Maurice Taylor, CEO of Illinois-based Titan International, a $1 billion manufacturer of off-highway wheels, tires and more for industrial and agricultural equipment, is fed up with his state government. “The government doesn’t know how to create jobs and any jobs they hire for cost people a lot of money.” He’s upset about Illinois’ ballooning pension crisis, the country’s most poorly funded plan, and broader fiscal debts that led to a recent 66 percent hike in state income taxes in January. As a result Taylor is “talking to a few states” about moving Titan’s company headquarters out of Illinois.
“I’ve spoken with the Governor [of Illinois] and I told him that our government service is going down the tubes,” says Taylor. “He’s got to balance the budget… he said he can’t do that. The traction is to move out.”
Taylor is not alone. In the midst of a severe budget crisis, with record revenue declines, high unemployment, rising healthcare costs and a fragile housing market, states are now facing what experts suggest may be a $3 trillion-plus shortfall in assets needed to cover promises made to government workers and retirees. The crushing debt load is hurting states’ competitiveness as America’s business leaders recognize that “pension reform” mostly entails tweaking unrealistic pension funding formulas for newly hired workers across the country—the path that meets with the least resistance from unions but also brings little near-term savings for taxpayers. As a result, CEOs of businesses in the most profligate states are exploring the possibility of moving their companies elsewhere.
The Center on Budget and Policy Priorities estimates that 45 states and the District of Columbia are projecting budget shortfalls totaling $125 billion for fiscal year 2012, and yet state tax collections, adjusted for inflation, remain about 12 percent below pre-recession levels. The crisis frustrates America’s business leaders, who say that lawmakers are saddling companies with ever more and higher taxes to fund irresponsible state spending while reducing services for everything from education to airports. In 2009, more than $24 billion in state tax increases was levied on businesses and high-income earners, the largest tax increase ever according to Kil Huh, director of research at the Pew Center on the States.
Dire Strait States
The states facing some of the largest and most immediate pension problems include Illinois, New Jersey, New York and California. Illinois has the largest relative shortfall in funding its pension obligations in the country. In fact, the unfunded liability is more than three times the state’s annual payroll costs, according to the Pew Center. It has only half of the assets required to pay for future liabilities and the state’s fiscal situation is so dire that Illinois recently was forced to borrow money to fund some of its immediate obligations, including its pension funding requirements. New Jersey is slightly better off; it has 73 percent of its obligations funded.
“I think about expanding my business but I am afraid to hire employees in this state because of the cost.”
The two other states that face unique and immediate pension problems are California, which is 87 percent funded, and New York, which has funded 107 percent of its obligations. Despite seeming relatively well funded, these two pension plans—the largest in the country—are in states that have suffered such steep revenue declines that their pension plan funds may be plundered to solve more immediately pressing budget problems.
Arizona, Connecticut, Kansas, Michigan, Nevada and Rhode Island are among the many other states grappling with severe pension problems. Still others, including Colorado, Mississippi, New Mexico and Ohio, face severe long-term pension problems, albeit without the additional burden of huge budget crises, according to Donald Boyd at the Rockefeller Institute of Government.
CEOs of companies are increasingly being forced to consider moving some or all of their businesses out of states that are increasing taxes due to fiscal crises. Opening satellite operations in states with lower tax rates enables companies to use allocation factors to take taxable income that would otherwise be subject to their home state’s jurisdiction to a more favorable locale.
In addition to spreading operations into other states, CEOs in states troubled by pension funding issues are reluctant to augment their payrolls and are resorting to contracting work rather than hiring more employees. In fact, of the 12 CEOs interviewed for this article, all reported ways that they are contracting out more work to avoid having to hire new employees and add to their own payrolls.
The net result? Depressed employment and the loss of payroll taxes for states in dire need of revenue.
CEOs also express frustration that the states cannot manage their budgets properly, yet few are following Taylor’s lead to reach out to lawmakers about fixing the problems. They say it isn’t likely to help, although the CEOs are in agreement that government should follow the lead of the private workforce to change pension plans from defined benefit to defined contribution or 401K plans, shifting some of the financial burdens off employers and onto workers to share the cost of retirement benefits.
Philip Doyle, CEO of New Jersey-based 24-7 Networking Sales, a company that generates sales leads, says the pension system in the state is “criminal.” No business would operate the way the state does, he says. New Jersey “must do more to clean up the state” and “repeal some of the very generous promises” that were made to state workers. It makes me extremely concerned about taxes.”
His frustration is echoed by Lilli Steinberg, CEO of Tri-Utility Cost Reductions, a utility auditing firm that does work for a wide range of companies such as United Airlines, Donald Trump’s real estate holdings, and more. She says she is “considering moving out of New York to Florida because of the tax issues.” She is also concerned that some of her clients have left the state in recent years and “I am very concerned about New York’s ability to attract business when it faces all these debt issues.” She asks: “Why can’t New York run its state like a business?”
That’s a question that Bill Howell, Speaker of the Virginia House of Delegates loves to hear. He uses Virginia’s fiscal health as a key marketing point to attract companies to move to his state. Virginia’s credit rating is Triple-A, and it has held its AAA bond rating for 70 years—longer than any other state, meaning that both the state’s access to capital is good and its borrowing costs are relatively low. “I’ve been telling the governor to hire someone just to roam Illinois and California” to entice companies to relocate to Virginia, he says.
The ploy is working. From California alone, a state facing an estimated $28 billion budget shortfall through 2012, Virginia has pilfered defense contractor Northrop Grumman this past year, as well as hotelier Hilton Worldwide and technology company VeriSign. Other companies that have relocated or built new facilities in the Mother of Presidents’ state recently include technology firms CSC and SAIC as well as automakers Rolls-Royce N.A. and Volkswagen of America.
Love It, But Leaving
California-based CEO Michael Swartz, founder of website development and Internet marketing firm MJS Web Solutions doesn’t blame companies for leaving. “I know our state is in bad shape, and we’re being hit on a local level,” he says mentioning that he’s been thinking of moving his business out of California since his town began seriously considering consolidating schools to save the teachers’ pensions while also jacking up business fees.
“I think about expanding my business but I am afraid to hire employees in this state because of the cost,” says Swartz, who notes that the annual renewal fee for his company’s local business license went up by 85 percent last year alone. Instead of hiring, he’s filling in the gaps by working with independent contractors.
Like many others, Swartz is outraged by the pension crisis. “I know everything is not fair in this country, but when I work, pay taxes and [am essentially] funding these pensions and I hear that some city managers are making up to $500,000 a year it is insanity,” he says. “And I wonder when it stops. There is no accountability.”
And in large part that is true. For while historically, public retirement benefits were set up as a way for states to attract and retain a quality workforce, today’s public pension plans are hostage to the collective bargaining power of public unions. Unlike unions in the private economy, a public union has a natural monopoly over government services. The head of the teachers’ union, transit workers or policemen knows that the city is not going to close all the schools, buses or police stations.
This monopoly power, in turn, gives public unions inordinate sway over elected officials. Union member dues fund political campaigns for officials, who are then supposed to represent the taxpayers during the next round of collective bargaining. With union representatives sitting on both sides of the bargaining table, politicians have made increasingly generous benefit offers to public workers without considering how the retirement plans would be paid. In some states, such as Illinois, the plans are so generous that many state workers are not eligible for Social Security benefits.
Investment Losses in 2008 for Select Pension Plans
Equally problematic are blind spots in retirement plans’ financial disclosures that don’t even enable lawmakers and policy experts to accurately evaluate plans’ financial health. Problems abound in how plans smooth their financial results, make projections about employee contribution rates, calculate the normal cost of pension benefits and more. There is no easy fix.
Pension expert Eileen Norcross, a senior research fellow at the State and Local Policy Project at George Mason University, conducted a study to assess state pension reform proposals around the country and found that lawmakers in most states are failing to accurately account for their pension liabilities or to move away from the defined benefit model that created the problem and that private employers dumped years ago in favor of defined contribution, 401K-like plans.
“I am very concerned about New York’s ability to attract business when it faces all these debt issues.”
Of the 18 states that adopted pension reforms last year, Norcross wrote that the boldest move was in Utah, which joined Michigan and Alaska to move many new hires into defined contribution retirement plans. She also found that three states, Minnesota, Colorado and South Dakota tried to reduce retirees’ cost of living adjustments, moves that are now being litigated.
So what should CEOs do if they are located in states facing a looming pension and broader fiscal crisis? Rockefeller’s Boyd suggests the following:
- CEOs should evaluate their state’s fiscal situation.
- Analyze the government’s leadership to address the crisis. Is each step contentious, or only a patch? Is there a real effort to make the public workforce share in the costs of their retirement plans?
- Are state tax hikes and service cutbacks posing risk to your future workforce? Are the cuts damaging to the infrastructure that you need to run your business?
Boyd also mentions that many of the pension proposals will not be solved for a long time, as multiple facets of every plan are likely to be litigated. “The courts will have to rule on changes in plans policy by policy,” he says. “There are some promises that states will not be able to give up and very little is known now.” Boyd estimates that Illinois and New York are among the states where promises to state workers seem immutable.
Cynthia DeBartolo, CEO of Royal Doctors, an international medical tourism company located in New York, thinks that’s a shame. “The pension problem is a huge concern because so many people today are committed to working for a state knowing they have a pension but the pensions are suspect. It is becoming musical chairs. People may be precluded from getting what had been promised to them.”
The state’s problems have prompted her to consider relocating. In the meantime, she says, “I am considering setting up various hubs” in other states. She is also using independent contractors instead of hiring in-house. “It is too expensive to run your business as you’d like. I’d like to hire people and have the comfort level of long-term employees and the allegiance to my company and my vision, but there is an enormous cost to doing that here. A good CEO must look at their P&L and manage that and avoid waste,” she says. “If New York is the not the place because we can’t be competitive or deliver the right level of service, then we must look to alternatives.”
States Facing Large and Immediate Pension Problems
|Illinois||54 percent of its pension obligations are funded, for the worst record in the country. It was forced to borrow money to fund some of its obligations—a move unseen elsewhere in the U.S.|
|New Jersey||73 percent of its obligations are funded for the second-largest funding problem in the nation. It faces the challenge of not only paying old obligations, but also moving forward paying current obligations.|
|These two states face a unique pension challenge since they have the largest pensions in the nation. Although California has funded 87 percent of its pension obligations and New York has met 107 percent of its pension obligations, these large states have faced such a steep drop in state revenues that the money that would normally continue to fund these plans is competing with other state priorities.|
- States face a $3 trillion-plus shortfall in state pension plan funds.
- In 2009, more than $24 billion in state tax increases was levied on businesses and high-income earners.
- CEOs in troubled states are considering relocating.