California’s Public Employees Retirement System (CalPERS) provides pensions to 1.4 million former state employees. These retirees receive benefits under a “defined benefit” plan, whereby the state guarantees pension payouts based on a combination of salary and years of service.

Under the current system, an employee with 30 years on the job, having earned a peak salary of $50,000 a year, can retire at age 55 and receive an annual pension of $30,000, or 60 percent of his or her top salary. The state’s public safety officers get an even sweeter deal. At 50, they can retire with 90 percent of their working income. California’s benefits are some of the highest in the nation.

According to the Legislative Analyst’s Office, an employee retiring at age 65 receives a whopping $17,000 more a year than his counterparts in Florida and Illinois. While these benefits are very attractive to state employees, taxpayers foot the bill.

CalPERS receives its funding from payroll contributions by both the employee (paid for by taxpayers) and the employer (state agencies funded by taxpayers). These funds are invested in the stock market under the supervision of a 13-member board. Ten of the 13 board members are union members, union officers, or current or former politicians who depend or once depended on union support. The funds currently total more than $170 billion, one of the largest investment pools in the country.

Ideally, the returns on the invested funds cover the promised benefits to retirees, thereby not requiring additional taxpayer dollars. Recently, that has not been the case.

From 2000 to 2004, the investments under-performed and CalPERS suffered severe cash-flow problems, forcing taxpayers to pick up the tab: $160 million in 2000, $611 million in 2001, $1.2 billion in 2002, $1.6 billion in 2003, and $1.9 billion in 2004. The governor and the legislature are attempting to defer a portion of the 2004 bill by selling $800 million in bonds, a move that the Pacific Legal Foundation claims is unconstitutional and is fighting.

While bonds might dull the pain, they would not change the reality that the CalPERS deficit consumes 1.7 percent of the state’s budget and is growing. With projections showing retirement-related costs increasing $1 billion during the next five years, things are not looking good. The pension problem is worse for California’s cities and counties.

The city pension system in San Diego, for example, has enough funds to cover only 68 percent of its obligations. Contra Costa County allocates 11 percent of its budget to pensions, while the city of Bakersfield allocates 14 percent. There are literally dozens of localities facing bankruptcy because of their pension obligations. They and the entire state urgently need to fix this problem.

Governor Schwarzenegger backs a constitutional amendment that would modernize California’s public-pension system. The amendment, ACAX1 introduced by Assemblyman Keith Richman (R) of Granada Hills, would limit all new public employees—city, county, and state employees—hired after July 1, 2007, to a “defined contribution” pension plan.

This 401k-type plan would require the government agency to match an employee’s contribution up to a specified amount, and the funds would be vested immediately. Rather than having the funds managed by a government board, the individual employee would control his or her own investment account. In addition, the pension would be portable, allowing the employee to take the money with them if they move into the private sector. And the money could be bequeathed to heirs after the employee’s death.

Millions of California’s private-sector employees already enjoy the flexibility of personal retirement accounts as more companies have scrapped traditional pensions for 401k defined-contribution plans. According to the U.S. Department of Labor, between 1975 and 1998, the United States experienced a 50-percent reduction in the number of defined-benefit plans while the number of defined-contribution plans more than tripled. IBM and Verizon have recently switched to defined-contribution plans.

California’s public sector is behind the curve and risks being left in the dust. Switching to a defined-contribution system would provide greater fiscal stability since the state’s pension obligations would be predictable. With the success of pension investments resting squarely on the shoulders of employees, taxpayers would not be burdened during under-performing years. State and local governments would be unchained from pension deficits, freeing up tax dollars to repay debts or balance budgets.

Without reform, California will be plagued by a flawed and bloated pension system that will saddle taxpayers with projected deficits of $2.6 billion in 2005 and $3.9 billion by 2009. Because of this, CalPERS deserves the Pacific Research Institute’s 10th California Golden Fleece Award. For their part, the taxpayers of the Golden State deserve a reformed public-pension system.

About PRI
For more than two decades, the Pacific Research Institute for Public Policy (PRI) has championed individual liberty through free markets. PRI is a non-profit, non-partisan organization dedicated to promoting the principles of limited government, individual freedom, and personal responsibility.