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Tax Law

State Net Capitol Journal – April 9, 2012

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Budget & Taxes 

RISKY PENSION INVESTMENTS NOT PAYING OFF: Hoping to boost their investment returns and shrink looming deficits, public pension systems across the nation have been turning to riskier investments, such as private equity and hedge funds. But their returns haven't been rising nearly as much as their management fees. In fact, in recent years, more traditional investments like stocks and bonds have outperformed the alternative investments and incurred a fraction of the fees.

The Pennsylvania State Employees' Retirement System, for example, has more than 46 percent of its $26.3 billion in assets invested in riskier alternatives, including private equity funds and real estate. Over the last five years, the system paid roughly $1.35 billion in management fees - over 5 percent of the total value of the fund over a five-year period - while realizing an annualized return of just 3.6 percent, well below the 8 percent it needs to meet its financing requirements and also lagging behind the 4.9 percent median return for all public pension systems. Georgia's $14.4 billion retirement system, meanwhile, which is prohibited from investing in alternative investments, earned 5.3 percent per year over that same five-year period and paid only about $54 million in fees.

Those two retirement systems represent the opposite ends of the spectrum, with Pennsylvania among those with the highest percentages of assets in alternative investments and Georgia among those with the lowest percentages of assets in such investments. But funds with over a third of their money in alternative investments had return rates more than a percentage point lower than those of funds that avoided such investments and paid nearly four times more in fees.

Some retirement system managers say a five-year period is too short to judge the performance of alternative investments. Joseph A. Dear, chief investment officer for California's Public Employee Retirement System, the nation's largest, said while Calpers' real estate investments had been "a disaster" and its hedge fund investments hadn't met their benchmarks, its private equity holdings had easily outperformed public stock returns over the last ten years.

"Over the longer term, that kind of outperformance represents real skill, not luck, and it's worth paying for," he said.

Ultimately, the heads of pension funds don't feel like they have much of a choice. Putting their money in low-risk investments like 10-year Treasury notes with a yield of a about 2 percent just won't allow the funds to keep pace with what they pay out to retirees.

"We can't put it in Treasury notes and bonds; that's just not making any money," said Sam Jordan, chief executive of the Austin Police Retirement System in Texas.

Unfortunately, the Austin Police Retirement System's choice of alternative investments in 2000 wasn't the most propitious: real estate in Nevada and Florida, epicenters of the real estate collapse. (NEW YORK TIMES, 89.3 KPCC [SOUTHERN CALIFORNIA PUBLIC RADIO])

TAX REVENUES BOOSTING PUBLIC EMPLOYMENT: After four years of teacher and other public employee layoffs, state and local government employment is starting to stabilize as tax revenues rebound.

The public-sector workforce shrunk by just 7,000 in the first two months of this year, less than a third of the 22,000-per-month average in 2011, according to U.S. Labor Department data.

"We're at a point where we're nearing the bottom," said Christopher Hoene, director of research for the National League of Cities, adding that some cities aren't far off from hiring again.

"In the sense of the business cycle for local governments, the curve is starting to change,"

The public sector has shed 689,000 jobs since April 2009. But Deutsche Bank is forecasting that total government employment will rise by a few thousand jobs per month in the second half of this year, while IHS Global Insight and Moody's Analytics are projecting employment gains next year.

The turnaround is being fueled by improving state and local tax collections, which increased by 4.5 percent last year, the biggest gain since 2006. Property taxes have also risen for two consecutive quarters, according to Census data.

But not all local governments are on the verge of a hiring binge. Detroit, Michigan and Stockton, California are among cities struggling to avoid bankruptcy. And property taxes are about to fall in Baltimore, Maryland for the first time since the collapse of the housing market because of the way assessments are phased in there. The city has cut about 1,000 jobs since 2009, mostly by eliminating vacant positions. It may have to cut another 230 positions now.

"I'm not sure that's a dramatic change," said the city's budget director, Andrew Kleine. "As I see it, we're not out of the woods by any means." (BLOOMBERG BUSINESSWEEK)

BUDGETS IN BRIEF: The KANSAS Legislature's failure to pass a supplemental budget is forcing a shutdown of the court system for five days over the next two months (KANSAS CITY STAR). • The IDAHO Legislature passed a $35.7 million tax cut for the state's top earners before wrapping up its 81-day session last month (SPOKESMAN-REVIEW [SPOKANE]). • A federal court has thrown out a COLORADO law passed in 2010 aimed at spurring online retailers like Amazon to collect state sales taxes. The law and the rules implementing it "impose an undue burden on interstate commerce" and are unconstitutional, U.S. District Judge Robert Blackburn wrote in his opinion (DENVER POST).

- Compiled by KOREY CLARK

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