Rare News Desk
No city exemplifies the dire consequences of decades of fiscally disastrous dealmaking between public-sector unions and local governments quite like Detroit.
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The Motor City spent the last half century striking generous pension and pay deals with unions such as the American Federation of State County and Municipal Employees – including handing out $1 billion in so-called “13th-check” bonuses to pensioners – as its population went into free-fall.
By June 2013, Detroit was saddled with officially-reported pension liabilities of $2.1 billion, $5.7 billion in unfunded retiree healthcare costs, and $2.8 billion in pension obligation bonds (including interest payments over the next two decades).
All that is about to change. In fact, Detroit might actually serve as an important example of how local governments, school districts, and state governments can address the long-term defined-benefit pension woes that are busting their budgets.
Starting next week, Detroit will no longer offer a traditional defined-pension, not only to new employees (as customary under most pension reform plans), but to existing employees. Instead, as part of a deal struck by the city’s emergency financial manager, Kevyn Orr, with AFSCME and other unions, workers will get a hybrid pension which features a defined-contribution component similar to those for private-sector workers.
Newly-hired employees will have to contribute eight percent of their salaries to the pension. More importantly, current city workers, who contributed nothing under the current pension, will now have to devote between four-and-six percent of their salaries to their retirements.
Detroit’s retired workers, who have long garnered pensions equal to 67 percent of final year’s salary, will still collect annuity checks. But as part of another deal, this time struck with the union representing the annuitants, those payments will be cut by 4.5 percent. They will also no longer receive annual cost-of-living raises, which exacerbate unfunded liabilities.
The Motor City’s retired police officers, will still get cost-of-living raises, but they will only get one percent annual hikes instead of the 2.25 percent annuity increases currently handed out by the city’s pension.
This is good news for Detroit’s beleaguered taxpayers, who will now see a halt in the growth of its unfunded pension and retiree healthcare liabilities. It’s also great news for many local governments and school districts throughout the country dealing with the consequences of compensation deals with public-sector unions they can no longer afford.
States must address at least $980 billion in pension deficits, according to a 2013 report by Moody’s Investors Service. Taxpayers are increasingly aware of the virtual insolvencies of the 2,329 local pension systems and how these burdens weigh heavily on municipalities.
Some governors, mayors and other officials have taken modest steps toward reform. Last May, Jacksonville Mayor Alvin Brown struck a deal to reduce the costs the city will bear from its police and fire pension by $1.5 billion over 30 years. A month earlier in Chicago, Mayor Rahm Emanuel convinced Illinois’ state legislature to pass a law allowing the Second City to make modest reforms to two of its five pensions.
Emanuel’s next step is to address the city’s teachers’ pension, which officially reports an underfunding of $9.6 billion, but is more-likely at least $12.5 billion, according to an analysis of its comprehensive annual financial report by my Dropout Nation. The bellicose president of the American Federation of Teachers’ Chicago local, Karen Lewis, is already fighting against Emanuel’s plans.
Until Detroit’s far-reaching restructuring, none of the plans offered up to this point have truly attempted to address the biggest problem when it comes to municipal pensions: growing unfunded liabilities from benefits offered to Baby Boomers and other current workers.
Until recently, cities have been hamstrung by court rulings that workers have so-called vested rights to pensions. Under this legal theory, municipalities not only owe their employees a defined-benefit pension, they cannot even adjust annuity payments in times of financial distress.
This changed in December when the judge overseeing Detroit’s bankruptcy ruled that defined-benefit pensions are merely contracts subjected to the U.S. Constitution’s Supremacy Clause. This means bankrupt municipalities can lower annuity payments for retirees, restructure defined-benefit pensions, and even replace traditional pensions with defined-contribution plans so long as it is approved by its creditors.
Because of this ruling, the AFSCME’s Motor City local and other public-sector unions were forced to accept Orr’s pension reform plan.
This good news doesn’t simply extend to Detroit and other bankrupt municipalities. A city could use the threat of a Chapter 9 filing to force public-sector union locals to the negotiating table, leading to pension reform plans that move existing employees into defined-contribution plans and reduce unfunded liabilities over time.
Even in states where local governments and school districts pay into a statewide pension system, the Detroit ruling may allow municipalities and districts to take more-comprehensive steps to reduce their pension woes. While municipalities in California, for example, pay into the CALPERS pension system, their contributions are treated like separate accounts and are for all intents and purposes, local pensions.
For taxpayers, this is welcome news. For AFSCME, the AFT and other public-sector unions? Not so much. After all, more-comprehensive pension reforms strike at the heart of the grand bargain they have struck with rank-and-file members.
Since the 1950s, when Wisconsin forced municipalities and districts into collective bargaining, public-sector unions have collected millions in union dues in exchange for ensuring that the rank-and-file gain perks such as generous pensions, free healthcare benefits, and the ability to retire earlier than would be possible in the private sector.
But now, municipal leaders realize that defined-benefit pensions and no-cost healthcare is unsustainable. Thanks to Detroit’s bankruptcy filing and its move to end defined-benefit pensions, unions can no longer argue that municipalities are obligated to keep such fringe benefits in place. And that’s not good for their business.
