A Bipartisan Legislative Initiative to Address a Bleak State Budget Situation

In August, the Economic Policy Workgroup, established by New Jersey Senate President Steve Sweeney, released the report titled “Path to Progress.” The intent of the document is to address the mounting fiscal gaps in the state budget.

The committee—which included extensive participation from Republican and Democratic leadership and a volunteer group of 35 policy and fiscal experts— did not analyze in any detail the state’s tax structure or future tax policy but rather developed a series of 40 recommendations that focused specifically on reducing the cost of government and addressing the state’s long-term fiscal problems.

But first some background.

The appropriations act for fiscal year 2019 was enacted in a timely fashion. It is balanced; it contains reasonable revenue estimates; and it funds basic needs. The budget also provides an increase in funding for school aid, contains an increase in dollars for the severely underfunded pension system and contains a minimum surplus. That’s the good news. However, the future is still bleak. New Jersey has the lowest credit rating of any state, except one—and has one of the worst-funded pension systems in the nation.

Unfavorable Projections

Based on reasonable projections of future revenue growth and future spending, the gap in the state budget will reach between $3.2 billion and $4 billion in the next few years—principally driven by increasing pension and health costs. These numbers assume no economic slowdown.

If the economy stumbles, the situation is worse.

At the local level, the story is not much different. Property taxes are too high—usually viewed to be the highest in the nation. Similar projections assume that no matter what is done those taxes will increase each year, as they have for each of the past 40 years. Many argue New Jersey simply has too many local governments and school districts (21 counties; 565 municipalities and 596 school districts—and numerous state and local authorities)—and most do not share services.

Most would say: We need a plan to address this problem. Some argue, “economic growth will cover the shortfall.” Others say, “cut the bureaucracy.” Still others insist, “reduce taxes and don’t worry about the impact on programs.”

Each of those recommendations is a poor and incomplete prescription.

The biggest burdens facing state spending are increasing pension and health-benefit commitments, as well as the continued increase in school aid based on the existing formula. School funding is by far the single largest item in the budget (41 percent of all spending).

Pension and health benefits are the fastest-growing items in the budget—projected to increase in the next four years, from $7.7 billion to $12 billion. These costs are now 19 percent of all spending and will increase to 26 percent of the budget. These rising commitments will crowd out other demands, such as transportation, public safety, Medicaid, infrastructure and the wide range of other critical state programs.

Overall Recommendations

Reforms recommended in the Path to Progress report include five broad areas—K-12 education; county and municipal government administration; tax structure; leveraging assets and by far the most critical—pension and benefit reform. First some summary comments about the key components of the recommendations made for the first four areas:

• Education. Two major reform areas were addressed—school district regionalization and special education. School districts with less than 1,000 students cost taxpayers 12 percent to 15 percent more per pupil than larger districts and are unable to provide as diverse a curriculum. Meanwhile, extraordinary special education costs that should be the state’s responsibility burden local school districts and too often prevent parents from obtaining the education their children need and deserve. The recommendations suggest merging all K-4, K-5, and K-6. And K-8 school districts into K-12 regional districts to promote efficiency and improve quality of education. They also urge a move toward full state funding and administration of extraordinary special education.
   
• County and Municipal Reform. Formal municipal consolidation has not been successful in New Jersey—one in the past fifty years, and the prognosis is not good. But, shared services among municipalities has had some success and saves monies. So, the recommendations would authorize a legislative commission to undertake a study of shared services to identify the proper size, scale and level of government at which services—from 911 calls to code enforcement to health services to police protection— can be delivered most efficiently and then act on the conclusions. They also suggest establishment of  county-wide or regional tax assessment practices, as currently most of New Jersey’s 565 municipalities have their own assessor.
   
• State and Local Tax Structure. It was the general consensus that a separate and permanent commission was necessary to study in more depth the present state and local tax structure. Some of the interim recommendations suggested changes to sub-chapter S-corporations, LLC and partnerships; an examination of the numerous tax exemptions in the sales tax code; revisions and consolidation of the numerous property tax relief programs; and a review of the current incentives to attract and retain business development. Finally, the report calls for permitting a “revenue-neutral” multi-county 1 percent sales tax to be used to reduce property taxes.
   
• Leverage Assets to Stabilize the Pension System. Recently New Jersey shifted ownership of the State Lottery to the pension funds, resulting in a $13 billion reduction in unfunded liability and an annual flow of $1.1 billion in revenue. New Jersey, as well as all states, own, operate, manage or otherwise control a wide range of assets and activities. Many of these assets have an inherent value that perhaps could be captured to reduce the unfunded liabilities of the pension systems.        

Pension and Health Benefits

In my judgment, the most significant recommendations relate to the underfunded pension systems and the costly health benefits both for current employees and retirees.

Fixing pension systems is a complex issue. Policymakers need to guarantee the long term fiscal viability of the pension funds to ensure current employees and retirees receive the pensions they have earned without the systems becoming insolvent. Furthermore, any plan needs to balance the competing interest of employees, retirees and taxpayers within the context of existing laws, court rulings and legal opinions that limit the range of options.

To address this problem the following recommendations were made:

• Shift all new employees of state and local governments (municipal, county and school districts), along with employees not yet vested, from the current defined-benefit system to a cash balance system (similar to a 401(k) but better for the employee). Or a similar variation would be to provide a blended system that establishes a defined benefit pension for the first $40,000 of income and a cash balance account for income earned above $40,000. In addition, the retirement age for full benefits for new employees and non-vested employees would be the same required for full collection of Social Security benefits (current law in New Jersey is now age 65 for full coverage).
  
  The working group considered a “hard freeze’ that would have frozen all current employees at the level of pension benefits they had earned and shifted them immediately to the cash balance plan. While the “hard freeze” would have immediately frozen the unfunded liability and might have saved more money in the long run, it would have added $1.5 billion per year to the budget as the affected current employees would no longer be contributing to the pension systems. Furthermore, the “hard freeze would have a major impact on the lives of tens of thousands of government employees who made career decisions based on the existing system.”
   
• Shift all state and local government employees and retirees from the current platinum-level health coverage (the highest) to gold coverage (second highest), with other, smaller health-coverage adjustments.
  
  New Jersey’s current platinum-level health benefits system has the highest percentage of any government health care system in the country—an actuarial coverage of 97 percent of cost. The estimated actuarial value of the gold-level coverage is 80 percent and would be comparable to the best private sector corporations in New Jersey. Furthermore, new retirees would be required to pay the same percentage of premium cost they paid when working rather than based on their pension. New Jersey is the only one of 45 states that provide retiree healthcare coverage where retirees do not pay the same as current employees

Further Observations and Recommendations

The foregoing actions will significantly bend the curve of future state and local costs: that is critical and must be undertaken. Additional analysis is needed to determine the exact savings; however, these recommendations alone will not close the entire budget gap. The recommendations essentially “stop digging the hole deeper” and in some instances may possibly start filling that hole.

Unfortunately, additional revenues will be needed or sizable budget cuts will have to be made to important state programs. I neither subscribe to the latter approach, nor do I believe it reasonable or doable. This is certainly a hard message to deliver. Do I mean to say: “We make these difficult decisions and cost reductions, but we still have a large budget gap?” A realistic analysis suggests it is true. More hard choices are needed by state leadership.

New Jersey’s budget problems did not develop overnight, but action is needed now. The state needs a new budget strategy for today and the future. Delay is not an option. New Jersey should start with the key reforms outlined above—particularly for the pensions systems and determine what other revenues or fixes are needed.