PHILADELPHIA — Pennsylvania will have a Democratic governor and a more Republican legislature in January.
It also still has an unfunded pension liability estimated at around $50 billion and faces the specter of even more downgrades from bond rating agencies if it continues to do nothing.
York businessman and former state revenue director Tom Wolf succeeds Republican Tom Corbett in the governor's office in two months. In a counter move, Republicans, who widened their majorities to 35 votes in the House of Representatives and 10 in the Senate, replaced Dominic Pileggi of Chester with Jake Corman of Bellefonte as Senate majority leader.
How will they avoid gridlock?
"That's the million-dollar question," said Alan Schankel, a managing director at Janney Capital Markets in Philadelphia.
"The pension thing has to be resolved. Something has to be done on pensions," said Schankel. "I think you'll see some kind of compromise, though not as much as I would like. But I think you'll see something done. It's needed and the governor will want some accomplishment, at least in his first four years."
All three major bond-rating agencies lowered Pennsylvania this year. During the same week in September, Fitch Ratings and Standard & Poor's dropped the state's general obligation rating to AA-minus from AA. In late July, Moody's Investors Service lowered Pennsylvania to Aa3 from Aa2.
All cited the unfunded pension liability of Pennsylvania's two major pension plans -- the State Employees Retirement System and the Public School Employees Retirement System. Including other post-employment benefit, or OPEB, obligations, and municipal and county packages, the tab is around $73 billion.
"More negative financial news for Pennsylvania is piling up," Janney director Tom Kozlik said in a commentary. An Independent Fiscal Office report last week projected a nearly $2 billion budget shortfall for fiscal 2015-16, citing the commonwealth's reliance on stop-gap revenue fillers. In addition, Treasurer Rob McCord implored the state to resolve a $1.5 billion line of credit soon.
More downgrades loom if Pennsylvania continues to do nothing, said William Rhodes, chairman of the public finance department at Ballard Spahr LLP and practice leader of its municipal recovery initiative.
"I'm not sure how you can avoid them," he said. "The number one issue is public pension liability. I can't speak for the rating agencies, but they're saying that pension liability is tantamount to debt, although there are arguments for and against that."
Unity in Harrisburg could be challenging, according to Rhodes.
"I'm not sure how they can work together. They'll have to look for some common ground. They'll have to pass budgets," he said. "The new governor hopes to make the state income tax more progressive, but I don't think that will be warmly received by the Republicans in the legislature."
State pension woes represent a "daunting political lift" for any elected official, according to Richard Dreyfuss, a Hummelstown, Pa., actuary and adjunct fellow at the Manhattan Institute for Policy Research. He worries that compromise could lead to watered-down and ineffective changes.
"Proper pension reforms need to include adopting compliant funding policies coupled with a standalone defined contribution plan," said Dreyfuss, a Hershey Foods executive for 21 years. "More likely, it would appear the continuing debate will focus on pseudo-pension reforms which include pension obligation bonds and hybrid pension plan arrangements."
Aside from pension overhaul, school funding and whether and how to tax natural gas production in the state's Marcellus Shale lurk as hot-button items.
"[Pileggi] was considered too moderate," Villanova School of Business professor David Fiorenza said of his replacement as Senate majority leader by Corman. "This move will look to be in direct opposition of the new governor-elect and his plans for higher income taxes and or sales taxes."
Wolf's agenda of raising taxes to help fund schools "only works in theory," said Fiorenza, because school funding is a function of more than just taxes.
"At this point, assessed value of commercial and residential property along with local earned income taxes have been the way to fund schools throughout the commonwealth," Fiorenza said. "Relying on sales taxes and the personal income tax is too risky and not a steady stream of revenue like the real estate tax."
With a Democratic executive and two GOP legislative branches of government, Pennsylvania's landscape mirrors the nation's.
"Generally, the state is better at handling these problems than Washington," said Schankel. "I'm optimistic."
