Methods of gathering funds not enough to protect schools from rising pension costs
Much of the intrigue in this year’s legislative session centers around lawmakers’ push to raise corporate taxes by $2 billion to better fund Oregon’s struggling K-12 schools.
Meanwhile, behind the scenes, Gov. Kate Brown is aggressively shaking the sofa cushions of state government in a companion effort to protect that investment from being spent on school districts’ increasing pension costs.
It’s a desperate attempt to take action that everyone agrees is needed. But it appears that for all of Brown’s efforts, she’ll come up short — an illustration of the sheer size of the pension problem and the paucity of available revenue streams to address it.
The stark reality behind the governor’s push is that Oregon won’t make much headway on education if it plows a big chunk of new money into schools only to see most of it disappear into the pension system, which is exactly what could happen over the next decade as pension cost increases continue unabated.
That’s the challenge: finding enough money to hold school districts harmless from ballooning pension costs. It’s an effort that grew out of a task force she set up in 2017 to look for ways to pay down the pension system’s unfunded liability, which now stands at nearly $27 billion. Holding down school districts’ rates is a less ambitious goal, as it puts a Band-Aid on just one group of employers without addressing the deficit as a whole.
Ultimately, Brown would need to scrape together around $2.7 billion — on top of any tax increase — to protect school districts from rate increases expected in 2021. Yet the solutions she and others are exploring are not only financially uncertain, but legally and politically dicey.
What follows is a look at some of those revenue streams, and what they might raise.
Brown’s basic plan has been to plow money into a PERS fund that the Legislature set up in 2018 to provide pension cost relief to all public school districts, public charter schools and education service districts. While it doesn’t directly address the unfunded liability, it’s still called the School District Unfunded Liability Fund.
The theory is that the fund, invested alongside the regular pension fund, could be gradually drawn down over the next 20 years to help cover schools’ increased pension costs.
But making a dent would require a substantial account balance, and PERS has already said there won’t be enough money in the school fund to make any difference in the coming two-year budget cycle.
According to PERS’ analysis, it would take a $495 million account balance to offset every 1 percentage point increase in schools’ pension contribution rates. The PERS actuary expects schools’ pension rates to rise by 5.4 percentage points in 2021, which means Brown would need nearly $2.7 billion in the account to hold rates constant in 2021.
Lawmakers agreed to divert portions of four state revenue streams to capitalize the school fund in 2018. But deposits from three of those sources — proceeds from debt collection, capital gains taxes and estate taxes — would only occur if the amount collected by the state exceeds historical averages. Only the portion exceeding historical averages would be deposited, and in the case of capital gains taxes, only 25% of the excess collections.
State analysts offered a back-of-the-napkin analysis of those revenues when the bill was under consideration. They found proceeds from the debt collection bucket could range from zero to $14 million during a two-year budget cycle. Proceeds from capital gains could range between zero and $60 million in any given biennium. State revenue analysts don’t expect estate tax revenues to exceed historical averages, but they speculated that this revenue source could generate up to $90 million in any given two-year cycle, depending, presumably, on how many rich people die. Finally, interest on unclaimed property held by the Department of State Lands could range from nothing to several million dollars every biennium.
As outlined in the law, the state will divert those revenue streams for three two-year budget cycles. In the unlikely event that they all generate the maximum amount, they would bring in about $170 million for the school district fund in each budget cycle. That’s enough to offset about one third of one percentage point in rate increases in 2021, rising to about 1 percentage point by 2023.
In other words, not much.
Raid the SAIF surplus
Another idea to offset schools’ PERS costs is to divert some of the $1.9 billion capital surplus held by SAIF Corp. into the school district fund.
The governor hasn’t publicly endorsed this plan, but meeting notes obtained by The Oregonian through a public records request show that Brown’s staff members are meeting with industry experts to evaluate it.
It’s not a new strategy. Gov. Vic Atiyeh pulled the same maneuver in 1982, taking $81 million of SAIF’s surplus to balance the state budget after several special sessions failed to do so. After being sued, the state was forced to pay back the money with interest a decade later.
The legal landscape may have changed, as lawmakers adopted statutory language in 1982 that allowed the state to tap any surplus in excess of actuarially sound practices. But there may not be much money to wring from this source.
Notes from those initial meetings show there was discussion of extracting as much as $1.4 billion from the SAIF surplus. But SAIF’s chief executive, Kerry Barnett, says that’s unrealistic, and that he has explained why to the governor’s staff in meetings over the last two months.
SAIF needs to meet minimum capital requirements established by insurance regulators — $314.3 million at the end of 2017, according to SAIF’s financial statements. But Barnett says that’s an absolute minimum, and that SAIF’s board has determined that it needs four to five times that amount, at a minimum, not only to protect against potentially catastrophic events, such as an earthquake or terrorist act, but the risk of a prolonged recession or a return of high inflation rates in medical costs.
Much of the growth in SAIF’s surplus over the last decade has come from adjusting its claims reserves. That’s the pile of money set aside to cover workers’ compensation claims, which can pay out for decades. Those reserves have consistently been adjusted downward in recent years, by $283.1 million in 2017 for instance — when costs were less than forecast.
Barnett says that’s because medical cost inflation has been so low — 2% to 3% versus historical inflation of 8%. Those excess reserves then transfer into the surplus, part of which — around $160 million annually in recent years — has been paid out to policyholders in dividends.
But if those medical costs turned around, SAIF might need to bolster its claims reserve again, tapping the surplus. Likewise, in an economic slowdown or recession, SAIF’s underwriting revenues decline, as they are essentially tied to payrolls, while claims would not fall off as rapidly, Barnett said. That would translate to larger underwriting losses and another hit to the surplus.
Even so, that leaves several hundred million dollars, perhaps $500 million, on the table.
Then come the legal and political questions. This proposal leaves business groups frothing at the mouth. They contend SAIF’s surplus belongs to policyholders, a good chunk of which are small-business owners. That cushion helps SAIF afford those employers some of the lowest workers compensation rates in the country, one of the few competitive advantages the state offers.
“Litigation by policyholders would be very likely,” Barnett said. “How that would come out I can’t speculate. … The board feels pretty strongly. They have a fiduciary duty to the industrial accident fund and making sure dollars are used appropriately.”
Diverting the kicker
Now we head into a major gray area — a proposal the governor hasn’t endorsed, yet.
There are at least two proposals afloat to divert the kicker rebates taxpayers are forecast to receive — the current estimate is about $750 million — when they file their 2020 taxes. Both of them could help schools with pension costs, though neither is specifically tailored to Brown’s strategy of holding school districts’ PERS costs constant after 2019.
One bill co-sponsored by Sen. Kathleen Taylor, D-Portland, and Rep. Karin Power, D-Milwaukie, would divert the money into an incentive fund that all public employers, including school districts, could tap to reduce their pension costs. Using the money this way would dilute its potential impact on school pension costs.
Another proposal, introduced as a Senate Joint Resolution at the request of Senate President Peter Courtney, would place the kicker in a rainy-day fund that schools could access to meet increasing expenses.
Meanwhile, Democrats have already agreed to divert $108 million of the kicker for general budget purposes.
Whatever form this takes, it’s a stealth tax increase, and in public, Brown has hedged on the idea, suggesting that “hardworking families should get their kicker rebate.” But she acknowledges the Legislature was having conversations about the concept, “at least for the short term.”
If this proposal were made, it would potentially be the largest pot of money to underwrite a one-time injection into the school district fund. Taxpayers clearly like their kicker rebates, and some might deeply resent a diversion. But unlike the corporate tax increase currently being floated, or the proposal to raid SAIF, there’s no deep-pocketed constituency waiting in the wings to file a ballot measure to knock this one down.
The Legislature could divert some or all the money by passing a bill on a two-thirds majority vote. They’ve done it before, in 1991 for the personal income kicker and in 1993 and 2007 for the corporate income kicker, according to the Legislative Revenue Office. But the supermajority requirement might mean a close vote, particularly in the Senate.
Employee cost sharing
This is an evergreen proposal, and potentially a make-or-break proposition in Brown’s quest. This session, it was built into Senate Bill 531, a wide-ranging pension reform bill sponsored by Sen. Tim Knopp, R-Bend, that never received a hearing. But this concept is always waiting in the wings for an end-of-session bargain.
In fact, former Gov. Ted Kulongoski and members of the business community filed two PERS cost-sharing ballot measures last week, which might increase pressure on lawmakers to do something during the current session.
Since 2003, public employees have not been contributing to the pension fund, making Oregon an outlier among publicly administered defined benefit plans. Instead, employees’ mandatory 6% retirement contributions go into a supplemental defined contribution plan, assets that are invested alongside the pension fund but belong directly to the employee, like a 401(k) or Individual Retirement Account. The individual account program is supposed to compensate new employees for some of the pension reductions that took place in 2003.
The cost sharing concept is to divert some or all of the employees’ contributions back into the pension fund. The bottom line here is that every dollar contributed by employees saves a dollar in pension contributions by schools, or a dollar out of the school fund.
It’s potentially big money: more than $400 million per biennium if the entire 6% contribution from all school employees was diverted into the pension fund. If that did happen, Brown’s problem is essentially solved in the two-year budget cycle beginning in July 2021, when schools are expected to face an additional $410 million in pension costs.
That’s not realistic. This plan was a bargaining chip at the end of the 2017 session. Yet in that case, state leaders including Brown supported a version that would have diverted 1 percentage point of the employee contribution to the pension fund. Even that idea died quickly.
A contribution of that size wouldn’t be very consequential, though it would trim the amount that the school district fund would need to generate. It is anathema to public employees. And it’s not clear where Brown stands either. During her recent election campaign, she was adamant that she didn’t want to reduce compensation for teachers and firefighters, which is exactly what such a plan would do.
Assume for a moment that Brown, Courtney and Kotek can twist enough arms to divert $500 million of the SAIF surplus into the school district relief fund.
And though unlikely, also assume all the revenue sources currently dedicated to the school district fund come in at maximum forecast levels.
In 2021, with the best of circumstances, the school district unfunded liability fund might have $670 million. That’s one quarter of the sum Brown would need to shield schools from the PERS cost increases currently forecast for that year.
Now let’s say lawmakers adopt a progressive kicker diversion, leaving it in place for families and individuals with median income and below, diverting the rest to the school district fund.
That might raise $500 million. So best case, that leaves Brown with about 40% of the money she needs to protect schools from rate increases in 2021.
The takeaway? The governor’s gonna need a bigger fund.