Debt-Laden New Jersey Struggles to Make Ends Meet

To even the most seasoned and hardened observers of New Jersey’s long-running fiscal follies, the dead-of-night, lightning-fast sale of $300 million in bonds to refurbish the ancient statehouse in Trenton was a cause for marvel.

The opaque sleight of hand that produced the deal in mid-May was particularly audacious. Then again, it could be seen as business as usual, adding one more tranche of debt to a long history of borrowing whose e cumulative effect has been to place the Garden State’s credit rating lower than any but that of Illinois. The State House deal will fund improvements in a capital asset, and so may not be deemed as problematic as earlier bonds that funded operating expenses. Those debts are coming due, and along with the pressing need to fund public employee retirement plans, they threaten soon to squeeze ongoing public spending programs.

State budget analysts declared in mid-May that revenues would fall short of projections by $274 million in the 2017 fiscal year, which ends June 30, and another $413 million in 2018. The shortages weren’t treated as particularly big news, absorbable in annual budgets that are running at about $35 billion.

Yet students of New Jersey’s longer-term fiscal prospects see big trouble in the not-so-distant future from years of ducking bills to fund employee pension and retirement health-care plans, and accumulation of other debts.

This dire situation was underlined in the matter-of-fact, dry prose of a credit agency’s report issued on May 25. Existing tax and spending policies will produce a deficit of $3.6 billion in fiscal 2023, said Moody’s Investors Service. Moody’s has downgraded the state’s debt four times since 2011. The latest action came March 27, when it assigned New Jersey general obligation debt to the A3 category, just above the Land of Lincoln’s Baa rating. These very low ratings still qualify issuers’ debt as investment-grade. But they raise the cost of borrowing, as purchasers of the debt demand higher interest rates to account for higher risk.

As the days counted down to the end of the month, Republican Gov. Chris Christie and leaders of the Democratic-controlled legislature were busy cutting deals to balance this year’s budget and the budget for 2018, and to ameliorate the tough public employee retirement benefits problem.

One idea they’ve had is to pledge the “assets” of the state lottery to shore up three of seven public employee pension funds. In fact, the lottery doesn’t have any assets, but it does throw off $1 billion a year in revenue for the state. By pledging the annual income of the lottery to defray pension payment obligations, proponents of the plan say they can count the “assets” as worth $13.5 billion, thus reducing the pension plans’ unfunded liability—to an estimated $36.5 billion-—and cutting the state’s annual payment to fund them.

Of course, the lottery’s revenue is already pledged to a variety of public programs in New Jersey—higher education programs, psychiatric hospitals, centers for people with developmental disabilities and homes for disabled soldiers. These would have to be funded from general revenues, but State Treasurer Ford Scudder last month told reporters that the funds would become available because the transaction would lower the state’s required contribution to defray the pension plans’ unfunded liabilities.

Other experts say it would be very difficult to actually convert the supposed assets into cash that could be used to pay pensioners. Rex Reid, legislative representative for American Federation of State, County and Municipal Employees, on June 15 told a meeting of the Senate Budget and Appropriations Committee that the deal was little more than an accounting “gimmick.”

A similar view was voiced by Richard F. Keevey, who served as budget director and comptroller for two New Jersey governors. “How do you get at that asset to pay people when they retire?” Keevey said in a recent interview with Route Fifty.

Still, the lottery proposal went over well in the legislature. Democrats agreed to it as part of a deal that would add $350 million for various programs they favor. The budget was all but completed on June 30. But a disagreement between the Governor and State Assembly Speaker Vincent Prieto over treatment of the assets of the state’s largest insurance company was not resolved, and Christie that night declared he would shut down many government functions, including state parks that are heavily used over the July Fourth weekend.

New Jersey’s Debt Spiral

Keevey is a keen observer of Garden State fiscal practices that have led to the looming deficit crisis. Another expert observer is Gordon A. MacInnes, a former Democratic legislator who now serves as president of New Jersey Policy Perspective, a progressive policy analysis and advocacy organization. Both said during interviews with Route Fifty that the government faces a long climb out of the fiscal hole it has excavated over two decades, and both decried this year’s budget gimmicks and new debt accumulation, and the lack of transparency in Trenton’s corridors of power.

In September 2016, MacInnes published a 15-page paper titled “The Notorious Nine: How Key Decisions Sent New Jersey’s Financial Health Spiraling Down Over Two Decades.”

Beginning in the 1990s, he writes, New Jersey abandoned four decades of fiscal probity that saw balanced budgets and prohibitions against long-term borrowing to pay for current needs. Those policies had helped create a “state that emerged from a gray industrial corridor into an economic powerhouse with a modernized transportation system, an expanded network of public colleges and universities, a million acres of preserved open space and a coveted AAA credit rating that kept borrowing costs low for long-term improvements.”

The nine decisions that drove the state’s budget and creditworthiness downward shared two unstated assumptions, the paper says: “that policymakers can promise essential services without bothering to pay for them, and that future taxpayers should bear the burden for today’s spending even though they will not benefit from it.”

New Jersey for many years has relied on locally raised property taxes for the bulk of public revenues. Efforts to cut the burden haven’t met with much success: in 2014, the median property tax bill was $7,452 a year, far ahead of second-place Connecticut ($5,369) and the national average ($2,139).

The state undertook to ease the local property tax burdens in 1976, when it enacted a state income tax and a constitutional amendment pledging all of its revenues to relieving residential property taxpayers.

In 1993, campaigning for reelection, then-Gov. Christine Todd Whitman pledged to cut the income tax. A 30 percent cut was phased in starting in 1994. In the first 10 years of the lower rates, the state forwent some $14 billion in revenues that could have been used for property tax relief.

To alleviate the budget problems flowing from the tax cut, Whitman promoted a Pension Reform Act that allowed state and local governments to reduce their pension contributions by $3.5 billion over four years. The plans’ unfunded liabilities skyrocketed from $800 million to $4.2 billion in the next three years.

This was a bad deal for workers: while their paychecks were reduced by the full amount they owed to their pension systems, their employers, the state and its local governments, were stiffing them with a continuing series of “pension holidays.” The state has projected that it will run short of money needed to fully pay retired teachers what they are due by about 2027, and that the fund for other civil servants will reach that threshold three years earlier. Altogether, some 800,000 current and retired state and local employees participate in the plans. Unfunded liabilities in the plans total some $66 billion, of which about $50 billion is owed by the state.

Whitman and her agents also indulged in a familiar dodge: estimating unrealistically high returns in the state’s pension funds. Their projection that the assets would return 8.75 percent meant that the state wouldn’t have to contribute as much to keep up the solvency of the funds. Current estimates of returns are much lower—though still too high, according to Moody’s.

Whitman wasn’t done with her raids on public employee retirement plans. She also engineered a cut in contributions to fund employee health benefits, a change that led to today’s huge unfunded liability for these plans: roughly $65 billion.

Whitmas also made a fateful decision to do to the bond markets for money to cover some of the shortfalls in pension contributions. In 1997, New Jersey borrowed $2.8 billion. State and local governments were allowed to skip pension payments, their shares partly covered by the bond sale proceeds.

But the state took on hefty interest payments on the bonds—at a permanent rate of 7.65 percent, not renegotiable under terms of the contracts. The state was buying just three years of budget relief at a cost of $10.3 billion in bond payments over the next 31 years. As of last year, taxpayers still owed $2.3 billion in principal and annual payments needed to amortize the bonds will approach $500 million a year by 2020.

The bond issue was accompanied by another pension holliday. MacInnes writes: “From mid-1999 to mid-2006, the state paid in, on average each year, just 4 percent of what was required to keep the pension system healthy (about $23 million a year instead of $600 million.)”

The issuance of these bonds without voter approval was challenged in court. But the New Jersey Supreme Court passed on its chance to stop such borrowing, opening the floodgates for more.

“By the early 2000s,” writes MacInnes, “the combination of the state Supreme Court’s decision, successive governors and legislatures that failed to provide the revenues to meet pension obligations, and a run-up in the stock market [allowing projection of unrealistic returns in the pension funds], created a new culture of financial irresponsibility in Trenton.”

In 2001, another fateful step was taken at the behest of New Jersey’s then-acting governor, Donald DeFrancesco, who took office when Whitman left to become administrator of the U.S. Environmental Protection Agency. The state increased pension benefits while at the same time reducing employee contributions by one-third.

Long-term borrowing to cover short-term costs continued in the administration of then-Gov. Jim McGreevey. He engineered bond sales to gain immediate access to funds that tobacco companies had agreed to pay to the states over a 25-year period. “Because future administrations and taxpayers would be deprived of those revenues while significantly increasing the state’s debt burden, New Jersey received downgrades in its credit ratings from the three major credit rating agencies,” says MacInnes’ report. McGreevey also promoted “securitization” of future revenues from new taxes on cigarettes and drivers license fees. Together these increased long-term debt by $2.3 billion to help balance three budgets.

After passing on several chances to stop the state’s borrowing spree, the New Jersey Supreme Court finally ruled in 2004 that long-term borrowing to balance budgets in the short term was unconstitutional under the state’s Debt Limitation Clause. But it was “too late” in MacInnes’ view—and the ruling did not apply to McGreevey’s bonding plans that year, only to schemes like this that might arise in the future.

Then, in August 2010, the U.S. Securities and Exchange Commission charged New Jersey with fraudulent misrepresentation in bond prospectus disclosure statements issued from 2001-2007. It was the first time a state had been so charged.

According to the SEC, New Jersey sold 79 bond issues totaling $26 billion in the six-year period that created the false impression that the Teachers’ Pension and Annuity Fund and the Public Employees’ Retirement System were adequately funded. Most of the bond issues were to fund capital projects, not to fund the government’s operating deficits.

The SEC said faulty disclosures masked New Jersey’s inability to make contributions to the two pension plans without raising taxes or cutting services. As a result, the agency said, investors were not given sufficient information to be able to evaluate the state’s ability to fund its pensions or to assess the impact of the pension plans on the state’s financial condition.

The state did not contest the findings.

Coming Home to Roost

Governors were not done, though, with creative ways to avoid paying the bills. In 2010, Gov. Chris Christie decided to cancel New Jersey’s support for a new rail tunnel under the Hudson River into Penn Station in midtown Manhattan, the so-called “Access to the Region’s Core” (ARC) project. Reallocation of $1.3 billion in funds allowed Christie to avoid a much-needed increase in taxes for the state’s Transportation Trust Fund, which pays for capital projects—and the trust fund ran out of money in mid-2016. The ARC project (and its delayed successor, the Gateway Project) are vital to the economic health of the state and the region.

Christie finally agreed to a 23-cents-per gallon gas tax increase last year-- the first tax hike of his long tenure as Governor. At the same time, he lifted a statewide construction freeze that idled more than 1,000 road, bridge and rail projects, taking crews off the job at the height of construction season.

But Christie also insisted on tax cuts to offset the $1.3 billion a year the increased gasoline levy would produce. The bill he signed into law on Oct. 14 eliminated the estate tax, raised the retirement income tax exclusion, increased the Earned Income Tax Credit for the working poor, created a tax deduction for veterans, and rolled back the sales taxes three-eighths of a percentage point.

Samantha Marcus of The Star Ledger and NJ.com reported at the time:

Christie has praised the tax cuts as making New Jersey more affordable, though budget analysts questioned the soundness of giving up $1.4 billion a year while the state struggles to make ends meet and fully fund education and public worker pensions.

Moody's Investors Service weighed in, saying the lost revenue, "equivalent to 2.9 percent of current revenues, will worsen the state's existing budget challenges."

But Moody’s and other analysts conclude that the the largest problem is with the employee retirement plans whose underfunding dates back so many years.

Christie has wrestled with the problem ever since he took office in January 2010. A pension reform plan enacted in 2012 pledged to increase state contributions to the retirement plans by one-seventh each year, so as to reach the “Annual Required Contribution” needed to fully fund the plans by fiscal 2021.

But a budget gap exceeding $800 million emerged in 2014, so pension contributions were cut that year and the next.

Christie, looking for new solutions, in 2014 created the nonpartisan New Jersey Pension and Health Benefits Study Commission, headed by the well-regarded Thomas J. Healey, who had served as assistant secretary of the Treasury for domestic finances under then-President Ronald Reagan.

Its report, issued in 2015 and updated last year, predicted dire consequences if the state did not move to address the retiree benefits crisis. In an op-ed in February 2016, Healy predicted “calamity” if nothing was done. “With New Jersey's public employee pension plan ringing up debt at the rate of $10 million a day, the threat of a system collapse impacting virtually everyone in the State looms larger than ever,” he wrote.

Healey’s commission focused on finding savings in retirement health benefits programs, which it described as “platinum-plus” and “rarely found in the private sector.” These, it said, “have contributed to crippling the system by consuming revenue which otherwise would have been available for pensions.”

The commission proposed to cut over $2 billion in health benefit spending annually and to use the savings to provide stable funding for pension benefits earned to date.

“Going forward, retirement benefits would be provided through a cash balance model, which -- while still a substantial annual expense for the State -- will be affordable and sustainable because it is much less subject to the investment and funding risks which have undermined the current pension plans,” Healey wrote.

No action has yet been taken on the commission recommendations. Public sector unions, noting that they’d already made sacrifices in earlier budget deals, have opposed the reforms. Keevey praised the commission’s suggestions, while also suggesting that “additional state monies would be necessary under any scenario.”

In 2015, the state decided to stretch out the glide path toward ARC to 10 years. This year, it appropriated $1.8 billion, and next year’s budget is supposed to include $2.5 billion. Next year, as an added measure of good faith, the payments are supposed to be made on a quarterly schedule. (But none of this is legally binding, noted Moody’s New Jersey analyst Baye Larsen in a recent interview. Rather it amounts to a statement of “intention,” she said.)

The Moody’s report from May 25 predicted that ramping up pension contributions to the full ARC by 2023, as now scheduled, would mean that 33 percent of New Jersey’s budget would be consumed that year to what it calls “fixed costs”—pension contributions the largest, followed by debt service on state-backed bond issues, followed by contributions to employee retirement health benefits.

Given current spending trends, said Moody’s, this will produce a $3.6 billion gap in the budget in 2023. Its report concluded that all solutions are difficult, but that “slightly stronger economic growth, tax increases and structural spending cuts [retirement plan reforms] would close the deficit and make the rising fixed costs affordable.

Moody’s very low rating of New Jersey credit sits at A3 stable. Stable means that the ratings agency doesn’t anticipate a change within the next 12-24 months, Larsen said. About 10 states, mostly in the energy economy, have negative outlooks, though they are rated higher than A3.

Down to the Wire

Against this backdrop, the secretive negotiations on the State Lottery deal and the State House bond financing seem much like business as usual.

The State House deal is a classic case. The bonds were, pre-approved by legal counsel with ties to the governor.

The deal was approved by an obscure body, the State Capitol Joint Management Commission, whose eight members are selected by the governor and legislative leaders, after a short closed-door meeting. The bonds, MacInnes, pointed out, have no dedicated source of guaranteed repayment.

In a complex leasing deal to its Economic Development Authority, which will use the revenue to pay off the bonds. A court challenge by legislators was rendered moot in the rapid-fire dealing, as the approvals had been made and the bonds had been sold within hours in a private placement that negates the normal level of scrutiny.

Including interest payments, the cost of the State House deal could balloon to $700 million. But Christie evidently believes it’s worth it—that his successors will have nicer quarters than he enjoyed. And, of course, he will no longer be responsible for meeting the state’s fiscal challenges.

Editor's Note: This article has been updated to clarify and add some more background information about the U.S. Securities and Exchange Commission's Aug. 2010 action against New Jersey and to clarify information about locally raised property tax in the state and other information.