Fat pensions spell doom for many cities
Vallejo,
Calif., took the extreme step of filing for bankruptcy to get out of generous
obligations to public employees. Other cities and states are watching.
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By Janice Revell, Money Magazine senior writer
June 3, 2008: 5:49 AM EDT
NEW YORK (Money
Magazine) -- The jig is up. For years, politicians have been playing what
amounts to a multi-trillion-dollar shell game with state and local pensions.
They've doled out lush retiree benefits to their heavily unionized workforces,
knowing that they could shove the cost for those benefits onto future
generations of taxpayers.
But a
recent financial bombshell dropped by a San Francisco suburb shows why that
shell game is now starting to unravel in a nasty way. And it's a cautionary
tale that you can't afford to ignore.
Here's
the skinny: In late May, Vallejo, Calif., became the largest city in California history to declare bankruptcy.
Its financial demise was brought about partly by the real estate crash, which
decimated home prices in the area and put a major dent in the city's tax
revenues.
But the
real nail in Vallejo's
coffin was the city's labor costs. Under the current labor agreement, the
average police officer walking the beat in Vallejo will be paid $122,000 this year
before overtime, according to city documents. An average sergeant will make
$151,000; a captain, $231,000. The average firefighter, meanwhile, will bring
in $130,000 before overtime.
That's just
the salaries, though. The final budget-crusher was the city's pension plan.
Thanks to retroactive benefit enhancements approved by the city council in
2000, police officers and firefighters can now retire at age 50 and receive an
annual pension equal to 90% of their final pay (assuming 30 years on the job),
an amount that gets increased every year to help keep pace with inflation. The
old plan had given the workers a pension equal to 60% of their final pay at age
50.
So a Vallejo police sergeant
making $150,000 a year can now retire at age 50 and receive an annual pension
of $135,000, increased each year for inflation. To put that amount in context,
you would need to amass a retirement nest egg equal to about $3.5 million to
produce a similar retirement income on your own.
It
wasn't just police and firefighters who benefited from the city's largess. The
annual pensions for rank-and-file city employees were jacked up from 60% of
final pay at age 55 (after a 30-year career) to a whopping 80% of pay, increased
each year for inflation.
Other towns in trouble
Here's
the scary part: What's going on Vallejo
isn't unique.
Back at
the turn of this century, when the stock market was still booming, public
pension plans across the country were suddenly overflowing with surplus money.
Politicians responded by handing out heavily sweetened pensions.
Then,
even though the stock market collapsed, politicians couldn't stop the trend. In
2001 alone, pension benefits were increased in at least 17 state plans, as well
as some major cities.
For a
while, inflated housing prices came to the rescue, handing many municipalities
a windfall in increased property tax revenues.
Now that
bubble has collapsed and the stock market is floundering. State pension plans
alone are about $360 billion short of the assets they should ideally hold for
future retirees, according to a recent report by the Pew Center
on the States. And that's not including city plans.
Cities
and states that enriched their benefits in the past few years are especially at
risk. That's because no matter how badly a pension plan's investments perform,
the enhanced pension benefits promised to state and local employees back in the
boom times can't be taken away, or even modified - they are locked in by
constitutional and legal guarantees.
There
is, however, one potential option for cutting back on public pension benefits:
bankruptcy. And that's what it has now come to in Vallejo. Elected officials in other
struggling areas will surely be watching.
Of
course, nobody wins in a bankruptcy. Vallejo
must now slash services and lay off workers to make ends meet - a sad outcome
for both the city workers and residents. Bankruptcy will also wreak havoc on
the city's credit rating, making it much more expensive to borrow money for building
roads and schools and maintaining the city's infrastructure.
So
what's the lesson here? I'm certainly not suggesting that state and local
workers be deprived of the pensions they were promised when they started their
careers. That was part of the deal they signed up for and it should be honored.
The police and firefighters of Vallejo,
for example, were told they'd get a pension equal to 60% of their pay at age
50, and so they should.
But the
practice of retroactively boosting public sector pensions without any serious
debate or approval by taxpayers has got to stop. As the Vallejo debacle illustrates, the stakes are
simply too high.
Historically,
the justification for these types of pension enhancements has been that public
sector workers are forgoing the salaries they would have otherwise received in
the private sector, in exchange for better retirement benefits.
But that
no longer seems to hold true. According to the federal Bureau of Labor
Statistics, the hourly salary (before benefits) of public-sector professionals
(including teachers and lawyers) was $31.51 in December 2007, virtually
identical to the $31.75 for private-sector professionals. Public-sector service
employees (including many blue-collar jobs) averaged $16.72 an hour in salary,
compared to $9.87 for private-sector employees.
This is
an election year. As such, many states and municipalities are under heavy
pressure to sweeten the pension plans for their workers - Massachusetts,
South Carolina and Pennsylvania are but three high-profile
examples. And ironically, just a few hours south of Vallejo, the city of
Rialto, Calif., recently approved a similar retroactive pension increase that
will give police officers a pension equal to 90% of their salaries at age 50.
The
bottom line: If similar changes are being considered in your city or state, the
Vallejo
disaster tells you that it's well worth your while to get the facts.
Maybe
you'll discover that your local pension fund is flush with money and that
elected officials in your area have out laid out a sound, fiscally responsible
plan for funding any pension improvements. But I wouldn't bank on it.
Questions or comments about retirement? Send
e-mails to jrevell@moneymail.com.