Last week the plot thickened on the drama surrounding a proposed partial state bailout for Detroit. The debate that had been, “Should or shouldn’t the state give Detroit money?” suddenly became, “If we give money should it come with reform requirements?” Legislation was introduced specifying a number of specific reforms.
Among these is requiring the city to adopt the only pension reform that is genuinely transformational: No longer offering traditional “defined-benefit” pensions to new employees. This would start Detroit on a process of gradually climbing out the financial hole of unfunded employee legacy costs.
Defenders of Detroit’s dysfunctional status quo are fighting back against this genuine pension reform, and attempting to mystify lawmakers with a false claim it comes with burdensome “transition costs.” The truth is there are no transition “costs,” there is only transition accounting. That is, the city would have to revise how its financial statements account for “catching up” on unfunded pension liabilities, but it would not have to actually pay any more up-front money to amortize these more quickly.
Those promoting this claim rely on a demonstrably false interpretation of official accounting rules (the rules explicitly state that no extra up-front payments are required) and insinuate that “the bond market” will look unfavorably on the city’s debt if it does not take this cash-flow hit. Importantly, they have no evidence for this claim.
In fact, the evidence from the real world shows just the opposite: Other governments that have already stopped offering new hires retirement benefits that create long-term taxpayer liabilities — in particular the states of Utah and Alaska — did not comply with the mythical up-front payment mandate, and if anything their credit ratings improved.* (The state of Michigan also closed its system to new state employees back in 1997, and while the circumstances were different, this too provides no evidence for the transition cost claim.)
The proposed bailout conditions also contain some institutional changes whose potential impact relies on circumstances beyond the Legislature’s control. In contrast, ensuring that no new taxpayer liabilities are created every time Detroit hires a new employee is concrete, long term and potentially transformational, independent of what others or may not do.
A bailout is a bad idea even with reform conditions, but if one is approved then lawmakers owe it to the residents of both Detroit and Michigan to ensure we all won’t be back here again with another Motor City meltdown in five or 10 years. Without the pension reform the current exercise will very likely turn out to be just one more “kick the can” bit of political “business as usual.”
(*Alaska actually did get sucked in by the same false “transition costs” claim for just one year, but in effect said “the heck with that” and stopped making these payments. A recent credit rating upgrade from Fitch cited the state having closed its defined benefit plans to new employees.)