The Deeper Dig is a weekly podcast from the VTDigger newsroom. Listen below, and subscribe on Apple Podcasts, Google Play, Spotify or anywhere you listen to podcasts.
Editor’s note: A previous version of this podcast mischaracterized a conversation with former Gov. Howard Dean. While he spoke about inheriting an “enormous deficit,” he did not specifically blame it on spending under former Gov. Madeleine Kunin.
[O]ne-point-five billion dollars. That’s the amount the state owes in pensions for future retired teachers that isn’t covered by existing assets. It’s a funding gap that’s casting a cloud over the entire state budgeting process.
“There’s nothing left,” said Senate Appropriations Chair Jane Kitchel, referring what’s left of available revenue after pension liabilities are paid down. About 40% of that revenue will cover pensions, with most of the rest funding bond payments and debt service. Kitchel said this makes funneling new money to government programs practically impossible.
But this problem isn’t new. For years, the state’s budget writers have faced a growing burden from the teachers’ pension fund liability. It dates back to 1989, when Gov. Madeleine Kunin’s administration decided to underfund pensions to free up cash for current spending. Her successor, Gov. Howard Dean, who inherited a deficit, drove pension funding even lower — a decision he says today that he doesn’t regret.
“It was that, or cut people off their health care,” Dean said. “We just had to make tough choices.”
Gov. Jim Douglas continued to underfund for his first few years in office, eventually funding 100% or more of the recommended amount starting in 2007. Douglas said that before the 2007-09 recession, projected returns on the state’s investments were higher than they should have been.
“Most of us don’t remember the Great Depression,” Douglas said. “So I think there was a greater sense of optimism.”
Now, the state is pursuing a more aggressive plan to pay down the liability by 2038. But doing so will require an average annual commitment of $150 million — a sum that will constrain future budget writers facing funding requests.
On this week’s podcast, former Govs. Dean and Douglas reflect on their handling of the pension fund. Sen. Kitchel and Treasurer Beth Pearce describe how the funding gap affects this year’s budget. And VTDigger’s Colin Meyn explains how the state’s actions now could have ramifications in the future.
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Colin Meyn: Every interview started with a pile of documents.
Our editor Colin Meyn has been looking into Vermont’s pension debt crisis. It’s a project that’s generated a lot of paperwork.
I have to ask, what are all these stacks of paper?
Meyn: So this is Beth Pearce’s, she’s sort of done a dive into all the, the sort of history…This is Tom Pelham’s—his sort of mathematical argument for why what they were doing at the time made perfect sense…This is Peter Fagan’s one sheeter about the cost of all these things…And this is an amazing presentation that Beth put together about the whole thing.
We should probably get a bigger table.
We’re talking about pensions because lawmakers are trying to draft the state budget, which means the people behind different proposals are going to the appropriations committees and saying: Here’s why the state should fund this.
Meyn: And then Debbie Downer Jane Kitchel, the Senate Appropriations chair, is telling them, you know, thanks so much, this is very important. But basically she’s saying, we are not going to be able to fund a lot of this stuff, both because there’s a lot of competing interests, but then there’s this giant lump of money that’s got to go towards paying down teacher pension liabilities. This year, it’s $120 million.
Kitchel: Forty percent of available revenue is off the table already. And so when people are coming in saying, why don’t you do more for this particular service area, or this program hasn’t had a benefit increase in years, the expectation is there’s more money, but if you take 40% right off, and then you’ve got to deal with all those ups that I just outlined, there’s nothing left.
Let’s define what that giant lump of money is. When you’re talking about teacher pension liabilities, what is that in plain English?
Meyn: Vermont is by law required to basically prepare the teacher pension fund for the future. Teachers’ retirement pensions, they pre-fund them. And the pre-funding is done to accrue interest on investments, the same as sort of parents building for their kids to go to college, that if you wait to pay for that college until they’re 18, then you’re going to pay a lot more than if you start building up a college account when the kid’s born and you’re paying, you know, a few dollars here, a few dollars there, that’s going to accrue interest over 20 years, and you’re going to actually save a lot of money on college. So the state has done the same thing with pensions: that if you start putting money in right now, that money is going to be worth a lot more in 20 years when these people actually retire.
Kitchel: So this document right here, which you’ve seen, right? And I can give you a copy.
Jane Kitchel told us that around 2005 she noticed these investments had been underfunded for decades. In fact, she showed us the documents.
Kitchel: Anyone who sits in this room is really the recipient of so many requests for funding, and we’re having to make some very difficult decisions. And it’s like, why are we feeling so constrained? Money that was not paid in, the whole compounding impact, was just not there.
Meyn: She talks about the importance of sort of building up compound interest, you know, and this goes back to the sort of college analogy that I was drawing, that money put in today is going to be worth a lot more 20 years down the line. And she pointed to a song in Mary Poppins actually, where bankers are singing about how if you put your money into their bank today, it will you know, make you a very wealthy person by the time you grow old.
Mary Poppins banker: If you invest your tuppence wisely in the bank, safe and sound. Soon that tuppence, safely invested in the bank, will compound.
She’s trying to say that if we fund this stuff now, the value of doing that is going to be exponential.
Meyn: That’s right. And that in Mary Poppins, you know, there are these kids, you know, they get a few dollars and the bankers are saying, put your few dollars into the bank today and it will be worth that much more later. The Howard Dean administration decided not to put a few dollars in the bank. There’s a huge sort of opportunity loss for that money to sort of grow and help pay down the teacher pension liability.
Mary Poppins banker: In the hands of the directors, who invest as propriety demands.
It’s 1989. You and I are 3 and 4 years old, Madeleine Kunin is the governor. How does this conversation about funding teacher pensions suddenly arise?
Meyn: I mean, Madeleine Kunin was known to be a big spender. Certainly. You know, I mean, the sort of state budget grew faster under her watch than it has under any recent governor. And there was a sort of heated conversation about whether or not to fully fund teacher pension funds. The decision was made in her term to do underfunding. And then that underfunding increased into Richard Snelling’s and then into Howard Dean’s administration.
In Howard Dean’s administration, the level of underfunding was pretty remarkable. It went down to like 50% of the fiduciary recommended amount, which is, they hire a consultant who says, here’s what you need to put into the fund to prepare for the future.
You talked to Howard Dean about why his administration made the decisions they did. What did he tell you?
Meyn: Yeah, he’s not an easy guy to get in touch with these days. But then we sent him an email at 5:01, I think, on Monday afternoon, just sort of telling him that we were working on this story and got a call back at 5:03. So…
Dean: Hello?
Meyn: Hi there.
Dean: It’s going to work, right?
Meyn: It’s working.
Meyn: He was pretty anxious to talk about it, and it’s certainly an important part of his legacy. And I think that, you know, there’s an appeal in 2019 to blame people who are in office in the ’90s, because that’s a lot easier than blaming the people in office today.
Dean: We certainly underfunded it.
Meyn: And why did you guys make that decision consistently?
Dean: Because, for two reasons. First of all, it was a terrible recession, there was that or cut people off their health care and things like that. And the other is that the investment advisory group has been underperforming for a long, long time, and that was part of the problem.
Meyn: His position is, he was making really tough decisions in the ’90s. He was not going to increase state spending faster than the economy was growing. And that was really his mantra. And he made a lot of really tough decisions to make that happen. [Editor’s note:A previous version of this podcast mischaracterized a conversation with former Gov. Howard Dean. While he spoke about inheriting an “enormous deficit,” he did not specifically blame it on spending under former Gov. Madeleine Kunin.]
Dean: It was because times were really, really tough, and you have to make really hard choices, and I just wasn’t going to take healthcare away from poor people and I wasn’t gonna raise people’s property taxes by shifting it all out of the education department. So I chose not to fully fund the pensions. You know, it’s always easy to change course in retrospect, but had I had to do that, people would have lost their healthcare and property taxes would have gone up. And I didn’t think that was the right thing to do.
I mean, there’s always a battle between — the state treasurer has, you know, only one job in budgeting, and that’s to try to get the pensions fully funded, and that’s understandable. Governors unfortunately have a much greater problem and that is, in times of great financial distress — which happened when I took over and also as I was leaving, we had the recession at the beginning of George W. Bush’s administration — we just had to make tough choices. And we just we chose to underfund.
Meyn: I think people in office today would say that, you know, tough decisions and all, that it allowed him to sort of keep the government going in a way that was just sort of kicking the burden down the road. So that it makes today’s decisions much, much harder.
So the Dean administration decides that they’re going to underfund these pensions in order to pay for other stuff. How do they go about actually putting that into policy?
Meyn: You know, it was an annual conversation where they would go into the House Appropriations and Senate Appropriations committees, and they would say, you know, here’s our recommendation, here’s how we justify it. And the way they would generally justify it is saying that, you know, this money is better spent to go towards basically the things that we think are important, the things that you think are important, so let’s not put $7 million into this pension fund, let’s put $7 million toward expanding health care, let’s put $7 million towards building prisons, let’s put $7 million towards building a bridge. You know, so things that certainly had more pressing importance that were much more sort of concrete, literally and figuratively, things that you could do right away, rather than this sort of abstract debt that you’re gonna have to pay later.
Now we’re at later, and it’s a huge burden on the budget process.
One person who watched this play out was the treasurer at the time, who later became governor: Jim Douglas.
Douglas: You know, you’re taxing my memory, Colin, but I often say they’re taxing everything else in Montpelier, so you might as well tax that too.
Douglas said the Dean administration had the numbers to back up their position. The economy was strong, which boosted the returns on the state’s investments. So on paper, it looked like they were meeting obligations just fine.
Douglas: I mean, intellectually, we knew that the economy would never continue to expand, without some, some retraction from time to time, but most of us don’t remember the Great Depression. So I think there was a greater sense of optimism and that was well founded in terms of the actual returns on our investments then, the recession of 2000 or so offered a dose of reality. And then obviously then the Great Recession ’07, ’09 was a heavy dose of reality and, and I think we’ve now realize there’s a new normal in terms of expected returns.
Meyn: Farsighted treasurers will always say like, ‘don’t make decisions based on what’s happening now, make decisions based on how we best predict what’s going to happen in the next 30 years, 50 years, hundred years.’ When you say, the stock market’s doing really well this year, so we don’t need to put our budget into these funds, it’s really short sighted. Because you know, the stock market goes up and down. And if it goes down for the next decade, then you want to have extra money in the tank to deal with that.
Douglas: As you know, we have to look long-term on on pension systems, and decisions that are made at one point can have impacts many years later. And so I felt, as a fiduciary, as a trustee of the systems, I needed to advocate for full funding and did, but you know, didn’t always succeed.
What approach did the Douglas administration take to this?
Meyn: He follows the path that was laid down by Howard Dean. Both of them are seen as fiscal conservatives, but for a couple years under Douglas, he was at like 50% funding. But then he sort of rights the ship and starts funding it over 100%.
What do we see for the next few years after that?
Meyn: Then it stays above 100% from there. Jeb Spaulding was the treasurer at the time. And then Beth Pearce took over from him. They’ve both really strongly advocated for fully funding. And the politicians have listened, at least for now.
Pearce: If you don’t invest your dollars, you lose the ability to take advantage of compound interest. And when you do that, the taxpayer suffers, and our actuaries have estimated at least, and I want to say at least, $25 million of what we’re paying today every year between now and 2038, is because of the decisions that we made in the ’90s.
The treasurer has been working on ways to ease the debt. You can see them in more documents.
Pearce: So let me find a chart.
She’s brokered deals with the teachers union to increase the amount teachers pay into the system. And teachers now have to wait five more years before they start taking money out of the system.
Pearce: The state will be paying 1% and 3%. This is the actual cost of your pensions. This is the decision making and the bad choices, the actuarial variances that we have had the investment changes, you know, with the Great Recession and the underfunding have led us. But when we pay that off, you’re going to see, you know, lower costs, 1% and 3% of payroll.
But a lot of the pension fund’s status still comes down to how the money is invested.
Pearce: So you know what we learned in the Great Recession, was you know, if you if you have all your dollars in certain investments, you were in worse shape than others coming out of it. So what we’ve tried to do is diversify without being too complex. There’s some products that were created post-2008 that I think we’re unnecessarily complex, you know, in response to those market conditions. And we’ve gone through some of those phases. And we’ve learned from those. To me, you don’t want to put you know, you don’t want to put 80% of your money in stocks, for instance. You might do that at home, you might take your own bet on that. But downside risk is important to the taxpayer. And for us, we want to be that steady, upward trend, and not that big volatile up and down, because that’s not, that’s not helpful for the taxpayer.
Meyn: Do you have any regrets about investment decisions that have been made under your watch?
Pearce: I think that we’re moving in the right direction. I think that coming out of the Great Recession, we were probably a little more complex than we needed to be. I think that we have moved in the right direction, and I’m proud of those decisions.
Meyn: So they’re predicting 7.5% return in the next sort of 20 years. A lot of people say that’s way too high — that if you look back at the past 10 years, it’s been something like three and a half percent return. And a lot of this is really a guessing game about how the economy is going to perform in the years to come. And it’s very appealing to have a higher estimated interest rate for the same reason that it was appealing to underfund, because if you say that you’re going to get 10% return on your investments, then you have to put less money into the budget on a year on year basis.
But then what happens when that 10% doesn’t actually come through?
Meyn: Then the amount that you owe actually goes up. So you know, the current projections are that for the next 20 years, Vermont’s going to have to pay $150 million into this fund every year until 2038. If that guess is wrong, the 7.5% say goes down to 6.5%, then that number 150, it can go up to 200 million. We don’t really know. It could go up to 220 million. So the extent to which current projections are accurate has a huge part to play in how much the state pays year on year, and whether the state can sort of meet this rather ambitious plan that Beth Pearce has laid out that would have them pay off this liability by 2038.
Pearce: My bottom line is there’s no quick fix. There’s no quick fix in this thing. You’ve got an unfunded liability, the choices we made, as well as economic recession, that we had, those things factored in. They’re there. We have to do the right thing by the taxpayers and make this as financially affordable as possible by making finance changes by taking a look at other ways that we can work with employer groups. If you look all in the different things we’ve done over the years, those are going to save the taxpayers $1.3 billion, and that’s a conservative estimate. 1.3 billion. So we’re doing the right things. We need to continue to be vigilant and not rest on our laurels, continue to move forward and be innovative, to be good stewards of those dollars.
Why should people care about this? I mean, other than the retired teachers who have their pensions on the line, why is this something that any Vermont taxpayer really wants their legislators spending all this time on?
Meyn: Yeah, I mean, I think that becomes really clear when you sit in the appropriations committees and hear what people are asking for and what people need. You’re talking about childcare for people, talking about the money that the state is supposed to pay to single parents who are impoverished and need to feed their kids, you know, money that goes to people who are in nursing homes and need some basic living costs, money that goes to training the workforce, money that goes to reintegrating prisoners into communities so that we can get more people out of prison. All of these ideas about how to make the state better and how legislators can do their job of serving their constituents, and they’re not gonna be able to do a lot of it because so much money has to go toward paying down this pension fund.
Kitchel: I think next year is going to be worse, from a budgetary perspective, because of what we anticipate the revenues to be. I don’t see it dramatically changing. You look at our challenges relative to our population. And we’re a small state. I don’t think we should just focus on we’re old and unaffordable, because I do think we have tremendous human capital here and other opportunities. But I think that until we get this bill paid, we’re going to be working in a constrained budgetary environment. And I don’t think that there’s anything historically that would suggest otherwise.
Meyn: It’s a pretty depressing conversation, because, you know, basically, she’s saying that this year, it’s going to be really tough, but this is actually a really good economic year. The state has gotten all this sort of unexpected revenue. Every time they sit down to talk about revenue forecast, they’re adding a bit to what’s expected. And even in this situation, the budget is so tight that she’s telling people to prepare for the worst.
And then next year, economists are predicting that the economy is going to cool down, and that we’re heading towards a recession. So like, the idea that, you know, during a very good economic year, this is such immense pressure on existing revenue, really makes you wonder, in the years to come, basically, they’re going to be deciding what programs need to be cut. I think that’s really the conversation that they’re going to have to start having if there’s another recession, because there’s not going to be this additional pool of revenue to talk about.
The state is committed to paying down this pension liability. And you can imagine the same conversations are going to start happening again, which is whether or not you want to take $10 million or $150 million, and put it into teacher pension liabilities, or whether you want to put that into something that’s urgently needed right now, and say that hopefully they can figure out 10 or 20 years down the line, whether or not, or how they can somehow afford to pay down these pensions.
What’s the worst case scenario here?
I think the worst case scenario is that they can’t afford the $150 million a year that they’re expected to pay. And then they have to sort of push this timeline beyond 2038. And that it continues to grow. And that 20 years from now, a couple podcasters are sitting down and saying that we’re having to pay $400 million each year in order to somehow escape this that has been accrued because of political decisions made year after year.
Thanks, Colin.
Meyn: Yeah, it was a pleasure. I mean, I’m sure you got lost in the weeds, but maybe you can find your way out.
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