New Jersey and its municipalities are likely to face greater fiscal pressures in the year ahead after the state opted to lower the assumed rate of return for pension assets, according to Municipal Market Analytics.
The state treasury’s decision to change the investment return assumption to 7% from 7.65% is “an unwelcome gift” from outgoing Gov. Chris Christie to Governor-Elect Phil Murphy, MMA analyst Lisa Washburn said in a Jan. 3 report. The more fiscally conservative assumption will translate into higher unfunded pension liabilities, lower funded ratios and higher required contributions for New Jersey local governments, Washburn said. The timing is also problematic, she said, because the state’s revenue-raising ability “has likely been impaired” following a tax overhaul package signed by President Trump that caps the federal deduction on state and local taxes at $10,000.
Washburn said the investment return decision is likely to remain once Murphy takes office on Jan. 16, though the new Democratic governor and legislature could opt for a phase-in-reduction similar to action taken in California last year when CalPERS reduced its rate.
“A more gradual move to the new rate would soften the budgetary impact to New Jersey and its local governments but pension liabilities and funding will, in MMA’s opinion, continue to threaten other budget priorities and credit ratings over the medium-term, absent meaningful pension reform,” Washburn said in her report. “Pension funding is already an intractable problem for the state and its locals, consuming an ever growing portion of budgets at the expense of other more productive spending.”
While the state is able to adjust its pension payments to combat budgetary pressures, Washburn said, New Jersey localities are generally required to make their full annual actuarial contribution. Prior to the rate reduction, state pension contributions were scheduled to rise over the next few years in small increments from 50% to 100% of the actuarial required contribution. She said the rate reduction alone adds about $6 billion to the state’s liability and increases its actuarial required contribution by almost $400 million for the upcoming 2019 fiscal year.
“At the 60% ramp-up-rate in place for FY19, the result is approximately an incremental $240 million that the state would need to fund out of its perennially constrained budget, assuming it keeps up with its funding promise,” said Washburn. “The increased pension costs would make it more difficult for the governor-elect to propose a state budget for FY19 that delivers on his campaign promises of funding pensions while increasing spending on education (pre-K through college), infrastructure, and other items.”
Washburn said that at a 60% pension funding level, state’s contributions in aggregate will increase by about $888 million to $3.4 billion in 2019 from $2.5 billion in the current fiscal year. Pension liabilities at New Jersey localities are raised $4.8 billion by the rate reduction and their actuarial contributions will jump by about $425 million, according to the MMA report.
The new pension challenges for New Jersey’s newly elected governor came along with barriers to his plan of raising taxes on high-income earners, Washnurn said, citing “the adverse impact” from the federal tax plan on high tax states. New Jersey local governments rely on the property tax for funding, but with the highest property taxes in the nation, Murphy’s ability to use this revenue source is limited.
“Governor-elect Murphy faces a politically difficult situation,” said Washburn. “Reversal of the decision to lower the investment rate would likely be viewed unfavorably by unions/pension beneficiaries since it would undo changes that are intended to enhance the pension system’s fiscal position.”
Washburn expects that rating agencies will view the change in assumption as “mainly positive” since municipalities will be put on a “sounder” funding plan with slightly less risk of potential for investment in higher risk assets aimed at produce higher returns. She said Murphy will face an early balancing act in weighing the state’s credit conditions against the needs of voters who sent him into office
“The additional budgetary pressure on the governments imposed by higher contributions would likely be mean fewer dollars spent on meeting campaign promises and other productive spending,” she said. “Additionally, local governments are likely to wage a campaign for the state to provide some sort of relief as their options to address the rising costs are constrained.”