New York City is in dire straits. You might not know it, but the city is staring bankruptcy in the face. Stakeholders are scrambling for answers to this issue, but there’s been little talk about one of the main causes of the city’s growing debt: public employee pensions. As of today, nearly 75 percent of the city’s $197.8 billion deficit is due to pension and other retirement liabilities.
What will happen if the city goes bankrupt?
Public services will face cuts first, impacting everything from public employee salaries to public transportation. Would the city survive if its subways aren’t running and its roads aren’t maintained? Sick of high taxes, residents and businesses are already leaving in droves, so it’s possible that this would just lead to a wider exodus. Fixing the pension problem should be step one toward stopping a crisis.
Currently, NYC offers five different pension plans to its municipal employees, from teachers to members of the school board. These pensions serve as a source of retirement income to former city employees and are defined benefit plans, meaning that benefits are guaranteed by the employer. The employer is making investment decisions and managing investments for the plan so that when employees retire, they receive the promised benefit. For that to happen, all the actuarial assumptions need to be correct in their predictions about investment returns, demographic trends, and other variables.
The rate of return adopted by the board is its assumption of what the plan’s investments will return on average.
Essentially, those are all educated guesses, since there’s no way to know for sure what’s going to happen in the future.
Whenever actuarial assumptions are not realized—investment returns are not as high as they were budgeted for or people live longer than projected—employer contributions to the plan rise, therefore increasing the pension plan’s cost for the city.
Although more in-depth analysis is needed, there is one particular actuarial assumption that NYC, like many other municipalities, got wrong: the assumed rate of return. The rate of return adopted by the board is its assumption of what the plan’s investments will return on average.
Take, for example, the two largest pension plans in NYC that cover most public employees—the New York City Employees Retirement System (NYCERS) and the Teachers Retirement System (TRS). NYCERS and TRS (as well as the other three city’s pension plans) have assumed a rate of return of eight percent between 2001 and 2012 and 7.0 percent from then on. The actual market returns on both pension plans have averaged about six percent between 2001 and 2017. This means that the plan was consistently receiving less investment income than it planned, thus putting more financial strain on the city.
So it’s no surprise that the pension plans’ funded ratio, which shows the ratio of the plans’ assets to liabilities, has dropped to 71.4 percent for NYCERS and 58.6 percent for TRS—thanks to accumulated debt.
In particular, the NYCERS has been fully funded up until 2004, whereas the TRS was close to being fully funded as late as 2001. This means that the value of pension assets was either equal or close to being equal to the total amount of pension obligations.
The city’s enormous debt is a result of years of financial mismanagement, and the pension system’s role in the problem is clearly massive.
Employer contribution rates, the amounts that the employer needs to contribute annually to the pension plan, have, on the other hand, increased by 25 percentage points for NYCERS, reaching 26 percent of payroll and by a whopping 34 percentage points for TRS, reaching 44 percent of payroll. This means that for every dollar spent on NYCERS payroll, 34 cents goes toward pensions, and that number is 10 cents higher for TRS.
Pension liabilities are affecting the city today. Pension contributions make up 11 percent of the city’s total budget and consume 17 percent of the city’s tax revenues. And it’s worth remembering that in the city ranked number one in local tax burden in the United States. All the resources that could have gone toward maintaining the roads, funding schools, or even salary increases for public employees, are instead spent on pensions.
The city’s enormous debt is a result of years of financial mismanagement, and the pension system’s role in the problem is clearly massive. If no action is taken, the situation will only get worse. In order to guarantee promised benefits and ensure that pensions are not driving NYC toward bankruptcy, existing pension debt should be the number one priority for the city’s policymakers.
This article originally appeared at the Foundation for Economic Education.