Wednesday, June 27, 2012

What catering to public employee unions has wrought

The city of Stockton, California is on the verge of declaring bankruptcy. If it does, it would be the largest U.S. city to do so. Why this happening is quite instructive. The fault lies not in the economy, but in the employee benefits that the city is on the hook for to its retired workers.
The city has a little over $300 million in general-fund backed debt, but an $800 million unfunded liability for pensions and retiree health benefits.

The latter, which are not pre-funded, are expected to grow by 7.5% annually for the foreseeable future. Pension costs are about 40% of what the city pays on worker salaries and are also growing. The average firefighter costs the city about $157,000 a year in pay and benefits and can retire at age 50 with a pension equal to 90% of his highest year's salary plus nearly free lifetime health benefits.
Well, a city can't go on paying those sorts of benefits to retired workers for very long and stay solvent. Something has got to give and that something has been current expenses.
The city has laid off a quarter of its police officers, 30% of its firefighters and 43% of general city staff to pay for these generous benefits. Yet the city still faces a $26 million deficit on a $180 million budget. Soaring retirement costs mean that the gap will grow even if the city's housing crisis ebbs and revenues begin to recover. You can't build a city on debt and retirement checks.
The unions have made a few concessions for current workers. But the options for the city are few. They can cut pensions for new hires, but it is going to be very difficult to cut pension benefits for the rest of the employees unless the unions agree. Otherwise, they'll have a momentous legal battle which will soak up scarce municipal funds.
Mr. Deis, the city manager, has said he won't try to modify pensions even in bankruptcy because of the cost of litigation. The California Public Employees' Retirement System pushed back hard when some on Vallejo's city council suggested restructuring current worker pensions in bankruptcy court a few years ago. That California city instead cut payments to bondholders, modified pensions for new hires, and scaled back retiree health benefits. Stockton is likely to do something similar.

But perhaps a better model for Stockton and other insolvent cities is Providence. Rhode Island's capital city earlier this year faced a roughly $30 million structural deficit, $900 million unfunded pension liability and a shrinking tax base. Its city council—all Democrats—averted bankruptcy by voting to cap pension benefits at 150% of the median household income and suspending retiree cost-of-living increases. City workers and retirees overwhelmingly backed the deal.

Providence heeded the canary in nearby Central Falls, which declared bankruptcy last year after workers and retirees refused to renegotiate their retirement benefits. Their pensions were cut by half in bankruptcy. Central Falls provided an instructive lesson in the high costs of delaying reform for Rhode Island's government workers and lawmakers.
There are lessons to be learned here. But politicians who were put in office by the unions aren't going to be learning those lessons any time soon. And if unions insist on getting their pounds of flesh and refuse to allow substantive reforms in their current pensions, more and more cities will be facing Stockton's dire choices.