The Millionaire Next Door

In my last article, I explained how the Johnston County School Board spiked its Superintendent’s salary by $130,000 to increase his pension, how the Superintendent then retired at age 50 with a pension of $143,436, and how the State Treasurer then sent Johnston County a bill for $435,000 to pay for the ‘pension spike.’

Today, I’d like to discuss another side of the problem called pension spiking.

Say a private sector worker met with his financial planner and asked how much cash he’d need to put in his retirement fund or IRA in safe investments to be able to retire at age 50. Safe investments like the U.S. Treasury earn about 2.5% so a $143,000 pension is worth somewhere around $6 million. Which means to match the Johnston County Superintendent’s pension, a worker would have to be a millionaire six times over.

Of course, the Johnston County School Superintendent doesn’t have a $6 million IRA, but he receives a pension that is worth the equivalent of a six-million-dollar retirement account.

And whether you’re a school superintendent or another state employee that math makes pension spiking a sore temptation. It’s not surprising that, over the last two years, twenty of NC’s 115 school systems have received bills from the Treasurer for pension spiking.

Here in Hickory City a school system retiree made the list by retiring on August 1, 2015 while generating a pension spiking charge of $151,000. The school board gave him retirement plan with an investment value of around $4 million.

On July 1, 2015 a retiree in the Alexander County Schools made the list as well – when the Treasurer sent those local taxpayers a bill for $65,000 to pay for its pension spiking so he could retire with benefits approaching $3 million.

As I explained, gaming the pension system is a hard temptation to resist. But there’s a clear bottom line: The more spiking drives up the cost of pensions, the more money it takes out of classrooms.

A Silver Lining

Along with dropping temperatures, fall brings newspaper stories about shortages of school supplies and teachers paying for classroom supplies out of their own pockets.

But this fall the headlines also brought a different kind of story.

Not long ago the State Treasurer sent bills to four counties claiming they owed the State Pension Fund money for ‘pension spiking.’ Johnston County – which received an invoice from the Treasurer for $435,000 – is an example.

Here’s what happened: When state employees retire their pensions are based on their salaries. Just before Johnston County’s school superintendent retired the local school board increased his salary by a whopping $130,000. How the Board did that was interesting: It converted $44,000 in fringe benefits to salary, made $50,000 in special payments to the Superintendent, and paid the Superintendent $36,000 for unused vacation and bonus days.

Then the Superintendent retired at age 50 with a state pension of $143,436 a year.

The State Treasurer decided the Superintendent’s $130,000 salary increase was ‘pension spiking’ – and sent Johnston County a bill for $435,000. In effect, the Treasurer said to Johnston County, You have to pay for the pension spike not us. 

Johnston County promptly sued. And lost. But may appeal.

It’s worth noting that the State Superintendent for Public Instruction (who serves all 100 North Carolina counties) makes $127,561 – so the retired 50-year-old Johnston County School Superintendent will be paid nearly $16,000 more for not working than the State Superintendent will be paid for working.

Does that make sense?

We hear a lot about the challenges facing teachers in the classroom. And I believe that. We have lost focus on where education actually takes place. We lavishly fund pensions for bureaucrats and administrators instead of spending money in classrooms.

That’s a lot of less than happy news – but there is a silver lining in every dark cloud: At least, now, the next time a school needs classroom supplies, we know where to find the money.

Stop Digging

The story goes that when asked to name the most powerful force on earth, Albert Einstein replied, ‘Compound interest.’ I’m not arguing.

If you’re an investor and understand how to harness it that force works well.

But if you find yourself on the wrong side of that force it can feel like the scene at the end of the movie Thelma and Louise – where you’re sitting in a ’66 Thunderbird heading straight for a cliff.

And when it comes to the State Retirement Fund that’s where taxpayers are headed.

For decades, politicians have promised state employees and teachers they’ll receive fixed monthly pension checks and free medical insurance when they retire. Each year the state put cash in the Retirement Fund, invested the money, figured it would earn 7.25% a year, and that would pay the bills.

It worked fine until it didn’t.

In fact, the State Retirement Fund hasn’t earned a 7.25% return in 15 years – so instead of compounding interest it’s been compounding debt. But nobody seemed to notice.

One Wednesday morning a couple of weeks ago I started the day in Raleigh listening to a report about the Retirement Fund’s unfunded debt – which is $80 billion. This year state taxpayers paid $1.5 billion into the fund towards covering that debt. Within a decade that payment is projected to grow by $3 billion – to a total of $4.5 billion a year. And when that happens we face two hard facts: 1) We either cut spending, or 2) raise taxes.

Let’s put a spending cut that big in perspective: $3 billion a year is the approximate amount the state spends to pay for the entire UNC system.

It’s not a pleasant picture. But the debt is there. It exists. And there’s no avoiding it. So tax increases, spending cuts, or some combination of the two are going to happen.

But that’s not the whole story. The State Retirement Fund’s debt isn’t sitting there frozen. It’s compounding. And growing. The debt’s getting bigger every day. So isn’t the first step to stop incurring more debt?

Unless it’s ‘Not Possible’

When you take on a $80 billion debt you’d better keep an eye on whether it’s going up or down.

And $80 billion is roughly how much the State Retirement Funds are in the red.

The Pension Fund is run by the State Treasurer, who collects incoming payments from the General Assembly and current state workers, invests the money, and then, hopefully, earns a 7.25% return. And that’s how the Treasurer gets the cash to send pension checks each month to state retirees.

This system rolled along fine for years, until a seismic shift in markets and interest rates sent out a tremor that rocked the edifice. To stay in the black, the Retirement Funds need to earn a return on investments of 7.25% each year – but that hasn’t happened for the last 15 years.

Instead of interest compounding to help pay the Fund’s bills, it’s had debt compounding. This year state taxpayers paid $1.5 billion into the Pension and Medical Insurance Funds to cover debts. That payment is projected to triple to $4.5 billion over the next ten years.

Where will that additional $3 billion come from? Taxes.

Which brings us to the State Treasurer’s race. And the NC Retired Government Employees Association’s newsletter, reporting Republican Dale Folwell’s and Democrat Dan Blue’s views on how to fix the problem.

Dan Blue III is an eminently qualified candidate. His studies at Duke earned him a BS in Engineering, a J.D. and an MBA. And as a former investment banker, he surely understands the problems the Pension Fund faces.

But no one figures the best way to get elected State Treasurer is to announce you’ll ask the General Assembly to raise taxes $3 billion to keep the Retirement Funds afloat.

Nor, at the same time, does anyone figure it’s a good idea to tell 900,000 state retirees they won’t be getting more money in their retirement checks (say for cost of living increases) because the Retirement Funds are in the red.

So, Mr. Blue didn’t exactly grab the bull by the horns.

Instead, he told retirees what they wanted to hear: He said he’s all for giving state retirees more money and higher pensions and COLA increases – then he added, Unless it’s ‘not possible.’

It was like watching Santa Claus telling a child he’d bring him every gift he wanted for Christmas – then adding, Unless it’s not possible.

What’s the Number?

It’s a dry subject, but a storm is forming offshore that could cost taxpayers billions.

Here’s how the NC’s pension plan works: Say the state hires 25-year old man and promises to pay him a pension. That amount, when he retires in 30 years, will be determined by a formula- but let’s say his pension will be $50,000 a year.

For the next thirty years, both the employee and the state each pays a fraction of his salary into the state pension fund. The Pension Fund, itself, which is managed by a Board of political appointees, invests the money.

In theory, when the worker retires, the money he has paid in, plus the money the state has paid in, plus the money the Pension Fund has earned on its investments – like Treasury bonds – will be enough to pay his $50,000 a year pension.

But what if it’s not? What if – 30 years from now – the money in the fund will only pay him a $35,000 a year pension? If that happens the state steps in and pays him the additional $15,000 each year.

It’s what’s called a Defined Benefit Pension Plan. And it’s great for workers. No matter what happens to the economy – dips, recessions, stock market meltdowns – state retirees face no uncertainty.

At one time these defined benefit plans were commonplace. But with all the ups and downs in the economy over the past decade governments are now about the only ones still offering them.

Most private companies long ago changed plans – where they say to their employees, You invest part of your salary in a pension plan, we’ll match part of your salary, then whatever the plan earns over the years will determine how much pension you receive.

Now, NC is obligated to pay state retirees nearly $69 billion in pensions. But the latest projections show the pension fund will only have the money to pay out $65 billion. So there’s a $4 billion shortfall (or unfunded liability) taxpayers will pay. That’s a problem. But given the size of the state budget it’s not an end of the world problem.

Except there’s another hitch.

To end up with only a $4 billion deficit the Pension Fund will have to earn a 7.25% return on its investments each year.

But can it?

Once upon a time earning a 7.25% return on investments – like Treasury Bonds – was simple. But then the world changed: Markets collapsed and interest rates turned upside down.

Today, the 30-year return on U.S. Treasury bonds isn’t 7.25% – it’s 2.5%.

That creates a massive problem for the state Pension Fund – which the political appointees on the Board ignore.

When the Board met in January it chose, even in the face of overwhelming evidence, to not adjust the retirement fund’s projected returns. It voted overwhelmingly to stick with the 7.25%.

Now surely the Board Members know, just as average citizens know, that a return on investment of 7.25% in today’s world is a dream. But in government decisions about spending money aren’t always rational.

So what’s the difference between a return of 7.25% and a return of 2.5%?

The result is shocking: Instead of a $4 billion deficit (or unfunded liability) the Pension Fund’s deficit soars to $47 billion – and taxpayers will be on the hook to pay every penny of that money.

By their nature, politicians aren’t inclined to face a multi-billion-dollar crisis that’s years away. Plus, state workers want bigger pensions – which isn’t likely to happen if the Pension Board projects a $47 billion hole in the budget. So ignoring the problem will work out fine for the politicians and for the political appointed board. By the time the storm makes landfall they will have long since retired. And paying those unfunded liabilities will be someone else’s problem.

By ignoring this problem and dreaming of 7.25% returns the Pension Board has us heading straight for a fiscal cliff. But it may also be true that using today’s Treasury rate of 2.5% is too low. The actual return may well fall somewhere between 2.5% and 7.25%. The problem is figuring out where.

So here’s the billion dollar question: What’s the number?

Collapse

Great civilizations seldom fall to foreign invaders. Because it’s not a simple matter to walk in and take over a great nation. And especially one like ours which is bounded by two oceans and has more guns than citizens.

On the other hand, there’s plenty of proof – from San Bernardino to Fort Hood — that a combination of our porous border and an enemy like ISIS has wreaked havoc. We have the power to defeat Isis but we also have two problems: 1) Obama, and 2) a government so big, bloated, and strength-sapping that on an average day it can’t whip much of anyone.

And I’m not just talking about government in Washington. After spending the last few years in the General Assembly, I have to admit government foibles aren’t limited to our nation’s capital. Here’s an example:

14 years ago, during a big storm in Hickory, the biggest sinkhole in North Carolina opened up beside U.S. Highway 70 and swallowed some fellow’s new Corvette. Which made national news – for about 15 minutes.

A decade and a half later the reporters are long gone. But the sinkhole is still there.

Which is creating a couple of problems: First, the sinkhole’s blocking the storm drainage system which simple engineering says will result in floods during big storms. And, second, eventually those blockages and floods will destroy the area’s entire storm sewer system.

Now if that sinkhole was in some out of the way cow pasture somewhere, it would be one thing. But when it floods a 5-lane U.S. highway through a major commercial corridor that problem is a little more serious.

Over the last 14 years, state government and local governments have spent hundreds of millions of dollars to give incentives to private corporations, to pay for public recreation facilities, and to build parking lots.

But at the same time the State of NC, with a $22 billion budget, and the City of Hickory, with a $100 million budget, have been unable to find $3 million to fix that sinkhole – and $3 million is roughly the damages suffered by a local business due to floods during the last big storm in Hickory in July.

Private business can build their own parking lots. And they can provide recreation facilities galore. And, for years, businesses in North Carolina prospered without government incentives.  But what the private sector cannot do is build and maintain an entire community’s basic infrastructure. That’s government’s responsibility.

I’m not sure how we fix all the political problems in Washington. Or in Raleigh. Or Hickory. But one way to start would be by asking a simple question: Why, after fourteen years, is that sinkhole still there?

flooding

Real Money

Unlike House Bill 2, state pensions and other benefits for state employees seldom land on the front page. But there’s money involved. Real money.

For example, the state has promised to provide every state employee with free health insurance after they retire, for life. But, it turns out, there’s one hitch: Not one penny has been set aside to pay those bills. How big a problem is that? It’s an unfunded liability of $26 billion that’s going to land on taxpayer’s doorsteps when the bills come due.

The state’s second promise – to provide pensions for all state employees – has been funded. Money has been set aside. But the question is, is it enough?

Using widely accepted actuarial tables, the pension system is $3.7 billion short of being fully funded. That may sound like a big miss but in the pension world it’s not bad, making NC one of the best funded systems in the country. But now, like a category 4 hurricane, two outside storms are heading our way that could make matters a lot worse.

A state employee can retire with full benefits after working 27.5 to 30 years. That means it is possible for a state employee to retire with a pension and free health insurance when he or she is forty-five years old.

If a state employee retires at age fifty and lives to be eighty – that’s thirty years of benefits. Second, to remain solvent the state’s pension fund needs to earn a return of 7.25% each year.

However, that’s a pretty steep mountain to climb. The policies of today’s politically controlled central banks (including our own Federal Reserve) make reaching that goal nearly impossible.

The risks here are enormous: If the pension fund earns a 2.5% return instead of 7.25% then the taxpayers face a staggering bill of $47 billion.

Obviously, piling up debt to fund pensions and retirement benefits comes with enormous risk. We’re digging a massive financial hole that’s getting deeper every year.

In the long run we might be better off to simply pay new employees cold hard cash – by raising their pay – and make them responsible for their own pensions and health care benefits. Then if they set aside enough money to retire when they’re 50, more power to them.

As I said, unlike social issues, pensions and state benefits hardly make the front page. They’re boring stuff. But they’re also real money. And someone’s going to have to pay the bill.

Specks and Planks

Occasionally someone will ask, “Doesn’t the legislature have anything better to do that talk about bathrooms?”

I am not sure we do.

House Bill 2 may be called a bathroom bill but it serves as a proxy for the fundamental split in our society about how we resolve firmly held beliefs among differing groups of citizens.

So far, both sides appear to be following Winston Churchill’s prediction of doing the right thing only after trying everything else.

2000 years ago, we were asked, “Why do you look at the speck of sawdust in your brother’s eye and pay no attention to the plank in your own eye?” That pointed out a simple truth that people are different and while we all share a commonality; we have arrived in the present by very different paths.  That’s the problem with judging others – using a flawed process to apply your own life experience to someone else’s life. It never works.

At least the positions were more clearly (if not satisfactorily) defined when, on May 4th, the U.S. Justice Department waded in with a letter to NC Governor McCrory saying NC’s “sex-segregated restrooms” are discriminatory because they treat “transgender employees… differently from … non-transgender employees.”

That may be so. But eliminating sex- segregated restrooms and changing facilities in all public and private buildings across NC (and the nation) will leave a large number of our citizens feeling like they are facing another kind of discrimination.

Perhaps some of us are just not sufficiently open-minded to fit the modern world. Maybe we are just old. Either way, discounting long and deeply held feelings and beliefs as simple bigotry won’t help raise anyone’s awareness.

Neither will huge corporations like PayPal (facing ethical challenges of their own) piling economic punishment on our state ease the personal discomfort resulting from sharing restrooms and locker rooms with members of the opposite sex.

We are offered stories about the heartbreaks of growing up as a transgender child along with demands that something must be done.  The LGBT community doesn’t have a monopoly on painful childhood memories.  If there is a hell on earth, it can likely be found inside a school locker room filled with adolescents of varying stages of physical development.  It’s hard to see how mixing in members of the opposite sex will make those childhood lives better.

A friend once asked me, “Do you prefer to be right or happy?”

That question suggests that, in a conflict, getting your way at any cost may mean you pay later. In other words, it’s unlikely we will permanently protect the rights of one group by trampling the rights of another.  Even if, with the help of the federal government, the power is there to do it, will that guarantee happiness?

More Over Regulated

If you rounded up all 55 of NC’s Occupational Licensing Agencies (OLA) and put them under one roof it wouldn’t be a massive new department of state government – but 485 employees is nothing to sneeze at either.

Altogether, those 55 boards handle $67 million dollars a year.

By way of comparison, with 2/3 of the OLA’s 485 employees, the General Assembly budgets and oversees $54 billion a year from state and federal taxpayers – 800 times as much money as the OLAs.

A better comparison may be the State Treasurer’s office which only has 334 employees, a third less than the OLAs, while managing $90 billion in retirement funds for teachers and state and local employees.

You can say I’m comparing apples and oranges – but look north to Virginia.

If Virginia managed their licensing agencies like NC, they would have to raise license fees by 40%. Instead, Virginia keeps their expenses down ($68 per licensee vs. NC’s $96) while handling just as many license related complaints and disciplining more licensees than NC.

The OLAs say these costs really don’t matter since their $67 million comes from fees paid by the people they license instead of taxes. And that’s true – OLAs do not receive tax dollars. But the money has to come from somewhere. And the answer is, ultimately, it comes out of the pockets of consumers and customers.

And, in the end, it doesn’t really matter whether the legislature is pulling dollars out of your pocket with taxes, or by granting an OLA the power to charge your barber for a license before he can give you a haircut. It’s still part of his cost of doing business. And it’s still dollars coming out of your pocket.

Naturally, OLAs keep telling legislators not to change a thing – that everything is fine.

But a little digging through financial statements shows OLAs have turned into a costly mess. Granted, this mess has been years in the making and isn’t the most urgent problem facing taxpayers – but for those of us who are fiscal conservatives, it’s getting harder and harder not to clean it up.

New Technology, Old Regulations

Out in the private sector, things change in the blink of an eye – while government struggles to keep up. And, in fact, government doesn’t have much reason to keep up.

A change in technology may offer the opportunity to save money. The private sector jumps at a bargain. For a bureaucrat, saving money may mean a reduction in his department’s budget, fewer government employees, and a loss of power.

But sometimes, outside forces overwhelm even the most cautious bureaucrat – to force a change. Transportation funding is an example. State governments are struggling with a simple fact: Better fuel economy is good news for drivers but means fewer gas tax dollars to build and repair roads.

Some propose toll roads as a solution. But anyone who lives near I-77 north of Charlotte can tell you toll roads also create problems of their own.

So maybe it’s time we looked at changing a few obsolete regulations.

Years ago, when we had to cross a small stream and the size didn’t require a bridge, we used a round pipe or a square pipe called a culvert. Back then we just laid the pipe on the stream bottom knowing the water would rise up to get through then waterfall out the other end.

It was a solution that worked until the environmentalists pointed out it created an environmental problem – by creating barriers for fish and other water creatures who couldn’t safely navigate the smooth concrete bottom, much less, climb the wall at either end.

So the environmentalists proposed a solution called stream mitigation. What that meant was simple: Every time the state blocked a stream with a culvert, it had to go out and find a degraded stream somewhere else and improve it to offset the harm done by the culvert. It’s hard to argue with mitigation as a theory but hard evidence of a benefit is less obvious.

And one thing is certain, mitigation costs a lot of money – almost $800 per linear foot of impacted stream. For a steam crossing requiring a 300-foot culvert, that means mitigation costs of $233,000. That adds up to NC spending over $5 million per year for mitigation. And that’s $5 million that could have been spent to build regular roads instead of toll roads.

Over the last 20 years the private sector found a better way to cross streams. They simply started burying culvert bottoms so that the stream flowed though unchanged. The creek critters could freely move from side to side.

It was a win-win solution and you’d think, surely, the regulators in Raleigh would have responded by not requiring mitigation where better technology could be used.

No. They didn’t. Apparently the regulators still live in 1995.

It gets worse. Mitigation in not just expensive, it’s complicated.

To speed up highway projects engineers started going around the need for mitigation by building bridges instead of using culverts.

That did make projects simpler and faster.

And much more expensive.

Short span bridges cost twice as much as culverts, last half as long, and add more tens of millions to the taxpayer’s bill.

This has gotten silly. With a little effort, and innovation, we can kill three birds with one stone: We can cut government spending, protect the environment and build more roads.