In January 2013, Gov. Jerry Brown bragged about the state’s new commitment to fiscal responsibility. He talked about “living within our means and not spending what we don’t have.” A year later, in his State of the State address, Brown insisted that “fiscal discipline is not the enemy of our democracy but its fundamental predicate.”
Yet here we are in the middle of 2016, and few states’ fiscal health are worse than California’s. The Mercatus Center’s 2016 ranking of states by fiscal condition places the Golden State 44th overall, the same position it held last year.
The state is below average in cash needed to cover short-term liabilities – it ranks 47th – and total debt has hit $118.17 billion, says the report. California ranks 46th in long-run solvency, meaning it’s woefully short on “assets available to cushion the state from potential shocks or long-term fiscal risks.”
While revenue exceeds expenses by 4 percent, “on a long-run basis California is heavily reliant on debt.” The California government’s “total unfunded pension liabilities are $756.67 billion, and other post-employment benefits are $29.05 billion.” The debt combined with the unfunded pension liabilities and other post-employment benefits equals “46 percent of total state personal income.” In Iowa, the 25th-ranked state, that figure is 29 percent.
Clearly, this state is in a jam. How did it happen?
Public employee pension plans have become an enormous problem. Government employers have long provided defined-benefit pensions for their workers. Under this plan, retirees receive predetermined benefit amounts. Employers are responsible for making contributions that fully fund the plans. The private sector has moved away from these retirement plans due to their enormous costs. Governments haven’t been as smart.
Federal law requires private-sector employers that have defined-benefit plans to be particularly rigorous in their accounting practices. They must ensure that future liabilities are covered. But state and local governments aren’t bound by the law. Consequently, many are runaway trains headed for a wreck – they’re on the hook for pensions into the trillions that they haven’t put enough money away to fund.
Other estimates of the state’s unfunded pension liabilities are not as high as the Mercatus figure. But Wayne Winegarden, the Pacific Research Institute’s senior fellow in business and economics, doesn’t believe it’s out of line with reality.
“The unfunded liabilities of California’s public pension systems are orders of magnitude larger than the official estimates,” he says. “Therefore, California’s fiscal health, which is bad by official estimates, is even worse.”
Winegarden recently wrote in EfficientGov that “closing California’s unfunded liabilities (valued at market rates) requires an annual $28.3 billion tax increase over the next 30 years.” If such a tax hike were enacted, “California’s economy would be 21 percent smaller over the next three decades compared to the baseline growth path.”
There is an alternative, however. Winegarden says lawmakers could simply cut state and local spending 8 percent across the board to meet pension obligations. But that would mean a $5.4 billion cut for schools, a $2.9 billion reduction in higher education spending and $1.9 billion less for California’s hospital systems.
“Under either scenario, the vitality of California will be significantly dimmed in order to maintain current pension promises,” he wrote in a PRI report in January.
Winegarden suggests a third alternative: Place all new public employees in defined-contribution plans. In this arrangement, widely used in the private sector and favored by 70 percent of likely California voters, employers and employees contribute to an investment account, such as a 401(k). The costs associated with these plans are much lower. In fact, a defined-benefit plan can cost twice as much to operate as a defined-contribution plan.
In combination with this, current public employees are given an option: choose a lump-sum payment equal to the current value of their package, which would be placed in a retirement account, or stay in the defined-benefit system.
California is a profoundly mismanaged state. Needed change, however, won’t come easily. Entrenched interests – primarily the public employee unions and their elected allies – will resist pension reform. But it’s a fight that has to happen if the state is to begin its long journey to fiscal health.