Interest is growing in Annapolis in sending teacher pensions down to the counties. Manno’s bill offers a way out. But we are very cautious about predicting a happy end to this problem. Here’s why.
1. Target MoCo.
Is there anything easier to do in Annapolis than target MoCo? Our delegation has just two Committee Chairs and is packed with freshmen. Our County Executive does not have nearly the sway in the state’s capital that his predecessor had. And the county receives NO sympathy from any other part of the state. “You guys come across as a bunch of whiners,” says one high-ranking Annapolis source. The ICC is the one MoCo project that will be subsidized by the rest of the state through toll revenue transfers, and boy are they howling about it. Who cares when we howl about paying billions for Baltimore’s broken and convict-headed city government?
The only chance our delegation has at preventing a pension handoff is to emphasize its disastrous effects on the rest of the state. Here are the top ten beneficiaries of the subsidy in per-pupil terms in FY 2010.
1. Worcester: $1,134
2. Montgomery: $1,097
3. Kent: $1,050
4. Howard: $1,048
5. Somerset: $1,002
6. Baltimore City: $969
7. Prince George’s: $943
8. Allegany: $936
9. Garrett: $918
10. Calvert: $909
State Average: $931
2. Opposition from the business community.
Even if you are a tool-wielding proletarian, you should have sympathy for Maryland’s besieged business community. They have been clobbered again and again in Annapolis. The 2007 special session raised the top income tax rates, raised the corporate income tax and brought the hated computer tax. In 2008, the computer tax was replaced by the millionaire tax. Later that same year, transportation spending was slashed and the state’s tax competitiveness ranking dropped from 24th to 45th. And now there is talk of combined reporting and a permanent millionaire tax. Do the business lobbyists get paid enough to put up with all this?
Manno’s bill would stick the business community with the tab for teacher pensions. Business will reply, “It’s not our fault. The state screwed up its pension funds, not us. And you guys supposedly want to create more jobs, but where are they going to come from with new taxes?” One of our spies in the business community comments acidly, “I think they believe there is a jobs fairy.”
If the state employee unions get on board with Manno’s idea, there will be a titanic lobbying battle pitting labor against business. But it may not come to that. If the General Assembly decides to keep teacher pensions at the state level, they will choose the path of least resistance to finance them. Business will fight hard and perhaps avoid the guillotine, though some business taxes will surely pass. The ultimate targets will be the ones who are least aware of what is going on. As House Majority Leader Kumar Barve once told us, “In politics, when something unpleasant has to be done, it’s usually done to whoever squirms around the least!”
3. The chaotic nature of legislation.
In his comment above, Barve was referring to the genesis of the 2007 special session’s computer tax. The special session is not a desirable model for the inevitable 2011 deficit reduction package, but it is a very likely predictor of what will happen next time. Just as in 2007, the Governor’s staff will prepare a plan. Unlike in 2007, the Governor will not travel the state to sell it because no one talks about tax increases when running for re-election. In 2011, lots of freshmen will be serving in their first session. They will have no idea what is going on and will be easy prey for leadership and bureaucrats. Then the lobbyists will swarm in, ideas will be discarded as soon as they are created and chaos will ensue. The final result will bear no resemblance to sound public policy, but will be the easiest “fix” that can get to the Governor’s desk. We find nothing encouraging in such a scenario, but that is the way of Annapolis.
Manno’s bill is a sincere and intellectually honest effort to remedy the problems of the state’s pension system – problems which the state largely brought upon itself. Those who oppose his bill must either identify alternate revenues to pay for pensions or admit that county taxpayers will be on the hook when they are passed down. For us, honesty counts in government. Let’s see how much of it can be found outside Roger Manno’s office door.
Thursday, January 14, 2010
Can Teacher Pensions be Fixed? Part Four
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…
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.
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.
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.
Tuesday, January 12, 2010
Can Teacher Pensions be Fixed? Part Two
Delegate Roger Manno (D-19) has introduced a bill that would keep teacher pensions at the state level, but pay for them with an extension of the millionaire tax and combined reporting for corporations. That strategy creates a cascade of budgetary and economic questions that goes far beyond the pension system itself. We’ll begin asking those questions today.
1. Are the millionaire tax and combined reporting enough to pay for pension cost increases?
The state’s October Spending Affordability Briefing reports that to maintain solvency of the teacher pension fund, the state must increase its contribution from $676 million in FY 2009 to $928 million in FY 2011 – a $252 million increase in just two years. The employee pension fund, which would also benefit from the new revenues recommended by Manno, must have its contributions increased from $258 million in FY 2009 to $393 million in FY 2011 – a $138 million increase. The briefing is silent on additional increases in the out years, but they are sure to be substantial.
Manno’s bill has no fiscal note yet, so we will have to rely on other sources to calculate the additional revenues raised by a millionaire tax extension and combined reporting. The millionaire tax, which in its current form is actually a three-year surcharge starting in Tax Year 2008, was estimated to raise a peak annual amount of $154.6 million in FY 2009 with declining amounts thereafter. The drop in the number of Free State millionaires, caused almost entirely by the recession, suggests that the tax raised substantially less than projected. And while only about 2% of the state’s millionaires have moved out because of the surcharge, many more could leave – and many more could never move in – if the tax was made permanent. However much a permanent tax might collect, what is clear is that it is a VERY volatile source of revenue. And the pension system needs a reliable and increasing source of contributions.
As for combined reporting, 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. But the Maryland Chamber of Commerce noted:Tax year 2006 represented the highest level of corporate income taxes ever collected by the state ($868 million) during a robust economy. What would be the impact of combined reporting during the current recession when millions in tax losses could be imported into the state from out of state entities?
Moreover, if combined reporting did raise a large amount of money soon after its enactment, business would not sit still and simply absorb the losses. It makes sense that at least some of them would restructure their operations to adapt to combined reporting and minimize their tax liabilities. Some who could not sufficiently adapt might move out. So combined reporting could collect less over time. Further, corporate income is almost as volatile as top-level income tax revenue, generating more questions about contribution volatility in the pension system.
Based on the above, we believe that a permanent millionaire tax and combined reporting together could well generate tens, or perhaps even a hundred million dollars or more per year. But their tendency to experience huge swings with the business cycle suggests that more stable revenues need to be found to augment them to keep the pension system’s funding ratio from swinging like a pendulum.
2. What about the state’s tax competitiveness?
In considering any new taxes on business or the wealthy, policy makers must consider the consequences for the state’s ability to retain and attract jobs. Maryland could use some help on that score. From 1998 to 2008, Maryland added 272,600 jobs, an 11.7% growth rate, according to the Bureau of Labor Statistics. Over the same period, Virginia added 437,500 jobs, a 13.2% growth rate and D.C. added 91,300 jobs, a 14.9% growth rate. Maryland’s seasonally adjusted employment in October was 2,533,700, a decline of 3.1% from its all-time high of 2,616,000 in February 2008. Maryland’s seasonally adjusted unemployment rate has exceeded 7.0% for seven months starting in May 2009, the first time that has happened since 1983.
The 2007 special session’s tax increases for high income earners and corporations caused Maryland’s tax competitiveness to fall from 24th to 45th among U.S. states according to the Tax Foundation. Maryland remains at 45th in their latest survey. The principal reason for Maryland’s low ranking is its top income tax rate, which the Tax Foundation believes discourages entrepreneurship. Here’s how Maryland’s top rate compares to neighboring states.
Pennsylvania: 3.07% flat rate
Virginia: 5.75% over $17,000
Maryland: 6.25% over $1 million
West Virginia: 6.5% over $60,000
Delaware: 6.95% over $60,000
District of Columbia: 8.5% over $40,000
D.C.’s rate is not a fair comparison since the District government performs the functions of both a state and a local government.
Take away Maryland’s millionaire tax and it performs slightly better against Virginia. While Virginia charges 5.75% on income over $17,000, Maryland charges 4.75% on income between $3,000 and $150,000 and rates varying from 5% to 5.5% after that. But Virginia does not allow its counties to levy income taxes. Maryland does, and its counties can charge up to 3.2% as a flat income tax rate.
Here’s how taxes compare across several jurisdictions in the Washington D.C. area.
Like it or not, Maryland is in tight competition with Virginia and other surrounding states for jobs. Will retention of the millionaire tax have an employment cost over the long run? Furthermore, Delaware, Pennsylvania and Virginia do not have combined reporting. If Maryland enacts it, will those states get a competitive advantage?
We do not have the answers to these questions yet. But they should be answered before Maryland considers imposing a permanent millionaire tax or combined reporting. The latter issue is one of many now being examined by a commission established during the special session.
We’ll look at some more questions tomorrow.
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.
