Michigan is making headway in its government pension reforms, and retiree benefits at the local level are up next. Gov. Rick Snyder says this is a priority for him in his last year and a half in office, and local leaders should get on board.
If they don’t, the Legislature should intervene with stricter pension and benefit parameters.
Snyder formed a task force on local government retirement reform early this year and the group released its recommendations last month.
According to the task force, the state should require municipalities to prefund new hires’ retiree medical costs and help local governments facing substantial underfunding.
Such action would help avoid dumping today’s retiree costs on future taxpayers.
That is what’s happening now, and it is putting the state in a fragile financial position. A new report from the Mercatus Center estimates the state’s unfunded pension obligations total $147 billion. And it ranked Michigan 36th for its fiscal health, placing it below average among the states.
Economists factor return-on-investments less than state actuaries because the liabilities haven’t been paid out yet and it’s unclear how they’ll perform, says Olivia Gonzalez, one of the co-authors of the Mercatus report.
Economic optimism combined with a lack of preparation for volatile economic circumstances also explains how these municipal unfunded liabilities grew.
Now that the Legislature made major changes to the state’s teacher pension system in June, municipal governments are the last outpost of traditional defined-benefit pension plans. Of Michigan’s roughly 2,000 local governments, more than 800 offer defined benefit pension plans or health care benefits, or both, says John Walsh, the director of strategic policy for Snyder.
Pension plans are underfunded, but the gap is worse for other postemployment benefits—primarily retiree health care plans.
“At some point, either health care benefits are in peril, or, the services delivered by a community are reduced,” Walsh said. “Neither of those things are a good thing.”
Those negotiating pension plans did not foresee the rising costs of health care, diminishing returns, increased longevity and aging baby boomers leveling the ratio between workers and retirees, explains Walsh.
If these gaps increase, municipalities will have to raise property taxes to foot the bill. Staggering unfunded liabilities in Illinois, for example, led to higher property taxes and a drain in residents.
“If you disrespect your tax base, they will leave,” says Ted Dabrowski, spokesman for the Illinois Policy Institute.
That’s the last thing Michigan needs.
James Hohman, the director of fiscal policy at Mackinac Center for Public Policy, says promising benefits without saving for them along the way is “financial malpractice.”
Health care benefits deserve particular attention because, as Hohman says, local governments promise benefits but do not prioritize them in the budget. As a result, only about 10-20 percent is tucked away for retirees from municipal jobs in the police or fire departments.
The state task force couldn’t agree on benefit cuts or degrees of intervention, but it did agree on these recommendations for municipal governments: better actuarial reporting; a “fiscal stress test” that identifies retirement funding problems; and the creation of an oversight Municipal Stability Board.
Walsh says the level of intervention would depend on the fiscal instability. If communities score well on the stress test — meaning they recognize financial instability and are implementing measures to reverse that — the state wouldn’t get involved. But communities that don’t act quickly enough could face intervention.
Placing new hires in 401(k)-style plans is a step toward fiscal responsibility, and struggling local governments that haven’t already should make that transition.
This next round of pension reform could stabilize municipalities while preserving security for retirees. The state should act on the task force’s recommendations and avoid a more serious crisis in the future.