Pacific Research Institute

Despite Budget Action, Much Work Remains to Solve State’s Pension Crisis

Fox and Hounds

Anyone worried about an earthquake plunging California into the sea should be more concerned about what is really sinking the state: the cost of public-employee pensions.

In the just-enacted 2017-18 state budget, about $8 billion of the state government’s $183 billion spending package will go to the California Public Employees’ Retirement System, known as CalPERS, and the California State Teachers Retirement System, called CalSTRS. A supplemental $6 billion payment will be borrowed from the surplus funds of other state agencies to cover the state’s mandatory contribution to the pension funds.

By 2023-24, the state’s portion will be $9.2 billion, according to the governor’s office. But, as columnist Dan Walters writes, “the state would be very fortunate if it was paying out only $9.2 billion.” This is because CalPERS’ investments – one of the three streams of income for the pension fund, employee contributions being the third – are unlikely to reach projected returns, forcing the state to make up the difference.

Earlier this century, California public-employee pensions had a surplus. It seemed the good times for the pension fund investments would never end and state pensions were increased. But then deficits grew starting in 2003, due in part to CalPERS pouring dollars into crony and so-called socially responsible investments that lost hundreds of millions. By 2014, the shortfall had hit $241 billion, according to the California Controller’s Office.

Pacific Research Institute fellow Wayne Winegarden has found that all governments in California, from city halls to Sacramento, have amassed nearly $1 trillion in public-employee pension obligations, and when accounting for risk, between $300 billion and $600 billion of those obligations have no funding.

Unfunded liabilities have increased steadily since 2011, rising from a little more $150 billion at that time to the current figures that Winegarden cites.

The current trajectory is simply unsustainable. But don’t expect current government workers to feel much pain. They won’t agree to contribute more to their own retirements in contract negotiations. Nor will they have their pensions trimmed to a more reasonable level, as evidenced by the more than 20,000 state workers who were members of the $100,000 plus retirement club in 2016.

Nor will investments fill in the hole, given the pension funds’ habit of putting money in the wrong places, such as the “green energy” and “clean technology” investments that lost 9.7 percent from 2007 to 2013, and wrecking their portfolios. The return rate on CalPERS investments in 2014-15 was 2.4 percent, well below the 7.8 percent target. The next year, it slipped – crashed, actually – to 0.61 percent. 2016 was a recovery year, with returns hitting 5.8 percent. But even consistent years at that level will not meet the needs.

The pain will be borne by the taxpayers, who also must bankroll growing budgets, which, with this year’s spending plan, have increased 57 percent in eight years.

Meanwhile, any reform must be strong enough to counterbalance the weight of public employee unions.  They block reforms that would cut costs and improve outcomes and have won salary and benefit compensation that can be 20 percent higher than comparable private-sector employees, according to economists Andrew Biggs and Jason Richwine.

They are also “able to substantially direct — indeed sometimes dictate — the shape of public policy in the area in which they are employed,” John O. McGinnis and Max Schanzenbach wrote in 2010 in the Hoover Institution’s Policy Review. Teachers’ unions, for example, have created political and policy conditions that are a “great monetary cost to taxpayers.” It is a truism that all public-sector unions “are interested in growing government” and “are focused on getting high salaries and other benefits for their members as well as expanding their workforce.”

Winegarden suggests repealing the “California Rule,” which prevent public employee pension benefits from being trimmed; freezing the defined-benefit program for today’s workers and letting them choose between “receiving a payment equal to the present value of their benefits” or staying “in a reformed defined-benefit program that would include, among other adjustments, appropriate policies to accommodate market risk”; and offering new and current workers retirement plans funded by private-sector style defined-contributions.

Without profound changes, the state is on a path that’s leading down a steep slope into a deep hole.

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