In a recent State Journal editorial, “Borrowed retirement,” you mentioned the American Federation of State, County and Municipal Employees supports the use of bonds to address the difficulties of the Kentucky Retirement Systems. However, the column noted only a portion of the views AFSCME has presented thus far, while missing some key points on the concept of bonding.
First, AFSCME did not suggest fixing the entire problem with bonding. We suggested partial bonding, in an amount equal to the contributions that were not made from tax dollars in the past. Thus, the entire $4.3 billion amount quoted should actually be in the retirement systems today. The remaining unfunded liabilities would still have to be paid for in the manner advocated in the column – making the full actuarial contributions.
Further, this was one part of a broader set of recommendations made to the committee. Our other recommendations included adopting more cautious funding policies in the future, as well as looking at spending through the tax code (via special tax breaks and exemptions) to produce funding to pay off the bonds. While special tax breaks are always added to the tax code over time, they typically never receive the same scrutiny for effectiveness that other spending does. They should.
AFSCME’s driving concern is quickly getting to a place where the full actuarial contribution can be made every year, without further cuts to schools, higher education, public safety and corrections, roads, and all the other important services that Kentucky residents depend upon. We are not certain this is possible by simply saying “pay the bill,” especially given the weak revenue trends during this difficult recession.
If these special tax breaks (which will total $15.9 billion in 2014) could be trimmed by $250-$266 million to make the bond payments on $4.3 billion, it would immunize the cost of bonding and allow the state to finally get back on track making its full contributions every year. We also recommended changing current law to require full contributions are always made.
The column noted that pension debt is simply another form of debt, which is true. However, it is certainly not an “interest-free loan.” Had past contributions been made, they would have generated investment returns of 15.8 percent and 19.0 percent in 2010 and 2011. The state must now make up for both the missed contributions and the lost investment returns on those amounts.
The article is correct that the use of bonding is not without any risks. The key to bonding being efficient is generating investment returns over the next 30 years which are higher than borrowing costs. Thus, there are two periods when pension bonds would be very risky: when borrowing costs are high and when the stock market is overvalued.
Today, borrowing costs are at or near all-time lows (and we estimated that Kentucky could borrow at 4-4.5 percent.) In fact, borrowing costs are artificially low due to the historic federal efforts to help the economy rebound by lowering interest rates to stimulate investment. Current low rates present a window of opportunity, which explains why so many people are refinancing mortgages.
Meanwhile, the price-to-earnings ratio of the stock market suggest that stock prices are at a reasonable level compared to corporate earnings given historic norms. (Pension bonds issued in the late 1990s may end up being costly due to overlooking this factor.) Further, there is a good chance that the earnings part of that ratio will increase when the economic slump finally recedes – meaning there is upside potential. Meanwhile, KRS has averaged 9.2 percent returns from 1990-2011 – which included the worst decade for investments since the Great Depression.
With that said, not issuing bonds is essentially taking the other side of that bet. And, we are only suggesting partial bonding along with added revenues to pay the bonds.
Finally, we should mention another feature of bonding: It moves some costs from a contribution that increases each year (based upon projected payroll) to a flat-dollar payment (which will decline in value over time) – meaning we are addressing costs more quickly.
We appreciate the column noting that workers have always made their contributions. In fact, more than half of benefit accruals are paid for by workers now. And, workers have always made every required contribution from their paychecks for their benefit, which averages $16,826 per year for KRS retirees.
Our plan is aimed at getting Kentucky on a path where full contributions can reasonably be made as quickly as possible, while providing resources to pay for the bond costs, making the funding mechanism more cautious and assuring that we don’t do this again in the future. We realize no one likes to talk about revenues. But is excluding dividends from taxable income, keeping large loopholes in estate taxes or giving tax breaks for ships and vessels more important than maintaining funding for education, public safety and investing in infrastructure to create growth in the future? We do not believe so.
David Warrick, Indianapolis, is executive director of AFSCME Council 62. He began working for the state of Indiana in 1986 and became involved in the AFSCME organizing drive in 1990.