This article appeared in Crain’s Detroit Business
State and local government leaders throughout Michigan are discussing ideas for transformative uses of federal COVID-19 stimulus funding. However, they are forbidden from using this funding for what I believe could be the most transformative investment — assistance to get out from under their legacy debts, pension and retiree healthcare costs. This would free up precious resources to make our communities safe, attractive places to live and to run a business.
The $1.7 trillion American Rescue Plan Act (ARPA) funding is the fourth federal package to help individuals, businesses, the health care sector, and governments survive the pandemic. The purpose of the ARPA funding is to stabilize the economy and stimulate future growth.
ARPA included $350 billion for state and local governments, including $6.5 billion to the State of Michigan and $4.4 billion to its local governments — cities, townships, and counties.
Our current atmosphere of divisive politics led to the insertion of provisions in ARPA forbidding state governments from paying for legacy costs. Likewise, the Treasury Department’s guidance restricts local governments from funding their own pension needs.
These restrictions are striking. ARPA and previous COVID-relief packages have sent money to individuals to help families get through the pandemic. If Congress had included similar provisions on this funding, it would have allowed use of the funds for the purchase of appliances or electronic equipment and forbidden their use to pay credit card bills or back rent.
Local governments need this funding to backfill revenue loss caused by the pandemic. Many local governments suffered revenue losses because of reduced economic activity, fewer people parking in lots or ramps, less use of parks and recreation facilities, and uncompensated water and sewer use, among other things.
Local government officials are conjuring ideas for transformational change with this funding. Helping local governments get out from under the debt obligations related to retirement costs should be the next highest, best use of the funding.
The Michigan Constitution requires local governments to fund their pensions. Some have done a better job at this than others. A task force report at the end of the Snyder administration identified about $7.4 billion of unfunded pension liabilities.
These statewide totals are deceiving. Michigan’s larger local governments have professional staff to provide services. The economics of competing for capable labor has dictated that these local governments offer competitive wages with retiree benefits, usually defined benefit pension plans. Indeed, a very large share of the statewide total unfunded pension liabilities is owed by local governments in Southeast Michigan.
Local governments in most of the state have little staff. Most townships, villages, and small cities do not have professional staff and do not provide retiree benefits to their small or part-time staff.
For many years, the average local government paid lower salaries than the private sector, but the employees knew they would be taken care of in retirement. That has changed over recent decades. The transitory nature of young workers today suggests a competitive wage is more important than retirement benefits. The ability to attract workers, the balance between the cost of current and deferred compensation, and sustainability would be improved if competitive wages were offset by transitioning to defined contribution retirement benefits.
In the private sector, many businesses have transitioned their employees to these 401K-type retiree benefits. Those businesses may have been constrained by employment contracts (such as union contracts), but if those hurdles can be overcome the pension benefits can be altered or abrogated. Local governments cannot transition to these plans as easily.
The state constitution makes earned pension benefits an obligation that cannot be undone. This provision constrains local governments’ options for managing the financial bill for legacy pension debts. The pension plans can be closed to new employees, forcing them into 401K-type plans, but they cannot diminish the benefits or end the plans for retirees or current employees vested in the plans. Maintaining parallel retirement systems for employees and retirees creates additional costs at a time when the municipal finance system is placing fiscal pressure on these same governments.
Local governments are not likely to transition to defined contribution plans until they receive financial assistance to help bridge the transition costs. The influx of federal funding could have been an opportunity to assist in the transition. Because it is precluded from this purpose, transition assistance should become a priority of the state government.