This spring, the Oregon state legislature will consider whether to divert a constitutionally mandated tax rebate to the Public Employees’ Retirement System (PERS), which is the state’s pension plan for its public workers. While transferring rebate funds to the system would partially fill its large funding gap, legislators should consider pairing any diversion with systemic reforms to ensure that the gap ultimately closes.
Under Oregon’s constitution, taxpayers are entitled to receive an income tax refund or credit if actual state revenues exceed budget forecasts by 2 percent. Because Oregon uses a biennial budget, the credit, if any, is calculated and paid every other year. Strong economic performance during the current biennium will trigger the so-called “Kicker” rebate during the 2020 tax filing season. Currently, the credit is estimated to be $724 million. Under the state constitution, this rebate can be diverted to another purpose by a three-fifths vote of the legislature.
The 60% approval requirement will provide reform-minded legislators an opportunity for leverage they might otherwise lack. While a simple majority of state senators and representatives might vote to divert the rebate into PERS unconditionally, getting to three-fifths may be harder. This could create an opportunity to achieve meaningful and lasting reforms for the state’s pension system.
And some kind of reform appears necessary. As of December 31, 2018, PERS assets covered just 69 percent of the benefits promised to Oregon’s state workers. When side accounts belonging to employers are included, the funded ratio rises to 75 percent, but since these side accounts are mainly funded by proceeds from pension obligation bonds, they should arguably be excluded from the funded ratio calculation.
With actuarial liabilities estimated at $86 billion, diverting $724 million of Kicker funds into PERS would increase the funded ratio by less than 1 percent. Further, that benefit could be quickly offset if PERS adopts a lower, more realistic assumed rate of return. For example, if Oregon PERS transitioned to the 7 percent return rate assumption being implemented by California pension systems — the California Public Employees’ Retirement System (CalPERS) and the California State Teachers’ Retirement System (CalSTRS) — unfunded liabilities would rise by about $2 billion.
One set of reforms that may be attractive to both labor interests and fiscal conservatives are policies that would more aggressively pay down unfunded obligations on an ongoing basis. One way to achieve this is to switch from level percentage to level dollar amortization. Under level dollar amortization, Oregon public sector employers would have to pay a flat one 20th (5 percent) of the unfunded liability each year. Under the current system of amortization according to level percentage of payroll, first year amortization payments are much less since actuaries assume that PERS payrolls grow 3.5 percent annually. These low initial amortization payments are often overwhelmed by negative actuarial experience, meaning that the plan falls even further behind.
In good budget years, state and local governments can also add to their side accounts by making extra cash contributions rather than by issuing pension obligation bonds. The latter just converts one type of debt to another. PERS has already taken measures to make side account deposits easier by reducing administrative fees on side accounts, for example, but can do more by eliminating these fees altogether.
Examining new plan designs for new hires is also a way to lower financial risk to public employers in Oregon going forward. For example, new hires could be offered a choice between a better-designed pension plan that is more likely to avoid unfunded liabilities or a defined-contribution (DC) retirement plan. DC plans cannot produce unfunded liabilities because the employer’s responsibility is limited to making a payment to the employee’s account each pay period. Any type of plan design has its tradeoffs—DC plans do place more responsibility on employees, but they are also more portable, meaning that employees can still receive the benefits if they leave the job before vesting or move to an employer that does not participate in Oregon PERS. But if an employee saw themselves staying in that job for a full career, a financially sustainable pension option could still be available to them.
TriMet, the Portland area’s transportation agency, is an example of a government making a wholesale shift in its plan design. In 2003, TriMet started offering new management and staff employees a defined contribution plan where the agency deposits 8 percent of each employee’s compensation into a 401(a) retirement account; while the employee may contribute up to 15 percent of his or her salary to the account on a pre-tax basis. TriMet made the same change for new unionized employees in 2012 after a challenging but ultimately successful negotiation. While defined-contribution plans are sometimes criticized for high fees, the TriMet plan has been lauded for offering numerous low-fee investment options to plan participants.
Although the retirement benefits of current employees are protected by state law, Oregon legislators should consider asking them to contribute a share of their benefits. Currently, PERS has a 6 percent employee contribution but it is often “picked up”, i.e. covered by employers, a practice not seen in most other states. An explicit payroll deduction makes employees aware that funding pensions is a shared responsibility.
Further, legislators should consider making employee contributions variable based on how well the pension fund performs versus actuarial assumptions. This gives employees an incentive to support more prudent assumptions, like a lower assumed rate of return, to lower the risk that their rates will spike due to underperformance.
These are just some of the reforms that legislators should consider in order to make Oregon PERS sustainable over the long term. A one-time diversion of “Kicker” funds cannot solve the system’s funding problems by itself and the need to achieve supermajority support for the diversion creates a window for reforms that could put PERS on the road to fiscal health.