California was once defined by its natural beauty and milestones of human achievement. Today it’s known more for intractable problems, such as the public employee pension crisis. State and local governments have racked up nearly $1 trillion in pension debt. But because government employers have contributed only about 70 percent of what they are required to feed into the retirement accounts, that massive obligation is only partially funded.
The official claim says about $170 billion of the $1 trillion has no funding. It might not be realistic, though. When the risks of the investments that have been made with the pension funds are properly taken into account, the figure soars to at least $300 billion and might be as high as $600 billion.
There’s a hard landing ahead and it would be softer if defined-benefit pension packages were replaced with defined-contribution plans. Defined-benefit pensions guarantee a preset retirement income and are so costly that only about one in 10 private sector employees has one, according to Investopedia. Yet California public employees still enjoy lavish retirements from defined-benefit plans.
The problem is inflamed by the “California rule,” which, according to Calpensions.com, means “the pension offered at hire becomes a ‘vested right,’ protected by contract law, that cannot be cut, unless offset by a new benefit of comparable value.” Together they are enough to financially break state and local governments. Already cities are having trouble providing basic services because they must spend their limited resources funding pensions.
To address this escalating problem, Orinda Democrat Sen. Steve Glazer has introduced Senate Bill 1149, which, would let new state hires choose a pension option outside of the California Public Employees’ Retirement System’s defined-benefit plans, such as a 401(k), a type of defined-contribution plan in which the amount invested is set rather the amount received in retirement. There’s little doubt some new workers will choose defined-contribution plans because they’ll have more control over their retirements.
Given that it takes five years of government work for a public pension to vest, Glazer and others believe the defined-contribution option would appeal to young workers who don’t plan to stay in government their entire careers. They could invest right away, then take their retirement accounts with them when they leave for private-sector jobs.
Pacific Research Institute fellow Wayne Winegarden would take Glazer’s proposal further, proposing that only defined-contribution plans be available for new hires. Under the Winegarden plan, the state would institute a hard freeze “across all defined-benefit programs” so that “no public employee would be able to accrue any more benefits in the defined-benefit program.” Vested employees would be given a choice between a lump-sum payment equal to the value of their defined-benefit plan, or remain in it.
Give Glazer credit. But moving new employees into defined-contribution plans is a partial solution. Many current public employees will remain in defined-benefit plans that are preserved by the California Rule, which Winegarden calls “a bad policy that traps taxpayers in an unaffordable pension system.” The California Rule needs to be eliminated before their pensions sink the state.
Taxpayers, who face the largest tax hike in history to fund public employee pensions, would get a break, and public employees would gain choices they wouldn’t otherwise have. Jeremy Bulow, a Stanford Business School economics professor, has outlined three ways they would benefit.
One, they’d have “greater flexibility in negotiating how compensation will be distributed between current salary, pensions, medical benefits, and other compensation.” Two, their investment choices would widen.
Finally, employers would have less incentive to outsource public employee jobs “to private firms that can hire equal quality workers at lower cost by offering a more attractive mix of compensation.”
The California Supreme Court is scheduled to hear arguments in a case that could end the California Rule. It’s a more-likely starting point than Glazer’s bill. But reform-minded lawmakers are still an important part of the solution.