Noteware: Pension reform can no longer be postponed

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In previous articles, I discussed the explosive growth of City of Houston expenditures over the past twelve years. The per capita cost of City government has risen 46% over that time, and the City projects that its expenses will continue to outpace the combined rates of inflation and population growth. The largest drivers of this expense growth are the City’s pension programs for municipal employees, and required contributions to those programs are growing at an alarming rate. Absent substantial reform, spending on the pension programs will further “crowd out” essential services (such as public works and public safety).

The growth in spending on pensions is documented in City financial statements. As recently as 1997, the City paid $68.5 million into its employee pension accounts. By 2007, the contribution had surged to $143.5 million. In 2014, the amount was estimated at $217.8 million. Contributions for 2015 and 2016 are projected to grow another 21% and 26% respectively. Although elected officials tend to avoid discussing these details, the City’s Director of Finance, Kelly Dowe, offered a sober, candid assessment to Council in a July 2014 presentation: “Increasing General Fund pension expenditures are crowding out headcounts and services.” In other words, funds required for the pension are now beginning to be unavailable for essential city services.

This pension-related “crowding out” is precisely what happened in Detroit and Stockton (California), leading to their Chapter 9 bankruptcy filings. To avoid that undesirable outcome, the City’s pension expense must be contained.

To date, the City has addressed the increasing pension expenses by “underfunding” – that is, by paying less into the three employee funds (Police, Fire and Municipal Employees) than is required, with promises to pay more in the future.  These promises to pay are in effect loans, and loans that lock in high rates (currently 8.5%).  State law restricts how low the aggregate funding percentage can go, and the City is approaching these levels, so underfunding will not be an option much longer.

The City has also taken on other debt to fund the pension shortfalls, by issuing general obligation “pension” bonds. Under former Mayor Bill White, the City borrowed $600 million of pension bonds, contributing ~$550 million of the proceeds to the pension funds (and diverting $50 million into the distressed general fund). Some economists have a term for this method of selling bonds in a current year to cover obligations incurred in past years, with payments on the bonds to be made in future years by future taxpayers: Generational Theft! Mayor Annise Parker pledged not to issue any pension bonds during her administration.

A third mechanism to fund payments of pension obligations would be to raise taxes dramatically. However, balancing the City’s annual budgets would require progressively larger (property) tax increases. Over the next few years, this would cost property tax payers at least 20% more per year, which is obviously untenable.

Clearly, the City needs to contain its growing pension obligations. But, elected officials are not offering solutions. Indeed, current elected officials have faulted the state legislature for not stepping in, and have left it at that. Some observers have suggested the City should follow corporate America’s lead, and move from defined-benefit plans to defined-contribution plans for new hires, although Mayor Parker has said that she will not propose changing the structure of the City’s pension programs. Comprehensive, actuarially sound reforms simply have not been forthcoming.

Unfortunately, the crowding out made famous in Detroit and Stockton has already begun in Houston (potholes are proliferating and the police force is shrinking). Without reform, this trend will continue. The pension issue will be the largest and most urgent issue awaiting the new Mayor upon inauguration in January 2016. Because current elected officials are clearly punting on solutions, it is incumbent upon voters and media to insist that candidates in the 2015 campaign for mayor present detailed plans on how they will address this issue. The future of Houston depends on it.

A version of this article appeared in the Houston Business Journal on February 26, 2015

About Jim Noteware 18 Articles
Jim Noteware is a Houston-based real estate developer, focusing on suburban master-planned and urban infill communities. He also specializes in the turnaround of distressed properties, portfolios and organizations. He has served two big-city mayors, in Houston and Washington, D.C., working to improve the performance of large troubled public agencies.