Pensions: You Mean Paying Someone to do Nothing Doesn't Work?

The Capital highlights a problem that has been creeping up since, well, since pensions began.  (See HERE and HERE).  Labor economics theory predicts that a person will be paid an amount roughly equal to the value of what they produce.  The key here is that a person has to be producing something of value, i.e. working, in order to earn a salary.

Unlike 401K's, which are investments that provide a variable rate of return, pensions are guaranteed future payments.  

Problem #1: Pension funds rely on markets to grow their asset base and meet their obligations, and markets are variable.

Problem #2: The longer somebody works for a company / the government, the bigger the pension.  So, the more well trained the workforce, the more of an advantage a company has, but it also has a higher future labor cost, so it has a relative disadvantage.  See the paradox?

Problem #3: The burden of funding pensions falls disproportionately on the employer as compared to other fringe benefits.

Problem #4: Taxpayers are on the hook for existing pension obligations--they cannot be adjusted ex post facto.

The main problem is #1.  Pensions assume a certain rate of return that probably won't happen.  5 years ago, AACo's pension was like 98% funded.  Now it's 85% funded according to one of those articles up there.  This is because the rate of return on their assets was not what they expected, and they couldn't divert enough of our tax money to make up the difference.

Pensions have already destroyed the competitiveness of American automakers, who might very well shift their pension liabilities to you and me.  Governments aren't competitive in anything, so their pension cost goes directly to us.  

Fringe and retirement benefits need to be able to move up and down (specifically down) with market movements.  Pensions do not allow for this.  More appropriate benefits would be 401K's or other investment accounts.  Hopefully the transition can be made soon enough.

Former Annapolis Mayor Commits Suicide (30 years ago) Due to Budget, and Other Observations

Really?  Geez.  That tragic piece of history, previously unknown to me due to age and other detriments, at least offers the refreshing bittersweet quality that an elected official would actually care that much about taxpayer money.  

A friend of mine's father was in charge of preparing a county budget, and as a kid I always chuckled when he worked late during "budget time", because I wondered what was going on during the majority of the months during the year when it was not budget time.  The truth is, there's a reason why municipal budget officers routinely garner some of the highest salaries in government.  Government finance is complex, plus you're spending other people's money, and those people often get pissed about how you are spending it.

Josh Stewart took a look at historical budgets and provided his insights in the paper today.  Josh, I imagine, finds himself in a place I've found myself many times before.  It's a lonely place, where untold hours of digging through boring documents yields results only marginally different from what other, lazier people who didn't look anything up will claim to have known all along.

So, here's some stuff that stuck out to me.

Consider these inflation-adjusted figures: In 1990, the average Annapolitan paid $302 in taxes. Ten years later (in 2000), it was $257. Today, it's $394.

(Man, they must have a used a really early base year to calculate those inflation adjusted figures. In 2010 dollars people are paying like $5k-$10k ish and up just in property taxes.  If you don't care about base years, just ignore this writing.  It's inside parentheses; it's ok.  Shout out to my statistician homies who care about this nonsense.)

This isn't an "in my day a Coke cost a nickel" situation.  Theoretically inflation adjusted (a.k.a. "real") figures would stay roughly the same as long as the level of services stayed roughly the same.  In 2000, when the real per capita tax was $257, we had police and firefighters.  In 2010 we have police and firefighters, but real per capita tax is 53% higher.  I can't emphasize enough the difference between 'real' and 'nominal' figures.  A 53% increase over 10 years in nominal terms is equivalent to, say, a glass of wine with dinner.  A 53% increase over 10 years in real terms is like chugging heroin out of a fire hose.  So what's the main difference in the political landscape that occurred between 2000 and 2010?  That's right: blogging!  We require annual bribes to avoid publishing detrimental things about politicians we know are doing a bad job.  Your tax money paid for the heroin hose I am using while writing this post right now!  Just kidding.

Moyer stands by her fiscal policy and has a stack of reports that give a glowing view of her eight years in office. Yes, her budgets grew, she said, but only because she chased millions in federal grants and tackled long-planned construction projects.

So, for 8 of the years responsible for the 53% real tax increase, Moyer was mayor.  If her claims that she "chased" more money are true, then the real tax rate wouldn't have had to increase to fund the budgets.  Plus, if anything I would guess that Mayor Cohen is more likely to chase money, as he still finds favor with the state party peeps that hand out those grants and governmental transfers.  Is there any reason not to assume he'd be able to get the same amount of federal grants?  (Answer: no)

Governments have only a loose incentive to be responsible with money.  The stronger and more direct incentive is for them spend money in a way that helps their short term political career.  Time shall ever bear witness to how the city deals with this problem.

City Taking Steps To Affect Structural Budget

The original title of this post was to include the word "problem" at the end, but then I realized that there wouldn't be a problem if there was responsible leadership, and I didn't want to mislead my loyal public.

In any case, the city is taking a positive and proactive step to improve its financial situation. It has created a blue ribbon panel* to investigate certain aspects of the city's finances. The bill was sponsored by Alderman Israel, which means that it was well researched and/or based on viable theory. The rest of the city council is always eager to look as if they are part of such excellent research, and they ALWAYS request to be added as co-sponsors to Alderman Israel's legislation. In this particular case, comically, every other alderman plus the mayor are listed as co-sponsors to the bill.

(*I am so tickled by the phrase "blue ribbon panel". It reminds me of a prize pig a state fair. In 1998, I made a New Year's Resolution that one day I would commission a Blue Ribbon Panel to investigate the difference between a sun-roof and a moon-roof.)

The story goes like this. Annapolis is in a unique tax situation--it is home to many state buildings, many public housing projects, and many Naval Academy buildings--none of which are subject to property taxes. The state government (and I think the county government as well), instead pay PILOTs, which are Payments In Lieu Of Taxes. But, nobody has ever crunched numbers to see if the PILOTs offset the value of the lost property taxes, PLUS the value of the services that the city provides these to these locations, such as police, fire, water, sewer, and shoe-shining.

The unfairness of said situation is somewhat widely acknowledged, at least by city officials. The sidewalk tax was an attempt to circumvent this problem, with bills sent to every property owner in the city--even the ones exempt from property taxes.

(Post Intermission: Legislation in general is typically worded as follows. First, the word "whereas" is listed any number of times, followed by various, typically vague, assertions. Later, the phrase "Be It Resolved" is used, and is followed by what would change if this bill were to be adopted. In a perfect world, the 'be it resolved' changes would be at least partially justified by the 'whereas' facts. Example: Whereas dogs do not wear makeup, and whereas one of my friends misguidedly opened a dog cosmetic business, be it resolved that every dog must wear makeup in public so my friend won't go out of business.)

This bill basically says: whereas we don't get as much money as we should, be it resolved that several citizens determine how much money we should be getting, so come budget time we can ask for that much from the institutions that don't pay taxes. At least that's what I hope it's saying.

Is Annapolis Bankrupt?

The answer of course is yes, believing the words of the Mayor. If, however, your are of the 'actions speak louder than words' persuasion, we've got money to burn.

Most city expenses are required, and somewhat rigid. Around 85% of the city budget goes to salaries and benefits, which are negotiated only periodically via a union contract. (Hooray unions.) The other 15% is more discretionary, and 4 recent actions regarding the city's discretionary spending portray a care-free attitude when it comes to the taxpayers' money.

1. Sailing Hall of Fame. A group of sailors, well funded and led by the owner of the Boatyard Bar and Grill, want to raze a historic building downtown and put up a Sailing Hall Of Fame. The city gave them a grant of $260,000, which is $260,000 more than the organizers said that they needed, and $10,000 more than the legally approved amount in the budget.

2. Money For The Homeless. Citing only the hardship of being homeless in the winter, Mayor Moyer proposed giving money from 5 parking meters taken in during the coldest 4 months of the year to the homeless, based on the recommendations of a "Housing and Human Welfare Committee". No estimates were given as to how much money will be spent.

3. Going Green. A distant incarnation of the plastic bag ban, O-27-07 is now more of an omnibus environmental bill. Its passage would direct the city to spend up to 10% more on products deemed to be environmentally friendly, and would also direct the city to buy from 'reasonable' local sources without any price consideration.

4. Free Bus Rides. The transportation department is not what you would call an efficient operation. From inside accounts, the director is on vacation a lot, and they consistently spend more money than they take in*. Yet, they have again decided to offer free bus rides for a day in memoriam of Martin Luther King.

(*Interpreting the budget for transportation is tricky. If you scroll down to the transportation fund summary, you will see that it requires a $1.8 million 'subsidy' just to break even.)

For each of these actions, you could argue that the policy is appropriate (some arguments are better than others). My point is, they are not the actions of a financially weak city. Free bus rides and sailing halls of fame are not priorities when we have underfunded police. Any money problem in Annapolis is a spending problem.

City Finance Review: My Gift To You

So...........

I filed a request for information under the guidelines of the Freedom Of Information Act, and here is what I asked for:

A record of every non-payroll financial transaction for the most recent fiscal year that has been completed, including payee, amount, and which department and/or line item was affected.

I requested the information in electronic format so as to avoid the $.25 per copy charge, but I have been informed that such a format is unavailable.

Lacking the time or know-how to investigate the claim that the city only maintains paper records, and feeling deep-pocketed as a result of being the big winner at a recent poker night, I have agreed to pay the $150 necessary to print the 600 pages of documents.

I will let you know when I have made heads or tails of the information, which will likely be in January.

Bonds (Municipal, Not Barry)

In this post, I will carefully traverse down the overgrown path that is the city's finances. The point of this somewhat torturous exercise is to properly analyze a recent story in The Capital concerning the city's pursuit of a triple-A (AAA) bond rating.

The city's budget is actually comprised of two parts: the operating budget and the capital budget.

Operating budget:
This is where most of the action happens. Money comes from property taxes, government transfers, fees, parking tickets, grants, and from a special tree in Ward 5 near where I live. (No, I will not tell you where the money tree is). Money is spent on all city business: mostly on salaries and benefits for city employees, but also on supplies, city expenses, etc.

Capital budget:
This is slightly harder to wrap your mind around because the city is not actually spending this money, at least not right away. The capital budget plans the spending for BIG projects: typically city expenditures of several millions of dollars, but sometimes as low as one hundred thousand dollars. The nature of these expenditures are not the day-to-day or recurring expenses of the city; rather, they tend to be one-time investments in infrastructure that are very expensive. For example, some capital projects for FY2008 are: building a recreation center, fixing a roof, and undergrounding electrical wires. If the city has extra money in the general fund, it pays for capital projects with that money. If not, the city issues bonds to raise money.


Now for the confusing part. The city will take in about $75 million this year. But, the capital budget calls for spending of $129 million, and that's not even including the operating budget spending (such as salaries for police).


How are the capital projects paid for? 3 ways:

1. operating fund money. some of the $75 million the city will take in goes to these projects, usually determined by #2 (read below)
2. state or federal money, which usually requires matching. so let's say a bridge costs $20 million and the state helps pay for it, but only with a 50% match. if they pay $1o million, the city must kick in their $10 million as well. this is how the amount of city operating budget money spent on capital projects is determined
3. if #1 and #2 are not enough, the city issues bonds to raise money


The bond process:
When the city issues bonds, it essentially is using a very high limit credit card--they are borrowing money just like we borrow money from the credit card companies when we use our credit cards. The difference is, we know the interest rate we will have to pay when we use our credit card, and the city does not know until after the transaction is made. Three characteristics of the bond issuance process determine the interest rate:

1: face value--the total amount of the bond(s) that the city is issuing
2. term--the amount of time that the city will take to repay the whoever buys the bond
3. sale price--the amount that the buyer of the bond pays for it

Let me try and illustrate an example. Let's say that the city of Annapolis needs $1 million to build a 24 karat gold statue of Al Hopkins, but they don't have the money to pay for it. They will, through a broker, sell a $1 million bond at auction. (For simplicity's sake we will say the term is 1 year.) People who would buy the bond are investors. The investors will never pay the face value of the bond....if they pay $1 million for the bond, and get paid back $1 million, they will have earned 0% interest on their money. If they paid only $950,000 for the $1 million bond, they will be paid back $50,000 on their $950,000 investment, or 5% return on investment. Since you can earn interest on savings accounts at banks, or on many other investments, you would never willingly earn 0% because you would be wasting an opportunity.

The amount of return (interest) that investors demand in exchange for lending their money depends on the risk of the investment. The safest investment that you can make is to buy a bond from the United States Treasury. The chance of the United States of America defaulting on bond payments is next to zero. There are infinite amounts of riskier investments you can make, but the important point is that Annapolis is on the safer side. While it cannot print money, and therefore is not as safe as a federal bond, the city of Annapolis is reasonably unlikely to default.

Which brings us to the rating system. Instead of a credit score like you and I get, governments (and corporations) are rated by 3 major rating agencies. The highest rating you can get is AAA. Annapolis has the next highest rating, AA+.

The theory is, if our rating improves to AAA, investors will see that Annapolis is very unlikely to default, and will be willing to bid a higher price for the bond, therefore lowering the interest rate the city has to pay and saving the taxpayers money.

As the case is, this won't matter much. According to Tim Elliot, the finance director, we never have problems selling bonds. Most bonds are bought immediately by brokers, who then sell the bonds to their clients. The price that we get for the bonds is near AAA level already.

So, in summary, it is noble to pursue a AAA rating, but not of extreme importance. It would save us a lot more money if the government didn't spend so much money so we didn't have to borrow so much money in the bond market, then would wouldn't have to pay that interest at all.

That's just about enough for this post. I am not bored with it, because I am an ECON geek, but I can see the looks on your faces. Email me if you would like more info.