Pennsylvania state Rep. Frank Ryan, CPA, sees other states, such as Illinois and Massachusetts, enduring fiscal struggles, and he is determined to ensure that Pennsylvania does not follow in their footsteps. That is why he recently proposed a series of bills aimed at reducing the financial burden of the Keystone State. Get an inside look at Ryan’s legislative plan in this episode.
By: Bill Hayes, Pennsylvania CPA Journal Managing Editor
Improving the financial outlook of Pennsylvania is vital, and Pennsylvania state Rep. Frank Ryan has a detailed plan for accomplishing just that. He joins us to discuss that plan, as well as some of the decisions that have put Pennsylvania into a precarious position, the worst-case scenario, if the situation is not addressed, and what Pennsylvania has learned from states and territories that have gone through similar financial issues.
Can you tell us a bit about your plan to improve the financial outlook of Pennsylvania and why major improvements are necessary?
[Rep. Ryan] One of the things that we've been trying to emphasize to people since I've been in the legislature, and you might know from my experience since I'm a PICPA member as well that my entire career has been spent and focuses on keeping organizations out of bankruptcy. I prefer to keep people out of bankruptcy rather than help them navigate through bankruptcy because of the costs and the ability of the survival rate because most organizations don't survive bankruptcy.
So one of the things that happens in the Commonwealth as happened with most other states, there's a general perception that a state can't go bankrupt, which we want to be able to show that it's just not an accurate comment. But there are certain key operating metrics that every entity has that create what we call a critical success factor. And those critical success factors are those types of items that the presence or absence of which could lead to the success or failure of an organization.
So let me just give you a couple of different examples of why there is such a critical problem right now. One is we are seeing significant out-migration of young workers in the Commonwealth of Pennsylvania. Younger workers are leaving the Commonwealth in record numbers and the way our current tax code is structured, this is where the accounting profession and the tax practitioners and government policy really goes hand-in-hand with a lot of things. When you add those together, the exodus of so many younger people out of the state who are the ones predominantly paying the taxes usually means you're going to run into a graying of the Commonwealth, meaning that we're getting older, and I'm one of those people that's adding to the age averages here that aren't helping. But since we don't pay taxes as we retire, it's creating an entirely different set of circumstances.
That's an example of one type of critical success factor. Some of the other things that I would tell you is the unfunded pension obligations are pretty significant as well, and that's ... right now we're looking pretty close to $65 billion of unfunded pension obligations. Those are the kinds of things that I would tell you that we would encourage people to be concerned about, and that's just two of six or seven different critical success factors that we have to deal with or the Commonwealth will have a major problem then. Our bills that we've structured are designed to address every single solitary one of those issues.
What would you say are some of the decisions that were made previously that got the state into the sort of precarious position?
[Rep. Ryan] Let me give you a really great example. In 2001, the stock market was going gangbusters. We were having “.com” explosion. Stock market prices were going up and Pennsylvania's pension funds were overfunded. Without someone knowing all the financial implications, what they did, the governor at the time granted a 50% increase in benefits to state workers and to teachers and it was grandfathered in. In fact, that decision is ... we're still feeling the effects of that. Because if you retired prior to a certain date, in 1999 and 2000 you didn't benefit from that increase. So those workers are significantly disadvantaged to someone who might've retired a month later. That's how dramatic it was. But then shortly, literally not even six months after the governor did that, the stock market had “.com” bubbles bursting, and then all of a sudden we were grossly underfunded. And since that point in time, we've never gotten above 60% funded in that process.
That was one example of a decision. The other – and that's where I really encourage our fellow CPAs to get active in government because there's not an awful lot of financial acumen in terms of going to get the proper advice and PICPA does a great job of helping members understand; but these tax laws can be somewhat daunting and complicated – the second issue, and we've been dealing with this candidly since I've been alive: Pennsylvania doesn't tax retirement income. We're one of only eight states that does not. And what that has done has made us a magnet for people who are retiring in other states. The Independent Fiscal Office has shown that the net migration from New York, New Jersey, and Maryland is significant. At the same time, Pennsylvania retirees can't afford to live here because property taxes are going up so high.
That's why I did my property tax bill and those Pennsylvanians are moving out. Our tax code is an issue. We make it very tax-advantageous for one group, and I get that. I'm a senior. I understand what the purpose is, but that's a decision that we're paying for in many respects.
The other aspect is that we have a significant unfunded pension obligation, but that's because we use an actuarial earnings rate well beyond that, which we use in a commercial world. So we didn't fund our actuarial payments as each month was required, where we had to recession in 2009. I'll give you an example. In 2009, the pension fund lost $40 billion. And right now we're $65 billion underfunded. But that money's got to be made up, and the state didn't have the financial resources in order to be able to repay that money and put it back in.
So when you look at those, those are three critical issues. I get a lot of people, when I do my turn-around business, they will focus on very, very small things that, if you fix, it won't mean anything. Those three items that I mentioned now, if we address those head-on and the cost drivers in the Commonwealth of Pennsylvania that we can identify, we'll start to see that we will have a fairly significant improvement in the state's economy. The other big thing that I would tell you is that Pennsylvania’s corporate tax rate is one of the highest in the nation. It's 9.9%, 9.99% actually, and so, as a result of that, businesses are leaving the Commonwealth and taking their jobs with them.
When you add all of those issues together, it's not a tax climate that's favorable for the financial outlook to improve. If we don't address those drivers into business, the critical success factors we're going to find, we're going to have a major problem.
As you stated earlier, people have the impression that a state can't go bankrupt, but what is the worst-case scenario if steps aren't taken to address some of the financial difficulties facing Pennsylvania?
[Rep. Ryan] I want to say this as loudly and clearly as I can and I found this out when I was marketing House Bill 13, the School Property Tax Elimination Act. I've found loud and clear that the public sector pensioners felt that they had no skin in the game because their pensions were guaranteed. And that's true under the Pennsylvania constitution. The Supreme Court's already ruled that decision. However, all of those decisions get thrown away the minute a state becomes insolvent. So I introduced House Bill 1995 because of my School Property Tax Elimination Act and what I found – so that people recognize they have something at stake – my House Bill 13 showed seniors they've got something at stake in this issue. The House Bill 1995 is to say, be careful, the state could conceivably not be able to borrow money to do it.
Then I'm going to tell you what's going to happen. Illinois is likely to be the state that goes bankrupt first. And when that happens, the municipal bond market will collapse nationwide because the entire market is based upon a premise that a state can't go bankrupt. But we've already had one. The Puerto Rican bankruptcy plan has already shown that a state can go bankrupt. And the Supreme Court with President Obama and the then Speaker of the House and then majority leader of the Senate structured the bill in such a way that would meet a Supreme Court challenge and Puerto Rico declared bankruptcy on May 3rd, 2017, and then very sadly, even in light of its horrible financial circumstances, it was hit with a devastating hurricane that just made any survival of Puerto Rico that much more complicated as well as a very, very sad loss of life.
So we didn't learn our lesson nationally from what was going on in Puerto Rico. So Illinois will be the one where people will finally get the wake-up call. At that point, the minute the bond markets change, the ability for organizations and entities to borrow to fund these deficits will change. It will be the equivalent in the state and governmental markets of what happened in the housing market in 2008. It will be that severe and that's a guarantee.
You just mentioned House Bill 1995 and went into some of the information about it. It would create the Keystone Solvency Operating Study Commission. So what would be the role of this commission?
[Rep. Ryan] First and foremost, I'm not a big fan of commissions, but the purpose of the commission is to be able to provide a very focused, short-lived entity to challenge some of the assumptions that are commonly misunderstood in planning and running the state and an organization.
So the first part of it will be to identify some of the problems that happened in other states and there are five states that we've pinpointed as having major potential problems, worse than Pennsylvania. Illinois, Massachusetts, Connecticut, Kentucky, and New Jersey are in far worse condition than we are. We're about in the same condition as New York and California, but when those five states start to experience difficulty, what we want the state to do, this commission to do, is to analyze some of the issues that have gotten into their problems. They'll see a lot of it is the pension obligations.
Then, we want them to analyze, in the event that the state is not able to borrow money, what occurs. We want them to do this in concurrence with the Independent Fiscal Office to provide a five-year outlook, a worst-case scenario plan in the event that access to public markets starts to dry up and what those kinds of circumstances could possibly be.
We also want them to look at the fact that the alternative investments, which are typically under Accounting Standards Codification A20, are the valuations of level-three assets which are typically more difficult to evaluate. We want them to look at the fact that SERS is currently invested at 25% in alternative investments and that number is coming down. Then PSERS, Public School Employee Retirement System, is at 52% of assets, which is well beyond that which is normal. I'm on the PSERS board and I've been voting against making more alternative investments because those numbers are very high.
Those alternative investments are very difficult to value, but typically the valuation suffers the most in a recession. What we want this commission to be able to do is look at what will happen during the next recession. What do we need to do to prevent that issue and what concrete steps on the bills that have already been introduced into the House and the Senate can we implement? There was a substantial number of those bills that have already ... they are in various different ways so that we can get to the point where we can recognize that we're starting to bring some of these issues to a head and resolving the crisis is before they get out of control.
You mentioned here some of the struggles of Puerto Rico, Illinois, and some other ones you went into, such as Massachusetts. What lessons have you personally learned from the struggles of other U.S. territories and states, and how we need to work in Pennsylvania to address these things?
[Rep. Ryan] First and foremost, the thing that I would tell everyone is that when companies or organizations and states get into financial trouble, there's typically an unwillingness to challenge the status quo. I'll give you a perfect example. In the automobile industry, the perception was GM is too big to fail. Well, we found that that's not the case. In the “.com” bubble, we said that you could continue with the earnings improvement of 1 cent per share, you'd see a significant growth in the stock price and we heard comments during the “.com” bubble: “Earnings no longer matter. We're in a new economy.” We found that wasn't true.
Then in 2008 we had these no-doc loans for people where you didn't have to have an income in order to get a mortgage. What I'm finding is it's an unwillingness to accept economic reality, so a state can go bankrupt.
This perception that it can't ... nations have gone bankrupt since the history of time. As a Marine, I've been in seven nations in my lifetime that have collapsed economically and they no longer exist. And while we don't like to believe that can happen here, the longer you deny the ability that you have to keep your financial house in order, the greater the likelihood that we will be one of the casualties. I don't want that to happen. I can tell you, from my economic outlook, Pennsylvania has got 12 years before we will become completely out of cash, unless there's a catastrophic event, which means we have two to four years to turn the ship around now. Because a state our size takes anywhere from eight to 12 years to turn around.
Let's talk about House Bill 1053. Can you tell us what that bill would require and how it would help address the financial crisis as well?
[Rep. Ryan] That's my favorite bill. It's the LEAN – L-E-A-N – Government Operations bill and its designed to dovetail with what we've been doing in the private sector for decades now, which is to encourage our operations to go lean and that's a Lean Six Sigma approach. I've actually written a book about this where ... it’s called Revolutionizing Accounting for Decision Making. It's based upon the premises of the CGMA – Chartered Global Management Accountant – standards that we as CPAs have the ability to become. Very similar to the CMA. And what it does is ... and our House Bills 52 through 58, which is a series of bills from six of the representatives including Rep. Seth Grove and myself and a number of other state representatives, to restructure government to make it more functionally aligned to different markets we're attempting to serve. The goal is to reduce the general operating cost of state government by about 20% in the administrative category.
That would result in a cost savings of about 2-3% of the budget. 20% of overhead is the way to look at it. The other aspect that it does is it puts those lean operating principles in effect for government where you look at what are the measures of effectiveness that help a government decide whether or not it's going to do well or is doing well? Is it meeting the needs of the customers that it serves? And it provides a customer focus for state agencies so that they can better allocate resources and it's a forerunner to fully implementing activity-based costing at the state level.
Another bill: House Bill 985. This one would require auditors employed by the auditor general to be properly qualified for the audits they're performing. Is that currently a major issue that you see, the underqualification of AG auditors?
[Rep. Ryan] No, actually, the auditor general staff is actually pretty significant. The bill provides a set of training standards. I'm actually very, very impressed with many of the members of the auditor general staff, but the auditor general staff right now is not equipped to do fraud or forensic audits, and my bill was designed to give them that expansion capability.
There’s a significant number of CPAs on the auditor general staff and they do a tremendous job. I'm so impressed with the auditor general staff that the purpose of House Bill 985 is to give them a greater ability to get into more types of accounting services that would relate to forensic and fraud type investigations, which means my bill also has a subpoena power for the auditor general, so that if the local municipality or agency is refusing to cooperate, the auditor general would have the subpoena power.
We are running into some problems with the subpoena power, so I've agreed to an amendment which would basically say – it's already cleared the House of Representatives and it's in the Senate right now – and I've agreed to an amendment that has the auditor general have to work with the attorney general to get that subpoena, so that there's some balance and doesn't create an imbalance in the event that we have an auditor general that gets elected that might not have the capabilities and might use it as a political weapon, and that's what the concern was. Since the auditor general is an elected position, we want to make sure it's not unduly influenced by political pressures. Their staffs have not been affected by that political pressure and we found that they're very, very capable. So my bill, HB 985, will give a significant increase in the authority and the ability of the auditor general to take a look and find out what happened, what went wrong, and then to help recover that money. We think it could save as much as $400 million per year.
As part of the Reinventing Government package that's in this proposed legislation, eight existing state agencies will be merged into four new ones. Can you tell us a bit about that effort and what it's expected to accomplish?
[Rep. Ryan] That's House Bills 52 to 58 that I was mentioning previously. What that is designed to do is merge them and then create a government accounting office as well. When it does, it creates an ombudsman, but that's just part one of the entire process.
The other parts of this reinventing government that are so critical is we have a ... in one part of that bill is House Bill 320 and we have some House Bills 611, 612, and 613 category that are designed to restructure our municipal debt operations. As an example, we had a bankruptcy in Harrisburg. We learned a lot of valuable lessons. We've been trying to get those bills across the finish line since the bankruptcy in Harrisburg, because I'm a CPA and we have five other CPAs or total of five CPAs in Pennsylvania House of Representatives. We think that five of us can help get these bills across the finish line, which would be on the municipal side.
I just recently had a bill that became a law, House Bill 1203, which was on the auditing standards for municipal authorities. So that's all part and parcel of this issue of getting greater financial controls. If there's any one watchword I would say to everybody is we want to bring better management practices and cost accounting systems and measures of effectiveness performance metrics. Senator Bob Mensch has got an entire series of bills that have done that. Representative Seth Grove has got a smart act, which is to develop measurable and strategic goals and strategic keystone measures of effectiveness to help an agency know that they're on track doing the right thing. So all of our efforts are designed to make government more accountable, and as part of this reinvented government, we think overall, in addition to House Bills 52 to 58 giving us about 2-3% reduction in state spending, we believe some of the other bills such as the municipal pension reforms and the state pension reform bills that are already going over to the Senate, hopefully in the month of January or early February, we believe all of those could end up reducing state costs somewhere to the tune of about a billion dollars per year.
With that number that we're saving, we're hoping that those amounts of money can then be used to pay down some of our pension obligations and help us get out of debt because we can't have significant unfunded pension obligations, unfunded costs with post-employment retirement benefits in the neighborhood of about $25 billion. $60 billion of long-term debt in addition that we have to start to deal with, as well as significant infrastructure repairs that are not on anybody's financial statements. And that's just at the state level. We're trying to come to grips with all of these different issues to make sure that we can address the needs of a Pennsylvania that we want to grow into the decades and the centuries from this point on.