Monday, January 11, 2010

Can Teacher Pensions be Fixed? Part One (Updated)

Delegate Roger Manno (D-19) has proposed an ambitious plan to fix the state’s troubled teacher pension program as well as to prevent pension liabilities from getting passed down to the counties. But his remedy is sure to provoke big questions about tax competitiveness, equity and general fund deficit solutions, as well as to possibly pit two of the state’s most powerful lobbies against each other.

Maryland’s State Retirement and Pension System (SRPS) administers five defined benefit pension systems: teachers (106,107 participants on 6/30/09), government employees (89,448), law enforcement officers (2,445), state police (1,408) and judges (297). The five systems together had $34.3 billion in assets and $51.4 billion in liabilities in FY 2009, meaning that they were unfunded by $17.1 billion. The unfunded liability increased by $6.4 billion in just one year and the system is now only 65% funded. The employees covered by these plans are mostly state workers with the notable exception of teachers and other school employees. Counties negotiate contracts with the school employees, and the promised pension benefits – which are tied by formula to county-set compensation – are paid by the state. Some state politicians – notably Senate President Mike “Big Daddy” Miller - would like to see the counties pick up at least part of the cost of the teacher pensions.

In FY 2010, the jurisdictions that most benefitted from the state’s assumption of teacher pensions were Montgomery ($150 million in state-assumed costs), Prince George’s ($114 million), Baltimore County ($86 million), Baltimore City ($74 million) and Anne Arundel ($63 million). But in per pupil terms, the biggest beneficiaries were Worcester ($1,134 per pupil), Montgomery ($1,097), Kent ($1,050), Howard ($1,048) and Somerset ($1,002). We show all of these costs below.

In the 2009 general session, the Senate President introduced a bill that would have phased in county financing of teacher pensions over four years. The bill would have imposed more than a billion dollars in costs on the counties over the first four years and more than half a billion dollars every year thereafter.

Preventing a handoff of teacher pensions is a top priority for Montgomery County. Assuming that liability would devastate the county’s already-depleted budget. County Executive Ike Leggett memorably told Miller a year ago that he was drawing “a line in the sand” over teacher pensions. Montgomery House Delegation Chair Brian Feldman backed him up, saying, “This is one area, perhaps our highest priority, to make sure there aren’t changes made to the current system.” But Miller laughed it off, chuckling, “My good friend Ike Leggett said that he’s going to draw a line in the sand… You never want to draw a line in the sand. Believe me, because I’ve had to rub out many of them in my lifetime, and I’m going to help him rub that one out as well.” Montgomery should beware, because if anyone gets the last laugh in Annapolis, it’s usually Big Daddy!

Delegate Roger Manno (D-19) is seeking to break the stalemate by proposing a bill that would keep responsibility for teacher pensions at the state level, but devote two new revenue sources to pay for them as well as the state employees pension fund: making the millionaire tax permanent and enacting combined reporting. The bill would also end “Corridor Funding,” an accounting technique that allows the state to contribute less than is needed to maintain full funding of the pension system. Corridor Funding is one of the primary reasons why the system dropped from a 98.3% funding percentage in 2001 down to 80.4% in 2007, a period of significant gains in the stock market.

The millionaire tax was actually a three-year surcharge passed in 2008 raising the income tax bracket on people making more than $1 million per year from 5.5% (which has been the state’s highest since the 2007 special session) to 6.25%. The surcharge was estimated to raise $154.6 million in FY 2009, $113.3 million in FY 2010 and $60.6 million in FY 2011. But since the number of millionaires has fallen sharply due to the recession, the tax is likely raising far less.

Combined reporting requires multi-state companies to change how they calculate income earned in a state for purposes of paying that state’s corporate income tax. It prevents the practice of allowing companies to use accounting techniques to park their income in states with low (or no) corporate income taxes, or to use REIT structures to convert business profits to tax-free dividends. The Comptroller’s Office recently estimated that the state would have collected an additional $109-170 million in tax year 2006 if combined reporting had been in place. Twenty-three states have combined reporting, but Delaware, D.C., Pennsylvania and Virginia do not.

Neither combined reporting nor any change to the pension system will move through the General Assembly this year. But Manno’s strategy of using a permanent millionaire tax and combined reporting revenues to pay for pensions raises a number of issues that will be revisited in the future. We’ll begin exploring them in Part Two.

Update: The Comptroller’s Office explains combined reporting this way:

Currently, Maryland is a separate entity state. Every legal entity that is a C-corporation files its own tax return, generally without regard to the activities or tax returns of related entities. Under combined reporting, all members of a unitary group are generally treated as one entity for tax purposes. A unitary group is that group of corporations whose business activities are interdependent. Typically, some combination of centralized control, economies of scale and a flow of goods, resources or services demonstrating functional integration are used to determine whether a collection of entities is a unitary group. In addition, distortions caused by intercompany transactions are eliminated.