Charles Chieppo is a research fellow at the Ash Center of the Harvard Kennedy School.E-mail: Charlie_Chieppo@hks.harvard.edu
With a political culture that could charitably be called "colorful," you'd hardly expect Rhode Island to be on the cutting edge of government reform. But with the finances of both the state and Providence nearing the breaking point, the eyes of the pension-reform world are indeed focused on the Ocean State.
The latest drama is playing out at the city level. Providence's pension system is one reason why Rhode Island's capital and New England's second-largest city is on the verge of municipal bankruptcy. It faces a $23-$30 million structural budget deficit that is projected to rise to $67 million in four years, and Mayor Angel Taveras says that on its current course the city will run out of money by the end of this June.
Today, pensions and other post-retirement benefits consume more than half of Providence's annual tax levy. Nevertheless, the city's pension fund is only about one-third funded, while 70 percent is considered the minimum for a relatively stable government system. All in all, it adds up to a $903 million unfunded pension liability.
The biggest single cause of the problem is cost-of-living adjustments. The majority of city retirees receive a 3 percent annual COLA. But police and firefighters who retired in the late 1980s and early 1990s — 27 percent of all retired city workers — are eligible for 5-6 percent increases each year. A pension with a compounding 5 percent annual COLA doubles in 16 years; at 6 percent, the pension benefit doubles in 12-13 years.
On April 30, the mayor signed a pension-reform ordinance that was approved 12-0 by the city council despite union members who packed the council chamber waving signs like one that read, "To the widows of those killed, thank you for your service. Now give us back your COLA." The new law halts COLAs until city pensions are 70 percent funded (although it includes a provision to revisit the moratorium every five years).
The ordinance also caps individual pensions at 150 percent of the state's median household income and cracks down on the liberal awarding of disability pensions. And it calls for employees to continue paying into the pension system as long as they continue to accrue benefits, rather than stopping after 25 years as they can now.
All told, Providence's reforms would save nearly $19 million over the next year, $15.6 million of which would be generated by the COLA moratorium.
With bankruptcy looming, the alternative — raising taxes — is far worse. If property taxes go up 4 percent per year, by 2022 annual taxes on an owner-occupied home worth $200,000 would rise by $1,531. That would be the equivalent of Providence providing limo service to businesses and middle-class residents seeking to flee the city.
The state addressed its own severe pension problems with legislation enacted last November. Rhode Island's state-employee pension fund had fallen from a 62.3 percent funding level to 48.4 percent in just two years. Its unfunded liability was nearing $7 billion.
Led by state Treasurer Gina Raimondo, Rhode Island also went after COLAs, providing them only once every five years until 80 percent of expected pension expenditures are funded. In addition, the state raised the retirement age to the age at which workers are eligible for Social Security for most employees who are not currently eligible or nearing eligibility for retirement.
Rhode Island was in bad shape, though not quite as desperate as Providence. Still, it was the state that took an important additional step. Its reform scales back the traditional defined-benefit portion of the pension plan and adds a defined-contribution element that requires workers to contribute 5 percent of salary to an individual retirement account, matched by a 1 percent employer contribution. Adding the defined-contribution provision for all but public-safety employees will go a long way toward ensuring long-term sustainability by shifting some risk away from the state and making its costs far more predictable.
The state reforms don't impact any retirement benefits accrued by this June 30, nor will they affect those who are eligible for retirement by that date.
Crisis breeds opportunity, and with pensions threatening to overwhelm Rhode Island's finances and imminent bankruptcy a real possibility for its largest city, city and state officials have stepped up to make hard decisions. Thanks to their courage, residents will be spared deep service cuts and dramatic property tax hikes, and future public employees will be part of a system that can deliver on its promises.