Steven Malanga
The
Compensation Monster Devouring Cities
The
real battle over public workers’ pay is happening in city halls, not state
capitols.
New Haven mayor John DeStefano has had a
good relationship with his city’s municipal unions through most of his 17 years
in office. But lately, those ties have frayed, thanks to the Democratic mayor’s
claim that city workers’ wages and benefits—many granted by DeStefano
himself in plusher years—have become dangerously unaffordable. DeStefano describes New
Haven’s rising worker costs as “the Pac-Man of our
budget, consuming everything in sight,” and he is laying
off employees and exploring outsourcing to reduce expenses. The mayor’s actions
brought angry police into the streets, blocking traffic and blaring sirens in
protest. Members of a custodians’ union stormed out of a recent arbitration
meeting, outraged by a mayoral proposal to save money. City unions even
imported celebrity demagogue Al Sharpton to agitate
for their cause.
DeStefano’s plight will be familiar to mayors, city
managers, city councils, and boards of education across America. The national media (as well as many policy experts) have
focused on state budget battles, like the one in Wisconsin between Governor Scott Walker and
public-employee unions. But the truth is that America’s problem with
government-worker costs is disproportionately a local issue.
Compensation, including wages and benefits, accounts for just 30 percent of
state general-fund expenditures, the National Governors Association reports—which
makes sense, since states also spend money on programs in which worker pay
isn’t the main expense, such as Medicaid. In the typical city, town, or school
district, by contrast, compensation costs generally range from 70 to 80 percent
of the budget.
Those compensation
costs have soared over the years, as politicians made overgenerous promises to
local government workers—not just pay but also the right to retire on full
pensions at age 50 or 55, annual cost-of-living increases to those pensions,
and full health care for life. These concessions haven’t merely resulted in big
deficits; they have pushed many localities to the edge of fiscal ruin. Without
substantial reform—soon—local taxpayers are likely to face a lethal combination
of major tax increases and crumbling services.
Pensions are an enormous
part of the problem. New Haven’s
$475 million budget, for instance, is projected to grow by just $4 million this
fiscal year, but the city’s pension and health-care costs will rise $12 million, forcing cuts elsewhere. In San Francisco, pensions
consume about 14 percent of the budget, and rising retirement bills for city
workers accounted for one-third of this year’s $306 million deficit. Pension
and health benefits account for 20 percent of the $500 billion that the
nation’s nearly 14,000 public school districts spend annually. In a recent
National League of Cities survey, nearly 80 percent of municipal finance
officers listed rising pension payments as one of their most significant
budgetary problems.
Here again, the problem
is disproportionately local. Yes, state-sponsored pension funds have
accumulated anywhere from $750 billion to $3 trillion in unfunded pension and
retiree health-care liabilities, depending on how the calculations are made. A
huge portion of those liabilities, however, is actually owed by cities, towns,
and school districts. States employ just 5.2 million of the 13 million active
workers participating in state-sponsored pension funds; the rest are local
employees, often teachers, who work for districts too small to manage their own
pensions. Experts agree that pension costs for both states and localities are
going to skyrocket. But states currently spend just 4 percent of their budgets
on pensions, while many municipalities already spend 15 to 20 percent.
Pensions are certainly
at the heart of the budget crisis in Costa
Mesa, California, a
city of 110,000 residents that made news earlier this year when it decided to
contract out more than a dozen city services and send pink slips to 43 percent
of its employees. Costa Mesa’s workers, like those in many California
municipalities, participate in the statewide CalPERS
(California
Public Employees’ Retirement System). Ten years ago, the city’s annual pension
bill from CalPERS was $5 million. Since then, it has
tripled to $15 million—16 percent of the city’s $93 million budget—and Mayor
Jim Righeimer has warned that it could reach a
staggering $25 million by 2015. Since these bills are for services already
delivered, there’s no clear way to cut them; even the radical steps that Costa Mesa has taken will
limit only future costs.
What’s happening to Costa Mesa is no exception in the Golden State.
Earlier this year, California’s 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.” Los Angeles’s retiree costs currently make up an already troubling
18 percent of its budget, for instance, but the commission estimated that the
percentage would swell to 37 percent by 2015. Retiree costs just for L.A.’s public-safety
workers could double to $700 million annually, “enough . . . to fund a second
police department in a major city.”
The pension situation
is even graver elsewhere in California.
Anaheim is
already spending 22 percent of its $252 million budget on pensions, and its
mayor estimates that pension contributions could increase by 50 percent, or
about $27 million, in four years. San
Francisco’s comptroller has estimated that his city’s
pension bill will rise from $357 million this year to $422 million next year
and then to $800 million in just a few years. San Jose’s pension costs for police and
firefighters have already quadrupled over the past decade. Without reform, the
city estimates that its yearly pension costs, $63 million in 2000, will swell
to $650 million in 2015.
On the other coast, New York City has seen
its annual pension contributions explode from $1.5 billion (6 percent of city
funds) in 2002 to an estimated $8.5 billion (18 percent of city funds) in 2012.
Pension expenditures have taken more than one-third of the entire increase in Gotham tax collections over
that period. And the time bomb is ticking throughout the state—for example, in
school districts, which (apart from those in New York City)
fund teachers’ pensions through the New
York State
Teachers’ Retirement System. In a recent analysis, the Manhattan Institute’s
Josh Barro and E. J. McMahon estimated that school
districts’ total contributions to the fund will have to rise over the next five
years from $900 million to $4.5 billion. New York schools are largely financed
by property taxes, which would need to increase an average of 3.5 percent a
year for the next half-decade to keep pace.
Years of fattening
retirement privileges while blithely ignoring affordability have left some
cities’ pension systems teetering on bankruptcy. The Chicago Tribune
reported last November that Chicago’s public-pension funds were “racing toward
insolvency,” with unfunded liabilities estimated by Joshua Rauh
of Northwestern University and Robert Novy-Marx of
the University of Rochester at $44 billion—nearly eight times annual city
revenues. Late last year, Illinois passed a
law requiring municipalities to move toward properly funding their pension
systems—which in Chicago’s
case, city officials estimate, would require doubling
its property taxes within the next five years. (“From today on, you won’t be
able to sell your house,” outgoing mayor Richard Daley told Chicagoans.) The
burden is so heavy that Rauh and Novy-Marx
believe that a state bailout of Chicago
is likelier than gigantic local tax hikes.
A state takeover is
already an imminent possibility in Pittsburgh,
whose pension system is only 33 percent funded. If Pittsburgh doesn’t pump some
$200 million into its pension funds by the end of the year, it must cede
control of them to Pennsylvania—a situation that the city is desperate to
avoid, fearing that the state would require massive increases in annual
contributions, pushing them from $56 million annually to as much as $120
million within a few years. So Pittsburgh,
whose entire budget is just $450 million, has approved a plan to raise the
necessary money by devoting millions of dollars in parking-meter revenues to
the pensions. But that has made it harder to balance the city’s operating
budget.
Pensions are only one
part of the compensation squeeze choking municipalities. Local governments also
helped bring on their current budget nightmares by carelessly expanding hiring
and wages in recent boom years. In the decade leading up to the 2008 financial
crash, the number of workers for cities, towns, and schools increased 16
percent, even though the country’s overall population grew just 12.5 percent.
Wages also increased, and, of course, the hiring frenzy made those pension
obligations even worse. The result: over the same decade, the total in wages
and benefits that public schools paid to teachers and noninstructional
staff (to take one category of public-sector worker) jumped an amazing 72
percent, despite moderate increases in student enrollment.
California’s local
governments padded their employee count by 15 percent from 1999 to 2008, with average
annual pay rising 60 percent, to $61,185, not counting the cost of benefits,
according to the Little Hoover
Commission. Average pay for cops and firefighters climbed 69 percent, to
$89,056, again excluding benefits. According to the Rhode Island Public Expenditure Council,
enrollment in that state’s public schools fell 10 percent between 2004 and
2010—yet the schools employed as many people in 2010 as they did in 2004, and
local school boards actually inflated spending 20 percent, to $1.8 billion annually.
In New Jersey, where enrollment increased by just 69,000 students from 2000
through 2009, public schools hired 33,000 new full-time staffers—that is,
nearly one worker for every two new students.
Some cities face crises
because, as their populations shrank, their officials failed to downsize the
government workforce. Detroit, a city of 1.9 million in the 1950s, registered
only 713,777 residents in the 2010 census. But the city and its school system
eliminated jobs only slowly over the decades of population implosion, leaving Detroit with crippling
legacy expenditures. The city currently has nearly 13,000 employees but is
providing pension benefits to 22,000 retirees, a jaw-dropping ratio of retirees
to current workers. The annual pension bill for the city’s retired police
officers and firefighters alone is $150 million—as much as it costs to pay the
salaries of 65 percent of the police and fire departments’ active workers.
Shrinking cities often
banked on state and federal aid to prop up their payrolls as tax collections
stalled. As recently as 2008, for instance, Newark’s government and school
system received as much as three-quarters of a billion dollars annually from
New Jersey; meanwhile, city hall continued to dispense jobs and political
patronage, as it long had. Mayor Cory Booker, elected in 2005, vowed to change Newark’s corrupt culture, but he was late to rightsize local government until Governor Chris Christie
slashed aid to Jersey municipalities in 2010.
In a city where personnel costs made up four-fifths of the budget and had
swollen 60 percent over five years, Booker scrambled to close an $80 million
2011 budget gap by putting nonunion staff on a four-day workweek and laying off
hundreds.
The budget pain that
thousands of cities and smaller governments are experiencing is likely to
worsen. For one thing, states have balanced their own budgets by reducing the
financial aid that they send to municipalities and school districts. The
federal stimulus money that started to flow in 2009, sending nearly $300
billion in aid to states and localities, is now largely used up, too.
Worse, though property
taxes—the main source of revenue for many municipalities—actually kept rising
during much of the 2008 and 2009 downturn, reflecting multiyear assessments
that still included robust economic years, collections are starting to plummet.
That drop could continue for a while, if the past is any guide: the previous
recession reached its low point in November 2001, but the low point of
municipal tax collections didn’t occur until 2003, a National League of Cities
survey found. Local governments could conceivably face declining revenues for
another 18 months or so.
Cities are also running
out of fiscal alternatives to deal with their deficits. Like states (see “State Budget Bunk,” Winter 2011), many cities have used one-shot revenue deals,
hidden borrowing, and other gimmicks to bolster their finances. The weak
economy has lasted so long, though, that these techniques have been exhausted.
To balance its 2010 budget, for example, Providence,
Rhode Island, borrowed some $48
million (using its fire stations and headquarters as collateral); it also
drained most of its reserve fund, which shrank from $17 million to $2 million
in just one year. Moody’s Investors Service and Fitch Ratings subsequently
downgraded the city’s bond ratings by two notches, essentially ending its
ability to use fiscal gimmicks. But Providence
still faces a budget squeeze because its retiree costs amount to 50 percent of
tax collections. Newark
is up against the same wall. Last year, to close half of its budget deficit, it
raised a quick $40 million by selling and then leasing back city-owned
buildings—at a cost of $125 million in principal and interest over the next 20
years. Almost immediately after the deal, Mayor Booker admitted that Newark had used up its
one-shots, and now a new $40 million hole looms in next year’s budget. Richard
Daley balanced Chicago’s
budget by raiding funds raised in 2009 when the city sold the rights to its
parking-meter revenues to a private company for 75 years, bringing in $1.15
billion. The giant pot of money was supposed to last for decades, but less than
7 percent now remains; Chicago
won’t have parking-meter revenues available to it for 73 years.
Local politicians are
desperate to find other ways to reduce employee costs. One strategy rapidly
winning adherents is to outsource or privatize whole departments or functions,
on the assumption that the private sector can deliver many services that
government performs, but without the inflated benefits. Mayor DeStefano of New
Haven wants to jettison 200 school-custodian jobs in
his city and outsource the work to a private firm for an estimated $7 million
in annual savings. Chicago’s new mayor, Rahm Emanuel,
is touting “managed competition,” in which the city bids out certain services
previously performed by municipal workers. Emanuel estimates that by
consolidating the city’s sanitation services, now broken up into dozens of
smaller systems, and subjecting the work to competitive bidding, Chicago could save $65
million annually. Detroit mayor Dave Bing is also proposing privatizing
sanitation for his city, for $14 million in savings. Outsourcing doesn’t always
mean privatizing, however: Costa Mesa’s proposed outsourced services include
firefighting, which the Orange County Fire Authority would now handle, at a
savings of anywhere from 15 percent to 40 percent of employee costs.
Needless to say, unions
and their allies relentlessly oppose these money-saving strategies, forcing
some local politicians to try to negotiate concessions from unions or, failing
that, simply to slash government jobs, at the risk of gutting critical services
and harming cities’ quality of life. A National League of Cities survey last
fall found that 35 percent of cities had already used layoffs to reduce payroll
costs, while 75 percent had hiring freezes in place. After negotiations between
Booker and Newark’s
police union broke down earlier this year, he laid off 167 cops, about 10
percent of the force. After several years of crime declines that have been a
hallmark of Booker’s tenure, Newark’s
crime rate has begun rising again. San Jose is getting rid of 500 positions, or
10 percent of its workforce, this year—slashing library hours, shrinking the
police and fire departments, and eliminating some city inspectors. Reno,
Nevada, has cut about 570 employees, or one-third of its workforce, since the
housing bubble there burst three years ago. Even with the layoffs,
cost-of-living increases in contracts drove up the average compensation of a Reno city worker 8
percent last year, from $76,914 to $83,540.
Another way to reduce
the burden of local compensation involves reforming various things that states
require localities to do. These requirements, which can govern everything from
how cities negotiate contracts to how school districts can spend money, often
hamper local officials’ efforts to balance budgets. More than half of the
states, for instance, have laws limiting class size, a 2008 survey by the
National Council on Teacher Quality reported. Such laws often amount to
unfunded mandates because the state dictates what localities must do without
providing the funds to do it.
In response, New Jersey governor
Christie has developed a promising “tool kit” of reforms, including giving
municipalities the flexibility to furlough workers and to negotiate better
contracts with unions. The state has also modified its binding arbitration
system: when a police or firefighters’ union and local government officials
can’t agree on a new contract, the salary increases awarded by arbitrators are
now limited to an average of 2 percent annually. Other states have followed
suit, notably Ohio, where new governor John Kasich signed legislation in April
replacing arbitration, in the case of a negotiating impasse, with a mediation
process that places the final vote on a new contract in the hands of a local
school board or city council.
Potentially of even
greater consequence are new restrictions on the collective bargaining rights of
public-sector workers. Wisconsin’s
controversial new legislation gives workers and unions the right to bargain
only for wages. In arguing for the bill, Governor Walker explained that back
when he served as Milwaukee
County’s executive, the
state’s collective bargaining law hamstrung his ability to reduce costs and
restructure his workforce to avoid layoffs and service cuts. Michigan
has followed Wisconsin
with a narrower law that allows state-appointed monitors overseeing
municipalities in fiscal distress to suspend collective bargaining rights for
local workers. Indiana voted to restrict teachers’ collective bargaining to
wages, which Governor Mitch Daniels said would “free our school leaders from
all the handcuffs” that restrain reform efforts.
Perhaps the most
far-reaching budget reform for many states would be to fix their pension
systems. In June, the New Jersey
state legislature, responding to complaints from local officials about high
pension costs, finally enacted reforms that cut them. In Detroit recently, an arbitrator working under
the state’s new fiscal-emergency legislation took the unprecedented step of
ruling that the city could reduce future pension benefits for some current
workers. Without the reduction, Mayor Bing estimated, pension and health
benefits would consume half of the city’s general fund by 2015. But other
cities still need change. In New York,
Mayor Michael Bloomberg has urged the state legislature to raise the retirement
age for government employees to 65, from 55 for most workers, and to calculate
retirement pay according to an employee’s base pay only, excluding overtime.
Images of angry
government workers occupying state capitols or facing off against Tea Party
protesters have made for compelling television. Headlines portraying newly
elected governors like Scott Walker as union busters are provocative. But the
compensation monster is threatening local budgets, too, and it has officials desperately
fighting back. If they lose, cities, towns, and school districts across America face a
much darker future.
Steven Malanga is the senior editor of City Journal and a senior fellow at the Manhattan
Institute. He is the author of Shakedown: The Continuing Conspiracy Against the American Taxpayer.
http://www.city-journal.org/2011/21_3_public-workers.html