Annual retiree costs in Providence, R.I., now amount to an astounding 50% of city tax collections.
Although Democratic Mayor John DeStefano has enjoyed a good relationship with the New Haven, Conn., municipal unions through most of his 17 years in office, lately those ties have frayed. He says that workers wages and benefits have become “the Pac-Man of our budget, consuming everything in sight,” and must be cut. His budget-trimming proposals, including calls to privatize some jobs, have brought angry city workers into the streets in protest, and celebrity protester Al Sharpton to agitate for their cause.
While the national media has focused on state budget face-offs between government unions and governors such as Wisconsins Scott Walker, municipal officials like Mr. DeStefano are engaged in their own budget warfare. Wages and benefits account for 30% of state general fund expenditures, according to data from the National Governors Association. But U.S. Census surveys show that in the typical town or school district, employee pay and benefits can consume from 70% to 80% of the budget.
Pensions are an enormous part of the problem. While pension payments now consume about 4% of state budgets, many municipalities are already spending 15% to 20% of their finances on pension costs. Earlier this year, Californias Little Hoover Commission, a government oversight agency, observed: “Barring a miraculous market advance and sustained economic expansion, no government entity—especially at the local level—will be able to absorb the blow [from rising pensions] without severe cuts to services.”
Costa Mesa, Calif. (population 110,000) made news earlier this year when it sent layoff notices to 43% of its employees. In 10 years, the citys annual pension bill increased to $15 million from $5 million and now consumes 16% of the citys $93 million budget. In nearby Anaheim, pensions already account for 22% of its $252 million budget. San Joses pension costs for police and firefighters have quadrupled in a past decade. Without reform, the city estimates that its yearly pension costs, $63 million in 2000, will swell to $650 million in 2015.
Elsewhere the numbers are even scarier. Chicagos unfunded public pension fund liabilities are estimated by Joshua Rauh of Northwestern University and Robert Novy-Marx of the University of Rochester at $44 billion—nearly eight times annual city tax revenues. New York Citys annual pension contributions were $1.5 billion (6% of city revenues) in 2002. Theyve exploded to an estimated $8.4 billion (18% of city revenues) in 2012.
School districts in New York State contributed $900 million last year to the states teacher pension system, but districts may have to spend as much as $4.5 billion on pensions within five years to meet rising costs, according to a December 2010 study by the Manhattan Institute. Local property taxes would have to increase an average of 3.5% a year just to pay for those added pension costs, the study estimated.
Local governments have contributed to their budget nightmares by expanding hiring and wages well beyond the growth in population and private wage gains during recent boom years.
In New Jersey, where student enrollment increased by just 69,000 students from 2000 through 2009, public schools hired 33,000 new full-time staffers—nearly one for every two new students. Californias local governments padded their employee count by 15% in the decade leading up to the fiscal crisis in 2008, with average annual pay rising 60%, to $61,185 (not counting the cost of benefits), according to the Little Hoover Commission.
The budget pain is likely to worsen. Since 2008, states have balanced their own budgets in part by reducing the financial aid they send to municipalities and school districts. And although the main source of revenue for many municipalities—property taxes—kept rising during much of 2008 and 2009 because of multiyear property assessments that stretched back to good economic times, collections are now starting to plummet.
Many cities that have employed budget gimmicks in the past have run out of alternatives. To balance its 2010 budget, Providence, R.I., borrowed some $48 million (using its fire stations as collateral); it also drained most of its reserve fund, which shrank to $3 million from $17 million in one year. But the city remains under severe budget pressure—its annual retiree costs now amount to an astounding 50% of its tax collections, according to a new study from the Rhode Island Expenditure Council.
After years of hiring increases, officials surveyed by the National League of Cities estimated that they have cut their work forces by about 9% in the last two fiscal years. More reductions are on the way. Cities like New Haven, Detroit and Chicago are all looking at outsourcing jobs in areas like trash collection or custodial services to the private sector, where costs are generally lower.
Local politicians are also arguing that states need to reduce onerous unfunded mandates on municipalities. More than half of the states have laws requiring local school districts to limit the size of classes, according to a 2008 survey by the National Council on Teacher Quality. To give local schools flexibility in trimming their budgets, the Florida legislature last month cut the number of courses schools offer that must meet the states strict class-size mandates.
In the end, the most far-reaching budget reform for many states would be to fix their pension systems, whose rules often govern local pensions, too. Calling pension and employee health-care costs among the main drivers of local budgets, a coalition of New Jerseys mayors heavily backed Gov. Christies reforms passed last week, which require greater pension contributions from government workers. New York City Mayor Michael Bloomberg wants the state legislature to raise the retirement age for government workers to 65 from 55, and to calculate retirement pay according to an employees base pay only, excluding overtime.
Images of angry government workers occupying state capitols have made for compelling television. But the compensation monster is a far more serious threat to local budgets, and it has officials desperately fighting back.
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