Public pension funds around the country have fallen trillions of dollars behind in the amounts that should be set aside to pay pension benefits when they come due. Such shortfalls have arisen from many years of inadequate contributions, compounded by huge investment losses. Because benefit payouts are guaranteed no matter what happens with investments or prior funding, the shortfall becomes a debt that must be covered by taxpayers.
Like a mortgage, taxpayers are now scheduled to pay off this debt over the next 25 to 30 years. This is being accomplished through higher pension contributions on the public payroll. Here in Iowa, payments on the debt are about $380 million per year, just for debt service on public pensions. This is on top of the cost of the new benefits that accrue each year, of which taxpayers are financing another $380 million. In total, Iowa taxpayers are spending about three-quarters of a billion dollars each year for state and local defined benefit public pensions.
The increase in public spending for pensions has impacted the ability of our state and local governments in Iowa to pay for other services. The result is a decline in the quality of public services and an increase in property taxes. For example, all Des Moines libraries have closed an additional day each week just to help cover the cost of police and fire pensions. Urbandale is raising property taxes. Some have questioned whether it’s worth the substantial public cost to pay such a generous benefit to so few individuals. Police and fire fighters in our largest 49 cities can retire at age 55, and receive 82 percent of their highest salary each year for the remainder of their lives. Almost all of the retirees in this system will have a higher standard of living post retirement than they did during their highest earning years.
Now there’s an additional cost associated with public pensions in Iowa. Moody’s Investor Services has changed the way it evaluates municipal credit risk, now giving explicit consideration to the amount of public pension debt a government entity carries and its capacity to fund it. Using the new methodology, Moody’s has downgraded 8 of the last 12 cities it has reviewed in Iowa. Lower ratings mean higher borrowing costs for these entities. Cities with rating downgrades by Moody’s are shown below in red.
Moody’s uses its own methods and assumptions to estimate the amount of pension debt carried by each government entity. State government’s Iowa Public Employees Retirement System (IPERS) debt is estimated by Moody’s to be more than twice as much as is reported by the system. And while the Municipal Fire and Police Retirement System of Iowa (MFPRSI) reports a funded ratio (ratio of assets to liabilities) of 77 percent (with 100 percent being fully funded), Public Financial Management estimates the funded ratio to be only 55 percent – a truly alarming figure — using Moody’s methods and assumptions. In this plan, taxpayers are already paying 30 percent on top of salaries for pension contributions, with the associated budget and service impacts, but should probably be paying much more.
Moody’s understands the crowding out effect that a heavy debt burden can have on city budgets. Heavy debt means less is available to sustain city services, which can, ultimately, lead to a downward spiral as people leave and the tax base erodes. They have seen it happen in Detroit and elsewhere, with the result that bondholders and pensioners both lose. In recent reports, a typical comment from Moody’s would be, “The downgrade is a result of an elevated debt burden, due in part to retirement pensions for full-time firefighters and police officers. City XYZ has moderately elevated exposure to two statewide cost-sharing pension plans.”
Besides the additional cost of borrowing, Iowans should be concerned about the rating downgrades because they mean an independent entity is basically waving a red flag. Will we see it in time?