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How Did Connecticut Become a Fiscal “Basket Case?”

How did Connecticut become a fiscal basket case over the last two decades? After reading this, you will be surprised that it did not happen earlier.

Connecticut has become a fiscal “basket case.”

Connecticut is a wealthy state with one of America’s most “educated” populations.  However, the State is a fiscal basket case:

Economist Nicholas Perna described the State of Connecticut’s budget situation as being in a state of emergency.

https://ctmirror.org/2017/04/02/economist-perna-connecticuts-budget-is-in-a-state-of-emergency/

How did Connecticut deteriorate into a fiscal basket case?

Normal governmental checks-and-balances processes completely broke down, and were combined with inadequate controls on open-ended benefits obligations.

The biggest source of Connecticut’s fiscal difficulties are the rich pay and rich, open-ended state employee retirement benefit packages, although Connecticut has poor checks and balances in education funding (e.g. municipalities set school construction specifications, but the State pays most costs) and municipal teacher pensions (municipal school boards negotiate teachers’ pensions, but the State absorbs the costs.)

If someone wanted to design a system guaranteed to result in unsustainable debt obligations, Connecticut would be a “perfect” case study. 

This financial crisis has multiple root cases, but, with one exception, they were not caused by unusually dishonest, greedy, or evil people. 

However, governments have checks and balances on irresponsible behaviors, because the temptation to take advantage of their absence becomes overwhelming.  One dishonest, incompetent governor set this disaster into motion, but everything that followed resulted from the absence or breakdown of checks and balances. 

The fault does not lie with state employee labor unions.  They demand what will benefit their most vocal members.  However, those negotiating with them and the General Assembly need to say “No!” to unreasonable requests. Any system in which power is abdicated to one constituency is dangerous to democracy.  That describes Connecticut’s situation.

This essay will focus on retirement benefits, but, Connecticut government employees are also paid 42% more than comparable private sector employees, according to a 2014 study by the American Enterprise Institute.  Government employees did not sacrifice current pay for more generous retirement benefits; they got both.

“Connecticut, for example, pays its state employees 42 percent more than what similar private sector workers receive.”

https://www.aei.org/wp-content/uploads/2014/04/-biggs-overpaid-or-underpaid-a-statebystate-ranking-of-public-employee-compensation_112536583046.pdf

Proponents for higher state taxes argue that Connecticut should cover these benefits and its other budgetary obligations by increasing taxes on "the rich" to help the poor and the middle class.  However, in trying to fund state employee retirement benefits, Connecticut has increased taxes or reduced services significantly to 95-97% of the population to benefit the other 3-5%. It now has no more capacity to grow tax revenues or reduce services to support this wealth transfer of tens of billions of dollars from the vast majority of residents to the small minority who have used the machinery of state government to benefit themselves.

Middle and working class people are losing their jobs and becoming impoverished.  Most Connecticut homeowners are seeing the wealth tied up in their homes shrink or disappear. Connecticut is experiencing a sustained downward economic spiral without a national or regional recession because a small percentage of the state’s population used Connecticut state government machinery to benefit themselves.

When very wealthy people leave the state to avoid its increasing tax burdens, its hostile business climate, and its decaying infrastructure, the many middle and working class people who making a living providing services to them are put under severe economic stress because of their departure.

Contrary to the belief that, as wealthy people move out, they sell their homes to other wealthy people, the wealthiest Connecticut residents are simply leaving their homes vacant 8-9 months a year and change their residences to more tax-friendly states, while staying in Connecticut 3-4 months a year, instead of a majority of the year.

Having detailed the state’s dire economic straits, I want to detail how we got here.

Governor Rowland entered into a 20-year collective bargaining agreement that created operating expense obligations extending out 50-60 years.

In 1997, a Republican Governor, John Rowland  (now serving his second prison term, this one for federal election law violations), and a General Assembly with a strong Democratic majority, collaborated to enable a 20-year collective bargaining agreement relative to active employee and retiree benefits that effectively created obligations today comprising more than 50% of the State’s current budget.

No collective bargaining agreement or legislation should be able to create operating expense obligations several decades into the future.  Collective bargaining agreements should be no longer than five years in duration.

The legislature has refused to take responsibility for the creation, maintenance and growth of major financial obligations.

In most states, the legislature must approve any collective bargaining agreement entered into by the state’s executive branch. Connecticut is in a small minority of states in which collective bargaining agreements go into effect automatically, absent a legislative veto. 

In fact, Connecticut has an arguably unconstitutional delegation of authority from its legislators to the collective bargaining agreements its executive branch negotiates with state employees labor unions.  Currently, if a statute conflicts with a collective bargaining agreement, the collective bargaining agreement supersedes the statute.

In recent years, the Republican minority in the General Assembly has advocated for more direct engagement in the collective bargaining process by the General Assembly, but the Democratic majority has refused to do so.

Connecticut should enact legislation that requires the General Assembly to ratify through legislation a collective bargaining agreement with state employees, whatever that agreement’s duration.  It also should make duly enacted legislation take precedence over collective bargaining agreements.

Unelected arbitrators should not be making many critical state employee compensation decisions. 

Arbitration decisions with more than a nominal budget impact should also require legislative ratification.  The notion that unelected and often relatively unknown individuals make big decisions with long-term consequences for the State is abhorrent to representative democracy.  This is especially the case, when arbitration decisions have a very limited ability to be overturned in court.

Any arbitration decision with significant financial consequences should require General Assembly ratification.  Non-reviewable arbitration decisions should be limited to non-material items.

When Executive Branch and General Assembly members and their staffs secure many of the same rich retirement benefits as unionized employees, they have unavoidable and unacceptable conflicts of interest.

Those who negotiate with public employee union representatives should represent all of us.  They should not have strong financial incentives to benefit from what the unions demand.  When they reap many of the benefits the unions secure, they have inevitable conflicts of interest. While they do not have the same benefits specified in collective bargaining agreements relative to overtime pay or work rules, their benefits generally track what they negotiate with unionizeed employees.

Executive branch executives, employees, and managers, and General Assembly members and their staffs should not be getting the same benefits they negotiate with public employee unions.  They should be representing the public interest.

Those who benefit from the pension plans understand them far better than those who have to pay for them.

Not surprisingly, state union leaders and state government employees understand far more than the remainder of the state’s residents how to maximize their income potential from it.  To understand pension financing and accounting, independent experts skilled in pension plan administration and actuarial calculations who are not compromised by their desire to secure state contracts are needed.

What makes calculating the long-term financial effects of retirement benefits unusually complex?

Labor union members are highly skilled in mastering the pension benefits system because they have disproportionate interest in and resources devoted to exploiting benefit increase opportunities.  The public has no comparable ability to control these intricately complex benefits.

There needs to be far more transparency in the reporting of retirement benefits and a statewide, lengthy education campaign to help the public understand the magnitude of a retirement obligation. The obvious opportunities for non-transparent abuse need to be eliminated.  Ideally, there should be an advocate for the public who is tasked to master pension benefit accounting and report it to the public.

The design, implementation and accounting for retirement benefits invite massive, open-ended enrichment.

Unlike current-year salaries, which are known and fixed in advance, employees and managers friendly to them can take actions that significantly increase future pension benefits.

Private sector retirement plans generally eliminated overtime pay as a component of final pensionable earnings decades ago because it is uncontrollable.  Public sector retirement plans in Connecticut include overtime pay. 

Overtime pay limitations are wildly inadequate.  The State’s collective bargaining agreements generally cap “final average salary,” defined as the highest three years, at 130% of the average of the previous two years relative to “discretionary overtime” and 150% relative to “mandatory overtime.”

The application of this principle is subject to multiple kinds of abuse:

Overtime pay should not be factored into final salary in state employee retirement plans.  It holds too much potential for abuse.

Connecticut has automatic “cost of living” increases for all retirees, starting from the beginning of retirement.

“Cost of living” adjustments disappeared from most private sector pension plans over 25 years ago, partly because they are impossible to control and because retirees often secure other employment after retiring from state employment at age 55. Getting a post-retirement job with cost-of-living adjustments while receiving a pension is called “double dipping,” and is inconsistent with the purpose of retirement benefits.

More fiscally responsible states have either required annual legislative decisions to provide cost-of-living increases or delayed them until the retiree is old enough to be presumed completely retired.  Connecticut has neither control built into its pension plans. 

For someone not conversant with the compounding effect of an annual percentage benefit increase, an average compounded annual 3% cost-of-living increase (which it is reasonable to assume as a future cost-of-living increase) doubles a pension obligation in 24 years.  The life expectancy for someone retiring at age 55 is close to 28 years, which means that most retirees will more than double their initial annual pension benefit at some point after retirement.

Connecticut should discontinue automatic cost-of-living increases for existing retirees and eliminate them completely for all future retirees.  Moreover, even if legislators approve cost-of-living increases for retirees in a given year, they should not take effect until someone reaches the age at which they are eligible for Social Security benefits.

The multiplier impact of the income spiking through overtime pay rules and cost of living increases is staggering.

Most Americans do not understand the math or economics of compounding.  We do not know how often the following situation has occurred in Connecticut, but the fact that it could happen is terrible.  From the standpoint of maintaining fiscal responsiblity, the Connecticut employee pension benefit plans are like loaded weapons.  They have three separate "multiplier" impacts: the way overtime pay is credited, the duration of the benefit after retirement, and the automatic cost-of-living increases.

Consider Joe, a state employee, whose hourly overtime pay is $35.  He is 55 and in his last year of employment.  He works 15 minutes of overtime, which equates to $8.75 of useful work for Connecticut taxpayers. However, under some collective bargaining agreements in Connecticut, he is credited with four hours of paid overtime.  His pension is 50% of final average salary. How much does that incremental 15 minutes of work cost Connecticut taxpayers over his anticipated lifetime?

So how much do we pay over Joe’s retirement period? 

One 15-minute overtime segment in a Connecticut employee’s last year of employment at $35 an hour costs the rest of us $1,172 in overtime pay and pension benefits, most of which is paid over his post-employment lifetime.  He did $8.75 worth of work, but collects 133.9 times that much in pay and pension benefits.  Not only is this crazy, but, as we will show below, we will not realize how big of an obligation we have assumed until long after the events triggering it have happened.

It should not be possible for this to happen under any pension benefit program for which taxpayers are obligated to pay.

The cost of a pension plan is partially determined by the percentage the employee is expected to contribute from his or her salary.

The pension plan is mostly the employer’s obligation, but the employee is expected to contribute toward his or her pension.  The average mandated employee contribution to state employee pension plans around the United States is 7% of pre-tax income.  In Connecticut, the regular employee contribution to the pension plan, depending on the employee’s tenure is between 2-3%, which means that the State’s taxpayers pick up a higher percentage of the burden.

Connecticut should increase its employee contributions to 7% of pay.

In many respects, retiree medical benefits have the same open-ended obligation to them.

Connecticut retiree medical plan has no deductibles or premiums for employees retiring before 1997, which means that there are virtually no controls on healthcare system overuse or misuse.  Even for those retiring later, the premiums are less than $50 per month and there are no annual deductibles, which again opens up the potential for system overuse or misuse. 

There is a lot of excess healthcare in every health insurance system, especially those that requires employees to pay relatively ltitle for their health insurance or healthcare. Independent of the attempted oversight by capable state employees, a system like this one often contributes nothing to the health of those served, and often hurts a plan member's health, as has been the case with excess opiate prescribing, which is happening across most American health plans today. There are well-developed and broadly agreed-upon standards for wise and optimal healthcare system use that should be incorporated into Connecticut’s retiree healthcare program.  The state took good steps several years ago to manage active employee health plan more proactively, but it did not have the ability to rewrite the retiree health plans to do the same. Uncontrolled system use not only hurts the State’s taxpayers, but it does not improve the health of State retirees.  

We also need to tackle the open-ended cost of retiree healthcare.

From an accounting standpoint, the true long-term cost of pension benefits is hidden from voters. $1,032 of the cumulative $1,172 obligation for $8.75 worth of work contained in our example above is not subject to any accounting until we have to pay the bill for it each year.

Starting in 1987, private sector pension plans were required to account for and fund, not only the current year’s pension plan obligations, but also a portion of the future year’s obligations.  State governments, including Connecticut, only account for what they owe each year, and they have no comparable obligation to fund pension plans at the minimum levels specified in the federal Pension Protection Act of 2006.   We will not know what the Connecticut pension plans will cost taxpayers in any future year until the State prepares that year’s budget. 

Legislation enacted early in this year’s legislative session defers much of the pension plan contributions for retirees due between 2033 and 2047 until 2033, and then significantly increases the mandatory contributions after that.  The cumulative cost to taxpayers for this pension plan contribution deferral is over $10 billion.

Public sector pension accounting invites accounting practices significantly understating future obligations.

The most important assumption in public sector pension accounting that determines the reported financial obligation is the rate-of-return assumption. 

The rate-of-return assumptions on pension investments must bear some reasonable relationship to both what has been and will be achieved over a long period of time.  Connecticut’s pension plan rates of return over the last 15 years have been approximately 5.4%.  The State just recently lowered its current rate of return assumption from 8% to 6.9%.  Even at that lower assumption, it is unreasonable to assume that the State will suddenly increase its rates of return to a level almost 30% higher than the average of its last 15 years.

The true cost for pension benefits will likely be far higher when they finally come due.

The State should start by using realistic and defensible rate of return assumptions, so that taxpayers get a true understanding of the magnitude of the pension obligations that have been imposed on them.

Connecticut has an even more abusive pension obligation because it exempts 50% of the pension from state income taxes.

If non-state employees collectively received tens of billions of dollars of pension income, we would pay a 7% Connecticut state income tax.  Our state employees get 50% of their pension income exempt from state taxes. 

Additionally, 25% of all retirees receiving state employee pensions are no longer Connecticut residents, so they are paying no Connecticut taxes on their pension income. 

Businesses and wealthy, well-educated individuals, who could have provided checks and balances on abusive and over-reaching behavior, have disengaged from political advocacy in Hartford.

Connecticut used to have a critical mass of Fortune 500 companies and executives that could prevent fiscally irresponsible behavior. One by one, these companies were acquired, left the state, shut down, or significantly reduced their Connecticut presence.  The largest firms focused more on their increasingly global businesses, and redirected their efforts away from Hartford.

Wealthy and well-educated individuals have also disengaged.  Young people who used to volunteer, as I did, to advocate for specific governmental reforms are a declining part of the population because the cost of living is too high and Connecticut is not hospitable to young people.  That is one main reason why GE left the State.

The population of stay-at-home mothers, formerly the backbone of state and local political advocacy through volunteer organizations has declined.  Many younger mothers now work full-time, travel heavily on their jobs, and even commute into New York City, like their male counterparts.

Successful retirees motivated to engage formally with the State find it difficult to do so because of complex and onerous reporting and compliance rules.  Moreover, the punitively high inheritance tax rates in Connecticut have caused many of them to move to low-tax states increasingly attractive to older people.

There are too few outside constituencies, with notable exceptions like the Yankee Institute and the Connecticut Mirror, that actively monitor State decisions that affect its broad fiscal health.  The mainstream newspaper media have been thinned out, as have the mainstream cable TV news channels. 

When government affairs people from companies remaining in the state engage in legislative advocacy, they focus on issues of interest to the companies, not the overall health of the State. Business trade associations are generally focused on broad-based issues, but their ability to delve into the intricacies of retirement benefits is relatively limited.

To make a difference in the direction of State politics, there would need to be advocacy in individual legislative districts, but few government affairs people understand how to do this effectively, or where to focus their efforts.

All people, especially well-educated people, need to re-engage, particularly in participating in General Assembly election processes.  The population of political activists is too narrow.

We need to have an overarching set of long-term goals.

We have to start with these five goals, in addressing this fiscal crisis:

This State needs to become governable again, and we need to return power to all Connecticut citizens!