Pension Costs Will Cause Huge Worker Layoffs

City of Milwaukee officials continue to stare down a 2023 fiscal cliff.

As that day of reckoning draws closer, the actual amount of a required pension fund contribution is coming into focus. The city will need to come up with an additional $76.6 million annually, a 105% increase, starting in 2023. But the city doesn’t have the ability to raise taxes to plug that gap.

The city must increase its annual contribution to offset declining pension fund returns and increasing costs. The size of the increase is expected to affect every city department, potentially causing a cascading series of layoffs and service reductions or eliminations.

A report, presented Wednesday to the Finance & Personnel Committee by budget director Dennis Yaccarino, calls for 562 layoffs in 2023 and 506 in 2024. An additional 300 layoffs would need to take place from 2025 through 2027.

“That’s a lot of positions,” said Alderman Russell W. Stamper, II.

The 2021 budget funds 7,481 full-time equivalent positions, 47% of which are in public safety. The layoffs would reduce the workforce by more than 18% —  and this comes after the city has cut 650 jobs since 2004.

The layoffs would be made as the city also spends down its pension reserve fund. In 2023 the city would spend $40 million of its reserve funding, reducing the first year’s cost increase to $37 million. In 2024 the city would use the remaining $10 million in reserves, resulting in the tax levy impact growing to $67 million. It would need to bear the full amount in the following years.

Yaccarino and Employee Retirement System executive director Jerry Allen noted the city already does one thing to save a notable amount of money. Every year the city prepays its pension obligation. Yaccarino said that saves the city approximately $9 million annually. But it also means the city is effectively taking its medicine early. Allen noted that the city doesn’t need to increase its contribution until 2024. But waiting until then would compound the city’s problems.

The budget director is also looking at strategies to blunt the impact of layoffs. “One item to look at is whether we look to hold positions [open] now in anticipation of the future,” Yaccarino told the committee.

To deal with rising police costs in recent years the city has relied on reducing the size of the Milwaukee Police Department through attrition, effectively not replacing officers that retire. But that strategy won’t work in the future given the scale of the cost increase. “Based on the numbers we have we are going to have to look at some level of layoffs,” said Yaccarino.

The police department accounts for 55.1% of the expected pension contribution cost increases. The Milwaukee Fire Department accounts for 22.9%. The police department’s budget already exceeds 100% of the money the city raises through property taxes and almost half of the city’s general fund.

Members of both public safety departments are still protected by collective bargaining rules while the state stripped that protection for general government employees through Act 10 in 2011. The change, championed by then-Governor Scott Walker, came with a reduction in state aid. But a decade in, Milwaukee is being squeezed by a reduction in state revenue and increasing police personnel costs. Labor costs for the department — total salaries and benefits — will increase in 2021 even as the number of officers falls by 120.

Revenue Options

Comptroller Aycha Sawa and Deputy Comptroller Joshua Benson gave a presentation on one option to raise revenue: pension obligation bonds. The general theory is to borrow money at a lower cost than you project to make on your investment. Borrow at 5%, earn a return at 7.5%, and you will have made 2.5% on the amount borrowed.

But it’s that return that is the hard part. “It’s really hard to time the market and that’s where a lot of the risk comes in,” said Benson.

If the market returns 4% and you borrowed money at 5%, the bonds have made the problem worse. Benson said the bonds come with a higher interest rate and can be viewed negatively by credit agencies, increasing the cost of other borrowing. Milwaukee would also need state authorization, and likely a moral obligation pledge from the state to pay back the money if the city defaults.

Committee chair Ald. Michael Murphy said it’s unlikely Assembly Speaker Robin Vos would grant the city that debt repayment pledge. “I can’t imagine he would ever vote that way, nor any of Republican,” he said.

Alderman Nik Kovac asked if there were any examples of cities successfully using the bonds.

Milwaukee Public Schools and Milwaukee County have previously received authorization to use the bonds. MPS used the funds in a low-risk way for prepayment costs to the Wisconsin Retirement System.

Milwaukee County used the bonds in 2009 and given the market timing to date, has come out ahead. But Benson said what happens over the next decade could send the returns negative.

“Alright, so in 2030 we will know if this is a good idea?” asked Kovac. “Yeah,” responded Benson with a laugh.

“I do want to stress that pension obligation bonds are not a silver bullet solution,” concluded the deputy comptroller.

The committee went into closed session Wednesday to discuss other options. While it wasn’t publicly disclosed what was discussed, the city could be exploring modifying benefits for future employees, being allowed to join the state retirement system or other state legislative relief options.

The city cannot, without Legislature approval, institute new taxes not approved by the state.

Municipalities can levy fees on a number of items to raise offsetting amounts of revenue. The 2021 budget introduced a street lighting fee that removed existing costs from the property tax levy, freeing up approximately $9 million and raising additional funds to increase pay for city electricians in an effort to boost recruitment and retention.

Milwaukee will need any relief it can find quickly. The 2023 budget is scheduled to be introduced in September 2022 and adopted in November 2022.

Why Is There a Pension Crisis?

Since 2004, when Mayor Tom Barrett took office, the city will have gone from having to contribute nothing for many years to an overperforming pension fund to having to fork over more than half of its property tax revenue. At the same time, the city has seen an effective cap on property taxes instituted by the state and an inflation-adjusted reduction in state shared revenue of more than $100 million annually.

Following the Great Recession, the city instituted a five-year smoothing formula to determine what it needs to contribute to fully fund its pension, and that formula will reset in 2023, triggering the cash crunch.

The city charter calls for the pension fund to be fully funded, but it is currently 80.1% funded.

The City of Milwaukee entered the current five-year period assuming an 8% annual return was possible, but reduced estimates to 7.5% starting in 2019 based on recent past performance and future estimates. That change alone is cited as the largest driver in the need to increase funding.

The retirement system’s 2020 investment performance failed to reach the 7.5% target. Allen said as a result $95 million in costs will be spread over 25 years through actuarial estimates. In years the city overperforms the target those future costs are reduced. Allen called hitting the number exactly a “one in 100 years” occasion.

The COVID-19 pandemic and associated relief bills won’t directly influence the problem. The city estimates it lost up to $50 million in revenue last year, but will be able to use some of the $406 million it is receiving from the American Rescue Plan Act to address that shortfall. It can’t use that funding to directly pay for pension costs.

“Under the federal guidelines, and the law, none of the $406 million can be used towards the pension,” said Murphy.

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Related Legislation: File 201241