Tag Archives: Eileen Norcross

Eileen Norcross on News Channel 8 Capital Insider discussing Virginia and the fiscal cliff

Last week I appeared on NewsChannel 8’s Capital Insider to discuss how the fiscal cliff affects Virginia. There are several potential effects depending on what the final package looks like. Let’s assume the deductions for the Child Care Tax Credit, EITC, and capital depreciation go away. This means, according to The Pew Center, where the state’s tax code is linked to the federal (like Virginia) tax revenues will increase. That’s because removing income tax deductions increases Adjusted Gross Income (AGI) on the individual’s income tax filing (or on the corporation’s filing) thus the income on which the government may levy tax increases. According to fellow Mercatus scholar, Jason Fichtner, that could amount to millions of dollars for a state.

On the federal budget side of the equation,the $109 billion in potential reductions is now equally shared between defense and non-defense spending. Of concern is the extent to which the region’s economy is dependent on this for employment. Nearly 20 percent of the region’s economy is linked to federal spending. Two points: The cuts are reductions in the rate of growth in spending. For defense spending, they are relatively small cuts representing a return to 2007 spending levels as Veronique points out. So, these reductions not likely to bring about the major shakeup in the regional economy that some fear. Secondly, the fact that these cuts are causing worry is well-taken. It highlights the importance of diversification in an economy.

Where revenues, or GDP, or employment in a region is too closely tied to one industry, a very large and sudden change in that industry can spell trouble. An analogy: New Jersey’s and New York’s dependence on financial industry revenues via their income tax structure led to a revenue shock when the market crashed in 2008, as the New York Fed notes.

On transportation spending there are some good proposals on the table in the legislature and the executive. Some involve raising the gas tax (which hasn’t been increased since 1986), and others involve tolls. The best way to raise transportation revenues is via taxes or fees that are linked to those using the roads. Now is no time to start punching more holes in the tax code to give breaks to favored industries (even if they are making Academy-award quality films) or to encourage particular activities.

Virginia’s in a good starting position to handle what may be in store for the US over the coming years. Virginia has a relatively flat tax structure with low rates. It has a good regulatory environment. This is one reason why people and businesses have located here.

Keep the tax and regulatory rules fair and non-discriminatory and let the entrepreneurs discover the opportunities. Don’t develop an appetite for debt financing. A tax system  is meant to collect revenues and not engineer individual or corporate behavior. Today, Virginia beats all of its neighbors in terms of economic freedom by a long shot. The goal for Virginia policymakers: keep it this way.

Here’s the clip

The Problem with States’ Rights

This week, Eileen Norcross hosted a fiscal federalism symposium, bringing together scholars of various disciplines to discuss some of the challenges that our system of federalism faces today. Part of the discussion centered around Michael Greve’s new book The Upside-Down Constitution.

One of his key points is a reminder of the reason federalists believed that states’ rights are important. We shouldn’t care about states’ rights for the sake of states’ rights — states are merely groups of residents. Rather, we should care about people’s rights, and how these can be better protected in a federalist system than under a centralized government. This distinction sometimes gets lost when people advocate states’ rights rather than states’ enumerated powers. The problem with advocating states’ rights is that this nuance paves the way for states to collude rather than to compete.

A clear example of this collusion happened in 1984 when Congress passed the National Minimum Drinking Age Act. Because setting a drinking age does not fall under the federal government’s enumerated powers, when Congress wanted to change the rules in this area, it had to bargain using tax dollars. States that kept a drinking age in place below 21 would have lost 10-percent of their federal highway funding dollars.

While this may sound like the federal government is coercing the states, it’s key to remember that the goal of federalism is individuals’ rights. With the National Minimum Drinking Age Act, the states and federal government colluded to bring an end to competition in policy. This Act made state policy in this area the same, taking away Americans’ opportunity to choose to live in states with lower drinking ages.

When multiple levels of government pay for a given service, such as roads, many opportunities arise for this type of collusion, leading to the growth of government and the erosion of competition between governments. A competitive federalism means both that governments have incentives to provide the policy environments that their residents want and that people will have greater variety of policy climates to choose from. If the drinking age is an important issue to a family, competitive federalism could provide them with the option of living in a city or state with a higher or lower minimum age.

In the coming year, we hope to pursue research exploring what institutions limit competition within American federalism and what institutions prevent collusion between the federal, state, and local jurisdictions.

 

Reforming State and Local Pension Plans

The Government Accountability Office recently issued a report that provides a nice analysis on the changes that have been taking place in state and local pension plans over the past few years. According to the GAO’s tabulations, the following reforms have been implemented since 2008:

 • Reducing benefits: 35 states have reduced pension benefits, mostly for future employees due to legal provisions protecting benefits for current employees and retirees. A few states, like Colorado, have reduced post-retirement benefit increases for all members and beneficiaries of their pension plans.

• Increasing member contributions: Half of the states have increased member contributions, thereby shifting a larger share of pension costs to employees.

• Switching to a hybrid approach: Georgia, Michigan, and Utah recently implemented hybrid approaches, which incorporate a defined contribution plan component, shifting some investment risk to employees.

The reforms listed in this report seem to indicate that some states and localities are taking a step in the right direction in regards to pension reform. There is, however, a lot more work that needs to be done. One reform, for example, that we need to see more of is shifting public sector pensions from defined benefit to defined contribution plans (see Scott Beaulier’s recent paper for more on this topic). As the GAO report points out, roughly 78 percent of state and local employees participated in defined benefit plans in 2011 – compared to 18 percent of private sector employees.

Another important topic that this report touches on is the discount rate debate. That is, whether or not states should base the discount rate on the expected return of plan assets or on relevant interest rates in the bond market (Eileen Norcross has done some valuable research on this topic here and here).

 

New Education Funding in Illinois Goes to Pensions

Neighborhood Effects readers know that Illinois’s pension problems are much worse than reported. According to the state’s numbers, Illinois’s unfunded pension liabilities amount to roughly $85 billion but as Eileen Norcross and I have argued, the amount is actually closer to $173 billion.

There have been many discussions regarding pension reform in Illinois during the past few months and, unsurprisingly, little has been accomplished. In fact, an article in Statehouse News earlier this week provided evidence that Illinois is continuing to deliberately avoid dealing with the problem by providing temporary quick fixes and banking on the idea that the state’s pension problems will simply disappear when the economy recovers.

According to the article in Statehouse, Illinois’s

12 percent increase in higher education spending this year isn’t going to benefit students. Instead, the additional funding for fiscal 2012 is going into the State Universities Retirement System, or SURS, to address its underfunded pension program…. The dramatic increase in the amount of money being given to SURS, and the other state pension systems, seeks to make up for decades of chronic underfunding by governors and legislators, and shrinking returns on investments because of the stagnant economy.

Education costs are increasing across the country. Students in Illinois paid 30 percent more for a year of college education at a university in 2011 than they did in 2007. Instead of using the additional 12 percent in higher education funds to curb these increasing costs, the state put the money towards its SURS system. This fiscal year students in Illinois are dealing with the consequences of the state’s failure to properly manage its pension system. As pension costs continue to grow in Illinois, the state will likely continue putting more money into the system – which means less money will be available for other areas of the budget.

In related pension news in Illinois, the Daily Herald provided the following quote from Hanover Park Village President Rodney Craig:

We have a fear that at the end of the day the pensions won’t be there

Without serious structural pension reform, Mr. Craig’s fear will most certainly become a reality. Labeling Illinois’s recent pension quick fix as a disappointment would be an understatement. This is nowhere near the type of reform that needs to happen in Illinois. If the state legislature wants to ensure fiscal stability in the future of Illinois’s pension system then they must start by removing the constitutional protection of pension benefits, reducing the rate of accrual for current employees, increasing current employee contributions, closing the current defined benefit plans and moving all employees to a defined contribution plan.

 

AEI-Mercatus pension panel addresses need for reform

Yesterday Eileen Norcross participated in a panel discussion that was co-hosted by the American Enterprise Institute and the Mercatus Center. The event included two panels, one discussing the case for pension reform, and the second discussing the politics of reform for conservatives.

Eileen participated on the first panel, joined by Scott Beaulier of Troy University and Jason Richwine of the Heritage Foundation. They covered several points of the importance of pension reform, including the necessity for fund managers to use the correct discount rate when determining the pension liability, the importance of upholding fiduciary responsibility to workers and retirees, and the reality that public employee pensions are overly generous compared to private sector compensation.

Drawing on their previous research in pension reform, the panelists made a convincing case for the need for a shift away from defined benefit public pensions. Unfortunately, none were particularly optimistic that drastic reform measures will be undertaken. Scott pointed to Utah as a model states relative to others for responsible pension fund management but said that even their reforms do not go nearly far enough.

Pension Week at Mercatus

This week there are two new Mercatus research papers on public sector pensions. Eileen Norcross and her co-author Roman Hardgrave published a study on the effects of unfunded pension liabilities at the municipal level in New Jersey. Norcross’ previous studies have focused on the state level, and this work illuminates the even more devastating effects this funding gap will have for smaller, local budgets.

Scott Beaulier of Troy University and a Mercatus Affiliate Scholar has a study analyzing how states might make the transition from defined benefit pension plans to defined contribution. He cites the success stories of Michigan and Utah, two states that have moved toward defined contribution plans and have each saved billions in the process.

Both papers reach the conclusion that public officials should not be in the business of managing defined benefit pension funds because they do not have the correct incentives to steward these benefits. Politicians operate in the time frame of election cycles. They have an incentive to provide future benefits without raising taxes in the short-run and are thus in a poor position to be in the business of the long-term management of pension benefits.

We held a State Policy Working Group at Mercatus today to discuss these and other recent pension studies. If you would like to attend or call in to future working groups, please email mleland@gmu.edu.

Fitch Downgrades Cook County’s Bond Rating Because of Pension Liabilities

Fitch Ratings downgraded the general obligation bond rating of Cook County, Illinois, from AA to AA- earlier this week. Moody’s similar downgrade last June makes this Cook County’s second downgrade of the year.

It is of no surprise that the county’s pension liabilities were cited as an important factor in the downgrade. Cook County’s local governments currently face more than $108 billion in outstanding debt, almost a quarter of which can be attributed to unfunded pension liabilities.

This problem is further compounded by the fact that the City of Chicago has its own unfunded pension liability of $48.8 billion or $42,000 per capita.

Illinois’s pension problems, however, run much deeper than Cook County. Illinois’s FY 2012 operating budget reports that the state’s pension system is 45 percent funded with total unfunded liabilities amounting to $75.7 billion.

Although, in recent research, Eileen Norcross and I find that when using discount rates that reflect the risk of public pension liabilities, Illinois’s unfunded pension liabilities amount to $173 billion and the funded ratio across systems drops to 36 percent in FY 2010.

By 2018, Illinois pension system will require a tripling of the state’s annual contributions from $6 billion to $17.5 billion. Therefore, without serious structural reform, it is likely that Illinois’s pension liabilities will lead to additional rating downgrades in the future.

 

Windfall for Chicago Union Leaders

In Chicago, teacher union leaders have won the lottery of municipal benefits. Twenty-three union leaders will be receiving a total of $56,000,000 in retirement. For most, these pension benefits will be greater than the salaries that they made while employed by the union. On the 1991 law that has secured these benefits, the Chicago Tribune reports:

All it took to give nearly two dozen labor leaders from Chicago a windfall worth millions was a few tweaks to a handful of sentences in the state’s lengthy pension code.

The changes became law with no public debate among state legislators and, more importantly, no cost analysis.

Because of the secrecy surrounding the collective bargaining process between policymakers and organized labor in Chicago, the article explains that it is difficult to determine the lawmakers responsible for this policy. The $56 million in pension benefits is a relative drop in the bucket at this point for the Chicago Teachers’ Pension Fund, which has been underfunded by $5 billion in the last 10 years.

However, the process by which union leaders secured these benefits is symptomatic of Illinois’ larger pension problems. Twenty years ago when lawmakers agreed to guarantee these benefits, they were not concerned about the long-term repercussions to the pension funds’ solvency, or for that matter what the size of the bill might be for future residents.

Lawmakers have the incorrect incentives to manage pension funds because they think in terms of election cycles, where strong union support can make sure they stay in office, rather than the long horizon over which taxpayers will be forced to fund these promises. Eileen Norcross documents this misalignment of incentives in a forthcoming we will be discussing further here.

Illinois’ Fiscal Breaking Points

In a forthcoming paper with Eileen Norcross,“Illinois’ Fiscal Breaking Points,” we un-pack the current crisis in Illinois.

Our review of Illinois’ fiscal and economic indicators shows in addition to a $7.7 billion deficit in the state’s General Fund, Illinois faces $173 billion in unfunded pension liabilities as well as $70 billion in outstanding bonded debt.

To make matters worse the policies currently in place to keep state spending in check are loophole-ridden.  For example, the state has a balanced budget requirement but Section 25 of the State Finance Act allows the legislature to defer Medicaid claims and other payments into the next fiscal year in order to balance the budget.  This budgetary loophole has resulted in over $20 billion in deferred payments since FY 2000. The loophole is slowly being phased out as a budget balancing maneuver.

The recently enacted spending cap limits government spending to 2 percent of year-to-year growth in General Expenditures through FY 2017 and thus for the first time in Illinois’ history places limits on state spending.  However, as research by Mitchell (2010) shows, a TEL that limits budget growth to the sum of inflation plus population growth would be a much better option for the state.

Ultimately, Illinoisans have recognized that their state’s fiscal irresponsibility has resulted in a poor institutional environment and they are voting with their feet by leaving the state. Illinois lost a net of 1,227,347 residents from 1991 to 2009, the city of Chicago has fewer residents than it did in 1920, and the state consistently remains below average in its number of entrepreneurs.

In our paper Eileen and I argue that if the state of Illinois wishes to reverse this resident and business out-migration then the legislature and the Governor must stop focusing on revenue enhancements through increased taxation and borrowing and instead make serious institutional spending reforms.

Strengthen the state’s spending limit and balanced budget requirement, moving the state’s pension system to a defined contribution plan while also removing the constitutional protections to the current plan, and getting rid of tax incentive programs that target individual industries and/or activities.

Illinois is by no means a failed state. If the state continues to promote its growth enhancing policies, such as its flat rate income tax, while also taking the necessary steps towards institutional reform then Illinois’ future may not be as bleak as it currently seems.

Tim Pawlenty on Public-Sector Unions

Minnesota’s Governor has an op-ed in today’s Wall Street Journal, arguing that the growth of public-sector unions presents a major problem for any small-government reformers.

Federal employees receive an average of $123,049 annually in pay and benefits, twice the average of the private sector. And across the country, at every level of government, the pattern is the same: Unionized public employees are making more money, receiving more generous benefits, and enjoying greater job security than the working families forced to pay for it with ever-higher taxes, deficits and debt.

Governor Pawlenty notes three principals he’d like reformers to consider. First, normalize pay between the private and public sectors.

Second, get the numbers right. Government should start using the same established accounting standards that private businesses are required to use, so we can accurately assess unfunded liabilities.

Third, we need to end defined-benefit retirement plans for government employees. Defined-benefit systems have created a financial albatross for taxpayers. The private sector dropped them years ago in favor of the clarity and predictability of defined-contribution models such as 401(k) plans. This change alone can save taxpayers trillions of dollars.

Our own Eileen Norcross champions both these policies. Her recent paper, The Crisis in Public Sector Pension Plans, co-authored with AEI’s Andrew Biggs, uses New Jersey’s public-sector unions as a case study for the growing government work-force. They also discuss the moral hazard inherent in defined benefit plans:

From the perspective of workers, defined benefit pensions in the public sector are risk-free; they are guaranteed benefits by the state, which has the power to tax. This means, of course, that from the perspective of the taxpayer, the liability is a near-certainty. The discount rate chosen to value future liabilities in the plan, therefore, should reflect the low-risk character of the benefits promised to workers.

From the government’s perspective, it is appealing to use a higher discount rate to estimate plan liabilities because it produces a lower annual contribution. By contrast, a low discount rate will result in a higher annual contribution required by the employer (in this case, the government) to fund pension obligations.

Eileen and Andrew were also part of a Mercatus panel discussion with Utah State Senator Dan Liljenquist, Scott Pattison of the National Association of State Budget Officers and Jim Musser of Mercatus. Today she also released another paper, Getting an Accurate Picture of State Pension Liabilities.

Last year I addressed the incentive for governments to gamble with public employees’ retirement savings in an op-ed. Giving public employees control of their own savings is essential for any kind of fair relationship between governments, their employees, and the taxpayers. An accurate accounting system is crucial to any fiscally responsible discussion.

Correction: In my AOL piece there is an error: I wrote “Then there was New Jersey Gov. Christie Todd Whitman, who from 1998 to 2003 held “pension holidays,” suspending employee payments into the pension system so workers could spend the money elsewhere. . . . Today, New Jersey’s public pensions lack billions of dollars in funding, and both public employees and taxpayers will suffer.” Instead, the piece should read “so employers“, i.e, the state of New Jersey, could spend the funds elsewhere. Thanks to reader John for bringing that misstatement to my attention.