Malloy calls for big change in pension financing, modest business tax cuts
East Hartford — Gov. Dannel P. Malloy outlined Wednesday a sweeping plan to overhaul state government’s pension system, pushing some costs off for a decade and a half to control spiking costs that he argued could drive up taxes and drain vital programs.
But the governor also used a meeting of his commissioners Wednesday to propose about $10 million in new business tax cuts and suggest lowering the state workforce by 500 employees. Administration officials said some of the fiscal details of the plan were being refined and would be released soon.
Benjamin Barnes, the governor’s budget director, said actuarial assessments and other fiscal details of the plan, developed in cooperation with a study of the pension system performed by analysts at Boston College, would be released soon.
“There is no magic bullet to solve high pension costs,” Malloy told commissioners during a briefing at Rentschler Field in East Hartford. “We must pay for the mistakes of the past, and there is no easy way around it.”
Connecticut must contribute a whopping $1.51 billion to its state employees’ pension fund this fiscal year, and 82 percent of that payment stems from inadequate savings and insufficient pension fund investment earnings in past years.
For decades before 1984, Connecticut operated a pay-as-you go pension system, saving nothing — and therefore receiving no investment earnings — to cover workers’ retirement benefits. It simply paid the promised pensions out of the annual budget.
And even after annual savings contributions began just over 30 years ago, governors and legislatures between 1984 and 2010 often reduced contributions — with labor unions’ permission — to help ease various budget crises.
More importantly, the governor and his staff said, if nothing is done, state government is steaming toward a fiscal iceberg that could sink future budgets.
Pension costs could spike as high as $5 billion by 2030 and $6.65 billion by 2032, Barnes said. “We cannot sustain that,” he said. “We cannot survive that.”
Though Connecticut’s economy has grown over the past five years, the state’s income tax receipts — particularly its revenues from capital gains and other investment income — haven’t recovered to levels they enjoyed before the last recession. “In short, the economy is not producing revenues fast enough to keep up,” Department of Revenue Services Commissioner Kevin B. Sullivan said.
The basic concept behind Malloy’s solution is to legally split the pension system in two:
The assets in the fund would be assigned to cover the benefits of all workers hired after 1984, all of whom receive less generous pensions than pre-1984 staff.
The earlier group, commonly referred to as “Tier 1,” would become part of a separate pay-as-you -go system. This means the state, which still expects to pay those retirees more than $14.4 billion in total over the next three or four decades, would have to find the funds in its annual budget to cover those pension benefits.
“My administration has never been afraid of big ideas,” the governor said. “We’re not afraid to look ourselves in the mirror and understand what our deficiencies are.”
The administration does estimate that this new arrangement would dramatically reduce the annual contribution to cover pensions for workers hired after 1984. The existing pension fund assets already are enough to cover 95 percent of the long-term obligations owed to this group.
Under the governor’s proposal, starting in the 2018-19 fiscal year and continuing through 2033, total pension costs would be less than they otherwise would be under the current system. The annual estimated savings range from $200 million to more than $1 billion in 2032.
But total pension costs — which were supposed to drop rapidly after 2033 after two decades of scrupulous savings — now would remain significant for at least another decade and possibly into the mid-2050s.
The governor and his staff insisted this plan was not a maneuver to burden future generations with huge costs. The administration still must answer a few key questions to support that point, including:
- Though the state would save $8 billion in pension costs between 2018 and 2032, how much would costs rise after the latter date?
- How many years would those deferred costs be spread out over?
Some of Connecticut’s grants under the federal Medicaid program reflect the cost of providing retirement benefits to state health care workers. Gian-Carl Casa, spokesman for the governor’s budget office, said the administration is researching options to ensure these changes would have little or no impact on federal aid.
In a move toward fiscal reality, the governor also said Wednesday that it’s time for Connecticut to realign its expectations for the annual investment earnings of both the state employees’ pension fund and the pension fund for public school teachers.
The former assumes that investment returns, over a nearly 30-year cycle, will average 8 percent. The assumed return for the teachers’ fund is 8.5 percent.
Barnes noted that the state employees’ fund earned an average return of 5.5 percent over the past 15 years, and assumptions comparable to that mark would be more realistic.
Nearly all states have come under increasing criticism for having overly optimistic assumptions about pension investment returns. But if those assumptions are lowered, it also means states must contribute more to replace earnings that won’t be achieved.
Comptroller Kevin P. Lembo, the state’s chief fiscal watchdog, applauded the governor for a plan that “proposes significant and complex changes to Connecticut’s approach to its unfunded pension liabilities, business tax structure and other policies that demand solutions. Under the right conditions, I would like to support these solutions – but they require greater detail, deeper analysis, and raise several questions that we must consider.”
A spokesman for Treasurer Denise L. Nappier could not be reached for comment shortly after the governor’s meeting with commissioners.
The top Republicans in the legislature, Sen. Len Fasano of North Haven and Rep. Themis Klarides of Derby, thanked the Democratic governor in a written statement for offering the ideas.
“We look forward to exploring these ideas further in our bipartisan meetings and working together to put the state on a better path to fiscal sustainability,” the GOP leaders wrote.” … Clearly, staying on the path Connecticut is currently on would be devastating. It’s refreshing to see the governor acknowledge there’s need for a new approach.”
The governor said he wasn’t sure whether the pension changes he outlined would require the approval of state employee unions before they could be implemented.
But the chief negotiator for the State Employees Bargaining Agent Coalition, Hartford attorney Daniel Livingston, wrote in a statement that this is a matter for collective bargaining.
“By law, no change in funding provisions can occur unless both sides agree that it is fair to public service workers and the public we serve,” Livingston wrote. “We welcome the opportunity to work with the governor, other constitutional officers and the General Assembly on the most responsible way to pay down that old debt and sustain a system that benefits Connecticut’s economy.”
Malloy said Wednesday he also hopes to reduce labor costs by reducing the state workforce by about 500 employees. The governor did not mention layoffs but said he would use “attrition and some other means” to shed the jobs.
As of Oct. 1, Connecticut had 56,918 state employees, including 14,633 employed by UConn and the UConn Health Center, according to the legislature’s nonpartisan Office of Fiscal Analysis. The governor said the Executive Branch has about 1,000 fewer employees than when he first took office in 2011.
The ideas announced Wednesday came two days after the Malloy administration began talks with legislative leaders from both parties on how to address a budget deficit and craft a more sustainable budget framework. The Malloy administration pegs the deficit at $118 million. Nonpartisan analysts project it as closer to $250 million, while Republican legislative leaders say the gap is about $330 million.
The governor also confirmed Wednesday that he is asking legislators at these talks to consider some modest tax cuts for Connecticut businesses.
Among the changes would be:
- Re-writing the corporation tax rules regarding the controversial new unitary reporting system, including instituting a cap on maximum tax obligations. The unitary system is supposed to prevent companies with affiliates in other states from hiding earnings in those entities, thereby shielding them from Connecticut’s taxes. The unitary system, which has drawn intense criticism from business lobbyists, is worth about $24 million annually.
- Restoring the limit on research and development credits on the corporation tax to 70 percent of tax obligations.
Barnes estimated the tax cuts together are worth about $10 million this fiscal year.
Bonnie Stewart, tax specialist for the Connecticut Business and Industry Association, said afterward that “we are very appreciative of the governor’s efforts and the ideas he put on the table,” both to lower business taxes and to manage pension costs.
But the CBIA also has criticized state government for it’s long-term failure to save for pension costs, and when asked whether the organization was comfortable with a restructuring effort that would push some costs into the future, Stewart declined to endorse or oppose that concept. “We haven’t had a chance to dive into all of the specifics,” she said.
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