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Commentary By E. J. McMahon, Josh B. McGee

Defuse This City Pension Bomb

Cities, Governance Tax & Budget, Pensions

Wednesday, Mayor de Blasio presented a fiscal 2018 Executive Budget that called for pension contributions totaling $9.6 billion — another all-time high. Yet city pension plans remain significantly underfunded even by lenient government accounting standards, posing a big risk to New York’s fiscal future.

After increasing from $1.4 billion to $8.1 billion under former Mayor Bloomberg, pension costs have continued rising under de Blasio. Based on the mayor’s latest proposed financial plan, the pension appropriation in de Blasio’s fourth budget will be $1.5 billion (19%) above the level in Bloomberg’s last budget. By fiscal year 2021, according to the mayor’s latest projections, pension costs will reach $10 billion, or nearly 15% of city-funded spending.

New York City’s pension costs will soon displace social services as the second-biggest spending category in the city budget, consuming the equivalent of more than 80 cents out of every dollar raised by the city’s personal income tax.

But even with annual contributions approaching the once-unimaginable level of $10 billion a year — more than the entire budgets of all but a handful of large cities — the city remains vulnerable to a pension funding crisis within the next few years.

Consider some sobering truths: The city’s unfunded pension liabilities (i.e., pension debt) ballooned to an officially reported total of nearly $65 billion as of fiscal 2016, up from $60 billion just three years earlier. More than half of current pension contributions are required simply to pay down the pension debt instead of for new benefits for current workers.

Even assuming investment returns averaging 7% a year, the city will need at least 15 more years to eliminate this pension debt. In other words, a shortfall that can be traced back to the early 2000s won’t be paid off until 2032 — and that is only if the pension funds’ optimistic investment return assumptions pan out.

And yet, as we model in a forthcoming report from the Manhattan Institute, a much larger unfunded liability — more than double the officially acknowledged pension debt — emerges when the city’s future stream of benefit obligations is discounted using a lower “market value” rate of interest, as recommended by most independent actuaries and economists who have studied the issue.

We estimate, under this metric, that the five city pension systems ended fiscal 2016 with an average market-value funded ratio of 47% — meaning they had less than half the money actually needed to pay for the benefits workers have already earned.

In the wake of modest pension reforms enacted at the state level in 2009 and 2012, newly hired city workers are required to contribute more to their pensions and receive slightly less generous benefits in retirement. However, the financial impact of these changes is very small relative to the continuing cost of paying off the overhanging pension debt.

While New York’s pension funding practices are better than most governments’, de Blasio and the City Council cannot afford to stand pat. Another economic and financial downturn is virtually inevitable within the next few years, and could occur sooner rather than later. This will re-inflate the pension deficit — creating even bigger burdens and more difficult choices for the future.

There are steps that can and should be taken to chip away faster at the mountain of pension debt overshadowing the budget.

As a starting point, the city should reduce its investment return assumptions from 7% to 6.75%, as recommended by independent actuarial consultants in 2015. Even that slight change would add $655 million a year to pension contributions, according to estimates.

Enough money to cover the added contribution has been squirreled away in mayor de Blasio’s fiscal 2017 financial plan, in the form of a collective bargaining reserve to cover pay raises for city employees in the next round of union contracts.

New Yorkers already have foregone billions of dollars a year in services, infrastructure improvements and potential tax savings to backstop the state’s constitutional guarantee of generous pensions for city workers. City workers themselves should pitch in more to help make their pension funds whole again — before the hole grows deeper, forcing much more painful reforms down the road.

This piece originally appeared in the New York Daily News


E.J. McMahon is research director of the Empire Center for Public Policy and an adjunct fellow at the Manhattan Institute

Josh B. McGee is a senior fellow at the Manhattan Institute and vice president of public accountability at the Laura and John Arnold Foundation. In 2015, McGee was appointed to chair the Texas Pension Review Board by Governor Greg Abbott.

This piece originally appeared in New York Daily News