Arizona Election Results on Pensions

On August 25th, there were two local elections in Arizona-in Prescott and Phoenix, respectively-on ballot measures that will likely be of interest to those that closely follow public pension issues.

First, by a 56—44 margin, voters in Prescott rejected a proposed 20-year, 0.55% sales tax increase that would have dedicated the proceeds to paying down the city’s $72 million unfunded liability in the state Public Safety Personnel Retirement System, a sum expected to grow to $165 million over the next 22 years.

The city’s police and fire pension costs have been growing rapidly in recent years, in large part due to the growth in unfunded liabilities (pension debt) in the state system (the current funded ratio is roughly 50%). The city’s employer contribution rate for payments to the public safety pension system currently exceeds 50% of payroll for police and 60% for fire. This has the practical effect of making every new hire over 50% costlier than the sum of their own individual salary and benefits, making it more difficult from the employer’s (city’s) perspective to replace retiring workers or adjust wage and benefit levels for current employees.

The other practical effect of rising public safety pension costs is the budget impact. Police, fire and other public safety costs currently account for 71% (or $22.574 million) of the city’s general fund operating budget. Police and fire pension costs ($4.74 million last year) account for 21% of total public safety costs, and 15% of the total operating budget.

Further, police/fire pension costs are expected to rise at least $1 million in the next two years, which, in the absence of the failed tax, will force the newly elected mayor and council to make major service cuts elsewhere in the budget, undertake a major restructuring, or both. This is a stark example of how the risks inherent in defined-benefit pension systems can manifest themselves in the “crowd-out” effect, where rising pension costs draw funds away from public works, libraries, parks and other government services.

This would have been a precedent-setting tax both in Arizona and nationally. In Arizona, its failure keeps the pressure on municipal governments to find solutions for funding their public safety pension debt and on state policymakers to adopt systemwide reforms. It may also prompt some local governments to consider risky pension obligation bonds to try to reduce their unfunded liabilities (though we hope they might look to their asset mix instead).

Nationally, the defeat of the Prescott pension tax measure may signal to distressed cities in Illinois and elsewhere that asking voters to pony up more now for the actuarial mistakes and pension decision-making of the past may not be a winning strategy.

The other election result of note was the passage of Phoenix’s latest pension reform measure (Proposition 103) with 71% approval. After the defeat last fall of Proposition 487-which would have moved all new civilian (non-public safety) city employees to a defined-contribution system-city leaders belatedly acknowledged that they had created a bit of a mess with their last round of reform in 2013, specifically Proposition 201. As Reason colleagues Anthony Randazzo and Adrian Moore summarized last year:

[…] While well intended, [the 2013 reforms] require new city workers to pay half of the city’s annual pension debt payment, meaning new workers must pay for retirement benefits for older workers – something no other city in America asks of its employees. New workers will soon be paying 25 percent of their salary back to the city for pension costs. How many new workers will the city be able to hire with that bad deal? How much more will Phoenix have to pay just to attract people to work for the city?

In short, Proposition 103 was an attempt to tackle the major problem created in Proposition 201, which is that new employees were facing steadily increasing employee pension contributions projected to exceed 20% of their paychecks in the coming years. Prop 201 basically violated some fundamental principles of pension system design-namely that pension systems are by design intended to be pre-funded (unlike Social Security) and that intergenerational equity demands that future employees not bear responsibility for covering liabilities accrued by current workers and retirees.

Proposition 103 makes a number of changes:

• Creates a new pension tier for new hires with reduced defined-benefit multipliers (a graded system ranging between 1.85-2.10% depending on years of service, compared to 2.1-2.3% under the current tier);
• Changes the final average salary calculation to the five highest consecutive years over the last 10 years of employment (up from the current three-year calculation);
• Caps pensionable salary at $125,000 (with an annual CPI adjustment up or down);
• Places an 11% cap on employee contributions for new hires;
• Allows future employees to opt into a guaranteed annual COLA in exchange for a reduction in pension benefit;
• Eliminates credit for unused sick leave; and
• Caps the interest rate applied to contributions refunded to withdrawing members.

What Prop 103 does not do is anything to make a real dent in the system’s current unfunded liability-which exceeds $1.5 billion-as the city’s actuaries only project Prop 103-related cost savings of about $40 million total over the next 20 years. That’s primarily because while many of the measure’s provisions save money, those savings are largely neutralized by the associated costs of placing the 11% limit on employee contributions (since the city will have to pick up the remaining costs associated with amortizing the current pension debt).

Overall, Proposition 103 is a clean-up measure, not real reform. Most of the individual elements aren’t inherently bad in and of themselves-they’re generally aimed at reducing the city’s pension costs. But they are collectively insufficient to do much in the way of reducing liabilities and risks in the current system. (See Arizona Republic columnist Robert Robb’s similar critique here.)

Though the Prescott and Phoenix measures are just two datapoints and difficult to extrapolate from in isolation, the outcomes may suggest that voters remain open to changes in the design of pension systems for new hires (even weak ones, as in Phoenix’s case) but are not keen on paying higher taxes to cover pension debts. Both sentiments would be consistent with Reason’s national poll from March 2015, which found majority support for adjusting the benefits of future workers and widespread opposition to tax increases to fund employee retirement benefits.