Economics in One Lesson
If you are an active employee who is keeping an open mind about the Professional Fire Fighters of Arizona (PFFA) PSPRS reform proposal, you may be asking yourself this:
If SB 1609 already requires me to pay increased contributions into PSPRS, why do I care whether the extra contribution amount goes to pay COLA's to retirees or is used to pay down PSPRS' deficit since it comes out of my check either way?Okay, maybe you weren't asking that question, but it does allow me to go into some of the unintended consequences of the PFFA's reform proposal.
PFFA President Bryan Jeffries has stated that the PFFA reform proposal, ". . . would fund retirees' cost of living adjustments out of the pockets of current working public safety workers, not taxpayers." This would be done by taking the aforementioned extra contribution amount already being paid by active workers (currently 3.4%, but topping out at 4% on July 1, 2015) to pay down PSPRS' deficit, and instead, use it to fund COLA's for retirees. The destructive excess earnings model of paying COLA's would be eliminated. Active workers would see no net change in their paychecks, as they have to pay the additional 4% for their whole careers anyway; taxpayers would be off the hook for the COLA's; and retirees would still be able to get COLA's, though they will be at a reduced amount. Win,win, and not a total loss, right?
Not quite. If you are an active employee making contributions into PSPRS, it is true that your contribution will not change. However, you will have to consider the unintended consequences of your career earnings becoming the dedicated source of income for retiree COLA's. Governments (and public employee unions) love to have dedicated sources of income. This is usually done via some type of tax like a gas tax hike for road repairs, a tax on cigarettes for health programs, or a sales tax increase for some particular program (like was attempted in 2012 with Proposition 204, which would have made the temporary one cent sales tax increase permanent to fund education).
The dedicated funding source is fine as long as the economy is good. When there is a downturn, the tax will remain, even if the taxpayers are finding their own income diminished. If we are talking about gas, cigarette, or even sales tax, the taxpayer has some means to offset their loss of income by driving, smoking, or buying less in general. But what happens to active employees when there is an economic downturn?
Active employees, who have been dutifully funding retiree COLA's with 4% of their earnings, will now see the unintended consequences of the PFFA reform proposal. Their employers, suffering from decreased tax revenues, will have to find ways to trim their budgets. This is particularly harsh for those in public safety because economic downturns usually mean that PSPRS suffers investment losses, which in turn, means higher annual required contributions (ARC's) for employers. The employers are hit by this double squeeze of lower tax revenue and higher ARC's. This spells disaster for active public safety employees.
Wages and benefits are by far the largest part of law enforcement and fire service budgets. When an employer has to trim public safety budgets, it really has no other option than reducing payroll costs, either individually or in the aggregate. While it may be good to be the recipient of a dedicated source of income, it is not so good to to be the dedicated source of income. Active employees will find this out if the PFFA's succeeds in making their proposal part of the Arizona Constitution.
If there is another financial crisis, active employees are going to get hammered because they will be the only source of cost savings in the budget. However, retirees may not even notice the financial hardship visited on active employees because of the design of the PFFA reform proposal. Looking at the fiscal year (FY) 2014 actuarial report, we can see that active members contgributed about $152 million into PSPRS. If COLA's were being paid per the PFFA reform proposal, 4% of this amount, or about $6 million, could be used to pay retiree COLA's. There were about 10,500 retirees at the end of FY 2014 with an average yearly retirement benefit of $51,600. The $6 million allocated for COLA's would not be enough to pay a full 2% to all retirees. $6 million divided among 10,500 retirees would only be about a $571 annual increase for each retiree.
Now let's redo these calculations. Suppose a bad economy caused employers to give our active employees a 2% pay cut in FY 2014. This would reduce our total active member contributions to about $149 million from $152 million. 4% of the reduced amount would be about $5.96 million. With this lower amount to pay COLA's, retirees would receive a $567 annual increase versus $571.
However, the average FY 2014 salary of our active employees is about $75,000 per year. A 2% pay reduction means that our average employee loses $1,500 a year. Retirees will see their COLA reduced by $0.33 per month while the average active employee will see his monthly salary drop by $125. Even if we drop the active employees' pay 10% ($625 a month), our retiree will only see his monthly COLA reduced by about $4.17 a month.
Here we can see the truly insidious effects of the PFFA reform proposal. It shifts not only the burden of retiree COLA's on to active employees, but also the punishing effects of any future financial crises. Retirees will be insulated from most of the effects of any financial crisis since any reduction in their COLA's will be minimal in comparison to active employees. Active employees will take the brunt of nearly all the downside of financial downturns. Retirees will take virtually none. This is the same problem with the current excess earnings COLA model that has made it such a problem for PSPRS: all the upside to retirees, all the downside to PSPRS. Only now, instead of the costs of the bad model hitting PSPRS, the PFFA wants active employees to absorb them.
The PFFA's desire to make active employees the dedicated source of income for retiree COLA's is so egregious that it is could be used as an example of historian Robert Conquest's Third Law of Politics which says, "The simplest way to explain the behavior of any bureaucratic organization is to assume that it is controlled by a cabal of its enemies." With a friend like the PFFA . . .
In the next post we will discuss how this plan is bad for retirees as well.