There has been a lot of talk about cities in California defaulting and going into bankruptcy, but this problem is happening all over the country. One city in Pennsylvania is heading toward a similar financial cliff. Things in Scranton have gotten so bad that the mayor has broken contracts with city employees and declared their new pay scale will be minimum wage. How did Scranton get here? What lessons can we learn from this failure in budget management?
To answer that question, I interviewed Gary Lewis, a consultant for a big four accounting firm specializing in complex accounting for distressed assets with a focus on banking industry mergers and acquisitions. Mr Lewis has been following the ongoing crisis in Scranton and chronicles it on his blog, entitled "Scranton Is Broke." He has been quoted on CNN, The Economist , MSNBC, and other news outlets.
Here are some of the problems Mr. Lewis sees with Scranton and its rush off a fiscal cliff: First he points to the money spent on employee compensation, which cost $47,126,003.34 this year, or 83% of the revenues of the 2012 City Budget which is $57,017,639.93. So the expense of public employees alone cost the city of 75,995 about $620.12 per person. The average salary in Scranton according to Bloomberg is $36,500 which means that employee costs take up 1.7% of the average resident's salary. To put this in perspective, the city employs 398 people which means that the average cost per employee is $118,407.04. City workers are earning as much as three times what the average resident earns in the same city.
Another problem is the pension plan, which according to a Public Employee Retirement Commission report from November 10, 2010 was only 47% funded. The numbers break down as follows: assets are $64,281,927 to liabilities totaling $138,071,515. Then add another $15 million, which is the result of a settlement between the police and fire unions.
Sadly this is a trend in many cities around the country where the pension plans pay out far more than they take in each year. These plans can not be changed unless new legislation is drawn up and passed in PA dealing with municipal pensions. For now, cities are prevented from taking some steps that would help reduce their future pension obligations, such as moving to a defined contribution system similar to 401(k) retirement plans in the private sector.
Because of a state law, all cities in Pennsylvania must maintain a defined benefit pension formula– in which benefits are calculated by a formula of salary and years of service, instead of being based on a set contributions by employees and employers each year, as in defined contribution plans.
So what can Scranton do to start to turn this problem around? Well, as Stockton, California did, they could seek bankruptcy, which would not be a silver bullet, but as Mr. Lewis points out would give the city about 12-18 months of breathing room. This would allow a renegotiation of employee salaries, suspending health care costs, servicing of debt, and professional services which would add up to $24,000,000-- about the total of the 2013 budget deficit.