Update on Social Security’s Financial Condition

     The Social Security Board of Trustees[i] recently released their annual report on the financial condition of that system.  The report showed a small improvement in the system’s performance from last year, but underscored the longer-term challenges it faces.
     With improved employment, Social Security’s total income increased from $920 billion to $957 billion. It paid $916 billion of benefits and had expenses of $6 billion.  The result was a $35 billion positive cash flow, up from $23 billion last year.  This surplus increased the fund’s reserves to $2.85 trillion.  These trust funds are invested in U.S. government bonds.
     The current projections show that Social Security will continue to have a positive cash flow through 2021.  After 2021, Social Security will have to start dipping into its reserves to pay benefits at the current level.  The negative cash flow accelerates after 2021 as the full brunt of the baby boom retirees is felt.  The reserve is projected to be completely exhausted in 2035.  After the trust fund is depleted, the ongoing income will only cover about 77% of the current benefits.
     I generally find that there is a lot of confusion over the state of Social Security’s finances and its future prospects.  Young people frequently tell me that they are assuming they will never get any Social Security benefits because the system is going broke.  That is clearly not the case.
     Some of that confusion comes from a fundamental misunderstanding of how the system works and some comes from politicians’ hyperbole about the system’s condition.
     One of the fundamental issues when analyzing any retirement system is whether it is a “pay-as-you-go” system or a “funded” system.  In a pay-as-you-go system, no money is set aside from a worker’s current income to pay for future retirement system.  Instead the benefits are paid by future workers.  In a funded system, sufficient income is set aside by each worker to fund his or her retirement.  In other words, retirement systems either rely on income transfers between generations or on savings set aside during the worker’s productive years.
     For most of our history, societies have relied on systems that were essentially pay-as-you-go, with the burden of caring for the elderly mostly being organized by families or tribes.  But as the demographic age pyramid began to steepen and there were fewer younger workers to support a growing number of retirees, we have increasingly moved to systems that rely more on savings and less on intergenerational transfers.  Defined contribution pension plans represent the ultimate expression of the savings model.
     Social Security has some elements of both, but is fundamentally an intergenerational transfer model.  Most of the money we have paid into Social Security has not gone to create a savings account for us, it has gone to pay benefits to our parents.
     However, it was also designed to have a bit of financial cushion to make sure it could weather financial downturns.  So, in most years, Social Security has collected more than it has paid out, which has created the current $2.8 trillion reserve.
     I have never been able to find a calculation of the Social Security’s “unfunded liability” as that measure is calculated for regular pension plans, i.e., the present value of future benefits that have been “earned” by workers less the current reserves.  That is probably because future Social Security benefits are subject to adjustment by Congress where we generally assume that earned benefits in pension plans are sacrosanct (although as public employees are painfully learning, less so every day).
     Social Security has estimated the amount that the present value of its benefits exceeds the present value of its future receipts and current reserves over a 75-year horizon.  The report currently estimates that shortfall at $12.5 trillion, up from just over $11 trillion last year.  In other words, if there is no change in the future to taxes or benefits, we would need to contribute $12.5 trillion to Social Security today to pay the scheduled benefits.
     Of course, making 75-year projections is folly, especially when you consider that very small changes in the assumptions can make enormous differences in the outcome.  But it is clear that we are on an unsustainable course and are either going to have to increase payroll taxes or decrease benefits at some point in the future.
     The report gives some idea of the scale of the needed changes.  It found that payroll taxes would need to be increased from the current 12.4% to 15.2% or that benefits need to be cut by about 17% (or some combination of the two) to close the $12.5 trillion gap.  Those are not inconsequential changes, but they certainly do not amount to a catastrophic burden.
     The report does make clear that the longer we wait to begin implementing changes to Social Security to make it sustainable over the long term, the more painful it will be.  But having an adult conversation with the American people about Social Security and the changes we must make to it is something that our spineless politicians from both sides of the aisle are loath to do.  Much easier to just continue to promise lower taxes and no reductions to benefits.
     You can review a summary of the new report [here] or for a deeper dive the entire report is available [here].

[i] The Board of Trustees is comprised of the Secretaries of Treasury, Labor and Health and Human Services, the Social Security Commissioner and two public members appointed by the President.  The public member seats are currently vacant.
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Houston Chronicle Editorial Board Calls for Governor Abbott to Add Storm Surge Protection to the Special Session

     Kudos to my former colleagues at the Chronicle editorial board for calling on Governor Abbott to add action on a storm surge protection system to the special session.  [click here to read].
     Many of us had hoped the Legislature would make some progress on a storm surge protection system for our region this session.  But little was accomplished.. Nothing is as critical to our state than protecting our coastal region from the catastrophic storm that will inevitably show up one day.  And certainly nothing on the Governor’s call even comes close to the gravity of this issue.
     So please contact the Governors’ office and ask him to get this project moving.  If we start today, it would probably take a decade or more to have a functioning system.  Every year we go without taking action we are adding a bullet to the revolver with which we are playing Russian roulette.
     For additional background on the effects of a major hurricane making landfall just to the west of Galveston (referred to by researchers as the “Scenario 7 storm”), click [here] to view the outstanding Texas Tribune multi-media presentation and article on the consequences of a a Scenario 7 storm.
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The Tale of Two Transit Systems: The Folly of Rail in th 21st Century

     Metro is in the process of re-examining its long-term strategy and mission.  It is an examination that is overdue.  In considering where Metro goes from here, we should look carefully at the comparison between its experience and that of Dallas’ DART.
     At around six million people, METRO and DART have roughly the same population in their service areas.  However, DART’s service area is only about half the size of METRO’s (1303 sq. mi. vs. 657 sq. mi.) making its population density considerably higher, which is a significant advantage when developing a transit system.
     Shortly after their formations in the late 1970s and early 1980s, METRO and DART took very different routes to build out their transit systems.
     DART made an early commitment to rail, snagging federal grants and investing heavily with local funds, eventually building 119 miles of rail transit.  Houston, on the other hand, has been slow to commit to rail, only recently completing its 43-mile network.
     Conversely, METRO has continued a much more robust bus service, operating a fleet of nearly 1,400 buses while DART’s fleet is light less than half that number.
     By almost every objective measurement, METRO’s strategy of relying more on buses has worked out much better than DART’s reliance on rail.
Ridership
     In 2016, METRO carried about a third more riders than DART (89,000 vs. 66,000).   Both organizations have struggled to attract new riders.  Since 2000, DART’s ridership has only increased by about 10% notwithstanding its extensive investment in rail.  METRO has lost about 12% of its ridership since it began investing in rail in 2000.
     In 2012, DART completed a significant expansion of its rail system, yet its ridership has since declined almost 10%.  METRO recently opened the expansion of its light rail system and rolled out a new bus schedule.  Initially, the new light rail and revised bus schedule had little effect, but the 2017 monthly ridership so far has seen some modest improvement.  We will have to see more data to assess whether the improvement continues and whether it is the result of METRO’s changes or a firming up of the local economy.
Financial Costs
     The most dramatic difference in the agencies’ comparative strategies has been the effect on their finances.  METRO’s revenues and expenses are about 15% higher than DART’s.  But METRO has a significant advantage in the overall cost per rider at $9.27 versus DART’s $11.28.  Fares pay less than 10% of the cost of the service at both agencies.  (Why taxpayers should pay 90% of the cost of transit is another question for another day!)
     The differential on the balance sheet is stunning.  DART now carries over $4 billion in debt, more than double METRO’s.  That works out to a debt per daily rider of about $62 for DART compared to $21 for METRO.  The debt DART has incurred to build its rail system will be an albatross around the necks of Dallas taxpayers for decades.
Conclusion
     For years rail advocates have told us that if we build a robust rail system it will attract riders and reduce congestion.  They rarely discuss the costs because rail systems are so hideously expensive.
     But the DART experience clearly disproves their argument.  DART had every advantage to develop a successful rail system.  It began early when federal grants were paying a higher percentage of the costs.  Its service area is smaller and considerably denser than METRO’s.  It had local support to incur billions in debt to build out the system.  And yet, its ridership has only marginally improved since it began its massive investment of taxpayer funds and it has actually begun to decline in the last few years.
     Interestingly, transit ridership nationally also stalled out about a decade ago and has also declined for the last three years, very similar to the DART experience.
     Notwithstanding the massive investment in rail over the last two decades made throughout the country, only about 4% of the total daily trips made by Americans are on any form of transit, and less than 2% on rail.  Bus ridership has been unchanged for the last two decades.  It would be interesting, but ultimately impossible to know how bus ridership might have improved if even a fraction of the billions spent on rail had instead been invested in improving the bus service.
     With the advent of disruptive transportation technologies like ride sharing, self-driving cars and the electrification of transportation power systems, any further investment in this highly inflexible technology would be folly.  We need to be building a transportation system for the next century, not the last one.
    But there is something akin to a religious belief in rail that I have never been able to understand.  The late, great Bob Lanier best summarized it:
"First, rail's supporters say 'It's cheaper.' When you show it costs more, they say, 'It's faster.' When you show it's slower, they say, 'It serves more riders.' When you show there are fewer riders, they say, 'It brings economic development. When you show no economic development, they say, 'It helps the image.' When you say you don't want to spend that much money on image, they say, 'It will solve the pollution problem. When you show it won't help pollution, they say, finally, 'It will take time. You'll see.'"
     Dallas’ multi-billion dollar experiment with rail has proved Mayor Bob right.  Sorry to all my friends that continue to believe rail is the solution to our mobility problems, but time is up.
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Fact Check before Forwarding/Sharing

     Like most of you, I regularly get emails and social media posts from friends forwarding a “news story” that turn out not to be news at all.  Two, in particular, stand out.
     Just before the election I received an email forwarding a story that then Chairman of the Joint Chiefs of Staff General Joe Dunford had resigned and written a letter to President Obama essentially accusing the President of treason.  There was just one problem.  General Dunford had not resigned and had not sent any letter.
     The second was an email forwarding a supposed story from People magazine claiming that Donald Trump in a 1998 interview had said the Republican voters were stupid and he could lie to them and they would “eat it up.”  But same problem, the interview never took place.
     Both of my friends who sent the emails are intelligent, well-read, well-intentioned individuals.  But in both cases, the emails they received fit nicely into their predisposed beliefs about Obama and Trump.  It is human nature for us to embrace validations of what we believe and to discredit facts that are at odds with our beliefs.
     Before cable news and the internet, we had a more balanced national conversation.  We were all exposed to a more or less similar set of facts from which to inform our beliefs.  But today, information outlets are highly compartmentalized.  Our outlet selections and targeting by advocacy groups make it more likely we will only hear “news” that reinforces what we already believe to be true.
     Of course, the pursuit of truth requires exactly the opposite.  Science has taught us that we validate theories by testing them objectively and actively looking for data that contradicts the theory.
    I was skeptical of both of these emails and so I ran them through www.snopes.com.  Within a few seconds, I had determined that both were hoaxes.  If you are not familiar with Snopes, it is a website devoted to debunking fake internet and email stories.  There are several other sites that perform similar research such as www.FactCheck.orgwww.TruthorFiction.com, and www.Politifact.com.
     I “replied to all” to both emails, politely pointing out that each of the stories had been debunked.  I only received two emails in reply, one from each instance.  Both asked me to never email them again!
     Here is my suggestion.  If you receive an email of see a social media post that you are inclined to share with contacts, before you hit “forward” or “share”, run the story through Snopes or one of the other fact checking website.  I think you maybe surprised how often the “news” you receive in your inbox or on your social platforms are complete hoaxes, or at least, hugely taken out of context.  Let’s all endeavor not be part of this problem.
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HPD 2016 Crime Stats Show Small Uptick in Crimes — Mixed Performance in Solving Them

     I recently obtained a report from HPD that shows the number of cases reported and the percentage of those cases that were solved from 2012-2016.  The report shows about an 8% increase in violent crimes in 2016 compared to 2015, while non-violent crimes held fairly steady.  HPD had mixed results in solving its cases.
     Homicides – The number of homicides hit a low in 2011 at just under 200.  Since then the numbers have been tracking back up, reaching 298 last year.  This year was little changed at 290.  However, the rate at which HPD solves murders has been falling significantly in recent years.   In the early 2000’s HPD regularly solved only about 60% of the murder cases.  After some adverse publicity about the Homicide Division, their performance greatly improved, solving 90% of their cases in 2008.  But the numbers started going south again in 2012 and it has been pretty much downhill since.  In 2016, HPD only solved 58%, the lowest number since I began tracking these stats in 2000.
      Rape – Much like homicides, rapes had been on the decline through the early 2000’s.  In 2013, only 618 rapes were reported, the lowest number since 2000.  But the last three years have seen a dramatic and troubling increase in the number of rapes, topping out in 2016 at 1,035, a whopping 67% increase in just three years.  The increase appeared to catch HPD off guard as its clearance rate for rape cases plummeted in 2014 to just 24%.  But it has since recovered, solving 41% of the cases in 2015 and 53% in 2016.  Still having almost half of all rape cases go without justice is unacceptable.
        Robbery – Robberies in 2016 held steady at about 10,000 cases, a level that has been very consistent for the last two decades.  HPD has historically solved about 20% of the robbery cases and last year was no different.
          Burglary – Burglaries fell about 8% this year.  Burglaries topped out in 2009 at just under 30,000 and have been steadily declining ever since.  But HPD’s clearance rate on burglaries continues to be abysmal, coming in this year at 6.9%.  Since 2000, HPD has never solved more that 8% of burglaries, clearly demonstrating this is not a priority for the department.
         The most recent round of stats shows that HPD has been improving its clearance rate on violent crimes over the last three years, but the rate for nonviolent crimes has fallen below what were already anemic numbers.  HPD lags behind the national average in all categories, although to be fair, so do most other large departments.  However, in the robbery and burglary categories it solves only about two-thirds and half as many of those cases, respectively, as the national average  — a pretty clear indication HPD could do better.
         Some in law enforcement argue that the clearance rate is not a fair metric by which to judge the effectiveness of a law enforcement agency.  Certainly, there are other factors that should be examined as well, but I have long argued that this is one of the key metrics we should be using.  (See, “It’s the Clearance Rate, Stupid“, Houston Chronicle, May 18, 2008).
       Overall, when you look at HPD’s performance over the last 15 years, not much has changed, except the cost of the department.  The City has gradually whittled away at the total personnel in the department (more on that later), but number of police officers has hovered right around 5,000.  The number of cases solved has ranged from a low of 22,000 to a high of 34,000.  The 2016 total of 25,000 is about average.
      However, the cost of the department has skyrocketed.  It has more than doubled since 2003, rising from $422 million to over $850 million.  And that is not even fully accounting for the cost of the department’s pensions.   If that had been fully factored in last year, the cost would have topped $1 billion.  The average cost per crime solved has risen from about $16,000 in 2003 to over $34,000 last year, without fully accounting for the pension costs.
       Public safety now gobbles up about two-thirds of the City’s general fund budget.  More money for public safety will, undoubtedly, be the battle cry for those seeking to repeal the property tax cap this fall.  But we have been throwing more money at this problem for the last two decades with little to show for it.  It is time to start rethinking public safety.  What do we expect of it?  How is it managed?  What are the mission critical functions?  We may ultimately conclude that more resources are needed.  But until we have that kind of analysis, throwing more money at the problem again should not be an option.
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Houston Does Not Have a Revenue Cap

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.

Houston Pension Bill – As Passed

     As you have probably seen in media accounts, the Legislature has passed a bill making very substantial changes to the City of Houston’s pension systems.  The bill as passed was 260 pages and mind-numbingly complex.  When added to the existing statutory language, the Houston pension statutes will now run over 90,000 words, which in and of itself is absurd.
     The bill follows the general outline of what Turner proposed last October, but as the result of lobbying by the business community and grass roots activists, the Legislature made significant changes to Turner’s original proposal.  This is the first time that groups representing the taxpayers showed up in Austin to be heard on pension legislation.  In the past, local elected officials and the employee groups would make a deal and the Legislature would rubber stamp it.  That is not what happened this time.
Let me begin by emphasizing that while the final bill moves us in the direction of solving the City’s pension problems it is far from a permanent solution.  Many of the City’s claims about the virtues, like it will allow the City to pay off the pension debt in 30 years or it will save a million dollars a day, are patently false.  And other than the $1 billion in borrowed money, the bill actually allows the City put less money in the plans over the next 5-6 years.  Hardly a way to reduce the debt.
     So, the City will face another pension crisis.  The timing of that crisis depends in large measure on how the investments in the pension plans perform over the next few years.  If they continue to perform as they have in recent years (10-year average = 5.6%), that crisis will be sooner rather than later.
A detailed review of the bill is impossible here.  For those of you who want to take a deep dive, you can review the bill [here].  But here is the Cliff Notes version:
1.  Pension Cost Reductions for Infusion of Bond Proceeds – The only part of the new legislation that is likely to make any real difference in the City’s pension costs and debt are benefit reductions and increases to the employee contribution in the amount of about 15% or $2.6 billion.  It is important to emphasize that this reduction in pension liabilities is estimated because the actual amount of the savings is dependent on factors in the future, like interest rates.  Nonetheless, the savings are substantial and will bend the cost curve down in the future.
     The benefits reductions fall into two categories.
The police and municipal plans agreed to about $1.7 billion in cuts in exchange for the City’s agreement to infuse $1 billion from the issuance of pension bonds.  Some of you will recall that in the last mayoral campaign this was one of the scenarios I suggested as a tool to reduce the unfunded liability.  At the time, Turner was adamantly opposed, arguing, “You can’t solve debt with more debt.”  Fortunately, Turner changed his view.
     There are also benefit cuts and contribution increases totaling about $900 million for the fire fighters pension plan.  I have long criticized the fire fighters for being slow to accept that their benefit structure was unsustainable, but the changes to the fire fighter plan are deeply troubling to me.  Unlike the police and municipal plans, the fire fighters did not agree to the cuts in their benefits and will not get any bond money.
     Also, the cuts to the fire fighters’ benefits were dramatically more severe than those agreed to by the police and municipal plans.  The average benefit cut per member to the fire fighter benefits under Turner’s plan is about $150,000 compared to about $90,000 for police and $28,000 for municipal.
     There is no question that the benefits for fire fighters are the most generous benefits of the three plans and were badly in need of reform.  However, this plan does something that every candidate for mayor in 2015, including Turner, promised to never do – take away benefits that had been previously earned by our employees.  How many times did you hear all of us who ran for mayor declare “a deal is a deal” and promise that earned benefits would never, absent an agreement, be cut.  We, as a City, have now done just that and in doing so have clearly broken our word to the current and retired fire fighters.  That is not something that should be taken lightly or celebrated.
2.  Voter Approval of Pension Bonds.  One reform that was won by the business community and grass roots groups was the requirement that any new pension bonds must be approved by voters.  When the Legislature allowed cities to issue pension bonds in 2003, the legislation was silent on whether voter approval was required.  The Attorney General’s office has interpreted that silence (incorrectly I believe) to mean that voter approval is not required.  As a result, the City has already issued about $600 million in pension bonds without getting voter approval.
     That will no longer be the case.  The bill now requires the City to obtain voter approval before issuing any new bonds.  I have long said that pension bonds can be a tool to help manage our pension problems.  But like any tool, they can be used properly or they can be misused.  Voter approval is an important check to make sure any future pension bonds are not misused.
     You may recall that when taxpayer groups first insisted on a voting requirement on bonds, Turner declared it was a poison bill that would kill the bill.  But apparently after Turner saw polling that nearly 80% of Houstonians thought they should vote on any new bonds, the provision became less toxic.
3.  The “Corridor.”  The third major component of the bill is a complex mechanism that is intended to limit the amount that the City will contribute to the pension plans in the future as a percentage of payroll, which has come to be known as the “corridor.”  As nearly as I have been able to determine, no other entity, public or private, anywhere in the country, has ever implemented anything like the corridor.  It is a completely untested and experimental model.
     It is also hideously complex and the provisions are ambiguous and in some cases internally inconsistent.  That, in my experience is a recipe for litigation and I suspect you will see plenty of that in the future.  You will also see the administrative costs for the plans, which are already too high, rise even more.
     The real flaw in the corridor mechanism however, assuming it is actually enforced, is that it primarily relies on future increases to employee contributions if the City’s contribution rises above the limit.  It is highly likely this will occur because the plans are unlikely to achieve the 7% investment target over the long run.  And a small miss on the investment return equates to very large increases in the employees’ contribution.  These increases will be so large at some point in the future it will not be feasible to enforce the corridor.  That is the event that will likely precipitate Houston’s next pension crisis.
4.  Phasing out Defined Benefit Plans.  The biggest disappointment with the bill is that there is no immediate phasing out of the defined benefit model.  The bill does include a safety net of sorts that provides that if any of the plans fall below a 65% funded level, they must move all new employees to a cash balance plan.  Cash balance plans have some elements of both defined benefit and defined contribution plans.  Unfortunately, the bill also includes extraordinarily long grace periods (four years for police and fire and ten years for municipal) which will likely make the provisions meaningless for all practical purposes.  In all likelihood, the City will see its next pension crisis long before the expiration of those grace periods.
     Nonetheless, the inclusion of this safety net is an important symbolic victory, because it is a concession that phasing out defined benefit plans is the real solution to the City’s pension problems.
5.  The Constitutional Question.  There is one issue outstanding that may make this entire effort for naught.  There is a provision in the Texas Constitution that grants the right to set actuarial assumptions to the pension boards.  Of course, the entire point of the corridor is to force the pension boards to share that power with the City and the bill establishes certain limitations on the pension boards’ discretion in setting the assumptions.  While there is certainly an argument to be made that the pension boards should not be exclusively vested with the power to set assumptions, that seems to be what the State Constitution provides.  The fire fighter pension board has already filed suit to declare the legislation unconstitutional.
     The other boards currently have no plans to sue, but may find they are forced to do so to avoid liability from their members.  Also, it is possible that any member of the plans could bring such a suit.  Of course, that litigation will take time to resolve.  If the City implements the plan and then it is declared unconstitutional several years from now, we will have a real mess on our hands.
     Notwithstanding Turner’s public confidence that the City will prevail in this litigation, the City legal staff was manic during the negotiations to get the fire fighter board to agree not to sue.   I make no prediction about the outcome on the merits, but certainly on its face, the legislation appears to violate the constitution.
     There is also another practical effect of the fire fighters’ lawsuit.  The Texas Attorney General must approve the issuance of any bonds by local governmental entities.  Generally, their policy is to not sign off on any bonds when there is any pending litigation.  Whether the Attorney General’s office would find this litigation affects the issuance of the pension bonds is an open question.  But generally, that office has been pretty conservative in making such determinations.
6.  Conclusion.  Shortly after Bill White was elected in 2003, he received the bombshell that the pension plans were underfunded by over $2 billion.  White undertook a series of reforms that reduced benefits and he issued pension bonds to shore up the plans.  But he left the defined benefit model in place.  A dozen years later, our pension debt had tripled.
     White’s reforms unquestionably reduced the future costs of the pension plans, but ultimately his incremental approach proved not to be a permanent solution.  Such is the case with this plan.  It too reduces the pension costs immediately, but instead of biting the bullet and beginning the phase-out of defined benefit plans, it relies on an untested and what will be proven to be unworkable mechanism to do what moving to defined contribution plans would have accomplished without the cost, complexity, litigation and uncertainty of this plan.   And as a result, Houston taxpayers and employees will suffer in the long run.
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City’s Sales Taxes Drift Lower after Super Bowl

     The Texas Comptroller reported today that the City’s sales tax receipts for June (based on April sales) were down by slightly over 2%.  After eighteen months of consecutive year-over-year declines, the City saw an increase in its sales taxes in March and April, reflecting January and February sales, which were boosted by the Super Bowl.  Sales taxes for those months increased by 6% from last year, about a $5.5 million pick-up. In May the City showed a slight decrease before posting this month’s 2% decline.
      In the last two years, Houston has posted year-over-year declines 20 times. For the FY2016-2017, sales tax collections were down by 2.5% from last year and the calendar year-to-date collections so far this year are down by 5%, even with the one-time shot in the arm from the Super Bowl.
     On the bright side, it does appear that the precipitous decline that began in late 2012 has flattened out. Of course, where we go from here will largely be dependent on oil prices.
     The sales tax receipts for Houston’s neighboring cities were mixed. Most saw increases, but several saw significant decreases. Generally, the suburban cities on the east side of Houston have held up better, probably because their economies are more closely tied to the oil and gas downstream, which continues to do well.  Also, the suburban cities that are farther from Houston have generally done better.
     The budget just adopted by City Council for FY2017-2018 projects a 1% increase sales taxes for next year. That may be achievable if oil prices recover. If not, it is probably overly optimistic.

Houston Gets Vote on Pension Bonds

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.

150 Financial Professionals & Executives Ask Legislature to Include Defined Contribution Plans for New City Employees

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.


 

* Additional names added after this printing.