Best of 2019: Lamont’s pension shift would leave CT’s children deep in debt
Note: This story was originally published on May 16, 2019.
Forget tolls, sports betting fees, or even marijuana taxes.
The largest bill proposed in the next state budget will be shouldered, eventually, by Connecticut’s children.
Faced with another multi-billion-dollar budget deficit, Lamont and Democratic lawmakers are weighing whether to shift billions of dollars in pension debt — plus a hefty interest charge — onto the next generation of taxpayers.
Lamont’s idea, which he sketched out for lawmakers in February, would restructure the state’s pension contributions over the next 13 years to save roughly $9.1 billion.
Future taxpayers would have to replace that $9.1 billion plus all of the earnings today’s taxpayers forfeited by not saving and investing those funds on schedule.
In other words, for us to save $9.1 billion now, the next generation would be stuck paying an extra $27.2 billion.
“This is all screwed up,” said Rep. Anne Hughes, D-Easton, co-chairwoman of the House Democratic Progressive Caucus, who said Connecticut has other resources it could tap before mailing another bill to its children. “There are people who are willing to be part of the solution now.”
The alternatives, however, are vastly unappealing.
They include ordering the fourth state income tax hike in a decade, gutting aid to cities and towns, or raiding Connecticut’s reserves in the hope that the next recession is still several years away.
And while the new governor says Connecticut’s economy simply can’t bear another tax hike, some lawmakers are balking at asking the state’s youth for a second bailout in three years.
“There are no easy choices,” said Lamont’s budget director, Melissa McCaw. “But if we are to grow Connecticut and the solution is not to increase taxes, then difficult and unpleasant choices … have to be a part of the solution.”
A huge legacy of debt
What all sides can agree on is the scope of the problem.
Connecticut saved nothing between 1939 and 1971 — and very little from 1971 to the mid-1980s — to cover pensions promised to state employees and teachers.
Even afterward, legislatures and governors routinely short-changed contributions to the pensions until 2011, forfeiting billions of dollars in potential investment earnings over the decades.
A 2015 analysis by the Center for Retirement Research at Boston College warned that annual contributions to the state employees’ and teachers’ pensions — each of which stood at about $1 billion at the time —were on pace to exceed $6 billion separately and $12 billion collectively by 2032.
Some critics said this was an extreme projection, arguing the collective annual bill likely would peak closer to $7 billion or 8 billion.
Either scenario is a nightmare in the context of an overall state budget of about $21 billion.
Meanwhile, surging debt costs leech funding away from health care, education, municipal aid, transportation and other priorities.
McCaw, who inherited a state budget on pace to run $3.7 billion in deficit over the next two fiscal years, said Connecticut needs to take a break from income tax hikes.
Legislators and governors raised at least one of the state income tax rates in 2009, 2011 and 2015. They also reduced the property tax credit from $500 to $200, costing middle-class households hundreds of millions of dollars each year.
“The administration started with the lens of how do we posture Connecticut for growth,” McCaw said. “The governor felt that it was critical that the number one solution is not to simply increase taxes, and so his approach was to look at opportunities to drive down some of those fixed costs.”
Lamont proposed a “debt diet” to scale back bonding for non-transportation projects, along with initiatives to reduce Medicaid costs and other health care costs.
And then there were the pension funds.
‘Similar to … your home mortgage’
Put simply, Lamont want to restructure the state’s pension contributions over two periods — from now until 2032, and from 2033 to 2049 — for a savings of $9.1 billion over the next 13 years combined.
Pension payments would actually drop $367 million next fiscal year and then climb by 3 to 4 percent per year through 2032 — but not as sharply as originally planned.
Lamont also would reform the teachers’ pension by assuming a more realistic 6.9 percent average rate of return on investments, rather than the current 8 percent. This would also force annual contributions to grow in future years.
“This is similar to what you would do on your own home mortgage,” Lamont said while describing the concept in his Feb. 20 budget address to legislators.
But the governor left out the part about how much money would need to be paid back – $27.2 billion – or who exactly would pay that debt. Future taxpayers would have to replace that $9.1 billion plus all of the earnings today’s taxpayers forfeited by not saving and investing those funds on schedule.
In other words, for us to save $9.1 billion now, the next generation would be stuck paying an extra $27.2 billion.
Critics of the refinancing plan reject the mortgage analogy, noting that few parents strike a deal with the bank and then direct their kids to pay off the balance — especially one as hefty as $27.2 billion.
“I don’t find that credible,” said University of Connecticut economist Fred V. Carstensen, adding it’s effectively recommitting the fiscal sins of the past by short-changing pension contributions at a big expense in the future.
Rep. Toni E. Walker, D-New Haven, longtime co-chairwoman of the Appropriations Committee, said she’s watched surging pension costs effectively drain dollars away from every program and service state government offers over the past decade.
“The biggest challenge we’ve faced is trying not to lose the budget, to lose the issues we care about, to the problems we inherited from our ancestors,” she said.
But is deferring pension payments — and significantly inflating the debt in the process — only ensuring legislators will be sacrificing health care, education and other programs to cover pension debt until 2050, Walker asked.
When asked to respond to Walker’s question, those supporting the pension debt shift noted it’s a problem more than 70 years in the making.
“To ask taxpayers to fix it over the next 10-to-20 years, in that short of a time frame, is a difficult choice to make,” McCaw said.
For decades, Connecticut residents were served by state employees and municipal teachers, but left it to a subsequent generation to fund the retirement benefits of those workers.
And between the 1980s and the 2000s — when the state began trying to save for workers’ benefits before they retired — each generation of taxpayers left a larger bill for its children than the one it inherited from its parents.
Is it fair for present-day taxpayers to resolve more than $34 billion in pension debt amassed by several generations? asked state Treasurer Shawn Wooden, who worked cooperatively with the Lamont administration to develop the restructuring plan.
“I think the answer, unequivocally, is that’s not fair,” Wooden said, adding that “as a practical matter, it’s simply not affordable.”
Once contributions to the teachers’ pension alone potentially top $2 billion per year, as projected in the mid-2020s, “that’s not sustainable. … It’s not a realistic choice.”
Taxing the wealthy or spending reserves?
But are there other realistic options?
Progressive Democrats want the governor to drop his resistance to an income tax hike, provided it’s aimed at the wealthy.
The Finance, Revenue and Bonding Committee recommended a surcharge on capital gains earnings, but only on those households already paying the top state income tax rate. This would mean individuals whose overall income exceeds $500,000 per year, and couples topping $1 million.
The capital gains tax is projected to generate about $262 million per year.
Sen. John Fonfara, D-Hartford, questioned whether this could be used to at least delay any talk of pension refinancing for a few more years.
“We deserve to at least know what the savings could be,” Fonfara said.
Former Treasurer Denise L. Nappier, Wooden’s predecessor, often cautioned against refinancing pensions, noting that deferring hundreds of millions in contributions could cost the state billions of dollars in lost investments decades later.
Republican legislators also have been critical of the refinancing deal.
Rep. Chris Davis of Ellington, ranking Republican on the Finance, Revenue and Bonding Committee, noted that Gov. Dannel P. Malloy and legislators already added billions of dollars to Connecticut’s pension debt when they approved a more modest plan to refinance the state employees’ pension fund in 2017.
Ten people who identified themselves as “wealthy Connecticut residents” wrote a letter to Lamont on May 14 asking him to raise income taxes on the most affluent, though they did not address pension debt.
Rep. Josh Elliott, D-Hamden, another member of the progressive caucus, said “the governor has consistently been saying ‘no, no, no,’” when it comes to taxing the rich. But Elliott added he fears many legislators don’t realize the alternative is billing Connecticut’s children.
“It really depends on the person,” he said. “We need to be discussing it more.”
But Democrats and Republicans also are staunchly opposed to raising taxes or reducing aid to cities and towns.
And many from both parties also have been reluctant in recent years to cut further into social services that were scaled back significantly over the past decade.
Tapping the rainy day fund?
So what other options are left?
Connecticut does have $1.2 billion in its budget reserve, commonly known as the rainy day fund. And projections have it swelling to a record-setting $2.65 billion by Sept. 30.
Could legislators raid about $640 million of that reserve? That’s roughly equal to the portion of pension contributions due over the next two years that Lamont proposes shifting onto the next generation of taxpayers.
Even delaying the refinancing debate for two years could save the state’s next generation billions of dollars in debt.
Wooden said Wall Street’s credit rating agencies like that Connecticut has rebuilt its reserves after depleting them entirely during the last recession.
“That rainy day fund, and the fact that it’s now growing, that is a positive,” Wooden said. “It is positively viewed by rating agencies, by investors, so do we want to undercut that? I say no.”
Carstensen countered that Wall Street might accept Connecticut spending its reserves to delay or postpone a pension restructuring plan that amounts to borrowing at very high rates.
“Let’s slow down and think this through carefully,” he said. “Playing these games with our pension obligations is not going to serve us well.”
But McCaw said some perspective is needed when it comes to the state’s piggy bank. Though difficult to believe, $2.65 billion is not as much money as it seems.
It still falls short of the 15 percent reserve level allowed under state law and recommended by Comptroller Kevin P. Lembo to safeguard state finances against the next recession.
That $2.65 billion represents 14 percent of annual operating costs based on the current fiscal year.
“Folks get very excited when they see a $2.6 billion reserve,” McCaw said, but Connecticut entered the last recession with $1.4 billion socked away and “we needed well north of $3.5 billion to weather that storm.”
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