contract would prevent any reduction in promised pension benefits, Kelly explained.

Corzine’s Attorney General’s Office reached the same conclusion when asked its opinion by the 2006 committee on whether pension benefits could legally be reduced.

Presumably, Christie and the Democratic-controlled legislature could change that non-forfeitable right for non-vested workers or future benefits, and certainly New Jersey’s pension system and state budget are in a deep continuing crisis that was not the case in 2006 before the Great Recession.

But apart from the legal and fiscal arguments, Christie has tangled very publicly with the state judiciary with his refusal to reappoint Associate Supreme Court Justice John Wallace. Judges and their employees would be among those affected by changes in promised pension benefits.

Furthermore, the “non-forfeitable right” language in the 1997 law is so strong that it is not clear that the state’s public employee labor unions would have the right to agree to pension benefit givebacks even if they wanted to. The unions could agree to increase pension copayments for current workers, but they could not bargain away any future benefits already agreed upon, including the controversial 9 percent raise of 2001, labor experts agreed.

For Christie and state legislative leaders, however, the choice between rolling back pension benefits already promised or finding an estimated $3.5 billion a year of additional tax dollars to pump into public employee pension funds — a virtual impossibility without raising taxes — may be an easy choice. New Jersey’s “non-forfeitable” pension right could be headed to court.

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