For decades, local governments begged the Legislature to pick up their enormous tab for pre-1977 police and firefighter pensions. Thanks to property tax reform, this year they got their wish.
Indiana will use a portion of its 1-percentage-point sales tax hike, which is expected to raise close to $1 billion annually, to underwrite the pensions. The state's additional yearly expense will be $115 million to $125 million.
"We believe the portion of the sales tax pledged will be sufficient to fund the additional annual cost, primarily because the pre-'77 plans are closed to new participants and have a finite number of members drawing benefits or eligible to draw benefits," wrote Christopher Ruhl, a director in the Indiana State Budget Agency, in response to IBJ's questions. "This results in a predictable and stable cost pattern that grows slowly, peaks and then decreases over time."
Pre-'77 police and firefighter pensions long threatened Indianapolis-and, to a lesser extent, Indiana's other urban areas. Indianapolis' annual tab for the pensions had been on track to surpass $30 million annually over the next decade, topping out at $65 million in 2031.
Local governments began setting up the pensions in 1925. Back then, officials assumed increasing tax revenue from a growing population would provide more than enough money to pay pension benefits.
Without sufficient pension funds set aside, Indiana began requiring police and firefighters who served after 1977 to join a defined-benefits program with regular employer contributions. Since then, the state has been paying half the tab on the pre-'77 pensions. The state paid its share with cigarette and alcoholic-beverage taxes, lottery revenue and investment earnings. Local property and income taxes paid the rest.
The state's total tab for the pensions will be $217 million in 2009. After that, the expense will grow 1 percent to 2 percent annually until it peaks at $255 million in 2020. It then will decline 2 percent to 5 percent annually as pensioners pass away.
Because sales tax collections rise over time-typically 4 percent to 5 percent a year-the state should generate sufficient funds to meet its pension obligations, Ruhl wrote.
The Public Employees Retirement Fund will oversee the pensions, but by law can't commingle that money with other assets. PERF has more than $16 billion in assets.
The state has a $247 million balance in its pension-relief fund, which can be used for pre-'77 pensions, PERF Executive Director Terren Magid said. That money is invested 70 percent in fixed-income instruments and 30 percent in stocks. However, investment gains aren't expected to significantly affect the state's total obligation.
The shift of the remaining pre-'77 pension burden to the state provides a windfall for Indiana's financially strapped cities. Previous Indianapolis mayors had to regularly divert money from police and fire operations to pay for pensions. Now, Indianapolis can devote excess revenue to more police on the street and more firefighter equipment.
Indianapolis is still stuck with the obligation for $100 million in 15-year bonds it sold in 2005 to pay its share of pre-'77 pensions in 2006, 2007 and 2008. The city will pay $9.5 million annually until those bonds are retired, City Controller David Reynolds said.
"I tried to get the state to take that," Reynolds said. "But they didn't want any part of it."