Wednesday, January 13, 2010

Can Teacher Pensions be Fixed? Part Three

Delegate Roger Manno (D-19) has proposed a bill to use revenues from a permanent millionaire tax and combined reporting to support the state’s beleaguered teacher and employee pension funds. Yesterday, we looked at whether those revenues would suffice and whether the state would suffer a competitive hit from new business taxes. Today we’ll examine a few more questions.

3. What happens to the General Fund?

Maryland’s General Fund is in big trouble. The last fiscal update projects General Fund deficits of $2 billion or more through FY 2015, with no estimate of what could be some ugly out years. We predict that the General Assembly will continue to use band-aids on the budget in 2010, but come back for a big tax hike in 2011. Manno’s plan would interfere in that effort in two ways.

First, Manno would get rid of the “Corridor Funding” method used by the state to calculate its required annual pension fund contributions. The State Retirement and Pension System (SRPS) described Corridor Funding this way in its 2009 Financial Report.

In the 2001 legislative session, the Legislature changed the method used to fund the two largest Systems of the MD SRPS: the Teachers Combined System and the State portion of the Employees Combined System to a corridor method. Under this funding approach, the State appropriation is fixed at the June 30, 2000 valuation rate as long as the actuarial funded status of these Systems remains in a corridor of 90% funded to 110% funded. Once the ratio falls outside this corridor, the appropriated rate will be adjusted one-fifth of the way toward the underlying actuarially calculated rate…

Under the present circumstances, the corridor method results in contributions that are less than those determined actuarially. We recommend a return to full actuarial funding at the earliest possible time.
Corridor Funding has been a disaster for employee pensions because it has allowed the state to systematically lowball its contributions. Prior to its adoption, the pension system had a 98.3% funding ratio in FY 2001. By FY 2007, the funding ratio had fallen to 80.4%. Bear in mind that the Standard & Poor’s 500 Index rose by 20% over this period, so the state lost a golden opportunity to capitalize on the stock market. Because of the continuous underfunding created by Corridor Funding, SRPS estimates that the state’s FY 2011 contributions will be 30% less than justified by actuarial requirements.

Manno’s junking of Corridor Funding means that the state would be paying more to adequately fund its pension promises. But that means the money will not be available to pay off the General Fund deficit.

Second, if the Lords of Annapolis do go for a big tax hike in 2011, a permanent millionaire tax and combined reporting could very well be part of the package. The state needs those revenues for its General Fund, but Manno would dedicate them to pensions. If something like Manno’s proposal passes, the state would have to look elsewhere for tax increases.

4. How do tax options compare between the state and the counties?

Advocates for passing down teacher pensions to the counties argue that they have an unsustainable impact on the state budget. But we won’t let them masquerade as fiscal conservatives, because if they do go to the counties, those jurisdictions will inevitably raise their own taxes to pay for their new costs. Cutting benefits is probably not an option given the fact that the state recently hiked teacher pension benefits – a measure signed by Republican Governor Bob Ehrlich. In any event, no one is talking about giving the counties any input over benefit levels.

What tax options are available to the counties? A recent state financial report shows that the counties derived 41% of their revenues from two sources in FY 2007: property taxes (23.7%) and income taxes (17.6%). But that is misleading because those revenues include state and federal aid. In terms of locally-generated revenues alone, property and income taxes accounted for 62.3% of county receipts.

The distinguishing characteristic of both of these revenues is that they are broad-based. Property tax rates are not allowed to vary between residential and commercial properties. County income taxes use flat rates that cannot exceed a maximum rate of 3.2%. Three counties – Montgomery, Prince George’s and Howard – are already at that cap. Seven more jurisdictions - Allegany, Carroll, Harford, St. Mary’s, Somerset, Wicomico and Baltimore City – are at 3.0% or higher. That means the majority of the state’s residents live in jurisdictions that have little or no room to raise income taxes. So if pensions come down to the counties, property taxes will go up.

The state’s General Fund revenues are heavily dependent on income taxes (which accounted for 50.2% of FY 2009 revenues) and sales taxes (28.1%). But the state has much more freedom than the counties in targeting those taxes. The state can establish any income tax brackets it likes, while the counties must charge flat rates. The state can establish separate sales tax rates for many different products, including services, while the counties cannot levy general sales taxes. Our point is that if teacher pensions are sent down to the counties, they will be financed with broad-based taxes like property levies. But if teacher pensions stay at the state level, they can be financed with targeted taxes according to the whims of the General Assembly. That may be good or bad, but it is an important distinction.

5. What is in Montgomery County’s interest?

One of the arguments made against the millionaire tax was that it was bad for Montgomery County because most millionaires lived there. Combined reporting may also disproportionately target Montgomery County because it leads the state in business income. But Manno’s proposal may still be better for the county than the alternative.

Why? Montgomery benefits more in absolute terms than any other county from the state’s assumption of teacher pensions, getting a $150 million subsidy in FY 2010. Montgomery’s subsidy equaled $1,097 per pupil, trailing only Worcester County ($1,134). So using a permanent millionaire tax and combined reporting to pay for teacher pensions amounts to using Montgomery-focused revenues to pay for Montgomery-focused benefits.

The alternative is simple. The state could institute a millionaire tax and combined reporting to pay for its General Fund deficit while at the same time handing down pension costs to the counties. The pension handoff could even be wealth-adjusted, impacting Montgomery even more. This would be the equivalent of a simultaneous head shot, body punch and low blow on the Economic Engine of Maryland.

We’ll wrap this up tomorrow.