Forgive Detroit Public Schools pension debt

James Hohman

The Legislature is debating bailing out Detroit Public Schools, but there’s been little discussion about how to address the district’s looming pension debt. This represents over a third of the district’s total debt and is in direct control of state lawmakers.

The state can fully forgive all of DPS’ pension debt if it chooses and free them from having to continue to contribute to the state’s underfunded pension system. All it would take are some votes in the Legislature and the governor’s signature.

All school district employees are mandatory participants in the state-run school employee pension system. This is set by state law and employees have no choice about whether they would like to participate. Pensions are paid by essentially taxing a district’s payroll. For every dollar a district pays for an employee’s salary, it also has to send a check for about 36 cents to Lansing to pay for pension benefits.

This pension system is a huge expense — retirement benefits in the private sector typically cost around 5 to 7 percent of payroll.

And most of that 36 cents doesn’t go to benefit current employees. Nearly 90 percent of pension contributions go to pay for the unfunded liabilities and retiree health care payments for benefits already earned by members. In other words, today’s pension payments are largely used to pay the costs of yesterday’s employees.

The state estimates that DPS has a $1.3 billion share of the total $26.5 billion in unfunded pension liabilities in this system. This is not what DPS “owes,” though — it is simply a pro-ration of its share of the total based on its payroll.

The pension system is a cost-sharing retirement scheme, meaning that if DPS no longer paid into it, the costs of the system would have to be picked up by other members (mainly other school districts, in this case). Indeed, DPS already has effectively off-loaded most of its retirement costs, because it used to be a much larger district. This reduction in size means that DPS is already paying a disproportionately smaller share of the system’s unfunded liabilities than it might otherwise.

Part of the reforms for DPS under debate involve requiring district employees to be part of a defined-contribution pension plan within the state retirement system. But even under this arrangement, DPS would still be responsible for paying the costs to catch up on the underfunded benefits — which are the overwhelming majority of contributions. Although moving employees into a defined-contribution plan will help contain pension costs in the future, DPS wouldn’t directly save any money from this deal. The costs are substantial: The district paid $108.4 million into MPSERS in fiscal 2015, according to its financial statements.

These costs do have to be paid regardless of whether the district is in the system or not. The state currently “caps” a district’s contributions and gives them extra grants to cover pension payments above the cap. The state also pays districts extra money to further reduce their contribution rates. Coincidentally, this amount is roughly the size of DPS’ current pension bill. The state could alter that payment and spread its new responsibilities to the other members in the system.

Or, since the state is already bailing out DPS’ other debts, it can bail out this debt, too.

The school employee pension system is a mess and the state needs to stop offering defined-benefit pensions that get underfunded. But since lawmakers are already discussing a bailout of DPS, it ought to reconsider requiring the district to continue paying for that mess. This would relieve the district of a large fiscal burden and enable it to dedicate more of its resources to students in classrooms today, rather than to yesterday’s employees.

James Hohman is assistant director of fiscal policy at the Mackinac Center for Public Policy.