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Commentary By Steven Malanga

The Pension Sink Is Gulping Billions In Tax Raises

Governance, Economics Tax & Budget

Remember that 'temporary' tax hike for California schools? Most is now going to public worker retirements.

California Gov. Jerry Brown sold a $6 billion tax increase to voters in 2012 by promising that nearly half of the money would go to bolster public schools. Critics argued that much of the new revenue would wind up in California's severely underfunded teacher pension system. They were right.

Last June Mr. Brown signed legislation that will require school districts to increase funding for teachers' pensions from less than $1 billion this year in school year 2014-15, which started in September, to $3.7 billion by 2021, gobbling up much of the new tax money. With the state's general government pension fund, Calpers, also demanding more money, California taxpayer advocate Joel Fox recently observed that no matter what local politicians tell voters, when you see tax increases, “think pensions.”

Californians are not alone. Although fiscal experts have warned about the worsening condition of government pension systems for years, many taxpayers felt little impact from the rising debt—until now.

Decades of rising retirement benefits for workers—some of which politicians awarded to employees without setting aside adequate funding—and the 2008 financial meltdown have left American cities and states with somewhere between $1.5 trillion and $4 trillion in retirement debt. Even with the stock market's rebound, the assets of America's biggest government pension funds are only 1% above their peak in 2007, according to a recent study by Governing magazine.

Under growing pressure to erase some of this debt, governments have increased pension contributions to about $100 billion in 2014 from $63 billion in 2007, according to the Census Bureau's quarterly survey of state and local pension systems. But the tab keeps growing, and now it is forcing taxes higher in many places.

A report last June by the Pennsylvania Association of School Administrators found that nearly every school district in that state anticipated higher pension costs for the new fiscal year, with three-quarters calculating their pension bills would rise by 25% or more. Subsequently, 164 school districts received state permission to raise property taxes above the 2.1% state tax cap. Every one of the districts cited rising pension costs.

Meanwhile, the deeply troubled Philadelphia school system's pension tab increased to $159 million in the current school year, which started in 2014 and goes to mid-2015, from $55 million in 2011. To bail it out, the Pennsylvania legislature crafted a special deal to increase cigarette taxes in the city by about $60 million annually.

In West Virginia, where local governments also face big pension debts, the legislature recently expanded the state's home rule law—which governs how municipalities can raise revenues—to allow cities to impose their own sales taxes. The state's biggest city, Charleston, with $287 million in unfunded pension liabilities, has already instituted a $6 million-a-year local sales tax devoted solely to pensions, on top of the $10 million the city already contributes annually to its retirement system. At least five more cities applying to raise local sales taxes, including Wheeling, also cited pension costs.

In April two-dozen Illinois mayors gathered to urge the state to reform police and fire pensions, which are on average 55% funded. The effort failed, and municipalities subsequently moved to raise taxes and fees. The city of Peoria's budget illustrates the squeeze. In the early 1990s it spent 18% of the property-tax money it collected on pensions. This year it will devote 57% of its property tax to pension costs. Reluctant to raise the property levy any more, last year the city increased fees and charges to residents by 8%, or $1.2 million, for such items as garbage collection and sewer services.

Taxpayers in Chicago saw the first of what promises to be a blizzard of new taxes. The city's public-safety retirement plans are only about 35% funded, though pension costs already consume nearly half of Chicago's property-tax collections. Strong opposition forced Mayor Rahm Emanuel to temporarily table a proposed a $250 million property-tax increase to help pay off pension debt. Instead, as a stopgap measure Chicago instituted a series of smaller tax and fee hikes, including a boost in cellphone taxes, to raise $62 million. But the city's pension bill will double next year to more than $1 billion, so a massive property tax hike is still on the table.

Chicago residents also face an enormous state retirement bill. The Civic Committee of the Commercial Club of Chicago recently estimated that if the Illinois Supreme Court sustains a lower-court decision overturning 2013 pension reforms, Illinois taxpayers will pay $145 billion in higher state taxes over the next three decades.

Burdened by so much debt, taxpayers in some places are unlikely to see relief soon. When California passed its 2012 tax increases, Gov. Brown and legislators promised voters the new rates would expire in 2018. But school pension costs will keep increasing through 2021 and then remain at that elevated level for another 25 years to pay off $74 billion in unfunded teacher liabilities. Public union leaders and sympathetic legislators are already trying to figure out how to convince voters to extend the 2012 tax increases and approve “who knows what else” in new levies, says taxpayer advocate Mr. Fox. It's a reminder that in some places the long struggle to pay off massive government pension debt is just starting.

This piece originally appeared in Wall Street Journal

This piece originally appeared in The Wall Street Journal