The year is 2020, just nine years from now, and the state is facing the worst budget crisis in years.
A new governor and Legislature are grappling with the inescapable fact that before they can spend a penny on schools, roads or welfare, they have to pay a $760 million bill — almost all of it debt from the past.
The bill has come from the Maine pension system. And if the state doesn’t pay every cent of it right on time, it will be in violation of the Maine Constitution.
The problem: The bill eats up 20 percent of the state budget — 10 times more than the court system, more than all 0f the state’s colleges put together and nearly as much as Medicaid.
Under this scenario, the state would have to increase taxes or dramatically cut state programs.
Until a few weeks ago, that scenario was on its way to being reality, according to state pension and budget data analyzed by the Maine Center for Public Interest Reporting.
But a new law — LD 1043, the biennial budget bill — has created a new picture, one that promises to be better for the state’s fiscal health, better for funding state services, but worse for the 75,000 teachers and state employees who depend on the state pension system as their primary source of income in retirement.
Former Republican State Sen. Peter Mills, who made pension costs one of his specialties in his 16 years in the Legislature, said the pension change “helps every single state budget in perpetuity ... it’s an extraordinary thing.”
That bill, passed by a two-thirds majority vote in the Legislature and signed by Gov. Paul LePage, reduces future benefits to retirees. The reduction means that instead of the state paying $9.63 billion in pension costs between now and 2028, the cost will be $6.19 billion — a 35.6 percent smaller bill.
Looking at 2020 again, instead of a pension payment of $760 million, the bill is projected to be $480 million. And instead of representing 20 percent of the state budget (based on an annual growth rate of 3 percent), the pension costs would be 14.4 percent of the budget.
Retirees pay a price
The savings come almost entirely by cutting cost-of-living adjustments for state retirees.
For retirees, those retired now and in the future, that means their pension checks will lose buying power.
Previously, retirees could get up to a 4 percent COLA each year on their entire pension benefit, depending on inflation. Now, they will not get a COLA at all for the next three years, unless there is a budget surplus. After that, they could get up to a 3 percent COLA, but only on the first $20,000 of annual retirement income, which is about the average.
For retirees on or below the average, there may not be a noticeable loss in buying power, as long as inflation stays at 3 percent or less. But a retiree with an annual benefit of $40,000, for example, would not get a COLA at all on half of his income, meaning that if inflation averages more than 1.5 percent, the value of his check declines.
That would not happen to state employees and teachers if they were part of the Social Security system, which has a COLA on the full amount of the benefit. (The state pension system is considered a replacement for Social Security.)
State employees have called the changes a new “tax” on their members that was used to reduce the state budget and fund a statewide income-tax decrease.
The governor, many legislators from both parties and others see it as an adjustment to benefits that doesn’t reduce retirement checks or change the eligibility rules, but was essential to putting the state’s fiscal house in order.
One nonpartisan voice in the debate has been the 2010 report on reinventing state government by Envision Maine, a think tank based in Freeport. The report called Maine’s pension debt “a mess” and made cleaning it up its No. 1 recommendation for enabling the state to invest for “a new prosperity.”
Co-author Alan Caron said that while his report did not recommend “charging current retirees, which is effectively what they did,” he said the governor and the legislature “overall did some good work ... it’s a pretty good first step. They turned it in the right direction.”
Sen. Richard Woodbury, an independent of Yarmouth, is the author of a study of public pensions and taxes for the Federal Reserve Bank of Boston.
He said there is “no question” that the reduction on the pension debt not only made possible the tax cut but helped restore some funding to health care for the needy.
The reduction of the pension’s unfunded actuarial liability from $4.1 billion to $2.4 billion “is a big positive,” he said, but, like Caron, he questioned how it was paid for. He voted against the budget bill that included the pension changes.
“The people taking the biggest hit,” he said, are retirees with high income, whom he estimated would take “effectively an 8 percent shift downward for their entire time of their retirement” if there is significant inflation.
One of the most widely consulted national experts on state pensions is David Crane, a special economics adviser to California Republican Gov. Arnold Schwarzenegger.
Crane, a Democrat, has written extensively about what he calls “pernicious displacement” — the hidden costs of pension debt that force out spending on state services.
He called Maine debt reduction “meaningful” because that crowding out has been reduced by about a third.
Mills, an unsuccessful candidate for the Republican gubernatorial nomination last year, later advised LePage on the topic.
Unless there is a system for new hires (one will be studied), Mills pointed out these changes affect everyone now retired, now working and planning to retire and those who will be hired in the future.
Still, he said that while the way the pension cuts “were pretty rough on the retirees,” the reduction in debt is “a big story.”
A veteran member of the Appropriations Committee sees the pension changes differently.
Rep. Peggy Rotundo, D-Lewiston, said that while it was “critically important to be fiscally responsible” and reduce the pension debt, the scope of the problem was “not as grave” as the governor and state Treasurer Bruce Poliquin made it out to be.
Stock market gains this year, she said, “are making things much better than they were.”
(The S&P Index was up 7.38 percent for the year at the time of the interview. The Maine pension system projections assume an annual 7.25 percent return on its investments over the next 17 years.)
Rotundo said LePage’s original proposal, including reducing the state’s contribution to the pension while increasing the employees' contribution, was “too extreme,” a view shared by most of the Appropriations Committee members. The panel unanimously rejected that aspect of the governor’s legislation.
Two state officials in charge of the budget and debt said recent meetings with the bond-rating agencies were encouraging because some of the negatives on the state balance sheet have since improved, including the pension debt.
Sawin Millett, the state’s chief financial officer, said, “I think they generally were favorably impressed with the direction we’re going in. We had strategies. I’m optimistic that we’ve turned the corner … the savings we’re achieving on the pension side, all of the structural changes we’ve made in this biennial budget, I can see the 2014-15 budget starting out without a structural gap.”
Poliquin, an unsuccessful candidate for governor who was later named state treasurer by the Republican-led Legislature, has been speaking all over the state since January about the pension debt.
He called the pension changes “very, very exciting. Breathtaking in its scope. It’s huge.
“By avoiding a downgrade by a bond agency — and S&P has a downward outlook — downgrading would have cost more interest payments and a black eye. That did not happen,” said Poliquin, a former New York investment manager.
Poliquin gave as an example the recent $108 million bond for roads, public lands and other projects approved by voters in recent referenda.
If Maine was downgraded one notch, he said, the cost of the 10-year bond would have been an additional $780,000 over 10 years.
John Christie is publisher and senior reporter for the Maine Center for Public Interest Reporting. He was a Reynolds Fellow at the recent pension seminar sponsored by the Society of American Business Editors and Writers. Email: email@example.com. Web: pinetreewatchdog.org.