Last fall, Colorado officials claimed a $1 billion tax increase was needed to save the state’s public schools. Voters did not approve the tax increase. If officials were telling the truth, one would expect that this year they would be directing every extra budget dollar toward K-12 education.
This is not happening. Instead, bills currently before the Legislature include an estimated $75 million in special interest tax giveaways.
The Office of Economic Development and International Trade will enjoy a $3.7 million increase. It works closely with the Colorado Economic Development Commission, which awards business grants from the taxpayer-financed “strategic fund.” In August 2013, the Colorado Economic Development Commission approved a $200,000 loan to “small, rural movie theaters that are facing financial pressure.” Given that almost all businesses face financial pressure, it is no wonder a Denver Post study showed nearly one-third of the businesses the commission funded had ceased to exist as independent entities.
Other economic development giveaways include $5 million in special rewards for television and film producers and a $5 million slush fund for the Advanced Industries Accelerator Program. The program benefits people involved with currently fashionable businesses like aerospace, bioscience and electronics.
The problem with taxpayer-funded grants, tax credits and tax exemptions is that one man’s tax preference is often another man’s tax burden. The Governor’s Office says the state needs $24.1 billion to run its government. Yet when favored businesses and individuals receive grants or tax exemptions, the businesses and individuals out of political favor are required to pay more. The state ends up taking money from successful businesses and individuals — money that might have been used to develop successful new enterprises — so it can fund business proposals it thinks might produce tax revenue in a decade or so.
Giving tax deductions for the interest on government bonds but not private ones biases investment decisions in favor of lending to governments rather than private businesses. Providing tax credits to businesses that create 20 new jobs at 110 percent of the county average wage biases the tax system in favor of businesses that hire high-wage employees at the expense of those who hire lower-wage employees.
Worse, such special interest preferences make it almost impossible to maintain a “clean” tax base. Clean tax bases seek to raise revenue while avoiding special preferences for particular types of consumption or investment. They tend to be easier to comply with and understand than ones with tangled labyrinths of special-interest concessions. Simple tax laws with a low general rate often raise more revenue than do complicated laws with a higher general rate and lots of special exemptions.
Lower rates in a simple tax system are also beneficial because they are less likely to trigger wasteful tax avoidance schemes.
As a rule, the political system is incapable of distinguishing legitimate economic arguments from illegitimate ones, and often distorts economic decisions by picking winners and losers on the basis of political power or emotional pleading.
Tax breaks blessing certain special interests at greater cost to the rest of us persist. Meanwhile, lawmakers scarcely have considered a liberating and cost-saving use of tax credits.
The current political practice favoring the consumption of K-12 education via public schools biases educational decisions. Nonprofit scholarship-granting organizations could serve more needy elementary and secondary students with private tuition aid if the organizations’ donors received a tax credit for their contributions. Children leave the public system to receive a quality education. The state comes out ahead because the scholarship costs less than the per-pupil amount for students remaining in public schools.
Colorado citizens already pay plenty of taxes. Before officials come back with additional proposals for tax increases, they should stop expanding the system of special tax rates for special groups and start rolling back existing ones. At the same time, they should look at enacting tax credits that provide a general educational benefit while reducing the expense to taxpayers.
Without reforms, Colorado voters have every reason to continue to say no to new taxes.
Linda Gorman is an economist at the Independence Institute, a free market think tank in Denver.
At present, everyone in Colorado pays the same marginal income tax rate, 4.63 cents out of every additional taxable dollar earned. Colorado officials and their allied interest groups support a constitutional amendment both to increase the state’s income tax and to create two tax brackets. They say the additional funding will improve K-12 education, although it is surprisingly difficult to find definitive evidence from other states showing that increasing spending from current levels will improve educational achievement.
What officials don’t talk about is the fact that higher state taxes may affect average incomes. The highest tax bracket would be 5.9 cents out of every additional taxable dollar earned by households with incomes above $75,000 a year. Households with taxable incomes of $75,000 or less will pay a marginal tax of 5 percent, 5 cents out of every additional dollar earned.
But people have all sorts of ways to adjust their taxable income. They can work less. They can increase mortgage deductions by buying a bigger house. They can shift their savings into tax-free bonds. And if one state’s income taxes are just too much, they can change their residence.
The following chart shows the historical relationship between federal marginal tax rates and average real income. It suggests that raising tax rates may affect income. When marginal taxes fall, average incomes tend to rise and vice versa. Given the strong correlation between parental income and school achievement, the children might be better off if their parents keep the money.
Source: Emmanuel Saez. 2004. “Reported Incomes and Marginal Tax Rates, 1960-2000: Evidence and Policy Implications,” Tax Policy and the Economy, 18, 117-173.
This article originally appeared on Complete Colorado Page 2, August 2, 2013.
Members of the Denver City Council are proposing an ordinance that would impose a 5-cent charge on disposable (paper and plastic) bags used to carry purchases at point of sale at grocery and convenience stores with “over 1500 square feet” of retail space.
Proponents call this bag charge a “fee.” But with even a little scrutiny, the ordinance is obviously much closer to a tax than it is to a fee. The difference between the two is hugely significant. New fees can be passed by the City Council, while under Colorado’s Taxpayer’s Bill of Rights (TABOR), new taxes must be approved by voters through the ballot.
Here’s what the Colorado Supreme Court had to say about the difference between a fee and a tax in the 2008 case Barber v. Ritter:
If the language discloses that the primary purpose for the charge is to finance a particular service utilized by those who must pay the charge, then the charge is a “fee.” On the other hand, if the language states that a primary purpose for the charge is to raise revenues for general governmental spending, then it is a tax.
The drafters of the Denver ordinance are very careful to include that “No disposable bag fees collected in accordance with this article shall be used for general governmental purposes.” This is apparently the clumsy justification, based on at least one part of the Supreme Court’s definition, that the bag charge can’t be a tax.
But that alone doesn’t magically make a tax a fee.
The draft ordinance goes on to describe thirteen different, and often vague, city activities that can be funded with the new revenue, including studies, education campaigns, community cleanups, a website and the hugely ambiguous “Any other activities determined by the manager [of the Department of Environment] to mitigate the effects of trash associated with disposable bags.”
So while the money might not be used for general government spending, it can be used quite broadly, and with significant discretion. This hardly satisfies the fee requirement that the charge be used to “finance a particular service utilized by those who must pay the charge…”
The disposable bag money is also going to fund the giving away of reusable bags to “food store customers” and (again at the discretion of the manager of the department of environmental health), “to other appropriate locations.”
In other words, among many other things, the city will be using the money paid by people using disposable bags to give away reusable bags to people who aren’t paying the cost; a redistributive give-a-way program on (literally) someone else’s nickel.
How does that possibly satisfy the “particular service utilized by those who must pay the charge” fee definition? How is that not a tax?
Moreover, what Denver politicians are calling a fee is actually treated the same as a sales tax in both its collection from the consumer and its remittance to the city. Like with a tax, grocery stores are required to collect the money from customers at the point of purchase. Like with a tax, stores keep a portion (two cents of each five cents collected up to a defined amount each month) of the money collected to offset the cost of complying with the law. Like with a tax, there are penalties and interest charges for stores failing to file and remit on time.
To call a charge that so closely resembles a retail sales tax a city government fee depends on a convoluted and insultingly obvious attempt to redefine the traditional understanding of the difference between a fee and a tax.
In fact, a similar disposable bag fee passed in Aspen is currently being challenged in Pitkin County District Court as a violation of TABOR.
The plaintiffs’ attorney, Jim Manley from Mountain States Legal Foundation notes in his motion for summary judgment, “The revenue stream provided by the bag tax may be small, but the legal principle at stake is significant.”
The stakes are indeed significant. If politicians in Denver or Aspen or anywhere else in Colorado find they can bypass voters by simply calling what is obviously a tax a fee instead, then there are really no longer any meaningful limits on the ability of Colorado governments to reach into their taxpayers’ pockets.
There is a solution to all of this. Denver City Council could simply err on the side of respecting the Colorado Constitution (which should be their default setting anyway) by recognizing the proposed ordinance for the tax that it is, and referring it to the ballot for Denver voters to decide.
This article originally appeared on Complete Colorado Page 2, August 2, 2013.
by Dave Kopel and Fred Holden
Gaylord Entertainment is offered $81 million in Colorado taxpayer money for its proposed 1,500-room Denver International Airport hotel and other projects. By what authority can the state government take tax money out of your pocket and give it away to a private corporation? The answer is that corporate welfare schemes, such as so-called “public-private partnerships,” flagrantly violate the Colorado Constitution.
Article V, section 34, of the Constitution states: “No appropriation shall be made for charitable, industrial, educational or benevolent purposes to any person, corporation or community not under the absolute control of the state … .” Very easy to understand.
Part of the Gaylord welfare scheme, and similar subsidies to developers, is that the developer gets to collect and keep Colorado sales-tax revenue, and then spend the tax money on the development. This violates the next section of the state constitution:
“The general assembly shall not delegate to any special commission, private corporation or association, any power to make, supervise or interfere with any municipal improvement, money, property or effects, whether held in trust or otherwise, or to levy taxes or perform any municipal function whatever.”
When a developer collects sales-tax money, and then spends that money to build roads, sewers, and so on, the developer is plainly levying taxes to make “municipal improvement.” The Colorado Constitution says that is illegal. Governments — not private corporations — are supposed to levy taxes and perform municipal functions.
Another provision of the Colorado Constitution requires that the government treat people equally. The government cannot pass laws giving a particular corporation special privileges: “The general assembly shall not pass local or special laws in any of the following enumerated cases, that is to say; … granting to any corporation, association or individual any special or exclusive privilege, immunity or franchise whatever.” Article V, section 25.
Yet giving Gaylord the special power to tax, and the special power to spend tax money on certain projects, is certainly a special privilege that is denied to everyone else.
Simply giving taxpayer money to a corporation is also illegal: “Neither the state, nor any county, city, town, township, or school district shall make any donation or grant to, or in aid of … any corporation or company … .” Article XI, section 2.
Back in 1991, United Airlines asked Colorado and Denver taxpayers for hundreds of millions to build an aircraft maintenance facility in Colorado. State Attorney General Gale Norton explained to the legislature that the bill to provide corporate welfare to United “would not pass muster under the Colorado constitution.” Yet she predicted that the Colorado Supreme Court would probably rule in favor of the United welfare bill.
She was correct. For decades, the Colorado Supreme Court has ignored the plain text the Colorado Constitution, and allowed taxpayer money to be donated to corporations.
In the case of United, the welfare from state government coffers would be laundered through the Colorado Housing and Finance Authority. The CHFA is a corporation created by the legislature in 1973, for the ostensible purpose of providing money to homebuyers and to small businesses.
Fortunately for Colorado, United found an even bigger sucker in Indianapolis. Funded by lavish corporate welfare, the United maintenance facility in Indianapolis opened in 1994. United abandoned the facility in 2003. Corporate promises about how the taxpayers will get rich by giving their own money to big business rarely come true.
While the Colorado Supreme Court has refused to do its duty to enforce the many anti-corporate welfare clauses of the Colorado Constitution, citizens have their own remedy: They can vote for state and local candidates who will uphold the Colorado Constitution. Under our constitution, big businesses are supposed to pay their fair share of taxes.
This article originally appeared in the Denver Post, June 16, 2012.
by Penn Pfiffner and Barry Poulson
This legislative session Colorado HB1250 was introduced to begin addressing an unfunded billion-dollar liability in the Public Employee Retirement Association’s (PERA) retiree health care benefit program. Its own sponsor then killed the bill after it came under a fire storm of hysteria-tinged and false criticisms, fueled by one-sided media coverage.
Colorado taxpayers lost an important opportunity for the Legislature to begin the fundamental reforms required to put PERA on a sustainable fiscal path. Instead PERA will continue to carry huge unfunded liabilities that in the absence of reform will eventually require a taxpayer bailout or PERA retirees being denied their promised benefits.
About a dozen years ago, PERA established a health care program for people who retire before age 65 and no longer are covered by their government employer for health insurance. Local governments, school districts and state government contribute annually. The program is a type of “defined benefit.” In other words, a promise with no cap to the cost.
The PERA health benefit also gives retirees a direct premium subsidy even after they turn 65 and begin using the taxpayer-supplied Medicare.
HB 1250 would have changed the program from an open-ended promise to pay retirees whatever it takes, to a $230 fixed subsidy — the amount they receive today. Additionally, eligibility for PERA’s retiree health insurance would have been restricted to those 65 years of age and under, and thus not eligible for Medicare or Medicaid.
Unfunded liabilities in PERA’s retiree health plan have doubled over the past five years to more than $1 billion, and are projected to continue to grow for the foreseeable future as health benefits paid to public sector retirees continue to increase more rapidly than employer (read taxpayer) contributions to the health plan.
An Independence Institute study last year found that PERA’s amortization period is in excess of 30 years. Its actual contribution rates are far below the required contribution rates that would meet standards set by the Government Accounting Standards Board (GASB).
What’s more, the funding crisis in PERA is actually worse than reported in their annual financial statements. PERA assumes an 8 percent return on assets and uses this rate of return to discount liabilities in the plan. GASB recently issued guidelines that recommend using a discount rate that is a blend of the municipal bond rate and the Treasury rate, a rate between 4 percent and 5 percent. Using this discount rate, a recent study by Robert Novy-Marx from the University of Chicago and Joshua Rauh from Northwestern University finds that on a per capita basis, PERA has one of the most underfunded pension and retiree health plans in the country, with unfunded liabilities equal to $33 billion in the pension plan and over $1 billion in the retiree health plan. The study projects that over the next two decades, state plans with large, unfunded PERA-sized liabilities are likely to go bankrupt.
A number of states have recognized the huge risk posed by their retiree pension and health plans and have begun to make changes that follow the lead of reforms that have already been enacted in the private sector. Most private employers have either eliminated retiree health benefits, or replaced them with a defined contribution plan in which the employer caps the subsidy to retiree health insurance at a fixed dollar amount, with employees picking up the remainder of the health insurance premium.
HB1250 was an attempt to address PERA’s impending fiscal nightmare with some sensible reforms. Unfortunately, the public sector retiree lobby is better organized and louder than the Colorado taxpayer lobby. Sure, HB1250 was not going to solve all of PERA’s problems in one fell swoop, but that is more a testament to how deeply flawed our public pension system is than anything else.
Fixing this mess is a massive undertaking that will require many reforms enacted through many steps. HB1250 would have been a great first step. Let’s hope, for the sake of both Colorado taxpayers and future PERA retirees, that some courageous legislators undertake this task, and soon.
The article originally appeared in the Colorado Springs Gazette, May 3, 2012.
by Harris Kenny
Solar panel-maker Solyndra has been in the headlines because it received $528 million worth of taxpayer-backed federal loans and then went bankrupt. But Denver residents don’t need to look at failed Solyndra to see the trouble that government loans can bring. Sadly, there are some prime examples closer to home.
Last month, The Denver Post reported ["Tattered sales twist finances," Dec. 9 news story] that roughly 15 percent, or around $20 million, of the loans in the Denver Office of Economic Development’s $127 million portfolio are currently in arrears or in default.
One of these loans, known as the Lowenstein Project, illustrates how local officials have been gambling with taxpayer money on dubious urban renewal initiatives. The Lowenstein Theatre, located across from Denver’s East High School on East Colfax, had been essentially vacant for 20 years. In 2006, former Office of Economic Development (OED) Director John Huggins proposed the Lowenstein Project, which would target the area for a $14 million redevelopment effort to build a movie theater, bookstore, music store and restaurants.
Denver officials loved the idea and helped private companies buy the Lowenstein property by handing out tax increment financing (TIF) loans of $475,000 each to Charles Wooley; Denver-based real estate firm St. Charles Town Co.; Twist & Shout; and Neighborhood Flix Cinema and Cafe.
By 2008, Neighborhood Flix Cinema and Cafe was bankrupt, taking taxpayer money that had been loaned to the company down with it. Then, in February 2011, the Lowenstein Project developers defaulted on their $2.4 million TIF loan.
Fast forward to now: On Dec. 19, the Denver City Council amended the $2.4 million TIF loan sitting in default so that a separate, more senior $1.5 million TIF loan can be paid off first.
As The Post reported, Huggins, who advocated for the Lowenstein Project in 2006, happens to be buying the loan in question for cents on the dollar from U.S. Bank. In other words, the rules are such that former politicians and bureaucrats can go through the revolving door and profit at the expense of the taxpayers once they’re out of office.
The OED claims that these TIF loans are innovative ways to jump-start projects. In truth, they are corporate welfare, which leads to socialized risks and privatized profits.
Politicians love the loans because they don’t have to pay for projects as they go, don’t have to issue municipal bonds, and don’t need voter approval.
Proponents of government-issued loans argue that government needs to provide assistance that would not otherwise be available in private capital markets. In other words, politicians and bureaucrats are taking risks with taxpayers’ money that banks, private companies and taxpayers aren’t willing to take themselves.
This is an unavoidable flaw when politicians and bureaucrats are in the business of issuing loans. However, some see it as a feature. As District 10 Councilwoman Jeanne Robb explained prior to the council vote, “All these loans are risky. That’s why OED makes these loans and private banks do not.”
In contrast, Councilmember Jeanne Faatz of District 2 cast the lone vote against amending the contract. Faatz said that the City Council’s “job is to do the best job we can with taxpayer money.”
Government-issued loans are often based on insider favoritism and politics. They rarely fulfill their supposed purpose of the public good. The companies that receive government welfare are given an unfair advantage over those that don’t. Corporate welfare encourages companies to be good at politics, instead of good at business.
Government-issued loans amount to taking money from productive taxpayers and wasting it on politically connected insiders. Politicians interested in urban renewal might instead look in the mirror and see if their own policies are stifling economic growth.
Harris Kenny is a Denver-based policy analyst at Reason Foundation (reason.org). He wrote this for the Independence Institute. This article originally appeared in the Denver Post, January 6, 2011.
by Barry Poulson
In November, Colorado citizens will vote on Prop 103 to increase taxes and earmark the revenue for education K-12. Prop 103 increases the personal income tax, the corporate income tax, and the statewide sales and use tax for the years 2012 through 2016.
The Fiscal Impact Statement prepared by the Colorado Legislative Staff estimates the cost of this tax increase at $2.9 billion. However, the cost of the tax increase for Colorado taxpayers will be significantly greater than estimated by legislative staff. That is because legislative staff uses static analysis, measuring only the direct impact of the higher taxes on state revenue. They ignore the negative impact the tax increase will have on economic growth and jobs in Colorado.
In a study for the Independence Institute, we used dynamic scoring to measure the impact the Prop 103 tax increase will have on the Colorado economy. Previous research has shown that for every one percent increase in a state’s tax rates, economic growth is reduced by 1/4 to 1/3 of a percent.
So we applied that finding to Colorado data for fiscal years 2007 to 2011, to see what would have happened if Proposition 103 had been in effect then.
The tax increase will significantly reduce personal income in Colorado. The cost of the tax is not just how much extra taxes that people will pay; another costs is the reduction in economic growth, which will reduce personal income. Thus, the total cost to Coloradans of Proposition 103 is estimated between $4.8 billion and $6.0 billion. The total cost per household is estimated between $2,169 and $2,711.
The higher tax and consequent reduction in economic growth will reduce job opportunities in Colorado. Proposition 103 will cost between 7,400 and 11,600 jobs.
By further slowing the economy, the higher tax will also reduce the tax base, and thereby reduce state tax revenues. So instead of raising $2.9 billion in tax revenue, Proposition 103 would actually raise about $2.8 billion.
The revenue generated by the tax increase is earmarked for education, but it is not clear what education programs would be funded. There is a high probability that most of the money will be used to cover operating costs of ongoing education programs. A basic rule in public finance is that one-time money should not be used to finance ongoing programs. “Annualizing” one-time money will exacerbate the structural deficit in the budget.
At the end of five years the Prop 103 tax increase will (supposedly) come to an end, but the ongoing education programs funded by that tax increase will remain. This structural deficit will put tremendous pressure on the state to extend the tax increase and make it permanent.
Because of Amendment 23, enacted in 2000, General Fund spending for K-12 education has already increased to 40 percent of the state budget; Prop 103 will result in an even greater share of the budget allocated to fund education K-12.
Colorado has created one of the best business tax climates in the country by reducing tax rates. As a result the state has experienced higher rates of economic growth than most states. The state has attracted new business investment and jobs at a higher rate than most states. People are attracted to Colorado by the rapid growth in incomes and jobs.
The tax increase in Prop 103 will reverse these trends. At a time when other states in the region, such as Oklahoma, are reducing tax rates, Colorado will be increasing those rates.
Some states, including Wyoming and Texas, impose no income tax. If Colorado tax burdens are rising relative to other states in the region, Colorado will become less competitive in attracting new business investment, and some Colorado businesses may emigrate to states with lower tax burdens.
Colorado has avoided a fiscal crisis such as that experienced in California and other states largely because of the fiscal discipline imposed by the Taxpayer’s Bill of Rights. Proposition 103 will move us toward a path similar to that in California with higher tax burdens, lower economic growth, and reduced job opportunities for Colorado citizens.
Article published in the Summit Daily News, October 9, 2011.
by Barry Poulson
In the November election, Washington citizens approved Initiative I-1053 by a more than 64 percent margin, requiring that “Legislative actions raising taxes must be approved by two thirds legislative majorities or receive voter approval.”
In other words, Washingtonians have elected to reign in their legislature’s ability to further tax them through a simple majority vote, and to have more say, at least temporarily, over how much state government is enough.
Washington voters approved a similar measure in 2007; it squeaked by with by a 51 percent margin. As quickly as the law allows (a two year waiting period in Washington) the initiative was temporarily repealed by the legislature until July 2011. Legislators argued this was necessary in order to increase taxes through a simple majority and close a budget deficit.
Initiative I-1053 reinstates the statutory requirement that legislative actions raising taxes must be approved by a supermajority vote of the legislature or receive voter approval. The initiative also requires that new or increased fees receive a supermajority of the legislature for approval.
The initiative was supported by a broad cross section of Washington businesses. The Board of Directors of the Washington Association of Business (AWB) voted unanimously to support the measure. AWB President Don Brunell stated that “Taxes and increased costs on business are the top issue of concern for our members right now. This fall’s elections will undoubtedly be about the impact of taxes on families and businesses. Our Board felt strongly enough about the measure to provide an early endorsement, in the hopes of raising the visibility of the issue among voters.”
Legislators who opposed I-1053 argued that citizens should leave tax and spending decisions to them. Gov. Christine Gregoire said of Tim Eyman, the sponsor of I- 1053: “For those like him who want to have a say constantly, come on down and run for election. Otherwise, leave it to us.”
But citizens in Washington have learned that a simple majority vote of the legislature is too easy a hurdle to raise taxes. Too often legislators respond to the special interests that benefit from higher taxes and increased spending.
The increase in citizen support for this measure from slightly more than half in 2007 to more than two thirds this year is very revealing. It is not surprising that legislators in Washington were not able to increase taxes while this constraint was in place. Securing a two-thirds vote of the legislature, or voter approval, is a high hurdle to raise taxes. Citizens have learned that this constraint allows them, rather than politicians, to decide how much in taxes they are willing to pay. With this measure in place it is up to citizens to decide how much government they want and are willing to pay for.
Citizens in Washington have sent a clear message to the governor; we are no longer willing to just “leave it to us.” As in other states, such as Colorado, where citizen approval is required to raise taxes, once citizens exercise this right they don’t give it up lightly.
Perhaps the governor and legislators in Washington will get the message this time.
This article was originally published in the Denver Daily News on December 24, 2010.
by Barry Fagin
As a long-time, hard-working federal employee who gives up a lot to work where he does, I have just one thing to say about the proposed federal employee pay freeze. I think it’s a terrific idea.
Well, maybe not exactly terrific, particularly if you think about how little difference it would actually make. But symbolic gestures can matter in politics. If this one lays the groundwork for something that’s actually important, then I’m all for it.
To get an idea of how utterly insignificant a federal pay freeze would be, take a look at the numbers fro 2008, the most current data available. For that year, the federal government payroll was about 15 billion dollars. During that same year, the Bush administration’s budget spent 2.9 trillion dollars.
Let’s suppose a pay freeze would save 10% of payroll costs, a figure that errs generously on the side of money saved. The fraction of spending reduced would have been 1.5 billion out of 2.9 trillion, a whopping one half of one tenth of one percent of all federal outlays. And let’s not forget this is 2-year-old data. Bush was the biggest spender since LBJ, but when it comes to red ink Obama and the until-recently-Democratic Congress make Bush look like a piker.
Hooray for the courage of Washington D.C! Through the miracle of bipartisan consensus, they boldly solved one half of one tenth of one percent of our spending problem. For our next trick, we’re going to treat drug addiction by flooding the streets with crack that’s only 99.95 percent pure.
Given that a pay freeze wouldn’t actually accomplish anything tangible, what about the intangible? How would a national government pay freeze work as a symbolic gesture? That’s a tougher question. Particularly since it’s hard to know what a pay freeze would actually mean.
Federal employee compensation is determined by the classification of your position and the “step” within that classification. It’s complicated to explain in a column, but basically your “step” goes up by one every year. Your salary is determined by a table released by the Office of Personnel Management. Look up your classification and your step in the table (with some non-trivial adjustments based on where you live), and that’s your salary. Period.
While in theory you could be denied a step increase, there are tremendous barriers in place to make sure that doesn’t happen. I suppose out of two and a half million Federal employees, somebody somewhere gets denied a step increase every once in a while, but in over 16 years of government work I’ve never heard of it.
This means that it’s easy to argue that federal salaries are “frozen” when they really aren’t. I’m guessing that a “freeze” would mean the OPM salary table would be held constant for one year. But we would still get step increases. Even though it would mean less of an increase than we were accustomed to, in the language of Washington that still counts as a “cut”. Compared to some employees in the private sector who might actually make less money from year to year, or who could lose their jobs through no fault of their own, I think that’s really insulting.
Don’t get me wrong, I could always use more money. I have two kids in college; my tuition payments are two and a half times my mortgage. Clearly I’m insane; I should be living in a much bigger house and sending my kids to cheaper schools.
But so be it. It’s a personal decision, and if my cash flow gets further pinched it’s my responsibility to deal with it.
But I think I speak for many federal employees when I say that if our salaries do get “frozen”, whatever that means, it would mean a lot more if it started a larger, much more substantive national conversation. Something that attempted to build consensus on cutting entitlements and spending in a substantive, across-the-board way. Something that truly held out realistic hopes for restoring fiscal sanity and long-term prosperity to America.
After all, we wouldn’t work for our country if we wanted anything less.
This article originally appeared in the Colorado Springs Gazette, December 8, 2010.
By Barry W. Poulson, Ph.D.
Colorado taxpayers are on the hook for more than $1 billion in unfunded liabilities incurred in the defined benefit retiree health plan administered by the Public Employee Retirement Association (PERA). An additional $79 million in unfunded liabilities was incurred in 2008, reflecting both a rapid growth in retiree benefits and losses in the assets held in the Health Care Trust Fund. Prospects are for continued volatility and deterioration in the funding status of PERA’s retiree health plan.
It’s time for the state to move from a defined benefit retiree health plan to a defined contribution plan. Here’s why.
The $1 billion in unfunded liabilities in the Health Care Trust Fund would not be such a looming fiscal crisis if there was some prospect that the liabilities could be paid off within 30 years to meet Government Accounting Standards Board (GASB) standards. But due to flawed actuarial assumptions used by PERA, the funding status in the Health Care Trust fund is actually worse than reported.
A four year smoothing technique is used to estimate the actuarial value of assets in the plan. This means that some, but not all of the decrease in the market value of assets in 2008 is reflected in the actuarial value of assets for that year. The loss in the market values of assets in more recent years is, of course, not reflected in the actuarial value of assets in 2008. These losses in the market values of assets in the plan will be reflected in the actuarial value of assets over the next four years. Thus, even with recovery in the stock market we are likely to see an increase in unfunded liabilities in the plan over the next four years.
Another flaw is to assume an 8.5 percent rate of return on assets in these plans. Because PERA assumes such an unrealistically high rate of return, they engage in a risky investment strategy, with 70 percent or more of assets in equities. The actual rate of return on assets in these plans has been zero or negative over the past decade. The best economic analysis of public sector pension and health plans, such as PERA, suggests that a more realistic rate of return on assets that is about half or less than that actually assumed by PERA.
The fatal flaw in defined benefit retiree health plans such as PERA’s is moral hazard. The reality is that politicians have promised retiree health benefits they can’t pay for. They offer public sector retirees generous health benefits as an alternative to better compensation because the cost of retiree health benefits is deferred to future generations. Public sector employee unions encourage this because it is less likely to generate taxpayer resistance than higher compensation which must be funded from current revenue.
Most private sector employers have either eliminated defined benefit retiree health plans, or replaced them with defined contribution plans. While most state and local governments have not eliminated health plans for their retirees, they have enacted a number of reforms to reduce the cost of those plans, including replacing defined benefit plans with defined contribution plans.
The Colorado Legislature should replace PERA’s retiree health plan with a defined contribution plan. In the recent Independence Institute study, “How to Save a Billion Dollars in Other Post-Employment Benefit Costs,” we estimate that in the short run this reform would reduce the employer annual required contribution to the plan from $72.6 million to $29.0 million. The annual required contribution from the state would be reduced from $24.6 million to $14.5 million, a savings of $10.1 million.
More importantly, this reform would reduce the accrued actuarial liabilities in the plan, and enable the state to pay off the $1 billion in unfunded liabilities over a 30 year period.
Dr. Barry W. Poulson is a Senior Fellow at the Independence Institute. The study referenced in this article may be found at How to Save a Billion Dollars in Other Post-Employment Benefit Costs.