Every year, when budget writers in Montpelier begin their work and legislators begin to determine what to spend, the backdrop of these conversations is marked by an unavoidable reality: Vermont has a serious problem with its unfunded liabilities.
All together, we have a total liability of just over $8 billion — that’s billion, with a “b.” For comparative purposes, that’s larger than our entire state budget. These liabilities are composed of our teachers’ pension ($3.4 billion), teachers’ other post-employment benefits, or OPEB ($0.9 billion), state employees’ pension ($2.7 billion) and state employees OPEB ($1.2 billion). We have a little over $3.5 billion of assets, leaving us with an “unfunded” liability of about $4.5 billion.
How did we get here? Well first, investment returns in these funds have not kept up with expectations. The actual return on investment has fallen consistently below what has been projected. For example, for the state employees’ pension, our actual rate of return of 6.93% was below our assumed rate of return of 7.50% in 2018, creating a net investment loss of over $10 million.
Similarly, our assumptions about demographics have contributed to this challenge. People are living longer and retiring earlier than they once were. Our non-investment net losses were over $42 million for the teachers’ pension in 2018 as a result of incorrect assumptions. This is why the demographic trends that Gov. Scott talks about (such as an aging population) are so serious: not only do they affect our economy and workforce directly, but they have ancillary impacts that are detrimental to our state’s fiscal well-being.
A major contributing factor to this current bloated liability was past years of underfunding. From the 1990s through the mid-2000s, the Legislature consistently underfunded our pension and OPEB liabilities. It wasn’t until 2007 that we started making full payments. But we’re still feeling the consequences of the lack of funding years ago, and have to make up for it with larger payments today.
Because of incorrect past policies, we now have a schedule to pay off these liabilities by FY2038. As a result, each year, the administration and the Legislature have to allocate millions and millions to pay down these liabilities. And because of the amortization schedule associated with this payback schedule, the next several years will require us to allocate millions more than the previous years.
However, there is some good news. Not only have our annual payment obligations been fully funded, but this year the governor and Legislature passed the FY19 Budget Adjustment Act, which pays off an outstanding balance of an interfund loan for teachers’ OPEB obligations, and dedicates $3.3 million to make a supplemental payment to the teachers’ pension, which will realize $14 million in savings down the road. Furthermore, last year, state government implemented contractual changes that reduced the state employees’ OPEB unfunded level by $211 million.
Still, every year, we will have to make millions in payments. These crowd out meaningful investments in other areas, like economic development, affordable housing, social services or tax relief. So while we must continue to make these important payments to reduce our liabilities, what can we do to to achieve a real positive difference in the long term?
David Coates, a member of the Vermont Business Roundtable and the Vermont Capital Debt Affordability Advisory Committee, has suggested setting up a defined contribution plan for new workers. A defined contribution plan is similar to what most comparable employers offer, like a 401(k). This structural change would isolate the pension challenges, and set us on a more sustainable path in the long-term. Even if we don’t mandate a defined contribution plan for new workers, we should at least examine the possibility of allowing state employees to opt-in to the existing defined contribution plan.
Another idea has been offered by legislators. Reps. Cynthia Browning, D-Arlington, and Linda Joy Sullivan, D-Dorset, have proposed a 1% tax on teacher and state employee retirement allowance and post-employment benefits. The tax would automatically be phased out once we reach an 80% funded level of our liabilities.
We need to have these conversations about substantive reform if we’re serious about paying down our liabilities while making financially responsible decisions for our state’s future. Until we tackle these challenges head-on, we’ll continue to be kept down by repeated structural budget deficits that threaten our ability to invest and provide relief for Vermonters.
Don Turner is a former state representative from Milton, former House Minority Leader, current Milton town manager and longtime member of the Milton Fire and Rescue departments.