December 20, 2006
The Real State Budget Problem

The stumbling-out-the-gate budget fumble by Chris Gregoire's staff highlights a bigger problem for the state budget that will pose a significant stumbling block for lawmakers: a large piece of the puzzle is the under funded state pension system which requires sizeable "catch-up" contributions from the state in coming years. That is about the least exciting increase in expenditures for lawmakers or the Governor to be able to tout, in part because it will take years to fix the problem, thus not likely to occur on the scale needed. In this case, the axiom of "good policy is good politics" gets turned on its head.

Yet, as Postman reported, the pension system's obligations have a huge impact the state's fiscal outlook. As such, it remains perhaps the most important issue for the state to address for long-term fiscal stability before considering other spending obligations. That's not what's happening with Gregoire's budget though.

State Sen. Joe Zarelli said it best, "I believe she's trying to do good things in the budget, but we're trying to do too much all at once and that puts us into a structural problem." It's not clear to which "good things" Zarelli is referring to though previously announced increases for K-12 math and science initiatives as well as to improve access and affordability to higher education are reasonable, modest proposals. One can and should argue about the details of the plans, and be concerned the uber Democratic Legislature will turn them into bloated, over-sized visions of Gregoire's original ideas by the time they arrive back on her desk for signature. But despite their individual validity, her budget does do too much taken as a whole.

What is missing is any effort to restrain spending in other programs, or to seriously address the pension shortfall that continues to plague the state. Rep. Gary Alexander noted he couldn't find spending reductions of any sort to offset increased spending even in part. On a related note, that means the Priorities of Government process used so well by Governor Locke and Dino Rossi is dead.

That's a shame; since this writer has seen the idea work exceptionally well in Snohomish County under a Democratic County Executive. Priorities Based Budgeting has been used there to restrain growth in overall general fund spending while allowing for the kind of modest increases in favored services the public expects. Moreover, Snohomish County - like other counties - faces the same pension problem as the state, since by law I believe, the County follows the state's lead in pension system contributions. When the state plays fiscal catch-up, local governments have to play fiscal catch-up too (and it's not as if local government budgets have been rosy in recent years either).

I need to wade through the budget in greater detail to comment further, but it seems clear right after Gregoire's release that her budget lacks the restraint necessary to be an effectively low-starting point from which the Legislature will no doubt go higher. Thus increasing the likelihood of continuing the very "boom and bust" budgeting cycles Gregoire herself would like to tame.

Posted by Eric Earling at December 20, 2006 08:15 AM | Email This
1. Under whose watch did the state pension fund become underfunded? Who was in control and why didn't they do something about it as future obligations rose and funding levels did not keep pace? How about asking Mike Lowry or Gary Locke and now Mrs. Gregoire? If the Dems want to lay claim to being fiscally responsible, they have some explaining to do.

Posted by: T Gething on December 20, 2006 08:24 AM
2. T Gething - you need to learn newspeak. Financially responsible means financing everything the people responsible for putting you in office want.

Posted by: Right said Fred on December 20, 2006 09:05 AM
3. YOU all miss the point. Democrats want to give promises but never pay for them. Then When a Republican comes to office and tries to fix the problem they can blame Republicans at cutting benifits for Government workers.
Democrats talk like they care but never do anything about it. Transportation needs fixing but only by funding Mass transit First. The only fix is raising taxes. The same for this shortfall in funding. Democrats promise but will only put it on paper and expect more taxes to be collected to meet those promises. Always steal more money from the people to keep buying votes and making payoffs to their supporters.

Posted by: David Anfinrud on December 20, 2006 10:53 AM
4. The Governor, to be sure, is providing zero leadership on the pension problem. But we can give her a little credit for proposing to get rid of gain-sharing in this budget. It remains to be seen, of course, how hard she actually pushes that during the session.

Even so, I can't see how Gregoire's abdication here isn't anything other than smart politics. No matter how much Zarelli or Dino howl, the newspapers and voters don't give a rat's behind about the pension gap. Chris knows this, and she knows that doing nothing until there's a crisis--after her reelection, of course--is the smartest way to go. Not the most honorable. But politically smart. As usual.

Posted by: DJ on December 20, 2006 12:38 PM
5. Isn't it about time the the pensions for state workers were reined in to someting the state can afford? When is Gregoire going to come up with a plan for pension reform? It's way overdue from the Democrats & their union supporters.

Posted by: Clean House on December 20, 2006 01:07 PM
6. When the Washington state pension fund finally hits critical mass, it will collapse this state's economy completely. Washington State is just following in Michigan's path. All you have to do to predict the pending economic disaster is look at Michigan now. (Another state run by "progressives".)

Posted by: Walters on December 20, 2006 02:33 PM
7. Why worry! the state will just raise our taxes to make up their coruption of our state funds, Unfortunetly our political partys have turned into Demopublicans which cater to special interests rather than the working peons that have to support this mess.

Posted by: earnest Rheault on December 20, 2006 05:18 PM
8. "The stumbling-out-the-gate budget fumble by Chris Gregoire's staff highlights a bigger problem for the state budget that will pose a significant stumbling block for lawmakers: a large piece of the puzzle is the under funded state pension system which requires sizeable "catch-up" contributions from the state in coming years. . .

"Yet, as Postman reported, the pension system's obligations have a huge impact the state's fiscal outlook. As such, it remains perhaps the most important issue for the state to address for long-term fiscal stability before considering other spending obligations. That's not what's happening with Gregoire's budget though."

This is not well informed. Only two of the state's eight state-funded pension plans is underfunded. The system as a whole is funded at almost 100% of projected liability. The state has for many years had an unfunded liability in a plan that has been closed since 1977, called Plan 1. It is required by law to amortize, or pay down, that liability over a certain period of years. The only reason this has become news in the last couple of years is because the Legislature twice -- in 2003 and 2005 -- amended the law to suspend payments to the Plan 1 unfunded liability. In 2006 it changed the 2005 law to resume those payments on a phased-in basis and establish an annual "floor" for future payments. (Republicans argued, with some merit, that we should have done more.) The Gregoire budget funds that policy in the next biennium. You also omit to note that Gregoire proposes elimination of the extraordinary pension benefit called "gain-sharing," which accounts for a large portion of the unfunded liability in Plan 1. So for those concerned about pension costs, she deserves some credit on that one. Let's see what legislative Democrats do now.

Posted by: ram on December 20, 2006 06:10 PM
9. "Only two of the state's eight state-funded pension plans is underfunded."

Sorry -- are underfunded. Yikes.

Posted by: ram on December 20, 2006 06:12 PM
10. ram - I'm not disputing your numbers or stats, but you are acknowledging the main beef: the state has underfunded a signficant pension contribution in the past, and meanwhile its catch-up payments (or the "floor" you refer to) are not nearly enough to stabilize the system, thus putting the state on awkward fiscal ground in the future.

Also, I agree getting rid of gain-sharing is to her credit, if the Legislature sticks to it.

Posted by: Eric Earling on December 20, 2006 06:17 PM
11. Eric -- What do you mean by "stabilize the system"? So long as the Legislature has a systematic method of amortizing the unfunded liability in TRS/PERS 1, the system is certainly "stabilized" (whatever that means). The difficulty is that the Legislature interrupted, for a time, that systematic method of payment, which has the result of increasing the size of the liability. One can certainly argue that having done that, the Legislature should have put in place a plan to catch up with the suspended payments more quickly, which would increase costs in the short term but decrease them in the long term. Republicans, indeed, made that argument. The main stumbling block was local governments, who also pay toward the Plan 1 unfunded liability, and who did not want to see their contribution rates go as high as a speedier catch-up would have entailed. That is a good debate, and one the Legislature may have again. But to say that current law is "not nearly enough to stabilize the system" is simply without substance.

Posted by: ram on December 20, 2006 07:14 PM
12. ram - I think we're playing a semantic game here, where you don't like the word choices I'm using thus object to the point. I've walked through the facts you're laying out a couple times in my work with Snohomish County on this issue, discussing the very impacts on local governments you raise. The point made in those discussions was that the "speedier catch-ups" needed to take place or the fiscal impact in the later years of the budget outlook becomes increasingly painful.

As you've acknowledged, the state has not stepped up to the plate to remedy the situation for a number of reasons. My read of the Gov's proposed budget is it does not change that (and if I'm wrong about that, I'm happy to examine information accordingly). Moreover, it is difficult to see the Legislature improving the situation for the reason I cited above (since such a move has fiscal costs with little PR value in a time when assorted left-leaning interest groups want their spending wishes addressed).

I've heard much greater experts on the state budget than I articulate this same problem. Rep. Sommers even expressed significant concern about the issue last year when Gregoire proposed deferring payments then. In the end, I think we agree it's a problem, you just don't like my choice of words to describe it.

Posted by: Eric Earling on December 20, 2006 07:57 PM
13. How does one budget for stabilization with a "gain-sharing system" in place? Anyone? Bueller? How does one expect a different result with the same folks in charge? Like Margerita Prentice who upon hearing of the magnitude deficit in the pension (which passed through who committee showing NO FISCAL IMPACT to the State)stated "Wow, that's a BIG NUMBER". Since they don't print money in Olympia, we can reasonably assume it will be extracted from the taxpayers.

Posted by: Huh? on December 21, 2006 09:30 AM
14. Sorry folks that should read "her committee" not who.

Posted by: Huh? on December 21, 2006 09:32 AM
15. Eric:

There's no question that this is an area where it's easy to get bogged down in semantics, but there's more to our disagreement than that.

We've both misused the word "catch-up" here, for which I apologize. It has a specific meaning in this context. Some background: Prior to enactment of the Pension Funding Reform Act of 1989, the state made contributions to the various Plans 1 on an ad hoc basis. From 1973 to 1991, it met the full funding requirements of each only once. After the passage of the Pension Funding Reform Act of 1989, state was required by law to make systematic payments to amortize the unfunded liability in Plan 1 by a date certain. For 12 years, 1991 to 2003, it did so, funding 100 percent of the actuarially required contributions each year. So the state did in fact, "step up," through some good budget years and bad.

In 2003, as one step toward closing a budget shortfall estimated at more than $2 billion without tax increases, the Legislature amended the relevant statute to suspend payments toward the Plan 1 unfunded liability for the two years of the 2003-05 biennium. This was a bipartisan policy. In 2005, the Democrats, with a much smaller budget problem than faced by the Republican majority Senate and Democrat majority House two years before, amended the statute again to skip the payments for another two years. The budget savings, in this instance, were far greater than two years before, because the scheduled payments were much greater. So potentially we were going four straight years without payment toward the Plan 1 Unfunded Liability. That's in part why this all became a news story, because suspending the payments as the state was doing, particularly in a time when contribution rates were rising, means that the cumulative cost of meeting this obligation by the statutory amortization date of 2024 becomes much greater. (It is akin to skipping the payments on a term loan.)

In 2006, with the budget picture having brightened, and the issue's profile having been raised, the governor and legislature proposed to resume the funding of the Plan 1 Unfunded Liability, phasing in, over three years, the payment that would have been due in fiscal 2007. The bill, HB 2681, also provided for minimum contribution rates below which employer and employee rates in each of the Plans 1, 2 and 3 could not fall in any year. This was referred to as a "floor." The idea was to avoid the pattern we'd recently seen of very low contribution rates followed by very high rates, and smooth out the market cycles somewhat.

The argument between Democrats and Republicans was that 2681 did not provide for "catching up" with the payments that had been missed in the previous three years. The Republicans argued that we could afford to that, and should, in order to avoid the much higher costs involved in amortizing those missed payments through 2024. Yes, your folks in Snohomish County are right -- incorporating "catch-up" in 2681 would have been painful. But understand: cities, counties and other local governments got three consecutive years with NO contributions toward the Plan 1 Unfunded Liability, and not catching up with the payments missed for 2004, 2005 and 2006 means that it costs them -- that is, local taxpayers -- much more over the longer term. As the guy in the oil filter commercial used to say, "Pay me now, or pay me later." Who was right in that debate? Depends on where you're sitting, I guess.

Your read of the governor's budget is wrong. It funds the policy set in HB 2681. By proposing to eliminate gain-sharing, she also significantly reduces the size of the unfunded liability.

Could she have proposed, given the size of the state's budget surplus, to do the "catch-up" proposed by Republicans this year, or otherwise accelerate payments? Yes, and we may well see that debate reopened. Any such proposal, however, is likely to run into the same opposition from local governments that it did in the last session.

"Huh?" asks how one budgets for stabilization with a gain-sharing system in place. That's a good question. The answer is that the state makes a projection of the likely frequency and amounts of gain-sharing payments 25 years or so into the future, based on historical investment experience, and builds that projected liability into contribution rates on an ongoing basis. The reason gain-sharing became an issue when it did was that between 1998, when gain-sharing was enacted, and 2004, the state had operated on the assumption that it could fund gain-sharing on a pay-as-you-go basis. In 2004 a new State Actuary determined that the state was required to recognize gain-sharing as a material liability of the system and to recognize its costs in present contributon rates; that it must, in other words, "pre-fund" gain-sharing. That's when the stuff hit the proverbial fan, because that determination resulted in significant increases in contribution rates, and so significantly higher pension funding costs in the budget.

There's more to the story, but that's enough. I'm sure by now we've bored readers to tears, assuming anybody's even read this. Will be glad to discuss further off SP. I'll just say in closing that media coverage of pension funding issues has for the most part been poor, and that that's given rise to a lot of misunderstanding of where we are with it in Washington.

Posted by: ram on December 22, 2006 07:46 PM
16. Well there you go! When government has to recognize and actually fund the unfunded liablities it creates by negotiating certain benefit packages the stuff truely does "Hit the Fan". And the taxpayers pay for it. Is gain sharing going to be removed anytime soon? And what will that cost for the buy out?

The sad fact is that is if the Government had to operate and account for funds in the same way the private sector has to under Sarbanes-Oxley, Most of the leadership in Olympia would be in jail.

Posted by: Huh? on December 23, 2006 06:17 PM
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