Proposition 443, approved by Prescott voters in November 2017, is a sales tax intended to pay down the city’s unfunded pension liability scheduled to expire when the fund reached a $1.5M balance or ten years whichever came first. The Citizens Tax Committee opposed it for several reasons. One reason was the risk of “tax shifting.” Tax shifting occurs when a tax proposal’s language is not written strictly enough to ensure that the tax dollars generated will not only go to the policy need identified but will also not allow these new tax dollars to replace or “shift” previously allocated budget dollars to other purposes.
The proponents of Proposition 443 assured voters that this would not happen. But the language of 443 did not prohibit it. This was a second reason that CTC opposed it. Once 443 was approved by the voters and enacted, the current city council publicly pledged to pay the full PSPRS pension payment plus add ALL of the new tax dollars generated by the 0.75 percent sales (TPT) to that PSPRS payment (which at that time was about $8.7M). The estimated annual TPT tax dollars that 443 was to generate was about $12M and this estimate has been shown to be pretty accurate with nearly $12.7M to be collected by the end of June this year.
Simple arithmetic would indicate that Prescott’s payment to PSPRS should be about $21M each year ($8.7M + $12.7M = $21.4M) until the city’s unfunded liability reaches $1.5M or 10 years transpires whichever comes first.
However, we just heard this past week at the Prescott City Council’s May 14th budget workshop that the PSPRS payment will be reduced to $20M.
Why is the payment $1M lower? And where did the expected $1M+ dollars go?
Let’s take a look at that PSPRS annual payment. This payment is known as the Annual Required Contribution (ARC is the acronym). The ARC has two components: the Normal Pension Cost (which is generally the actual payments going to the retired public safety officers of Prescott, both Police and Fire) and the Unfunded Liability payment (which PSPRS calculates as the payment needed to eliminate the city’s current liability of about $69M amortized over 20 years). Well, as we pay down our unfunded liability, mostly with the 443 tax dollars, our unfunded liability shrinks so our liability payment shrinks as well.
Now you can see that here’s where the tax shifting strategy has “raised its head.”
As we pay down the liability every year, our ARC payment goes down and the remaining funds we were expecting to pay (about $1M this fiscal year 2019-20) are shifted to other things. Not only is this strategy a violation of the promise made by council, but it also includes a number of risks:
- We only have 8.5 years left in the 443 tax period. The city should calculate its own payment based on a 8.5-year schedule NOT the 20-year schedule PSPRS sends us. We could run out of money before the 10 year expiration!
- PSPRS’s payment is based on an assumption that our funds will be invested by them and generate a 7.3% return every year. But the PSPRS investment team has shown they are not capable of producing such consistent returns. For the past 5 years, PSPRS has only generated a 5.8% return that includes the highest administrative fees of the top 100 public pension funds in the entire U.S. Those fees (which PSPRS doesn’t publish) are estimated at over 2 percent. Further reducing our return to about 3.8%. Should this continue in the future our liability will GROW by about $5M per year!
- Our local/state and national economy experiences normal business cycles that generate increases and decreases in business activity and consequently create increases and decreases in tax revenue. We are currently in an increase portion of such a cycle. Should a decrease occur over the next 8.5 years our ability to maintain our $21M total payment to PSPRS will be challenged.
- With a current increase in 443 tax revenue and a lowered ARC payment for the 2019-20 fiscal year about $1M of discretionary funds have been created.
If the city truly expects to pay down the PSPRS unfunded liability within the remaining 8.5 years of the 443 tax period, then the city must be more diligent in making the full and original ARC payment and recalculate the unfunded liability component based on an 8.5 year amortization schedule. If this policy is adopted and practiced, then this 443 tax might meet its goal.