Tax Hikes Are Not Going to Fix to Cities’ Growing Pension Costs

Growing public pension costs are affecting municipalities across America.

Entering the millennium, many state and local public pension plans were fully funded and in the type of good financial shape that would enable them to provide the retirement benefits promised to employees.

However, over the last two decades, the financial conditions of many public pension systems have deteriorated. By 2019 (well before the COVID-19-related recession), the average state pension plan had fallen to 73 percent funded— meaning it has just 73 cents out of every dollar needed to pay for promised benefits.

In an effort to fill this growing funding gap, many states and cities across the country are facing larger pension payments each year. Paying for this pension debt is putting a strain on local and state budgets, requiring political leaders to decide if they want to make budget cuts to shift money to pension payments or by raise taxes to fund the necessary contributions to their pension systems.

The city of Elmhurst, Illinois, for example, is asking for a 3.5 percent increase in property taxes this year to help pay for its growing public pension bill. One city councilwoman in Elmhurst said the increase is “completely driven by another increase in pension contributions”.

But tax increases like this target the symptom rather than the cause of growing pension costs. Truly comprehensive solutions to pension debt and the strain it puts on taxpayers must address the actual causes of unfunded liabilities, such as unrealistic actuarial assumptions and risky investments. Patch’s David Giuliani reported:

“This is completely driven by another increase in pension contributions,” Alderwoman Noel Talluto, chairwoman of the city’s finance committee, told the City Council on Monday.

She said the tax levy proposal recognizes and balances opposing pressures.

“An upward pressure continues to be felt through increasing pension payments, primarily the police and fire pensions,” Talluto said. “The other opposing pressure is our desire to keep taxes low and reasonable for the taxpayers of Elmhurst, especially given the hardships placed on residents and property owners due to the COVID pandemic.”

Even so, calls for raising taxes to pay for growing public pension costs have been widespread in recent years. Reason Foundation’s 2018 analysis of tax hikes in California cities found that many, while purportedly for general services, were used to finance rising pension costs in the cities’ general funds.

Similarly, Bond Buyer noted that numerous cities are passing tax increases that are supposedly for public works projects. Santa Ana, for example, passed a sales tax increase of 1.5 percent in 2018 that the city said would “the city says would go towards police and fire, addressing homelessness, fixing streets, maintaining parks and other general expenditures.” But the city knows its pension costs are problematic and will continue to grow over the next five years. Bond Buyer’s Imran Ghori writes:

The local governments in many cases say the new revenues are needed to pay for city services such as public safety, roads and other general services. But the tax increases also come at a time when they’re facing increasing pension costs that are contributing significantly to budget shortfalls…

The tax increase would bring an additional $60 million a year into city coffers through 2029. After that, the tax rate would go down .5% and provide $40 million a year.

One of the biggest cost increases the city is facing is for pension contributions which are anticipated to go up an average of 13.7% a year from $45.1 million in 2017-2018 to $81.2 million by 2022-2023, according to a February report to the City Council.

Santa Ana’s contributions to the California Public Employees’ Retirement System made up 14% of its budget, the report said.

Although the city will face higher pension costs, it’s not included among the expenditures that city officials have highlighted in the information on the measure.

This growing trend affects both small and large municipalities.

For example, Chicago’s pension costs have been causing the city financial distress for decades. Almost half of the city’s newest tax hike, which is expected to raise an additional $93.9 million each year, is earmarked to go directly toward its public pension payments.

Without tax hikes or any other type of additional funding, cities with growing pension debt are going to have to allocate a greater portion of their budgets to pay required pension contributions. Such actions take money away from other government services, including public safety and road repairs.

In the town of Normal, Illinois, councilmembers made the fiscally prudent decision to move its pension systems towards the goal of being 90 percent funded by the year 2040. However, this meant $1 million would be cut from the town’s operations fund each year—roughly 1.5 percent of its total budget—and would be reallocated instead to police and fire pension obligations.

In the village of Brookfield, Illinois, pension costs grew have grown about $285,000 year-over-year for the past decade. This meant that of a recent $9 million tax levy nearly three-quarters went towards the village’s police and fire pension obligations.

While this additional funding is often necessary, tax increases and influxes of cash are not enough. Nationally, there’s over $1.2 trillion in public pension debt. Tax increases will not solve the long-term problems these systems are facing because they don’t fix the underlying issues that caused, and will continue to cause, unfunded pension liabilities to grow.

If local governments don’t address the root causes of their public pension problems, the pension plans will likely continue to be exposed to an increasingly volatile and low-yield market, leading to more pension debt.

Some of the unfunded liabilities many public pension systems face are due to the “new normal” low-interest-rate investment environment and overly optimistic investment return assumptions. To combat this reality, policymakers must lower their assumed rates of return to more realistic figures, avoid taking on unnecessary risk in their investment portfolios, and guarantee that they’re paying their actuarially-determined contributions to their pension plans.

These pension reforms will raise the cost of financing public pensions in the short-run but will reduce aggregate costs in the long-run while also reducing the risk of added unanticipated costs.

Implementing more effective and comprehensive retirement policies would prevent pension debt from being pushed onto the next generation. After all, most citizens expect their tax dollars to go towards paying for today’s public services, not to make payments on past debts that political leaders failed to properly fund.

Update: It has come to our attention that the city of Elmhurst has taken notable steps to address pension underfunding in recent years. The city has lowered the pension plan’s investment return assumptions, which has led to higher pension costs in the short term but will lower long term expenses for taxpayers. In addition, Elmhurst continues to pay full actuarially determined contributions and is on track to be fully funded by 2036, nine years ahead of Illinois’ goal for the state’s municipal pension plans