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What Seattle's income tax fight says about our America's pension mess

Tue, 22 Aug 2017 15:15:00 -0400

The city of Seattle is in a battle with residents over a controversial new income tax, and the spat says something significant about America’s public sector pension crisis.

Lawsuits filed by several groups against the city contend that the 2.25 per cent tax, passed in July by the city council, violates the constitution of Washington state—one of only seven states without a levy on incomes. Seattle officials, who say they need the tax to fund a range of programs, argue that the tax is legal.

Although the case is being portrayed in the media as a legal face-off, one underlying but rarely mentioned factor in Seattle’s search for more revenues is the city’s huge pension bill. Seattle’s retirement system, like those of many local governments, is woefully underfunded, and the added cost of trying to fix the system will consume big chunks of the city’s tax revenues in coming years, squeezing the budget.

That’s a reminder that these days, when we see local battles over tax increases, the growing cost of pensions is a key factor-- even when pensions aren’t explicitly mentioned.

Although Seattle’s budget has grown since 2012 from $4.2 billion to $5.3 billion, city leaders say they need even more revenue. And they want that money from the city’s higher income residents. Seattle’s new income tax, which is aimed at those earning $250,000 a year or more, would provide additional revenues for expanding homeless services, building more affordable housing, creating, “green” jobs, and reducing the city’s carbon emissions. Budget officials estimate that after administrative costs the tax would net the city about $130 million annually.

But looking over Seattle’s pension woes, what’s striking is how much tax money the underfunded system is already gobbling up, and how much more it will require. Like many cities and states, Seattle guaranteed its workers generous pensions based on optimistic assumptions that have proved faulty.

The stock market crash that began in late 2007 devastated the retirement system, robbing it of hundreds of millions of dollars in assets. Its debt subsequently soared from $175 million in 2008 to more than $1 billion two years later. Despite a 9-year bull market, the retirement system’s funding level has failed to rise significantly, and today it has only 68 percent of the money that it has promised to workers.

A study earlier this year by Stanford University finance professor Joshua Rauh ranked Seattle as having the ninth worst funded system among the nation’s 40 largest cities. Though Seattle says that today it owes about $1.2 billion, Rauh says the bill could be as high as $3.2 billion.

A decade ago Seattle contributed about $40 million a year to pensions, but the city has been forced to increase the amount over time and this year put $108 million into the system. And that tab will keep growing.

According to the retirement system’s own documents, over the next 10 years, just the cost of paying off the pension debt will consume about $850 million in city revenues. That’s in addition to $570 million that the city will also spend to finance new pension credits that workers will be earning.

Even that won’t be enough. Based on the city’s own calculations it will take Seattle until 2042 to retire its current pension debt. And that is contingent on the pension system achieving an annual average investment return of 7.5 percent with the money it already has. If the retirement system fails to hit that number, the cost of fully funding the system will rise even higher.

In other words, the price tag for fixing Seattle’s pension system will grow so rapidly that it may soon be consuming much of the proposed new tax increase—if it ever goes into effect. The money spent on paying off that debt represents resources that could have funded a whole menu of worthwhile services or programs and could have made much of the wealth tax that Seattle is now trying to institute unnecessary.

What’s really troubling is that Seattle is not alone. On average, our state pension systems are only about 73 percent funded, even after a long bull market. Many of our largest cities are similarly underfunded.

As a result, states and cities are spending tens of billions of dollars every year in taxpayer money just to pay off this debt, and will have to continue doing so for years to come. That money is disappearing into pension systems at a time when our local governments are also struggling to find revenue to invest in roads and bridges, in schools, and to respond to crises like the opioid epidemic.

That’s why these days when you hear debates about the need to raise taxes and you wonder where the money is all going, remember the local government pension crisis.

What the rise of Republican governors tells us about the GOP's future

Thu, 02 May 2013 07:00:06 -0400

Editor's note: This article is adapted from the Spring 2013 issue of City Journal.

Shortly after Barack Obama won reelection in November, New Jersey Governor Chris Christie pointed out that Republicans’ cloudy political prospects had a bright silver lining. “One of the reasons you have 30 Republican governors in America, and why we’re the only organization to add Republican strength,” Christie said, “is because people see us getting things done.”

Christie’s stance countered most of the elite postelection commentary, which gleefully pronounced the Republican Party’s political irrelevance. But the governor was right.

Since Obama first took office in 2008, Republicans have picked up a net nine governorships, bringing their total to 30 states, which hold nearly 184 million Americans. In 24 of those states, containing 157 million Americans, Republicans also control the legislatures.

Democrats boast similar power in just 12 states, with a population of 100 million. Even Republicans’ unimpressive national showing last November didn’t reverse their state-level momentum.

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The next-wave Republican governors have ignored proclamations that President Obama’s victories have vaporized fiscal conservatism and opened a new era of American big government.

At a time when Washington policymakers seem paralyzed by our toughest problems, these state-level revolutionaries have restrained government growth and radically reformed local tax codes.

They’ve made their states friendlier to business, reshaped government-employee pension systems to reduce state debt, and restrained the power of public-sector unions over state and local budgets. Some have even proposed eliminating income and corporate taxes.

Christie, whose stock has risen in New Jersey as he heads into a reelection battle this year, believes that the next national leadership of the Republican Party will emerge from the ranks of its effective governors. “I don’t think this is a core philosophical examination we have to go through,” he has observed. “What this is about is doing our jobs.”

Few observers predicted this Republican resurgence back in 2008, when elections not only handed the Democrats the White House and Congress but also cemented their control of 29 governors’ mansions.

Even as the country seemed to lurch leftward, however, state voters began to revolt against Democratic governors’ tax increases.

In 2009, Christie defeated Democratic incumbent Jon Corzine with a platform that rejected new taxes. Over the previous eight years, Corzine and his Democratic predecessor Jim McGreevey had raised taxes by more than $5 billion.

McGreevey boosted taxes and fees $3.6 billion between 2002 and 2004 alone, raising everything from income taxes to levies on home sales. Corzine followed in 2006 with his own $1.1 billion sales-tax hike.

Three years later, he slapped a temporary income-tax surcharge on households making more than $400,000 a year, part of another proposed $1 billion in new taxes. But actual tax collections imploded, leaving Christie with a $4 billion budget deficit when he took office in 2010.

Christie ran enormous political risks in trying to shrink that deficit. Despite discontent over the high taxes, polls showed that voters wanted higher levies on the rich, so that the state could continue a popular program of property-tax rebates for homeowners. And though the voters favored winning concessions from government workers, they also wanted the state to keep subsidizing public schools richly.

Christie disagreed. He chose not to renew the surcharge on high earners and slashed aid to municipalities. He also reduced the property-tax rebates; after all, property taxes are imposed by localities, so the rebates amounted to a state subsidy that let cities and towns avoid making tough budget decisions.

When homeowners complained, Christie urged them to vote against the expensive municipal and school budgets that were driving their ever-rising property taxes. Voters responded, defeating nearly 60 percent of the school budgets proposed in 2010. Christie’s reforms slashed state spending by nearly 9 percent and balanced the state budget without new taxes.

Christie then pressed the legislature to pass reforms that restrained municipal spending, including a cap on annual property-tax increases.

He also signed off on roughly $347 million in business tax cuts, though he has yet to find the revenues to make good on his pledge to lower Jersey’s income tax. Christie’s favorability rating was just 44 percent after his first budget passed, but as Jerseyans watched his strategy play out, his popularity grew.

Even before his effective and sympathetic response to Superstorm Sandy, more than 50 percent of voters approved of the job he was doing; since then, his popularity has soared.

“Despite the challenges that Sandy presents for our economy, I will not let New Jersey go back to our old ways of wasteful spending and rising taxes,” Christie recently announced. “We will deal with our problems, but we will continue to do so by protecting the hard-earned money of all New Jerseyans first and foremost.”

A year after Christie’s victory came the 2010 elections, when 26 governorships were up for grabs. Republicans wrested 11 of them from Democrats and lost only five, an impressive tally.

Perhaps the most ambitious of the 2010 crop of reform governors is Michigan’s Rick Snyder, a former venture capitalist with no previous experience in office.

Snyder initially received less national attention than Christie or Wisconsin’s Scott Walker, whose battle with government unions grabbed headlines throughout 2011.

Perhaps Snyder’s post-partisan image was what kept him off the national press’s radar for so long: he ran as a wonk who would use his business acumen to fix the state’s finances.

In his first budget, Snyder sought to close a $1.5 billion deficit while pushing—successfully, as it turned out—to get rid of the hated Michigan Business Tax.

The MBT didn’t just tax businesses’ profits, as most corporate taxes do; it taxed their revenues as well, meaning that firms had to pay even when they weren’t making money.

Politicians and policy experts in Michigan had long acknowledged that the MBT was one of the nation’s worst corporate taxes and that it drove away business. But it brought the state $1.7 billion in yearly revenue that no previous governor had wanted to forgo.

Snyder’s tax-reform plan was audacious. To make up for the lost MBT revenues, he proposed a flat corporate levy; jettisoning $400 million in targeted corporate tax credits, which had tried to keep particular companies in the state; and (most controversially) taxing the pensions of all Michigan residents.

Michigan, Snyder observed, was one of only three states that exempted pensions from income tax. The anomaly had originated in the mid-sixties, when state pols and public-sector unions reached a deal to exclude government pensions from taxes and public anger over the favoritism led to a broadened exemption.

Snyder’s call to tax pensions understandably upset retirees and government-worker groups, who threatened to try to recall the governor. But he persisted, and the recall idea fizzled.

The Michigan legislature eventually agreed with him and reshaped the state’s tax code. The new arrangement moved Michigan’s corporate levy from next-to-worst in the Tax Foundation’s national rankings to 18th best. “The Wicked Witch is done,” Snyder said.

Nor was that the end of Snyder’s reform drive. Last year, he lowered Michigan’s personal income-tax rate. And now he’s seeking to eliminate the state’s so-called personal property tax, which is actually an outdated tax on business equipment. Snyder’s changes are “unshackling the state from its obsolete economic past and positioning it for new prosperity,” noted the Detroit News.

In Kansas, meanwhile, Governor Sam Brownback is pushing to extend a tax-reform program. Brownback roared into office in 2011 proposing to lower income-tax rates and to regain the lost revenue by capping some popular tax expenditures, like the mortgage-interest deduction.

Republicans in the state legislature, balking at ending the popular items, passed a tax-cut package without them, lowering the state’s income-tax rate from 6.45 percent to 4.9 percent.

“The governor said early on… ‘Go bold.’ And we did,” said Mike O’Neal, Speaker of the Kansas House of Representatives. Brownback paid for the tax cut in part by keeping state spending flat and by using increased revenues from a modest upturn in the state economy. He’s now hoping to end enough tax-code deductions and loopholes to save Kansas more than $1 billion in revenue.

States are laboratories of democracy, in Justice Louis Brandeis’s famous formulation, and the very different experiments that their Republican and Democratic governors conduct over the next few years—especially on issues that go to the heart of economic competitiveness—will be eye-opening.

In the months since President Obama’s reelection, it’s becoming clear that the Republican governors plan to lead in ways consistent with the reform agendas that got them elected. How they fare may steer the Republican Party’s course more decisively than any soul-searching in Washington does.

The beholden state – how government unions have doomed California taxpayers

Tue, 09 Jul 2013 12:00:00 -0400

Editor's note: The following opinion article is adapted from the new City Journal book, "The Beholden State: California's Lost Promise and How To Recapture It" (Rowman & Littlefield, 2013).

The camera focuses on an official of the Service Employees International Union (SEIU), California’s largest public-employee union, sitting in a legislative chamber and speaking into a microphone. “We helped to get you into office, and we got a good memory,” she says matter-of-factly to the elected officials outside the shot. “Come November, if you don’t back our program, we’ll get you out of office.’

The video has become a sensation among California taxpayer groups for its vivid depiction of the audacious power that public-sector unions wield in their state. The unions’ political triumphs have molded a California in which government workers thrive at the expense of a struggling private sector. The state’s public school teachers are the highest-paid in the nation. Its prison guards can easily earn six-figure salaries.

Meanwhile, what was once the most prosperous state now suffers from an unemployment rate far steeper than the nation’s and a flood of firms and jobs escaping high taxes and stifling regulations. This toxic combination—high public-sector employee costs and sagging economic fortunes—has produced recurring budget crises around the state.

How public employees became members of the elite class in a declining California offers a cautionary tale to the rest of the country, where the same process is happening in slower motion.

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California’s government workers took longer than many of their counterparts to win the right to bargain collectively. In 1968, the state legislature passed the Meyers-Milias-Brown Act, extending bargaining rights to local government workers. Teachers and other state employees won the same rights in the seventies.

These legislative victories happened at a time of surging prosperity which in turn led to rapid growth in government jobs—from a mere 874,000 in 1960 to 1.76 million by 1980 and nearly 2.1 million in 1990—and to exploding public-union membership. In the late 1970s, the California teachers’ union boasted about 170,000 members; that number jumped to about 225,000 in the early 1990s and stands at well over 320,000 today.

The swelling government payroll made many California taxpayers uneasy, eventually encouraging the 1978 passage of Proposition 13, the famous initiative that capped property-tax hikes.

Government workers rightly saw Prop. 13 as a threat. “We’re not going to just lie back and take it,” a California labor leader told the Washington Post after the vote, adding that Prop. 13 had made the union “more militant.”

The next several years proved him right. In 1980 alone, unionized employees of California local governments went on strike 40 times.

Aware that Proposition 13 had shifted political action to the state capital, three major blocs—teachers’ unions, public-safety unions, and the Service Employees International Union, which now represents 350,000 assorted government workers—began amassing colossal power in Sacramento.

Over the last 30 years, they have become elite political givers and the state’s most powerful lobbying factions, replacing traditional interest groups and changing the balance of power.

Today, they vie for the title of mightiest political force in California.

Consider the California Teachers Association. Much of the CTA’s clout derives from the fact that, like all government unions, it can help elect the very politicians who negotiate and approve its members’ salaries and benefits.

Soon after Proposition 13 became law, the union launched a coordinated statewide effort to support friendly candidates in school-board races, in which turnout is frequently low and special interests can have a disproportionate influence.

In often bitter campaigns, union-backed candidates began sweeping out independent board members.

By 1987, even conservative-leaning Orange County saw 83 percent of board seats up for grabs going to union-backed candidates. The resulting change in school-board composition made the boards close allies of the CTA.

But with union dues somewhere north of $1,000 per member and hundreds of thousands of members, the CTA can afford to be a player not just in local elections but in Sacramento, too.

The CTA entered the big time in 1988, when it almost single-handedly led a statewide push to pass Proposition 98, an initiative—opposed by taxpayer groups and Governor George Deukmejian—that required 40 percent of the state’s budget to fund local education.

To drum up sympathy, the CTA ran controversial ads featuring students; in one, a first-grader stares somberly into the camera and says, “Pay attention—today’s lesson is about the school funding initiative.”

Victory brought local schools some $450 million a year in new funding, much of it discretionary. Unsurprisingly, the union-backed school boards often used the extra cash to fatten teachers’ salaries—one reason that California’s teachers are the country’s highest-paid, even though the state’s total spending per student is only slightly higher than the national average.

With its growing financial strength, the CTA gained the ability to shape public opinion. In 1996, for instance, the union—casting covetous eyes on surplus tax revenues from the state’s economic boom—spent $1 million on an ad campaign advocating smaller classes.

Californians began seeing the state’s classrooms as overcrowded, according to polls. So Governor Pete Wilson earmarked some three-quarters of a billion dollars annually to cut class sizes in kindergarten through third grade.

The move produced no discernible improvements in student performance, but it did require a hiring spree that inflated CTA rolls and produced a teacher shortage.

During this contentious period, the CTA and its local affiliates learned to play hardball, frequently shutting down classes with strikes. The state estimated that in 1989 alone, these strikes cost California students collectively some 7.2 million classroom days.

Los Angeles teachers provoked outrage that year by reportedly urging their students to support them by skipping school. After journalist Debra Saunders noted in L.A.’s Daily News that the striking teachers were already well paid, the union published her home phone number in its newsletter and urged members to call her.

Four years later, the CTA reached new heights of aggressiveness after a business-backed group began a petition to place a school-choice initiative on the state ballot.

In a union-backed effort, teachers shadowed signature gatherers in shopping malls and aggressively dissuaded people from signing up.

The tactic led to more than 40 confrontations and protests of harassment by signature gatherers. The CTA’s top official later justified the bullying: some ideas “are so evil that they should never even be presented to the voters,” he said.

Armed with knowledge about the state’s powerful public-union heavyweights, one can start to understand how the state found itself in its nightmarish fiscal situation.

The problems grew intense starting after the 1998 gubernatorial election, in which the unions bet their future—and millions of dollars in members’ dues—on Gray Davis.

The candidate traveled to the SEIU’s headquarters to remind it of his support during earlier battles against GOP governors; the union responded by pumping $600,000 into his campaign.

Declaring himself the “education candidate” who would expand funding of public education, Davis received $1.2 million from the CTA.

Davis’s subsequent victory was followed by a series of breathtaking deals that left California state and municipal governments careening from one budget crisis to another for the next decade.

Perhaps the most costly was far-reaching 1999 legislation that wildly increased pension benefits for state employees.

It included an unprecedented retroactive cost-of-living adjustment for the already retired and a phaseout of a cheaper pension plan that Governor Wilson had instituted in 1991. The deal also granted public-safety workers the right to retire at 50 with 90 percent of their salaries.

When the stock market slid in 2000, state and local governments got slammed with enormous bills for pension benefits. The state’s annual share, estimated by CalPERS back in 1999 to be only a few hundred million dollars, reached $3 billion by 2010. Counties and municipalities were no better off.

Municipalities around the state are also buckling under massive labor costs. Contra Costa’s pension costs rose from $70 million in 2000 to $200 million by the end of the decade, producing a budget crisis.

Los Angeles, where payroll constitutes nearly half the city’s $7 billion budget, faces shortfalls projected to grow to $1 billion annually in several years.

In October 2007, even as it was clear that the area’s housing economy was crashing, city officials had handed out 23 percent raises over a five-year period to workers.

In the past, California could always rely on a rebounding economy to save it from its budgetary excesses. But the current California rebound is limited to areas like Silicon Valley and global centers like San Francisco.

By contrast, metropolitan regions throughout areas like the Inland Empire and Central Valley lag far behind the national recovery. In fact, 11 of the 27 metro areas in the country with double-digit employment rates as of last month are in California.

It will take an enormous effort to roll back decades of political and economic gains by government unions. But the status quo is expensive and ultimately unsustainable.

Driving America off a cliff: Obama and the refueling of the Highway Trust Fund

Wed, 09 Jul 2014 11:07:35 -0400

During the 2011 debate over President Obama’s American Jobs Act, which sought to subsidize local government jobs with hundreds of billions of federal tax dollars, Vice President Biden suggested that without Washington’s aid cities would sharply reduce police protection and violent crime would soar. Republicans killed the expensive bill anyway, and no such rise in crime occurred.

Now, in what has become a familiar pattern, the Obama administration is again warning of steep consequences, this time if Republicans in Congress fail to raise billions of dollars in new taxes to bolster the federal Highway Trust Fund. Transportation Secretary Anthony Foxx even claims that without the money, America will become “a slower, less safe nation."

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But if the Obama administration were truly worried about road safety, then it would put a greater priority on reforming the bloated highway financing program to be more effective with the money Washington already spends on everything from mass transit to urban bike paths to overpriced union labor.

The trust fund, which receives about $35 billion a year in gas tax revenues, has been slowly running out of cash because Washington spends billions more than that on transportation projects, including some of questionable value. The Obama administration wants about $200 billion for transportation spending over four years and has proposed taxing foreign operations of American companies to generate extra revenues. Other Democrats have suggested raising the nation’s gas tax.

The trust fund is a legacy of The Federal Highway Act of 1956, which authorized the construction of the nation’s interstate highway system. The fund was President Eisenhower’s way of assuring Americans that fees generated by taxes on gasoline would be dedicated to highways and bridges.

Although the states, with federal funding, largely completed the interstate highway system years ago, the trust fund lives on, and Congress has expanded its mission. For instance, about $8 billion a year from gas taxes finances urban mass transit, under the dubious proposition that this spending somehow reduces congestion for motorists.

In fact, after 30 years of federal subsidies paid for by gas taxes, mass transit’s share of commuting has fallen, according to a study by transportation expert Wendell Cox. One reason is that only a handful of cities like New York and Chicago have enough concentration of employment in business districts to attract enough transit users to make a difference in traffic.

Money spent elsewhere on everything from light rail to express bus service has accomplished little, but it has all helped to drain the transportation trust.

Congress also forces states to dedicate a percentage of the highway dollars to projects that encourage “alternate” transportation favored by environmentalists, including bike lanes, recreational trails, and pedestrian walkways. In 2014 the federal government designated $820 million for such projects even while the Transportation Secretary claimed our roads risk becoming less safe without more money.

Washington also obliges states to comply with the union-friendly Davis-Bacon Act, which requires that they pay the equivalent of union construction wages on transportation projects using federal dollars. One 2008 study by the Beacon Hill Institute estimates that Davis-Bacon increases construction costs by nearly 10 percent. Since states often mix federal funds with their own spending, repealing Davis-Bacon could free up $5 billion to $10 billion a year in additional spending on transportation.

The Obama administration shows no interest in such reforms, however, because they would anger its union and environmental allies in an election year. Sen. Ron Wyden, (D-Ore.), has proposed instead a short-term bailout of the trust fund by doubling the tax on heavy vehicles, part of legislation that contains proposals unrelated to transportation, including tightening mortgage interest reporting requirements.

Republicans object to new taxes and have suggested instead a short-term fix in the form of a controversial fiscal maneuver known as pension smoothing, which would allow companies to contribute less to their retirement funds next year, boosting profits and tax collections without actually raising tax rates.

The real solution may lie with giving states more freedom over current funds. Since 1956 states have performed virtually all highway construction, and today they finance most of it with only an assist from Washington. State politicians should demand that the federal government not tie so many expensive, politically-motivated strings to the gas tax money it collects from riders who use state-built roads.

Freeing up the states to make their own decisions on what to build, and how to build it, would be a far better alternative than continuing to have the federal government drive our local highway infrastructure into the ditch based on priorities dictated by Washington.