The major point of difference between the governor’s budget and the House budget concerns the use of idle funds. The governor’s plan sets aside $500 million in a new so-called permanent fund and $241 million more than the House in the state’s rainy day fund, while the House plan uses those funds to reduce budget cuts and increase direct payments to the underfunded pension systems.
The House plan is a better approach for this budget because it limits harm to critical education systems, gets us on the right path for our pension liabilities sooner and can achieve a greater return on investment for the underfunded pension plans.
Limits harm to critical education systems
The House budget puts money into wiping out deep nine percent budget cuts proposed by the governor to P-12 education, higher education and a few other services. It freezes, rather than reduces, education funding at its 2016 levels for the next two years. Supporting education is important for Kentucky’s economy both now and in the future.
In the short term, by stopping cuts the House budget would prevent job loss through attrition and possible layoffs, especially important to rural areas of the state where public schools and community colleges play a significant employment role. In the long term, we know that education is key to the skilled workforce and entrepreneurial leadership it takes to grow our economy and generate revenue to invest in thriving communities and pay down our debt over the next few decades.
Gets pension plans on the right path sooner
The House plan makes the full actuarially required contribution (ARC) to our pension plans immediately and with House Bill 1 sets that as the policy of the state moving forward for the teachers’ plan (a 2013 law did so for the state workers’ plan). The governor’s budget falls short of the full ARC for the teachers’ plan.
Both budgets actually contribute more than the ARC for the Kentucky Employees Retirement System (KERS) non-hazardous plan. The House plan contributes $90 million above the ARC over the biennium while the governor’s plan puts in $157 million over the ARC. A contribution above the ARC makes sense because it’s been calculated with an unreasonably high assumption about the plan’s future rate of return on investments given its low level of assets. The KERS board recently lowered that assumption and an amount significantly above the ARC is needed to reflect that revision.
While the House plan provides the full ARC for the Kentucky Teachers’ Retirement System (KTRS), the governor’s plan only puts in two-thirds of its required ARC. That makes the governor’s budget $345 million short of the KTRS ARC over the biennium.
It’s unwise to make only a partial payment to KTRS while setting so much money aside, as the Governor proposes. Doing so is akin to saving money for next year’s mortgage payments on your home while not making full payments this year. It’s much better to get on the right track now.
Anything less than the full ARC for KTRS could hurt the state’s credit rating. That’s because the accounting rule that kicked in last year requiring the state to report a much larger unfunded liability will presumably continue to apply.
Also, while it makes sense to add money to the rainy day fund with a growing economy, the $524 million the governor leaves in the fund is a huge leap from the $209 million that’s in there now – especially considering the important investments in our economy we’d have to forego. The House does add money to the fund, growing it by $74 million.
Can achieve a greater return on investment
Sending more money directly to the pension plans is better than leaving them in an idle permanent fund because the monies can be immediately invested with a long-term time horizon and can help with the plans’ cash flow problems.
Both the KERS non-hazardous plan and KTRS have a negative cash flow situation, meaning more money is going out of the systems than is coming in. That’s forcing them to sell investment assets to pay retiree benefits. In order to do so, they have to maintain more liquidity in their portfolios than is optimal. Especially in a down financial market as we have been experiencing, that means the systems are selling assets at a loss and are unable to diversify into potentially more lucrative opportunities. More money into the systems now can help address that problem.
Also, the permanent fund has an unclear set of investment goals. While the stated purpose of the fund is to help the pension plans as needed in the future, it’s not clear when those dollars would be infused into the systems and why. A shorter-term investment horizon would be needed, which would constrain options. One reason pension plans have achieved high rates of return historically is they are able to invest with 30-40 year time horizons. Putting more money directly into the pension systems would likely mean higher investment returns over time.
The House plan certainly doesn’t solve all the state’s problems and more will have to be figured out about the path forward beyond this two-year budget.
It still contains big cuts to many vital investments ranging from mental health to environmental protection, from services for the elderly to the arts. Except in a few areas like college scholarships, it doesn’t include needed new investments and continues to freeze funding in areas like the SEEK formula for schools — which constitutes a cut once inflation is taken into account. It’s built on a record amount of one-time money that is very unlikely to be there when the next budget is created, making a conversation about new revenue a necessity between now and then.
But given where we are, and with the time left in the session, it’s a responsible way forward.