Contrary to the claims of the Turner administration and the most media accounts, there is no cap on the City of Houston’s revenues. There is, however, a cap on how much the City can charge in property taxes every year. This distinction is important because property taxes only make up about 25% of the City’s total revenues and under the charter, that is the only source of revenue that is capped. There is absolutely no cap on 75% of the City’s revenues.
And even to describe the charter limitation as a “cap” on property taxes is somewhat misleading because the charter still allows the property tax collections to increase every year by the sum of inflation and population growth. And increase they have.
Since the charter amendment was enacted, the City’s property tax receipts have increased by 70%, rising from $646 million to $1.1 billion. The average increase since 2005 has been just under 5%. Twice since the charter was amended, the City has enjoyed double digit increases. For the last three years, the average increase was almost 7%.
And according to the City’s most recent monthly report, property taxes so far this year are up an eye-popping 15%. Eventually, that number will come down some due to refunds from value appeals, but the City is still projecting an increase of over 5% even with these refunds. I feel certain that the City has overestimated the amount of refunds since it is a little embarrassing to ask voters to repeal the property tax cap in a year when the property taxes are increasing by double digits.
Turner will inevitably make the case that he must be able to raise your taxes to pay for more police officers since everyone knows we need more officers. But you might recall that we have seen this movie before. In 2006, the City asked voters to increase the property tax cap by $90 million, which was supposed to be dedicated entirely to public safety. So, what did we get for that $90 million increase? A whopping increase in the HPD headcount of 212 (3% increase). And incredibly the Fire Department actually has 244 fewer employees than it did in 2006. I do not know what the $90 million was spent on, but it certainly was not spent on increasing the size of our public safety personnel. The City did, however somehow find the money to increase the headcount outside police and fire by over 1,000 employees.
But here is the real kicker. The charter provision that sets out the limitation on property taxes begin with these words:
“The City Council shall not, without voter approval . . .”
In other words, anytime the City administration and Council believe they must increase taxes by more than the cap, all they have to do is ask your permission. In the twelve years since the property tax cap was adopted, Council has never asked the voters for more money.
What Turner wants is the unrestricted ability to increase your property taxes. So far the cap has had relatively little effect on the City or taxpayers. But it has stopped City Council from indiscriminately increasing your property taxes year after year. And therein lies its true value.
Last year, Chicago increased its property taxes by over 20% and plans to increase them by another 30% over the next four years.
That will never happen in Houston . . . . as long as we have the property tax cap.
As you may have heard, the Texas Senate passed a bill yesterday which makes sweeping changes to the City of Houston’s pension systems. I am still reviewing the language of the final bill and will have a summary for you in a day or two, but one very important provision requires that future pension bonds be subject to voter approval.
There has been a long-standing tradition in Texas that bonds repayable from property taxes, referred to as general obligation bonds, must be approved by voters. In 1999, the Legislature formalized this tradition in Government Code 1251.
When the Legislature authorized pension bonds in 2003, the legislation was silent on whether voter approval was required. The Attorney General’s office has previously ruled that this silence on the voter approval allowed municipalities to issue bonds without voter approval.* So, the roughly $1.5 billion in pension bonds that have been issued by Houston, Dallas and El Paso, have all been issued without voter approval.
Senator Huffman made an early commitment to include a vote on pension bonds in her bill. Lt. Governor Dan Patrick and Senator Bettencourt both backed her up on the commitment. Turner initially railed against the provision, insisting it was a poison pill, but in negotiations over the weekend, Turner folded and agreed to its inclusion. Apparently the “poison” was not so lethal after all.
It is, however, unclear whether Houston taxpayers will get to weigh in on the initial $1 billion of bonds Turner intends to issue as part of the deal with the police and municipal plans for reduced benefits. This is because unless the bill passes both houses of Legislature by a two-thirds majority it cannot become effective until September 1. If it passes by a two-thirds majority, it becomes effective immediately on the Governor’s signature. The Senate easily passed the measure by a two-thirds majority, but if the House does not, Turner would have a three-month window to try and rush through the bonds before the effective date.
While issuing the bonds before the effective date would be an incredible slap in the face of Houston taxpayers, I am not particularly troubled by this possibility.
Many of you will recall that during the campaign I advocated using pension bonds to get benefit concessions from the pension plans, but always said any such deal should be submitted to voters for approval. Of course, during the campaign Turner was adamantly opposed to issuing pension bonds, but that is now the centerpiece of his pension plan.
The purpose of requiring voter approval for pension bonds, which are inherently risky financial instruments, is to ensure they are not misused. But the deal Turner struck, $1 billion of pension bonds for roughly $2.5 billion in benefit concessions, is a on balance a reasonable one. I would have preferred that they also be used to begin to phase out defined benefit plans, but there is some movement on that issue in the bill as well.
Polling shows that while voters strongly feel they should have the right to approve pension bonds, a majority would approve this particular deal, especially when it is explained that City employees made benefits concessions in exchange for the cash infusion which will be made from the bonds.
So, while I am philosophically opposed to issuing general obligation bonds without voter approval, I do not see any great harm if Turner issues the pension bonds before the effective date. And if the House ends up adopting the Senate bill by a two-thirds majority, this loophole will not be available and a vote will be required. Given the progress we have made on pensions generally in this new bill, if this proposition is submitted to voters I will support it.
Unfortunately, it looks like Houstonians will be the only municipal residents in Texas with the right to approve pension bonds. A bill authored by Paul Bettencourt to requiring a vote on pension bonds statewide easily passed the Senate but appears to be going nowhere in the House.
* Some lawyers, including yours truly, think the AG’s office got it wrong on not requiring a vote on pension bonds in their initial review. The AG concluded that at Govt Code §1251 (requiring a vote on GO bonds) and Local Gov’t Code §1.07 were in conflict and that therefore the savings clause in §1.07 controlled. However, a careful reading of the two sections suggests the two provisions are not in conflict. In that case, the voting requirement of §1251 should control. Hopefully Paxton will take another look at this issue.
In the last few days we have heard more of the same old tired, debunked rhetoric from the Turner administration that the City cannot make the transition to defined contribution plans from the defined benefits plans that have driven it into insolvency.
Well, 150 of Houston’s top financial professionals and executives disagree. They recently sent a letter to the Legislature asking it to include moving all new employees to defined contribution plans. [Click here to read letter.] *
These individuals represent some of the finest financial minds in our City. The educational pedigrees include advanced degrees from universities such as Rice, Stanford, Harvard and Wharton, to name a few. Combined they have over 4,000 years of financial experience in some of Houston’s leading financial institutions and professional practices.
It should be noted that their letter acknowledges that Turner’s plans represents a significant incremental improvement in the overall pension quagmire. But they also conclude it does not go far enough in two critical regards. First, they believe that all new employees should only be offered defined contributions plans and that the voters should approve the issuance of any pension bonds to provide a check on the imprudent use of those risky financial instruments. These are hardly radical ideas.
The Turner administration has tried to make the case to the business community that his plan’s “corridor” eliminates the need to begin phasing out of the defined benefit systems. But there are several reasons to be skeptical about the efficacy of the corridor. First and foremost, it is hideously complex and its provisions are ambiguous. In my experience, complexity and ambiguity normally leads to litigation. But the truth is that no one knows how it might work because it has never been tried before.
But even if the plan works as advertised, its basic enforcement mechanism is to increase employee contributions if the plans do not make the new investment goal of 7% annually. Even a small miss on the investment goal would subject the City employees to crippling contribution increases that could not possibly be enforced. To make matters worse, the fire fighters pension board’s attorney has opined that the corridor is unconstitutional and vowed to immediately file suit if it is enacted. So it seems inevitable that we will be tied up in litigation for years, which will also mean that the bonds used to secure the benefit reductions will be as well.
Because of all of this complexity and uncertainty surrounding the corridor it is completely reasonable to provide for a back-up plan to control costs in the future, one that we know works. And that back-up is to begin moving new employees to defined contribution plans. We know that plan will ultimately work because the private sector has proved it works.
During the Senate negotiations on Turner’s plan, it was suggested that a “trigger” mechanism be added to force the conversion to defined contribution plans if the corridor did not work. The suggestion was that if any of the plans fell below a 65% funding rate (a dangerously low level by anyone’s standard) new employees would automatically be put in defined contribution plans. It was a reasonable compromise, but the Turner administration rejected it out of hand.
This should make everyone even more suspicious of the efficacy of the corridor. If Turner is worried that the corridor will not even maintain a 65% funded ratio for the plans, he obviously has serious doubts it will work as he has claimed.
Everyone agrees that we need to deal with the Houston pension crisis in this session and not wait until 2019 to try again. But Turner’s “it is my plan or nothing,” is a false dilemma. There is no reason that his plan cannot be supplemented to add something we know works.
The Legislature should adopt Turner’s plan but (i) remove the fire fighters from the corridor to reduce the litigation risk, (ii) add a provision to phase out the old defined benefit plans with defined contribution plans for new employees, (iii) require voter approval on any new pension bonds and (iv) exempt older employees with lower benefits from the COLA elimination. That would be real pension reform we could count on.
According to a recent CNN survey, 96% of private sector employees have a defined contribution pension plan. The private sector phased out defined benefit plans over the last several decades because it is impossible to predict what their ultimate cost will be. They have proven to be particularly problematic in the public sector where elected officials, unions and pension boards have an incentive to understate the costs by jiggering the numbers – like assuming an 8.5% rate of return on pension assets.
Predictably, that kind of chicanery eventually catches up with the pension plans and the entities sponsoring them. One city after another that has played this game has found itself driven into insolvency and without sufficient revenues to provide basic municipal services. Which, of course, is where Houston finds itself today.
Turner has proposed a mechanism, the so-called “corridor”, to cap the growth of the City’s exposure to rising pension costs. No other entity has ever adopted such a measure. It is completely untested and experimental. It is also hideously complex. Complexity leads to ambiguity, which in turns leads to parties gaming the system and litigation.
Of course, you might want to ask yourself, if this is such a great plan, how come no one else has ever used it? You would have to believe that the same financial geniuses that got Houston into this mess have suddenly become so brilliant that they have devised a solution no one else in the country has been smart enough to think of. Excuse me if I am skeptical of that unlikely scenario.
But the truth is that no one knows how well it will work, or if it will work at all. I have previously expressed my doubts and reservations. Others, like the Arnold Foundation’s Josh McGee, have a more favorable view of its potential benefits. But I have not heard anyone, other than Turner and his surrogates, claim it is a permanent fix to our pension problems, because it clearly is not.
If our goal is to limit, to define the taxpayers’ exposure to pension liabilities, we know how to do that. We know how to do that because the private sector has already shown us the way — phasing out defined benefit plans in favor of defined contribution plans. By the way, in addition to the private sector, other public sector organizations in our area, such as the Port of Houston and Metro, have already done this.
The easiest, the fairest, and the least painful way to start the transition is stop offering new employees defined benefit plans. It will take years to work out of the problem, but at least, we know there is an end someday.
So, the question I have been asking for the last few weeks is this: Why not add phasing out the City’s defined benefit pension system in favor of defined contribution plans for new employees to Turner’s plan. There is nothing that prevents us from doing both. What is wrong with a belt and suspenders.
The only answer I ever get is that the employees will not agree to that. Huh? Let me get this straight, 20,000 employees, over half of which do not live in the City, are dictating what kind of pension plan the other 2 million of us are going to offer to new employees!! Are you kidding me?
I completely support someone who came to work for the City being promised a defined benefit pension to demand they receive what they were promised. But the employees have no right to veto taxpayers deciding to move new employees to defined contribution plans, something they favor by more than a 2-to-1 margin.
So why would our elected officials bow to such an outlandish demand? Well, as they say, follow the money. The employee groups, along with the vendors that are feeding at the pension trough ($50 million last year), make very generous campaign contributions. In the last City election, the “Workers’ Voice PAC”, which has a Washington, D.C. address, doled out over $300,000 alone.
Of course, the ultimate irony is that a continuation of defined benefit plans is just as bad, if not worse, for the current employees as the taxpayers. If Turner’s plan is implemented and really enforced, contributions from police officers and fire fighters are almost certain to rise to nearly 20% in a few years. And COLAs, well, you can forget about those altogether. What kind of luck do you think the City is going to have trying to hire new police officers when they tell recruits they have to contribute 20% of their salary to a pension that does not have a COLA?
But, of course, it is the taxpayers who will, at the end of the day, be left holding the bag. It is time for Houston taxpayers to take a stand and say, “NO MORE!” If Turner wants to put his “corridor” in place, so be it. But Houston taxpayers are entitled to a backstop in case the rosy promises we are hearing now end up being like the ones we heard about how the drainage fee was going to solve our flooding problem.
We know that phasing out the defined benefit pension by switching new employees to defined contribution plans will absolutely make this problem go away, eventually. So again, I ask the question, “Why not?”
A few days ago, I received an unmarked envelope. Inside the envelope was a copy of the draft bill that the Turner administration is proposing to amend the police pension plan.
Because of the secrecy in which this process is shrouded, I am not certain that I have the most recent version. The mere fact this process is being carried on in this cloak-and-dagger fashion is shameful and, of course, very telling about the proponents’ confidence in this plan. Of course, we still do not have any of the financial data that backs up Turner’s claims about the plan.
You can review the police pension statute as it would be amended by this bill by clicking Article 6243g-4 – Police (w proposed changes). The comments in the margin are mine. Also, you can read my detailed analysis of the bill by clicking WEK Bill Summary.
But here are the highlights:
Not a Permanent Solution – At the outset, everyone should understand that Turner’s proposal is not a permanent solution to the City’s pension woes. It does, however (1) represents about a 14% cut in the City’s costs of the pension plans and (2) establishes a hideously complex mechanism that, if enforced in good faith, would limit the percentage of payroll the City must contribute to the pension. These improvements are not trivial, but neither are they an ultimate solution to our pension woes. As I have said many times, there is no pathway to real pension reform that does not entail phasing out our defined benefit plans.
However, if defined contribution plans for new employees were added to this plan and the “corridor” mechanism were tightened to be both effective and enforceable, especially restricting the issue of pension bonds, we would be much closer to a real solution.
Pension Debt Not Paid in 30 Years – Notwithstanding the Turner administration’s repeated promises that the plan would retire all of the City’s pension debt in 30 years, that is clearly not true. Any year in which the pension plans do not make the 7% investment goal – as they have not in three of the last five years – the losses for that year are added as an additional layer of debt that is amortized over thirty years from that loss. For example, if the plans miss their investment goal in 2037, 20 years from now, that ensuing debt would not be paid off until 2067!
No Vote or Restriction on Issuing Pension Bonds – Part of the Turner plan is to issue $1 billion of new pension bonds without voter approval. But worse, this bill imposes no restrictions on future pension bonds nor does it require voter approval. The bill has provisions that may require additional bonds to be taken into account when calculating the City contribution, but it also appears to allow the City to borrow its annual contribution each year.
Future COLAs (Cost of Living Adjustment) Tied to Investment Returns – This may be the most surprising, and potentially most impactful provision of the plan, both to taxpayers and retirees. In the term sheets, future COLAs were frozen for some retirees for three years and then tied to Social Security’s COLA adjustment. But in this bill the COLA is set to 5% below the pension plans’ investment return. Over the last ten years the plans have averaged about 5.5%. If that trend continues, this provision would virtually wipe out COLA adjustments for all retirees. While the current COLA provisions are unrealistic and need to reworked, this provision would dramatically impact older retirees, especially those who retired prior to the big run-up in pension benefits at the end of the Lee Brown administration.
Pension Debt will go Up, not Down – As we suspected from the term sheets, the bill adopts a repayment schedule that negatively amortizes the pension debt. If the City’s contribution hits the maximum allowed by the bill, which just about every expert predicts it will, the pension debt will go up an additional $1 billion. In addition, because of other factors (e.g. lag times, asset-smoothing, etc.), it is a virtual certainty that the pension debt will rise for the next decade or so, at least. We could easily wake up 10 years from now with several billion dollars more in pension debt than we have today.
No Consequences if “Corridor” is not Enforced – This may be the most serious concern I have about this bill. There is no consequence to the City if it elects not to enforce the corridor mechanism. The bill requires the pension plans to reduce benefits if the corridor maximum is reached. But the bill does not specify what happens if they refuse. The only remedy would be for the City to sue. First, do we really have confidence that an administration and City Council that accepts hundreds of thousands of dollars in campaign contributions from employee groups would really initiate such litigation? And even if they did, the complexity of the plan and the glacial pace at which our courts move would keep enforcement action in limbo for years. I think we have been in litigation over the drainage fee for seven years now and it still is not over.
Huge Loopholes in Bill – As you will see if you review my bill analysis, there are huge loopholes in the bill’s corridor mechanism. Whether these are intentional or just oversights, I cannot say. But if we are to go forward with the corridor mechanism, these problems in the draft bill must be addressed.
Conclusion – There are very significant issues with the changes to the City’s pension system that are proposed in this draft bill. But, if it were amended to address some of these issues, it would represent a real improvement in the current situation. The two most important changes to the plan are the addition of defined contribution plans for new employees and giving voters the right to approve pension bonds, and these points should be non-negotiable. Anyone not prepared to support these common-sense ideas is not serious about pension reform and certainly not a fiscal conservative.
1. Turner has claimed that there will be $2.5 billion in savings from the plan from benefit reductions and increases in employee contributions. However, the City has refused to release the calculations from which these proposed savings were derived, notwithstanding the repeated requests to do so by third parties attempting to vet the plan. From the limited information we have, most of those familiar with the plans have been unable to generate a number anywhere close to $2.5 billion. Craig Mason, the City’s chief pension officer under Bill White, has flatly said the changes to the plan will not generate $2.5 billion in savings.
2. No drafts of the proposed legislation have been made public. A secret draft of the legislation for the police has been circulated to some select organizations but not made available to the public. Apparently some Houston residents are more important than others. This week the City refused to release the draft of the police bill claiming it was exempt from the Open Records Act. Of course, the mere fact that a “secret” draft is being circulated tells you all you really need to know about this process. How can any organization or individual endorse the “plan” without the actual legislation being released to the public?
3. The only potentially redeeming feature of the plan is the so-called “corridor” which would limit the City’s contribution to 37% (as absurd as that level is). According to the term sheets, once the contribution goes above 37% of payroll, the pension plans would either reduce benefits or increase employee contributions. The problem is that the enforcement mechanism for even this minimal protection for the City has never been defined. What exactly happens if the pension systems do not make the specified changes is anybody’s guess. That kind of vagueness and the inherent complexity of such a mechanism virtually guarantees that the pension systems and the City will be in litigation for decades.
4. The plan uses a repayment schedule that negatively amortizes the pension debt for about the first six years. Conveniently, the payments begin to dramatically ramp-up after the current administration will be out of office. At the end of the 30-year period, the annual pension payments would be over $1 billion.