Local governments aren’t likely to escape the pain when the General Assembly attempts to eliminate an estimated $3.5 billion hole in the next two-year budget. That estimate does not include the losses faced by local school districts to replace federal stimulus money that will dwindle next year and then disappear entirely in the second year of the budget.

The cost of retiree health care is turning into a hot-button issue for state legislators and local officials, who will learn today how much more local governments will have to pay for employee retirement plans. The increase that will be recommended to the Virginia Retirement System Board of Trustees by its actuary is small—about 1 percent overall on average among all localities covered by the state system.

State and local governments are looking at big increases to pay for employee retirement plans in the next two years. But it could have been worse. The Virginia Retirement System’s board of trustees temporarily suspended an accounting requirement yesterday to inflate the value of the retirement plan’s assets and cushion government from rate shock to fully fund the pension plan, which lost more than $6 billion in value in the stock market meltdown last year.

Both candidates for Virginia governor pledged yesterday that they would not reduce the state’s current level of contribution to the retirement benefits of state employees. Last week, Gov. Timothy M. Kaine said the state would defer its quarterly employer contribution to workers’ pensions in the Virginia Retirement System for the last quarter of fiscal 2010. The move is part of a wide-ranging effort to close an anticipated $1.35 billion revenue shortfall in the state budget.

Gov. Timothy M. Kaine’s proposal to defer a quarterly payment into the pension plan for state workers next spring may be just the first step toward a shift that could require workers to contribute a portion of their paychecks toward their retirement. “He is going to look hard at state employees making a contribution to the system,“ Secretary of Finance Richard D. Brown said. “At the end of the day, it may well be that state employees will be making a contribution.“

State and local governments will have to pay more into the Virginia Retirement System because stock-market losses caused a huge decline in the system’s asset value, the legislature’s watchdog group was told yesterday. “Under any scenario, VRS will be asking for higher contribution rates in the next biennium,“ said Robert P. Schultze, director of the pension system.

The Virginia Retirement System’s assets dropped by $12 billion, or 20 percent, in the first half of this year, the Joint Legislative Audit and Review Commission was told today. A. Marshall Acuff Jr., chairman of the system’s board of trustees, described the investment environment as “the most challenging” he has encountered in 43 years in the investment business.