Policy Documents

Reforming Texas' State and Local Pension Systems

Arduin, Laffer & Moore Econometrics –
April 26, 2011

Many people still remember Wimpy, from the popular Popeye cartoon, who was always willing topay next Tuesday for a hamburger consumed today. Unfortunately, this humorous cartoon line too aptlydescribes the situation of most state and local pension systems today.

Most state and local pension systems are not fully funded. The problems created by an unfundedpension system are no longer an issue for tomorrow. Unfunded state pension obligations are alreadycreating problems for states and municipalities. “Cities across the nation are raising property taxes, largelyciting rising pension and health care costs for their employees and retirees. In Pennsylvania, the townshipof Upper Moreland is bumping up property taxes for residents by 13.6 percent in 2011. Next door the city ofPhiladelphia this year increased the tax 9.9 percent. In New York, Saratoga Springs will collect 4.4 percentmore in property taxes in 2011; Troy will increase taxes by 1.9 percent.”

The unfunded liabilities of the state and local pension systems are a serious problem that must beaddressed. If the current liabilities and current assets are not aligned, the large unfunded liability willsignificantly reduce the economic competitiveness of the U.S. and significantly reduce the ability of thestates to provide legitimate and necessary public services to its constituents. But, states and municipalitiesmust address these problems with economically sustainable solutions. The municipalities in Pennsylvaniaand New York are further harming their economic competitiveness by attempting to improve the fiscalsoundness of their pensions through property tax increases.

Texas’ pension systems have at times travelled down a path similar to many other states and cities.According to the Pew Center on the States study, back in 1999 Texas’ pension systems were 103.6 percentfunded. However, between 1999 and 2008 the growth in liabilities significantly outpaced the growth inassets. By 2008, total assets were only 90.7 percent of total liabilities. According to the Pew Center, “Between 2003 and 2007, [Texas] paid less than 90 percent annually of what its own actuaries said was necessary.However, in 2008, it got back on the right track, paying 99 percent of its annual required contribution.Texas passed legislation in 2009 that increased the retirement age and service eligibility requirements foremployees hired after September 1, 2009. This legislation also increased the employee contribution rates formembers of the Employee Retirement System.”

The problems facing Texas are not dire—but they are troubling. According to the Pew Center on theStates as of the end of 2008 Texas’ total pension fund liabilities were $148.6 billion and total pension fundassets were $134.8 billion implying that Texas’ pensions were 90.7 percent funded—a $13.8 billion unfundedliability. However, only 2.5 percent of the $28.6 billion in health care and other retirement obligationswere funded. Due to the vagaries that surround actuarial assumptions, the pension systems in Texas arecurrently considered to be acceptably funded—albeit the lower-end of acceptably funded.

The sustainable solution to the problems facing public pension systems (including Texas) addresses two distinct problems:(1) the current unfunded liabilities of the state pension systems, and (2) addresses the fundamental problems created by adefined benefit pension system.

When a state or local government provides a defined benefit pension, the state is creating a government entitlementprogram. Entitlement programs violate the criteria of sound budgeting principles. Based on sound public finance principles,tax funded programs should be predictable and sustainable, and not reliant upon estimators, actuaries, market conditions, orthe legislatures resolve to be fiscally prudent. Entitlement programs create expenditures that are difficult to predict and limitthe government’s budget flexibility. Inevitably, entitlement programs lead to unsustainable government spending growth.Consequently, defined pension programs do not meet the criteria of sound fiscal policy.

State governments cannot solve the financial problems of entitlements—such as the Medicaid program—by simplyacquiring more assets from which future obligations can be paid. In the case of Medicaid, fundamental reform of both thehealth care system and the state Medicaid programs are required to solve the Medicaid crisis. The same is true for state pensionsystems. As such, the defined benefit pension system is the wrong compensation policy for state and local governments.

This paper provides recommendations that Texas can implement to address the public sector pension problems facingthe state without eroding Texas’ economic vibrancy. These recommendations are summarized in the table below.