Maryland Must Make Its Business Climate More Competitive

In Volume 2 of his Law, Legislation and Liberty trilogy, economist Friedrich Hayek explained that the everyday term "economy" doesn't adequately encapsulate the dynamics of functioning free markets. Hayek described "the order brought about by the mutual adjustment of many individual economies in a market." And he used word "catallaxy" to define this order of competing economies.

"Catallaxy" never captured public consciousness, of course. But the idea that economic competition takes place not only within particular regions or markets but also between different markets surely resonates with us. Living, as we do, in a Union of 50 states, we recognize that states compete with one another for opportunity, jobs, and business enterprise. A state's quality of life depends on its maintaining an economy that can effectively compete with the other 49 states, with a state's economic competitiveness vis-à-vis its immediate neighbors an imperative.

Now a special report just issued by CNBC offers Maryland a timely reminder about the state's pressing need to boost its business-friendliness and overall economic climate. In "America’s Top States for Business 2012," CNBC placed Maryland at #42 in "Cost of Business." Maryland also ranks #43 in "Cost of Living," making it the 8th most expensive state to live in. 

CNBC ranks Maryland higher according to some other important indicators. But for business start-ups or existing enterprises looking to grow, bottom-line business costs are a critical determinate of where to locate or migrate operations. Moreover, where Maryland's score fares better, neighboring Virginia scores better still. Maryland's #24 ranking in "Business Friendliness" pales next to Virginia's #3 ranking.

CNBC's Special Report should clue Maryland policymakers to the work they have cut out for them. As we've blogged about previously, steps for Maryland to improve its economic climate and attract new jobs and business opportunities include: getting its continuing budget deficit and public pension liability problems under control, reducing its business tax rate to more competitive levels, avoiding new taxes and regulations that punish technology and entrepreneurship. Otherwise, the best economic opportunities will take place outside of Maryland's borders.

More Reforms Needed to Relieve Maryland's Pension Liability Problems

The Pew Center On States' June 2012 Issue Brief, "
Widening the Gap Update" spotlights the problem of states' unfunded liabilities for public sector pensions and retiree health care. According to the Issue Brief:

In fiscal year 2010, the gap between states' assets and their obligations for public sector retirement benefits was $1.38 trillion, up nearly 9 percent from fiscal year 2009. Of that figure, $757 billion was for pension promises, and $627 billion was for retiree health care. 

Count Maryland among the many states whose irresponsibility in state budgeting practices puts them into pension liability predicaments. The Pew Center's
Fact Sheet on Maryland points out that Maryland has failed to pay in full its annual pension contributions since 2005. As of fiscal year 2010, Maryland's pension deficit was $20 billion, and the state had only funded 1 percent of its $16 billion obligation for retiree health care.

Also count Maryland among those states that have recently undertaken a number of reforms to shore up their pension and health care funding shortfalls. As the Fact Sheet explains:

Maryland lawmakers approved pension cuts in 2011, including increasing contributions from current and future employees and reducing annual cost-of-living increases for retirees. Lawmakers also reduced retiree health care benefits by requiring higher co-payments for prescription drugs.

But like many other states, Maryland has more reforming work to do. As the Issue Brief puts it, "continued fiscal discipline and additional reforms will be needed to put states back on a firm footing."

Next steps for Maryland to shore up its unfunded obligations should include:

• Adjusting its annual return on investment assumptions. Maryland's pension system assumes a rosy 7.75 percent annual return on investment. True, investments enjoyed high returns over the last two fiscal years. But with stocks tumbling in 2008 and 2009, that same investment return assumption is responsible for significant funding shortfalls. A May 27 New York Times article, for instance, cites a National Association of State Retirement Administrators' finding of an average 5.7 percent return for state pensions over the last ten years.
• Increasing and meeting its annual pension contribution amount. As explained in a June 20 MarylandReporter.com article, Maryland continues to rely on the "corridor methodology" as a means of avoiding full pension funding for each year. Under this method, the state can make annual pension contributions equal to the prior year's contributions plus 20% of the difference between the prior year's contributions and what it otherwise would have had to contribute in the current year. By eliminating the corridor method and increasing its annual payments, Maryland should meet its obligations in full, every year.
• Transitioning to a defined contribution or hybrid plan. As we've explained in prior blog posts, Maryland should transition future employees from a defined benefit pension (where benefits are determined by a set formula) to a defined contribution pension (where benefits are determined by investment returns). The Issue Brief points out that thirteen states have hybrid plans, with neighboring Virginia adopting a hybrid plan in 2012. Such plans combine features of defined benefit and defined contribution plans. A transition to a defined contribution or hybrid plan would more closely tie benefits to market performance, reducing the state's obligation to provide additional pension funding when markets experience economic downturn.

Further delay by Maryland in reforming its pension system will make it that much harder to achieve fiscal responsibility. 

Maryland Pension Problems Need To Be Addressed, Not Avoided

An excellent editorial in Wednesday’s Washington Post hit all the right notes regarding Maryland's steep public pension funding deficits. Once upon a time—that is, in 2002—Maryland's state pension was fully funded. But as the editorial points out, Maryland's financial shortfall in funding former state employee pension liabilities now exceeds $18 billion, with unfunded health-care obligations piling on another $15 billion.

With that dire $31 billion deficit in mind, the editorial provides highlights of how Maryland made a financial mess for itself when it comes to public pension funding:

• beginning in 2003, state lawmakers reduced annual payments into the pension fund
• in the latter half of the 2000s, state lawmakers increased spending on programs without attempting to meet increasing pension obligations
• in 2006, state lawmakers by increasing pension payouts to retired teachers and state workers retroactively to 1998, adding $1.8 billion to state pension liabilities over 25 years
  state pension equity investments underperformed without state lawmakers making pension fund adjustments
• the economic downturn beginning in 2008 that included steep declines in stock values without any corresponding fixes by state lawmakers to state payments further steepened the pension fund's financial imbalance

And so Maryland faces a $31 billion public pension funding shortfall. Now what?

The editorial goes on with some straight talk for state lawmakers and the commission recently tasked with studying Maryland's pension funding problem (see the blog post "Maryland's Slow-Moving Sustainability Commission"). The recommended remedial steps for Maryland include:

• moving future employees away from a defined benefit pension system (where the benefit on retirement is determined by a set formula rather than investment returns) onto a defined contribution pension system (where the ultimate pension benefit is determined by investment returns)
• phasing in over the next decade a that full payments be made for public pensions
• transferring a portion of retired teachers' pensions to local governments that incur long-term debts for the state through negotiated agreements between local school boards and teachers unions

One can also add that nothing should stop Maryland lawmakers from considering those steps—particularly modest increases on annual state payments to public pension funds—even before the Sustainability Commission issues its reports. If it's too much to ask lawmakers to solve Maryland's public pension problems, can't they at least be expected to hold the line on public pension liabilities and keep the situation from growing worse?

The editorial acknowledges that “[a]ny or all of these steps will be difficult and require leadership." But that is precisely what leaders are elected to provide. And the steps will only more difficult if Maryland lawmakers continue to avoid the state's pile of pension debts.

Maryland's Slow-Moving Sustainability Commission

With the State of Maryland now facing some $18 billion in unfunded liabilities for state pension benefits plus another $15 billion in unfunded retiree health benefits, the commission created to examine state employee and retiree pensions and benefits is finally set to meet. Almost.

According to an article in yesterday's MarylandReporter, staffers will meet today to set out a meeting schedule for the Public Employees' and Retirees' Benefits Sustainability Commission. A first meeting is slated for later this month—or next month. As MarylandReporter also details, Sustainability Commission members actually hope to complete their interim report by their year's end deadline.

The new Sustainability Commission was created as part of the 2010 budget conference committee compromise. But as pointed out in an April blog post by Cecilia Januszkiewicz ("A Fig Leaf For Maryland's Fiscal Folly"), this isn't the first time the Maryland legislature has dodged the decisions that ultimately need to be made by turning the issue over to an outside commission for further study. The Maryland Legislature's evasion of responsibility on the issue goes back at least as far as its decision in the 2005 session to create a Task Force to study the state's pension liability problems. Anyway, the 2010 compromise ultimately rejected the Maryland Senate's proposal to make some changes to pension and benefit funding. The Maryland Senate's proposal, in turn, came in the wake of a report from the predecessor Sustainability Commission about ways to ensure the long-term viability of the state's pension system. So here they go again.

That said, MarylandReporter's coverage highlighted public employee unions' opposition to any possible increases in employee contributions or cuts in benefits. Curiously, one public employee union representative asserted the need for a long-term perspective instead of a snap-shot view and downplayed the seriousness of Maryland's multi-billion dollar pension deficit. But this sounds like little more than a "the-problem-will-fix-itself" approach that no responsible Maryland official or taxpayer should take seriously. And it was reliance on a snap-shot view from an earlier time that included a more robust economy and a full state treasury that played a big role in the overspending and overly-optimistic rate-of-return projections that led to the budget and pension liability woes that the state now faces.

The Sustainability Commission's presumable interim report would be followed up by another report…in 2012. Should the final report be prepared and delivered on time, then the Maryland Legislature would finally be faced once again with making changes to the state pension system for fiscal year 2013. Don't expect Maryland's pension liability problem to fix itself before then.