As expected, legislation (HR 567) was once again introduced in the House of Representatives by Congressman Devin Nunes (R-CA) on February 9th to require State and local government sponsors of public pension plans to provide specific funding information to the US Treasury Department. Failure to do so would cause the offending State or political subdivision to lose Federal tax benefits with respect to any State or local bond issues. No hearings specifically on the legislation have been held before the House Ways and Means Committee, to which the bill has been referred, but there have been three hearings before other House Committee showcasing the legislation. A companion bill (S 347) has been introduced in the Senate by Senator Richard Burr (R-NC). While not a cosponsor of the legislation, Senator Orrin Hatch (R-UT), the new Ranking Member of the Senate Finance Committee, to which the bill has been referred, recently gave a speech on the Senate floor warning that public employee pension plans will bankrupt state and local government if nothing is done. He said he plans to work with his Senate colleagues who “have a proposal to address the problem.” NCTR, NASRA and seven other national organizations representing public sector organizations have sent a personal letter to every member of Congress opposing the legislation.
The new legislation, HR 567, entitled the “Public Employee Pension Transparency Act” (PEPTA), is identical to the bill (HR 6484), which was introduced on December 2, 2010, by Mr. Nunes, who is now the 5th ranking GOP member of the House Ways and Means Committee. As before, Mr. Nunes was joined in introducing the bill by Congressman Paul Ryan (R-WI), also a senior member of Ways and Means as well as the Chairman of the House Budget Committee, and Congressman Darrell Issa (R-CA), the Chairman of the House Oversight and Government Reform Committee. The legislation now has 44 cosponsors in addition to these three. All but one – Congressman Mike Quigley (D-IL) -- are Republicans, and four, including Ryan and Nunes, are members of the House Ways and Means Committee.
Were the legislation to become law, an Annual Report as well as potential Supplementary Reports would be required to be filed by the plan sponsor of a State or local government employee pension benefit plan (other than a defined contribution plan) with the Secretary of the Treasury. The Annual Report would have to include the following:
- A schedule of the funding status of the plan;
- A schedule of contributions by the plan sponsor for the plan year;
- Alternative projections for each of the next 20 plan years relating to the amount of annual contributions, the fair market value of plan assets, current liability, the funding percentage, and other matters specified by the Treasury Department to “achieve comparability across plans;”
- A statement of the actuarial assumptions used for the plan year;
- A statement of the number of plan participants who are retired or separated from service and are either receiving benefits or are entitled to future benefits and those who are active under the plan;
- A statement of the plan's investment returns;
- A statement of the degree to which unfunded liabilities are expected to be eliminated; and
- A statement of the amount of pension obligation bonds outstanding.
While it is true that several of these statements are already required to be developed as part of the plan sponsors’ current reporting obligations in connection with their Comprehensive Annual Financial Reports (CAFRs), several are not, such as the 20 years worth of alternative projections; a statement of the “degree and manner“ in which the plan sponsor expects to eliminate any unfunded current liability; and a statement of outstanding pension obligation bonds.
In addition, it is difficult to know what such other statements required by the Treasury Department to achieve “comparability across plans” might look like and what kind effort might be required to produce them.
Finally, as Paul Zorn with GRS has noted, it also depends on how the term “current liability” is defined. If current liability is defined as “the liability currently used by public pension plans,” then several of the statements, as previously noted, are already required by the Governmental Accounting Standards Board (GASB) to be reported. But what if “current liability” is defined to mean the liability based only on salary and service to date (i.e., determined using the traditional unit credit actuarial cost method)? As Paul points out, then none of the numbers would already be developed and reported because no state and local plans use that method.
Therefore, the legislation’s annual reporting requirement could potentially impose significant costs and confusion in terms of the development of the required statements.
Then there are the potential Supplementary Reports. These would be required in any case in which either the value of plan assets in the Annual Report is determined using a standard other than fair market value, or the interest rate or rates used to determine the value of liabilities or as the discount value for liabilities are not interest rates based on US Treasury obligation yield curve rates.
The Supplementary Report would be required to include certain information specified in the Annual Report -- specifically , a schedule of the funding status of the plan; 20 years worth of alternative projections; a statement of plan investment returns; and the degree and manner the plan sponsor expects to eliminate its current unfunded liability -- but determined by valuing plan assets at fair market value and by using certain Treasury yield curves based on the following three periods: benefits reasonably determined to be payable during the 5-year period beginning on the first day of the plan year; benefits reasonably determined to be payable during the following 15-year period; and benefits reasonably determined to be payable thereafter.
Clearly, these statements would be new for most plans. Here, the concern is not just the time and cost involved with their preparation, but the substantially increased, artificial liability measurements that the use of the Treasury yield curves would produce, which, along with the unsmoothed valuation of assets, would significantly understate funding levels. The results will be a set of measures that differ substantially from those used to fund plans or required for accounting and financial reporting purposes under GASB. They will only serve to confuse the public, not provide clarity with regard to public pension accounting.
Loss of Federal Tax Exemption for State, Local Bonds
Finally, there is the matter of what could happen if a report fails to be filed in a timely manner or there are errors in the report.
Actually, despite the requirement that the plan sponsor is to file the Annual Report and any Supplementary Reports, it is the failure of “State or local government employee pension benefit plans” to meet reporting requirements that triggers the penalty. This clearly raises the question of whether only the plan files the report, of whether each employer covered by the plan must file its own report.
As for the penalty itself and how it is to be applied, the legislation says that in the case of a plan’s failure to meet reporting requirements, then, “with respect to any plan maintained with respect to employees of one or more States or political subdivisions of one or more States, no specified Federal tax benefit shall be allowed or made with respect to any specified bond issued by any such State or political subdivision (or by any bonding authority acting on behalf, or for the benefit, of such State or political subdivision) during the noncompliance period.”
Needless to say, it appears somewhat unclear as to whose bonds could be affected in the case of a “failure to meet reporting requirements.” Does the language mean that any plan covering State or local government employees that fails to report appropriately will trigger a loss of Federal tax benefits for every bond issued by that State and any of its political subdivisions -- or just for the bonds issued by the sponsor of the plan that failed to report? This would be particularly important when a number of employers are covered by a single plan, or in the case of cost-sharing plans.
Depending upon how the language is interpreted, the impact on governmental finances could be devastating. Also, there is a question as to whether the loss of the Federal tax exemption would apply to all bonds, whenever issued by the noncompliant State or local government, during the noncompliance period, or only to those bonds issued during the noncompliance period. (The bill language provides that “no specified Federal tax benefit shall be allowed or made with respect to any specified bond issued by any such State or political subdivision (or by any bonding authority acting on behalf, or for the benefit, of such State or political subdivision) during the noncompliance period.”)
Depending on the answer to this question, the legislation could totally undercut investor confidence in the municipal bond market and have a devastating effect on muni-bond holders, an increasing number of whom are individual investors.
This year, there is also a Senate companion bill, S 347, introduced by Senators Richard Burr (R-NC) and John Thune (R-SD). The bill is cosponsored by six other Senators – Isakson (R-GA), Grassley (R-IA), Kyl (R-AZ), Coburn (R-OK), Ensign (R-NV) and Chambliss (R-GA). Five of the bill’s supporters (Grassley, Kyl, Coburn, Ensign and Thune) are also members of the Senate Finance Committee, to which the bill has been referred.
Senator Burr was a former member of the House of Representatives for 10 years before being elected to the Senate in 2004, where he is a member of the Senate Health, Education, Labor, and Pensions (HELP) Committee. Senator Thune is also a former member of the House, having represented South Dakota from 1997 to 2003 before defeating then-Senate Minority Leader Tom Daschle. Thune is a member of the Finance Committee, as well as a member of the Senate Budget Committee.
Senator Thune is also the Chairman of the Senate Republican Policy Committee, which publishes a variety of policy papers that are used by Republican Senators and their staffs to prepare for committee deliberations, floor debate, and votes. One such paper, prepared last August and entitled “Taxpayers Cannot Afford More State Bailouts,” says that “Unsustainable and underfunded pension obligations are robbing state budgets and draining funds from vital state government programs. Every state bailout, ostensibly for daily operating funds, allows the states to continue to pour money into these unsustainable pension plans.” Every week the Senate is in session, Republican Senators hold a policy lunch meeting, hosted by Thune, at which they discuss issues before the Senate, review the anticipated agenda, and discuss policy options.
Although he has not added his name as a cosponsor of the legislation, Senator Orrin Hatch (R-UT), the new Ranking Member of the Senate Finance Committee, recently gave a speech on the Senate floor warning that public employee pension plans will bankrupt state and local government if nothing is done.
Senator Hatch is extremely critical of defined benefit plans while singing the virtues of defined contribution plans. “The rest of the world has moved toward 401(k) style plans,” he explained to his colleagues, because in DC plans, “costs are lower and more predictable” and they “fit well with an increasingly mobile and dynamic workforce.” State and local governments, on the other hand, “have remained wedded to expensive, traditional pension plans for far too long,” Hatch asserts.
Calling them “old-style, traditional pension plans,” Senator Hatch describes public sector DB plans as “costly, guaranteed lifetime retirement package, often with little or no cost-sharing by the public employee.” He lauds “forward-looking states” that have begun moving to 401(k) style plans. “In my home state of Utah, the traditional pension plan is being replaced,” Hatch insists.
Senator Hatch made it clear that it was his intention, “as Ranking Member of the Finance Committee, to find a way to address the public pension crisis.” In an apparent reference to the Burr legislation, he noted that “Some of my colleagues here in the Senate have a proposal to address the problem, and I will be working with them as well.” This could suggest that he will press for hearings on the legislation in the Senate Finance Committee.
Senator Hatch’s condemnation of public plans is particularly disappointing, given his past support for state and local government pensions. For example, in the late 1990’s, he was the primary Senate sponsor, along with Senator Kent Conrad (D-ND) , of legislation to provide a permanent moratorium on the application of the IRS non-discrimination rules to public pensions. In support of the legislation, Senator Hatch stressed that State and local government pension plans face a high level of scrutiny: “State law generally requires publicly elected legislators to amend the provisions of a public plan. Electoral accountability to the voters and media scrutiny serve as protections against abusive and discriminatory benefits.”
The one bright spot in all of this is Senator Hatch’s statement that “I have not yet settled on what I believe are the best solutions.” He states that “we are working hard and talking to the experts about the best way to proceed. “ NCTR intends to be among the “experts” with whom he consults, and has already met, along with other public sector organizations, with his new top pension counsel for the Finance Committee to discuss Hatch’s concerns.
There is a large coalition of supporters for the Nunes/Burr legislation, including Grover Norquist (Americans for Tax Reform) and Randy Johnson of the U.S. Chamber of Commerce. In an October 27, 2010 interview on CNN, Norquist explained that he is "in favor of moving all of our entitlement programs from defined benefit plans, which is what we have at present, what General Motors had for their pension setup, to defined contribution, basically to 401(k)’s." Norquist says that “The federal government could do that both with their employees, we do that with postal employees, which are a large chunk of government employees and we could do it with Social Security."
A new supporter for the cause is the National Federation of Independent Businesses (NFIB), who says that the bill “will protect small business owners from the costs associated with state and local governments' failure to address funding problems of their plans.”
While there are no hearings on the legislation currently planned by the House Ways and Means Committee or the Senate Finance Committee, the legislation has been discussed at three hearings in the House of Representatives before other Committees.
The first hearing was held by the Subcommittee on TARP, Financial Services, and Bailouts of Public and Private Programs of the House Committee on Oversight and Government Reform. It was carefully coordinated with the Nunes bill’s introduction in the House, and was held on that same day. Although the hearing was nominally on State and municipal debt, a memo from the Committee Majority staff to GOP members of the Subcommittee made it clear that the focus was on pensions, stating at the outset that “pensions are the largest driver of state and municipal fiscal problems.”
Nevertheless, Iris Lav with the Center for Budget and Policy Priorities did an excellent job in rebutting these charges. In her testimony, she stated that claims that states and localities have $3 trillion in unfunded pension liabilities and that pension obligations are unmanageable” overstate the fiscal problem, fail to acknowledge that severe problems are concentrated in a small number of states, and often promote extreme actions rather than more appropriate solutions.”
(Most recently, Ms. Lav has produced a report for the CBPP on the Nunes/Burr legislation entitled “Proposed Public Employee Pension Reporting Requirements Are Unnecessary.” In it, she states that the legislation “would effectively short-circuit and override the GASB process by issuing a federal edict on how pension funds are to report liabilities.” It would be “unsound policy,” she argues, “to substitute heavy-handed and unnecessary federal intrusion (which seems designed in part to advance ideological goals) for the GASB standards and the financial market discipline that induces state and local governments to comply with those standards.”)
The House version of PEPTA was also discussed at a February 14th hearing by the Subcommittee on Courts, Commercial and Administrative Law of the House Judiciary Committee on “The Role of Public Employee Pensions in Contributing to State Insolvency and the Possibility of a State Bankruptcy Chapter.” Witnesses included Joshua Rauh, former Goldman Sachs economist and currently an Associate Professor of Finance with the Kellogg School of Management at Northwestern University. Democratic staff was offered the opportunity to invite one witness, and they chose Keith Brainard, NASRA’s Research Director, who very effectively called Rauh’s underfunding numbers into question.
(In this regard, it is well to note a recent article in the February 2011 issue of Government Finance Review (GFR, a publication of the Government Finance officers Association ) by Ronald D. Picur, professor emeritus of accounting at the University of Illinois at Chicago, and Lance J. Weiss, a senior actuarial consultant with Gabriel, Roeder, Smith and Company, entitled “Addressing Media Misconceptions about Public-Sector Pensions and Bankruptcy.” This article also calls into question much of the work of Rauh and other of his colleagues. As this article notes, some of Rauh’s most frequently cited works are working papers that have not undergone the same academic scrutiny and vetting associated with submission to refereed academic journals. Such a vetting process, using acknowledged experts in the discipline to serve as referees to review the findings without knowing the authors, helps to emphasize objectivity and independence. As a result, none of this research has been subject to scrutiny by the appropriate subject-matter experts —namely actuaries who practice in the public sector -- before being cited as the “gold standard” for public pension facts by the media and others.)
Finally, the Nunes legislation came up most recently in another hearing by the Subcommittee on TARP, Financial Services, and Bailouts of Public and Private Programs on March 15th entitled “State And Municipal Debt: The Coming Crisis? Part II.” However, as with the first hearing, it was all about public pensions, with the Majority staff briefing memo once again claiming that “The largest threat to state and municipal fiscal security is government-sponsored pension plans.”
Dean Baker, the co-founder and co-director of the Center for Economic and Policy Research (CEPR), testified at this hearing and strongly disagreed. He also criticized the proposed Nunes legislation. Dr. Baker told the Subcommittee that:
- Most of the pension shortfall is attributable to the plunge in the stock market in the years 2007-2009.
- The argument that pension funds should only assume a risk-free rate of return in assessing pension fund adequacy ignores the distinction between governmental units, which need be little concerned over the timing of market fluctuations, and individual investors, who must be very sensitive to market timing.
- The size of the projected state and local government shortfalls measured as a share of future gross state products appear manageable.
These conclusions are more fully set forth in his recent CEPR paper entitled “The Origins and Severity of the Public Pension Crisis.”
In addition to assisting Congressional staff in preparing for these three hearings, NCTR has been working with other public sector organizations to get the facts out concerning the Nunes/Burr legislation. These efforts have included:
- A January briefing of key Senate staff of the Finance, HELP and Aging Committees on the state of public pensions, provided by Nancy Kopp, Maryland State Treasurer and President of the National Association of State Auditors, Comptrollers and Treasurers (NASACT); James E. Mitchell, Jr., member of the city council of Charlotte, North Carolina, and President of the National League of Cities (NLC); and Dana Bilyeu, Executive Officer of the Public Employees' Retirement System of Nevada.
- A personal letter to every member of Congress in opposition to the Nunes/Burr legislation from NCTR, NASRA, NASACT, NLC, the Government Finance Officers Association (GFOA), the National Association of Counties (NACo), the United States Conference of Mayors , the International City/County Management Association (ICMA), and the International Public Management Association for Human Resources (IPMA-HR).
- A fact sheet on the Nunes/Burr “PEPTA” legislation, describing what the bill does and doesn’t do.
- Meetings with key staff on the House Ways and Means Committee, the House Education and the Workforce Committee, the Senate Finance Committee, the Senate HELP Committee, and the Senate Special Committee on Aging.
- NCTR Press Statements on the introduction of the Nunes legislation and the House testimony of Keith Brainard.
The “score,” or cost to the Federal government, of the legislation has not yet been determined. While its requirements for increased staffing, drafting of regulations and the creation and maintenance of a new Federal database by the Treasury Department will have cost implications for the Federal government, what remains to be seen is whether the bill will be viewed as a possible revenue saver because of its prohibition on Federal bailouts of state and local pensions, and will therefore be given a positive revenue score.
It is unlikely that the legislation will move independently in either the House or Senate. However, it is not impossible that the House leadership could support its inclusion in a larger tax bill that could advance either this year or next. Stripping provisions from such a larger measure can be very problematic.
Therefore, it is critically important that this legislation be taken very seriously. It is not just a platform for media attention, but a serious effort at establishing a Federal take-over of public pension accounting that will so inflate the perceived “cost” of public sector DB pensions that State and local governments will see themselves as having little choice but to convert to DC plans.