What is the Average Pension for a Retired Government Worker in California?

SUMMARY

The average full career (30 years work) pension for a retired public employee in California was $68,673 in 2015, not including benefits. This is in comparison to the average pay (not including benefits) for an active full-time worker in the private sector in California, which in 2015 was $54,326, and to the maximum Social Security Benefit for a high wage earner retiring at age 66, which in 2015 was $32,244. Put another way, the average public employee retiree with 30 years of service collects a pension (not including benefits) that is 26% greater than the average pay for a non-retired full time private sector worker, and more than twice the maximum Social Security benefit.

There is ongoing public debate over the financial sustainability of public sector pensions. In California, significant work has already been done to evaluate how required contributions fluctuate according to market conditions, and incremental progress has begun towards reforms to improve the resiliency of the system. At the same time, while there is a great deal of anecdotal reporting on how much of a pension benefit, on average, California’s state and local workers can expect to receive when they retire, there remains substantial disagreement over the accurate number. This study is focused on that specific question.

In order to arrive at an accurate calculation, this study analyzed 23 of the largest pension systems in California, representing 95% of all state and local government retirees. In order to determine a “full-career” pension, we produced results using two assumptions, (1) the average of all post-2000 retirees with 30+ years of service, and (2) the average of all post-2000 retirees with between 29.5 and 30.5 years of service. The summary findings to follow use the assumptions in the 2nd example, which are invariably lower than the first. For reasons we state in our assumptions section, we believe these calculations are somewhat lower than what is truly representative of a full-career pension, and therefore can be relied on to not at all overstate the amounts.

For all systems evaluated, representing over 1.0 million records of California’s retired state and local government workers, in 2015 the average pension for a post-2000 retiree with between 29.5 and 30.5 years of work was $68,673. This does not include benefits.

Using the same criteria – the average full-career pension for a CalPERS retiree was $71,402, for a CalSTRS retiree it was $57,715, and for a University of California retiree it was $61,752.

There was a great deal of variation in the major independent county pension systems, with the highest full-career average in 2015 going Contra Costa County, at $85,091, and the lowest going to Tulare County, at $51,932.

To compare public safety pensions to pensions for all other employees, we evaluated data from three cities where each city has two independent pension systems, one for public safety, and another for all other employees. The 2015 results summarize as follows:

  • Los Angeles – public safety $89,183, all other retirees $54,782,
  • San Jose – public safety $130,439, all other retirees $74,649,
  • Fresno – public safety $54,860, all other retirees $40,927

Another way to compare public safety pensions to pensions for all other employees was to evaluate data from pension systems that reported, for each record, the former employing agency. Los Angeles County provided data that included this information. Los Angeles County was also the only major pension system to provide benefits data, yielding the following summary:

  • All retirees – pension $65,027, benefits $13,471, total $78,497
  • Sheriffs – pension $88,144, benefits $18,395, total $106,539
  • Firefighters – pension $104,905, benefits $20,350, total $125,256
  • All other retirees – pension $50,484, benefits $10,581, total $61,065

Data on disability pensions was available from two major pensions systems: In Los Angeles County in 2015, disability pensions were reported for 6.5% of former miscellaneous employees, for 40.5% of all retired former sheriffs, and 65.7% of all retired former firefighters; in San Jose’s retirement system whose participants are exclusively former public safety employees, 50.0% of the retirees were receiving disability pensions.

It is our hope that simply contributing this baseline information on average pension amounts, reported with a high degree of accuracy, will further the discussion of what constitutes a financially sustainable and politically equitable level of retirement security for California’s public servants.

 *   *   *

INTRODUCTION

This report calculates the average pension for California’s state and local government retirees. Unlike most analyses, especially those produced by representatives or advocates for the pension funds, this report examines the best data available to calculate average pensions based on years of service. This report is intended as a comprehensive update to several analyses produced over the past several years, in particular “How Much Do CalPERS Retirees Really Make?” (February 2014) and “How Much Do CalSTRS Retirees Really Make? (March 2014).

The scope of this study is restricted to providing the most accurate assessment of average pension payments to retired state and local public employees in California. To perform this analysis we relied primarily on data compiled by Transparent California, an online database sourced via public information act requests to pension systems. Using spreadsheets downloaded from this website, we were able to get usable data from 23 of the largest pension systems in California. In all we evaluated 1,135,653 individual payroll records.

Sorting Pension Averages by Years of Service

One major misconception concerning pension benefits regards just how much a state or local worker may expect to collect in their retirement. The primary source of this misconception is based a need to better explain the concept of a “full career” pension. For example, CalPERS, on their “myths vs. facts” webpage (Note: Link is to archived page – CalPERS removed the live page on March 6th, 2017), makes the following claim: “Myth: Public pension benefits are excessive… Fact: The average CalPERS pension is about $31,500 per year.” CalPERS is probably making an accurate statement, but they are not taking into account the average retiree’s length of service. Someone who works half of a normal career should not expect a pension equal to someone who has worked a full career. As will be seen, the actual average based on a 30 year career is well in excess of twice that amount.

In order to properly evaluate pensions based on length of service, all of the 23 plans we evaluated disclosed how many years each individual retiree worked. There were only six major independent plans we could not evaluate. Five of them reported data to Transparent California, but did not report years worked; the San Diego County Employees’ Retirement Association (SDCERA) with 15,113 participants in 2015, the Alameda County Pension with 7,814 participants, the San Mateo County Pension with 4,111 participants, the San Diego City Employees’ Retirement System with 6,799 participants, and the Fresno County Pension with 6,911 participants. Lastly, we could not evaluate the Los Angeles Dept. of Water and Power Pension System, with an estimated 10,000 participants, because they have not provided any data at all.

Differentiating the “Enhanced Pensions”

In addition to length of service, which must be considered when evaluating the true value of a lifetime pension, another important distinction we noted was the disparity between pensions awarded recently and those awarded a generation ago. The principal cause of this disparity were the pension benefit enhancements which were enacted between 1999 and 2005 by the pension systems, starting with the California Highway Patrol via Senate Bill 400 in 1999.

The SB 400 enhancement increased the pension formula as follows: Previously, CHP retirees would earn a pension equivalent to 2% times they number of years they worked, times their final annual salary. So if a CHP officer had worked 30 years and retired at a final salary of $100,000, their pension would be calculated as 30 years times 2.0% times $100,000, which equals $60,000 per year. SB 400 raised this “multiplier” to 3.0%, which meant the new CHP pension, using the same other variables, would be 30 years times 3.0% times $100,000, which equals $90,000 per year. This benefit enhancement was enacted retroactively, meaning that a CHP officer retiring in 1999, using the same variables, would get a $60,000 per year lifetime annual pension, whereas one retiring in 2000 would get a $90,000 annual pension. The significance of this change is reflected in the average pensions all state and local government retirees receive, and to illustrate this, we have not only calculated the overall average pension, but have differentiated between the average pensions for those who retired prior to 2000, and those who have retired in 2000 and since then.

It’s important to note that these more recent retiree averages are the ones that matter, since funding these more costly pensions is the burden that taxpayers currently face, and collecting these larger pensions is what all currently employed state and local workers expect.

Public Safety Pensions

Another important distinction which we have tried to make is between public safety pensions and pensions for all other workers. Unfortunately it is difficult to get good data on this unless either (1) there are pension systems that are exclusively for public safety employees or exclusively for other employees, or (2) if there are pension systems whose records clearly indicate whether or not a retiree’s former employer was a public safety agency or not. While the largest pension system, CalPERS, and most others, do not provide this information, fortunately some major pension systems do. For example, three cities, San Jose, Los Angeles, and Fresno, each have two independent pension systems, one for their public safety employees and one for everyone else. And in one notable case, Los Angeles County, the data clearly allows an analyst to differentiate between average pensions for their public safety employees as distinct from the averages for their other employees.

Disability Pensions – One area where very little good data was available concerned disability pensions, because very few of the independent systems provided information on their retirees who were under disability status. It is important to call attention to this category of retiree, because state and local retirees who are classified as disabled receive significant tax breaks. In some cases they are permitted to exclude up to 50% of their pension from income tax liability. For this reason, it is important for the public to have confidence that these disability exclusions are based on genuine need. We do have disability statistics from two major pension systems, the public safety retirement plans for San Jose and Los Angeles. We will report our findings on these two plans but believe the importance of this issue may merit work in subsequent studies.

Other Post-Employment Benefits

Similarly, an area where very little good data is available is with respect to benefits. This is regrettable, because in some of the cases where the information included benefits data – typically payments to retirees for health insurance – the amount of these benefits averaged in excess of $10,000 per year. We will report our findings here, but also believe this is an area that merits additional research.

Assumptions

It is necessary to reveal some of the assumptions we were required to make as well as some of the sources of possible inaccuracies in this analysis. First, in most cases we could not use all the data. While all 23 systems we analyzed provided data for years of service and year of retirement, in nearly all cases there was a small percentage of records where this information was not provided. Because these percentages were not large, usually in the range of five percent or less, we simply excluded them from the dataset used to calculate averages. In many cases the missing year of retirement data was replaced by the term “beneficiaries,” meaning the original retiree was deceased and a survivor was collecting the pension. Based on the small percentage of records with missing data, and the assumption that the missing records were randomly distributed within the range of pension amounts, retirement years, and years of service, we believe excluding this small percentage of records does not affect the averages we have calculated.

Also, we believe minor inaccuracies were introduced into our calculated averages based on two factors. First, we included 2015 retirees in the dataset, despite the fact that some retirees may have only left their employment, in the middle of 2015, in which case their pension would have been only half of their annual entitlement. We measured the impact of leaving these records in vs. taking them out and found the difference to be slight enough – less than one-half of one percent – to value keeping the larger sample size even though it caused the average pension calculation to come in lower. Another factor which is impossible to measure but which undoubtedly also caused our average pension calculations to come in lower than what is truly representative is based on part-time career employees whose final pension calculation was based on only a fraction of what a full-time employee would have earned. For example, a substitute teacher who worked a few weeks per year for 30 years would be included in our dataset, affecting the average for retirees with 30 years of service, even though their pension may only be a few thousand dollars. Both of these sources of inaccuracies, if it were possible to correct them, would result in the averages we have calculated to be higher, not lower, so we do not think they affect the veracity of our findings.

One final consideration. Previous attempts to stratify pension averages by years of service have provided results within a range that is arguably too broad. For example, we have reported pension averages for less than 20 years of service, 20-25 years of service, 25-30 years of service, and 30+ years of service A valid criticism of this method is that it might attempt to imply that the average for 30+ years of service is how much a retiree can expect after working 30 years, when retirees who may have worked 40 years are also in that sample. To avoid this concern, we do provide these conventional ranges in this study, but add another layer of analysis. Because the dataset is so big, with over 1.1 million records, we can review narrower ranges of service years while still having adequate sample sizes. To that end we have isolated three groups of retirees; those who worked between 19.5 and 20.5 years, those who worked between 24.5 and 25.5 years, and those who worked between 29.5 and 30.5 years. By doing this we believe we can assert with confidence that these averages truly represent what someone who worked 20, 25, and 30 years, no more and no less, can expect to earn as an annual pension.

 *   *   *

AVERAGE PENSION PAID TO CALIFORNIA’S STATE/LOCAL GOVERNMENT RETIREES

The tables to follow all use the same basic format. All numbers represent the average pension received for retirees in each subset.

Data for every pension system is represented in three standard rows. Row one shows averages for pensioners who retired before 2000. Row two shows averages for those who retired during 2000 or afterwards. In row three (“avg all ret years”), the average pension is shown for all retirees regardless of their retirement year (rows one and two combined).

The columns depict average pensions based on years of service. Column one (“0 – 100) shows the average pension regardless of years worked, i.e., all retirees. There are two variations to these tables that have been prepared for all of the pension systems. Tables 1-A, 2-A, 3-A, and so on, show average pensions by a range of service years. Column two (“0-20”) shows averages for workers who retired after working 20 years or less. Column three (“20-25) shows averages for workers who retired after working more than 20 years but no more than 25 years. Column four (“25-30”) shows averages for workers who retired after working more than 25 years but no more than 30 years. Column five (“30-100”) shows averages for workers who retired after working more than 30 years.

Average Pensions Based on Data from 23 Major Systems

Table 1-A reports pension averages using data from all 23 pension systems we analyzed. We estimate that these 23 pension systems represents 94% of all of California’s state and local government retirees. As a result, we believe these calculations are very accurate. As discussed in the preceding paragraphs, Table 1-A is formatted to report pension averages sorted according to when pensioners retired (rows) and also according to how many years pensioners worked (columns).

Two numbers stand out in this and all of the subsequent tables, and are highlighted in yellow. The first highlighted result, to the left, shows that the average pension for a typical retired state or local worker in California is $38,101. This average is for all retirees, regardless of how many years they worked, or when they retired. The first two averages in column one differ significantly, again showing the impact of SB 400 on retiree pension benefits. The top number, $28,527, is the average for all pensioners who retired before 12/31/1999. The middle number, $41,757, shows the average for all pensioners who retired after 1/01/2000. While SB 400 had a significant impact on this disparity, another contributing factor is the rate at which end-of-career wages escalated faster than the rate of inflation over the past 20 years. Less of a factor is inflation eroding the value of the pre-2000 retirees’ pensions, since most pension benefits include automatic annual cost-of-living adjustments that nearly keep pace with inflation and in some years exceed it.

The second number on this and all of the subsequent tables that is highlighted, to the right, depicts the average pension for retirees who left the workforce after 1/01/2000 and worked 30 years or more. We believe this is a more representative average because it reflects the pension benefit formulas available to active workers today, and because it reflects what an active worker can expect to collect as a pension if they work for a full career. The average, $73,009, is very nearly twice the $38,101, which is frequently cited as the “average” pension California’s state and local workers receive.

Table 1-A
Average Pension – Consolidated Records from 23 Major Systems

(by range of service years, entire database)

The next table, below, offers a variation in the column format common to not only this Table 1-B, but also 2-B, 3-B, and so on. This version is created in order to more precisely report the average pension based on an exact number of years of service. Because over one million records were analyzed, even these narrow slices of data from the retiree population still yield reliable results. As can be seen, Table 1-B reports the average pension for retirees who worked between 19.5 and 20.5 years (column one), between 24.5 and 25.5 years (column two), and between 29.5 and 30.5 years (column three).

In this table, again, two cells are highlighted. The first one, to the left, shows the same average as in Table 1-A, $38,101 for all retirees, regardless of when they retired or how long they worked. The second highlighted cell, to the right, show s the average pension for retirees who worked just about exactly 30 years. The purpose of this format is to avoid any possibility of reporting misleading averages. For example, in Table 1-A, the data includes people who not only worked 30 years, but people who worked in some cases 40 years or more. Retirees in Table 1-A who retired after 1/01/2000 with 30-plus years of service had an average pension of $73,009, whereas the retirees in Table 1-B who retired after 1/01/2000 with exactly 30 years of service had an average pension of $68,673.

As will be seen, there is considerable variation between average pensions based on what system a retiree belongs to, and whether or not a retiree was a member of public safety or any other non public safety employee. But if one number should be represented as the average full career pension for a state or local government retiree in California, it is this one – $68,673 per year in 2015.

Table 1-B
Average Pension – Consolidated Records from 23 Major Systems

(by exact years-of-service; 20, 25, 30 – applicable portions of database)

Average Pensions in the Three Statewide Systems – CalPERS, CalSTRS, and the University of California

By far the largest public employee pension systems in California are CalPERS, reporting 625,135 retirees in 2015, and CalSTRS, reporting 260,892 retirees for that year. The University of California’s pension system is actually fourth in size, their 49,515 retirees in 2014 (data for 2015 was unavailable) trails the retiree count for Los Angeles County where they reported 60,613 retirees in 2015.

Because CalPERS has by far the largest population of active retirees, it should come as no surprise that the average pension is close to the average we calculated for all 23 major pension systems combined. CalPERS manages pensions for over 3,000 state and local government entities in California, with their largest employer being support personnel (teachers belong to CalSTRS) in LA Unified School District, followed by the County of Santa Clara, and only then their largest state employer, the Employment Development Dept., followed by the California Highway Patrol.

Similarly, CalSTRS manages pensions for nearly 1,500 public education entities, with the retired LA Unified School District teachers their largest cohort. The data inTables 2-A and 2-B show these pension averages based on ranges of years-of-service (2-A), and specific lengths of service (2-B). Once again, the most salient data present in these tables is highlighted in yellow – with the highlighted cells in the far left column showing the averages that are commonly reported to the press, and the highlighted cells in the far right column showing the averages that are most representative of employees who worked a full career. As can be seen in Table 2-A, the average pension for retirees with 30+ years of service who retired after 1/01/2000 was $67,889 for CalPERS, $76,200 for CalSTRS retirees, and $71,433 for University of California retirees.

Table 2-A
Average Pension – Statewide Systems: CalPERS, CalSTRS, and the UC System

(by range of service years, entire database)

Table 2-B, again, is provided in order to forestall any criticism of these “full-career” calculations being misleading. In this table the yellow highlighted cells in the far right column do not refer to averages calculated for retirees since 2000 who worked 30 years or more, but rather for those retirees who worked almost exactly 30 years. Only retirees with between 29.5 and 30.5 years of service are included in these calculations.

As can be seen, the surprising result for CalPERS employees is that when the calculation is limited to retirees between 29.5 and 30.5 years of service, the average, at $71,402, is actually higher than the average for retirees with years of service ranging from 30 years to the maximum amount recorded. We rechecked this very carefully. This is obviously counter-intuitive since a pool of data that includes retirees with 40 years of service or more should not yield a lower average pension calculation than one that is restricted to retirees who only worked 30 years, since if anything (there are ceilings on on how much an employee can accrue) the longer you work, the larger your pension gets.

There are several possible reasons for this, including that CalPERS retirees include a larger than average proportion of retirees who worked 30+ years, but worked part-time and therefore accrued a relatively small pension based on a full, but part-time career. This possible explanation is supported by the fact that CalPERS employers include hundreds of small agencies where there is a high percentage of part-time employees. In any case, it is important to make one main point: The average pension reported for full-career CalPERS retirees with 30 years of service is at least $67,889, if not more. That calculation is definitely not misrepresenting the data.

Table 2-B
Average Pension – The Big Three: CalPERS, CalSTRS, and the UC System
(by exact years-of-service; 20, 25, 30 – applicable portions of database)

Average Pensions in the Major Independent County Systems

The next two tables display average pensions for the largest 14 independent county pension systems, ranging from Los Angeles County, 3rd largest overall with 60,613 retirees reported in 2015, to Tulare County with 2,925 retirees in 2015. One clear conclusion from reviewing this large body of data is the tremendous range in average pension benefits. On Table 3-A, as highlighted in yellow in the far right column, the highest average full career pension for employees who retired after 1/01/2000 with 30+ years of service is Ventura County at $97,945. The 2nd highest average full career pension is Contra Costa at $90,592, followed by San Bernardino – a county with a history of serious financial challenges – at $89,571.

The lowest average full-career pension among these top 14 counties is Tulare, at $60,918, followed by Stanislaus at $67,200 and Fresno at $68,112. The county of Los Angeles, with by far the largest pension system, is roughly in the middle of the pack in terms of their average full career pension, at $81,605.

Table 3-A
Average Pension – Major Independent County Systems

(by range of service years, entire database)

The data on Table 3-B calculates pension averages for the 14 major independent county pension systems based on specific years of service, with the highlighted cells on the far right showing the average pension for post 1/01/2000 retirees with between 29.5 and 30.5 years of service. Predictably, these averages which exclude retirees with far more than 30 years of service are usually lower than those reported on Table 3-A. But not always.

For example, Los Angeles reports post 2000 retirees with 30+ years of service at $76080 (Table 3-A) vs. post 2000 retirees with exactly 30 years of service at a much lower $65,027. By contrast, San Francisco’s post-2000 with 30+ years of service retirees on Table 3-A average 81,605, vs. a higher average for exactly 30 years on Table 3-B at $84,473.

Regardless of how the data is evaluated, whether using ranges of years of service (the “A” tables), or a one year band to calculate averages for a very specific length of service (the “B” tables), there is great variation in the averages between the different independent systems. On Table 3-B, the lowest average for a post-2000, 30 years of service pension is Tulare, at $51,932. The highest is Contra Costa County, at $85,091.

Table 3-B
Average Pension – Major Independent County Systems
(by exact years-of-service; 20, 25, 30 – applicable portions of database)

 *   *   *

AVERAGE PUBLIC SAFETY EMPLOYEE PENSIONS

When calculating averages for most pension systems, it is difficult if not impossible to isolate the retirees who were public safety employees from the retirees who were so-called “miscellaneous” employees. But in California, four large cities have two independent pension systems, one for their public safety employees and one for their miscellaneous employees. Tables 4-A and 4-B display the averages for these three cities, comparing the averages for public safety retirees to the averages for miscellaneous retirees.

As can be seen on Table 4-A (ref. highlighted cells in far right column), there is both tremendous variation in full-career pension amounts between these three cities. Miscellaneous employee pensions range from a low of $41,792 in Fresno, to $64,973 in Los Angeles, to $75,236 in San Jose. Public Safety pensions also vary considerably between the three cities, with Fresno averaging $73,016, Los Angeles averaging $98,495, and San Jose averaging $132,752.

Table 4-A
Average Pension – Comparing Separate Systems for Safety vs. Misc Employees
(by range of service years, entire database)

As can be seen on Table 4-B which focuses on retirees who worked exactly 30 years (ref. highlighted cells in far right column), again there is both tremendous variation in full-career pension amounts between these three cities. Miscellaneous employee pensions range from a low of $40,927 in Fresno, to $54,782 in Los Angeles, to $74,649 in San Jose. Public Safety pensions also vary considerably between the three cities, with Fresno averaging $54,860, Los Angeles averaging $89,183, and San Jose averaging $130,439.

Table 4-B
Average Pension – Comparing Separate Systems for Safety vs. Misc Employees
(by exact years-of-service; 20, 25, 30 – applicable portions of database)

 *   *   *

OTHER POST-EMPLOYMENT BENEFITS (“OPEB”)

The primary source of retirement benefits apart from pensions is supplemental retirement health insurance. Because cities and counties have more flexibility in awarding or reducing employer paid retirement health insurance compared to pensions, there is even more variation between systems in the level of benefits provided. Moreover, it is harder to acquire data on OPEB. Only four of the 23 systems analyzed here including that information in their disclosures to Transparent California. In the case of Fresno County, while they reported 97% of the retirees receiving pensions also received benefit payments, the average annual benefit they reported for a retiree was only $646 per year. Another county that provided benefits information was Santa Barbara, but they only reported 19% of the retirees receiving pensions also receiving benefit payments.

One of the best sources of data on OPEB is Los Angeles County. The data they provided also offers excellent comparisons between public safety and miscellaneous employee retirement benefits.

Table 5-A shows pensions, benefits (OPEB), and total retirement averages (pensions plus OPEB) for four groups. The first section shows these averages for all Los Angeles County retirees. As highlighted in the far right column, the average pension for a Los Angeles County retiree who retired after 1/01/2000 with 30+ years of service is $76,000. They collect, on average, $11,993 in OPEB benefits, meaning their total retirement package in 2015 was $88,074.

The next three sections of Table 5-A show the same data, pensions, benefits, and total retirement averages, but each is limited to a particular subset of retirees; former sheriffs, former firefighters, and all other retirees. As can be seen, there is a stark contrast between the benefits collected by former members of public safety and those collected by all other retirees. As shown highlighted in yellow in the lower right of each section, retired Los Angeles County sheriffs with 30+ years of service who retired after 1/01/2000 collected a retirement package (pension plus benefits) that averaged $119,136 in 2015. Firefighters collected, on average, $140,879 in 2015, and miscellaneous (all other) retirees collected $76,037.

Table 5-A
Average Pension & Benefits – Los Angeles County – Public Safety Compared to Misc. Retirees
(by range of service years, entire database)

The next table, as done throughout this report, shows the average pensions for retirees based on a very specific period of service. This eliminates the potentially misleading results based on calculating averages on 30+ years of service, since those averages are skewed upwards by the presence of records for workers who may have worked 40 or more years.

As it is the averages for Los Angeles County retirees are significantly lower when using a service range of 29.5 – 30.5 years instead of 30+ years. As can be seen, the average retirement package for someone with between 29.5 and 30.5 years of service who retired after 1/01/2000 is $78,497 for all retirees, $106,539 for former sheriffs, $125,256 for former firefighters, and $61,065 for all other retirees.

With respect to health care, it is clear that at least in some cases – Los Angeles County being a prime example – they add substantially to the value of an employee’s average retirement benefit. Referring again to Table 5-B, the average payments for benefits in 2015 for someone with between 29.5 and 30.5 years of service who retired after 1/01/2000 is $13,471 for all retirees (17.2%), $18,395 for former sheriffs (17.3%), $20,350 for former firefighters (16.2%), and $10,581 for all other retirees (17.3). In all cases, these benefits added about 17% to the value of the average Los Angeles County retiree’s total retirement package in 2015.

Table 5-B
Average Pension & Benefits – Los Angeles County – Public Safety Compared to Misc. Retirees
(by exact years-of-service; 20, 25, 30 – applicable portions of database)

 *   *   *

DISABILITY PENSIONS

Information on pensions for retirees who have job related disabilities is even scarcer than information on other post employment benefits. Only four pension systems provided data to Transparent California; Ventura County, Contra Costa County, Los Angeles County, and the City of San Jose. It must be noted that this information can be acquired through public records acts to specific agencies, and determining the extent of disability pensions would be a public service. While that exercise was beyond the scope of this report, here is what we learned:

In Ventura County, disability status was reported for 15.0% of all retiree pensions (public safety and miscellaneous – the data didn’t include information on former employing agencies). In Contra Costa County, disability status was reported for 10.4% of all retiree pensions – like Ventura County, Contra Costa did not differentiate between public safety and miscellaneous, nor did they reveal former employing agencies.

Better data was found for Los Angeles County, where even though a single system manages benefits for both public safety and miscellaneous employees, they have reported the former employing agencies. As a result, we were able to calculate the percent of retirees on disability according to their former employing agencies, and the results are startling.

To provide full disclosure, we could not analyze 14,805 of the 60,614 pension records reported by Los Angeles County for 2015 because those records did not include “years of service.” Without that variable present we could not produce averages based on years of service. Nonetheless, because we had 45,809 intact records to work with, 76% of all retirees, we believe the averages we’ve presented thus far, and the percentages we’re about to present, are reasonably accurate.

In Los Angeles County in 2015, disability pensions were reported for 6.5% of former miscellaneous employees, for 40.5% of all retired former sheriffs, and 65.7% of all retired former firefighters. These are astonishing percentages. As an aside, of the 7,120 disability pensions reported, not including benefits, 1,645 of them, or 23.1%, were over $100,000.

The City of San Jose’s Police and Fire Pension System, which did not provide benefits data or former employer (in this case either police or fire) data, nonetheless reported which retirees were receiving disability pensions in 2015. The data was consistent with what was reported by Los Angeles County for their public safety retirees, in San Jose, 50.0% of the retirees were receiving disability pensions, and 15.1% of those pensions were over $100,000.

Without having better data from more pensions systems, it is not possible to extrapolate these results. But for two very large independent pension systems for which we do have data, Los Angeles and San Jose, we find that 40% or more of all public safety retirees do so on disability.

CONCLUSIONS AND RECOMMENDATIONS

The scope of this study was limited to investigating and reporting the average pensions for full-career employment in California’s state and local governments. Through the entire study we focused on two numbers – the average pension for all employees regardless of length of service or year of retirement (highlighted in yellow in the far left column of all of the tables), and the average pension for employees sorted by their length of service and by whether they retired before or after 1/01/2000. Because pension benefits were enhanced, retroactively for all active workers, starting around the year 2000, we believe that post-2000 averages are more representative of what California’s current state and local government workforce can expect.

To that limited scope, we added one twist, which was to provide a parallel set of tables (the “B” tables) that offered averages for retirees whose length of service was almost exactly 20, 25, or 30 years. To do that, we restricted the records used to calculate averages to those retirees whose length of service was between 19.5 and 20.5 years, between 24.5 and 25.5 years, and between 29.5 and 30.5 years. Because of the size of the datasets we used, over 1.0 million retiree records, we are confident the averages are accurate.

Accordingly, the conclusions we report here are all for post-2000 retirees with between 29.5 and 30.5 years of service. Apart from the contention that working 30 years might only constitute a “full career” in the public sector, we believe these averages are as accurate as possible.

Summary of Findings

For all systems evaluated, representing over 1.0 million records of California’s retired state and local government workers, in 2015 the average pension for a post-2000 retiree with between 29.5 and 30.5 years of work was $68,673. This does not include benefits.

Using the same criteria – the average full-career pension for a CalPERS retiree was $71,402, for a CalSTRS retiree it was $57,715, and for a University of California retiree it was $61,752.

There was a great deal of variation in the major independent county pension systems, with the highest full-career average in 2015 going Contra Costa County, at $85,091, and the lowest going to Tulare County, at $51,932.

To compare public safety pensions to pensions for all other employees, we evaluated data from three cities where each city has two independent pension systems, one for public safety, and another for all other employees. The 2015 results summarize as follows:

  • Los Angeles – public safety $89,183, all other retirees $54,782,
  • San Jose – public safety $130,439, all other retirees $74,649,
  • Fresno – public safety $54,860, all other retirees $40,927

Another way to compare public safety pensions to pensions for all other employees was to evaluate data from pension systems that reported, for each record, the former employing agency. Los Angeles County provided data that included this information. Los Angeles County was also the only major pension system to provide benefits data, yielding the following summary:

  • All retirees – pension $65,027 benefits $13,471, total $78,497
  • Sheriffs – pension $88,144 benefits $18,395, total $106,539
  • Firefighters – pension $104,905 benefits $20,350, total $125,256
  • All other retirees – pension $50,484 benefits $10,581 total $61,065

Data on disability pensions was available from two major pensions systems: In Los Angeles County in 2015, disability pensions were reported for 6.5% of former miscellaneous employees, for 40.5% of all retired former sheriffs, and 65.7% of all retired former firefighters; in San Jose’s retirement system whose participants are exclusively former public safety employees, 50.0% of the retirees were receiving disability pensions.

Observations

The purpose of this report is to provide a comprehensive reference for anyone who wants to know, using available data, what California’s state and local government workers receive in pensions if they work for 30 years. By reporting on average pensions sorted an exact service period (19.5 – 20.5 years, 24.5 – 25.5 years, and 29.5 – 30.5 years), comparing that to averages sorted by ranges of service years (<20, 20-25, 25-30, 30+), and by sorting based on pre-2000 and post-2000 retirees, we offer information that is accurate and avoids misleading assumptions or inaccurate simplification.

For example, CalPERS on their “Myths vs. Facts” page states “The average CalPERS pension is about $31,500 per year.” This is a profoundly misleading statement. As can be seen on Table 2-B in the CalPERS section, the yellow highlighted cell in the far left column corroborates CalPERS – our 2015 data showed an “average” pension of $32,678. But that average was for all retirees regardless of if they retired before benefits were enhanced, and regardless of how many years they worked. On that same table, highlighted in the far right column, it can be seen that a more accurate average, based on 30 years work and retirement after 2000, is more than twice what CalPERS claims, $71,402. It should go without saying that if someone does not work a “full career,” they should not expect the amount of their pension to be based on a full career of service.

Several additional points should be made. We assume that 30 years is a “full-career,” but why? After all, a typical American worker who enrolls in Social Security can expect to work well over 40 years, from, say, age 26 through age 65, before they are eligible for the full Social Security benefit. And to put these pensions in perspective, the maximum Social Security benefit for someone retiring on their 66th birthday is $32,244. As shown on Table 1-B, across all 23 pension systems that we analyzed, the average pension for a retiree with 30 years of service is $68,673, more than twice as much.

Much of the discussion surrounding pensions has focused on their financial sustainability. While this is a question of vital importance, too often overlooked is the moral question of whether pensions are simply too generous when compared to government retirement programs for private sector workers, regardless of their affordability. There is a compelling case to be made that if the government is going to offer citizens programs like Social Security, or pensions for government workers, then perhaps all citizens should have the opportunity to select from the same set of benefit formulas and incentives.

Recommendations

This report raises more questions than it answers, even when restricted to the question of just how much our public servants are, on average, receiving in retirement benefits for a full career of service. Towards answering these questions, our recommendations focus on how government agencies and citizen groups can create more transparency.

In all of these transparency recommendations, what is needed are individual records, not aggregate data. This way, analysts can develop average and median calculations based on examining all unique records, using whatever sort criteria they want to apply. Sentiments are understandably mixed on whether or not the names of pension recipients should be included with this individual data, and this report is neutral on that issue. The State Controller, for example, compiles individual pay records for active state and local government employees, and these records include a great deal of detailed individual information from which various and useful aggregate calculations can be made, even though they do not provide individual names.

At a minimum, individual pension records should disclose the following:

(1) Amount of pension, years-of-service, year of retirement,

(2) Amount of benefit payments such as retirement health care premiums paid by former employer,

(3) Disclosure if reported pension amount included one-time amounts such as DROP payments,

(4) Disclosure if recipient is designated as receiving a disability pension,

(5) Disclosure of how many years-of-service are the result of purchased “air-time.”

(6) If the recipient is a beneficiary, retain information about original retiree and provide the year deceased.

The following disclosures would be helpful if feasible:

(7) If other supplemental payments are made, disclose all of them.

(8) Disclose if the recipient is also a participant in Social Security as part of their government retirement benefit package.

(9) Disclose if the recipient also has a defined contribution account as part of their government retirement benefit package.

(10) Disclose whether the recipient gets a 2nd or 3rd pension payment from other pension systems, or whether the recipient was still actively employed while collecting their pension.

 *   *   *

Ed Ring is the vice president of policy research for the California Policy Center.

California City and County Fiscal Strength Index – 2017 Update

Relative to earlier years and their peers in other states, most California city and county governments were in good financial condition at the end of fiscal year 2015. California Policy Center’s study of audited financial statements and socioeconomic indicators show widespread fiscal strength, but a few trouble spots as well.

Our analysis extends a fiscal strength study published in The Fiscal Times in January. That study assigned fiscal scores to 116 US cities with population greater than 200,000. The six highest scoring large cities in The Fiscal Times review were all located in California. Here, we extend the study universe to include every California city and county that has published audited financial statements in 2014 or 2015 (we used 2015 statements when available, but relied on 2014 statements in a few cases in which 2015 statements could not be obtained).

Of the 511 cities and counties we analyzed, over 60% scored 90 or higher. But fiscal health was not universal: eight cities had scores below 50. Several of these cities appeared on a distressed municipality list published by California Policy Center in November 2014. The earlier CPC analysis used a different scoring system, but relied upon similar variables.

You can see all the scores with links to the financial statements we used here:

 

Excluded from the study were 28 local governments for which audited financial statements could not be found. These are mostly smaller towns and cities. In 2015, the federal government required public agencies receiving $500,000 or more in federal grant funds to file audited financials (this threshold has since been raised to $750,000), while financial regulations normally require governments borrowing on the municipal bond market to file these statements. So, if a municipality received less than $500,000 in federal funds and did not have outstanding municipal bonds in 2015, it did not need to prepare audited financials.

The scoring system is described in a new working paper which will be published by the Haas Institute at UC Berkeley in the next few weeks. It is based on empirical research that associates local government fiscal distress with weak revenue performance, high debt burdens and low or negative general fund balances.

While the first two factors are straightforward, the third may require more explanation. A government’s general fund is roughly analogous to an individual’s checkbook, and a negative general fund balance is like an overdraft. A government or an individual may have other assets available to pay day-to-day bills, but it may be difficult to get access to these assets when needed. The City of Vallejo went bankrupt in 2008, citing exhaustion of its general fund balance, even though it had $100 million of cash elsewhere. Stockton and Sen Bernardino also had low or negative general fund balances at the time of their 2012 bankruptcy filings.

The score is based on the following five factors:

1. the ratio of a city’s general fund balance to its expenditures (40 percent weighting)

2. the ratio of its long-term obligations (including the current portion and Other Post-Employment Benefits but excluding pensions) to total government-wide revenues (30 percent weighting)

3. the ratio of actuarially determined pension contributions to total government-wide revenues (10 percent weighting)

4. change in local unemployment rate (10 percent weighting)

5. change in property values (10 percent weighting)

Changes in the unemployment rate and home prices provide an indication of future revenue trends. The long-term obligation and pension contribution ratios provide insight into the government’s debt burden – including the debt that arise from making unfunded commitments to retired and retiring employees.

Data for the first three factors were obtained from audited financial statements, unemployment rates were obtained from the Bureau of Labor Statistics and home prices were gathered from Zillow. For some smaller entities, unemployment rates and/or home prices were unavailable. In these cases, data from a nearby city or county was used.

To receive a perfect 100 score, a city or county must have had all of the following five characteristics in 2015:

  1. General fund balance equal to 32% or more of general fund expenditures
  2. Long term liabilities no greater than 40% of total revenues
  3. Actuarially determined pension contributions no greater than 10% of total revenues
  4. Flat or declining unemployment rate
  5. Property value increase of 3% or more

It is not necessary to have a perfect score to be regarded as fiscally healthy. I consider a score of 71 or higher to be roughly equivalent to a rating of AAA, but it may be appropriate to make adjustments to the score before using it as a rating proxy. Analysts may wish to deduct points for a recent bankruptcy, late filing of audited financial statements or qualified audit opinions.

All 511 scores and supporting data are in an associated Google Sheet. The balance of this paper profiles the eight cities that scored lower than 50 (no county scored in this range).

Several of these low scoring cities were cited in our November 2014 study. Among the cities identified as highly stressed in the earlier analysis, three have significantly improved their financial position: Firebaugh, Huron and Sutter Creek. Ione is no longer required to file audited financial statements. Blythe, Calipatria, King City, Ridgecrest and San Fernando remain near the bottom of our rankings, with scores of between 51 and 60.

Atwater

Atwater, a city located just north of Merced in the Central Valley, has the lowest score in our survey. Like many inland cities, Atwater suffered a steep decline in revenues in the wake of the Great Recession. General fund revenues fell from $11.7 million in 2008 to $9.1 million in 2012. City officials were slow to cut spending in response, wiping out a large general fund balance. In 2008, Atwater reported a general fund balance of $4 million, which was 32% of that year’s expenditures. By 2012, the city’s general fund balance was negative $3.9 million.

Since then conditions have improved slowly, but Atwater’s general fund balance remained deep in negative territory. Most general fund revenue is spent on public safety, which has proved difficult to cut given the city’s high crime rate.

In 2013, voters overwhelmingly approved Measure H, a ½ cent sales tax increase to maintain public safety services. The additional revenue from this tax has been placed in a special fund overseen by a citizen’s oversight board. But the management of Measure H revenue has come under question. According to Merced County TV News, almost $900,000 of Measure H revenue was spent on a new 100-foot ladder fire truck despite the fact that the city has no building taller than 35 feet.

A large portion of Atwater’s public safety expenditures are attributable to pension contributions and retiree healthcare costs. According to CalPERS data, Atwater had 50 retired public safety employees in 2015 – double the number still employed by the city. These retirees benefited from the city’s generous 3% at Age 50 formula, so their annual benefits are large for a city of modest means. Required safety pension contributions are rising from $1.1 million in 2014 to over $1.8 million in 2018. Citywide retiree healthcare costs were $600,000 in 2015 and the city has an unfunded OPEB obligation of $5 million.

Aside from pension and OPEB obligations, Atwater is also carrying a heavy load of bonded debt which includes $79 million in outstanding sewer bonds. To the city’s credit, it is trying to keep residents informed of its financial difficulties. Atwater’s home page prominently links to a slide presentation that explains the situation.

Coalinga

Coalinga is located central California’s Pleasant Valley. Its main industries are agriculture, oil and incarceration. Total revenue declines from $30 million in 2009 to $18 million in 2014. The city was hit hard by Governor Brown’s decision to shut the Claremont Custody Center in 2011, and the more recent decline in oil prices.

In 2014, Coalinga had general fund revenues of $5.7 million and expenditures of $8.6 million. Some of the deficit was offset by transfers from other funds, but the city’s general fund balance deteriorated from negative $2.0 million to negative $3.4 million. Management attributed part of the deficit to difficulties arising from the termination of its 401a defined contribution plan. Coalinga expected to receive a termination payment from the plan sponsor, the International City and County Management Association (ICMA), but didn’t. Issues surrounding the plan termination are now being litigated in Fresno County Superior Court (Case Number 16CECG000082), with the city seeking damages from ICMA, Strategic Retirement Advisors (a firm that provides advice to public agencies on their retirement systems) and Verisight (a third-party plan administrator).

Coalinga’s 2015 audited financial statements are not available. The city’s financial director informed CPC that the long delay in the release of these statements was attributable to staff turnover and that they were expected to be released by the end of March. The city’s most recent budget showed a 2015 general fund surplus of $900,000.

More recently, Coalinga had some positive fiscal news. In July 2016, the city sold its vacant prison building to Ocean Grown Extracts, which will use the facility to grow marijuana and produce cannabis oil. The $4.1 million purchase price should eliminate Coalinga’s negative general fund balance. The new business will also generate incremental tax revenue for the City.

Compton

In our 2014 report, we named Compton as the state’s most fiscally distressed city. Our updated scoring system places the city further down the list, but its fiscal and management problems remain largely unresolved. Since our previous report, the city council has fired two city managers. After G. Harold Duffey vacated the position in December 2014, assistant city manager Jonny Ford stepped into the role. In October 2015, Compton hired former Lynwood city manager Roger Haley to permanently fill the position, but then removed him in July 2016. According to the Compton Herald, Haley was terminated because he spent a large amount of city funds to promote a sales tax increase on the June ballot and for failing to keep the Council properly informed about fiscal conditions. In January, Compton named Cecil Rhambo as its new City Manager.

The minutes of a March 2016 Council Meeting support the belief that Haley misinformed elected officials. At that meeting, a financial advisor is quoted as saying that the city was about to have its credit ratings restored and that the city has not been distressed since late 2012. Since that meeting, the city has sold two bond issues, neither of which carried a rating. Further, a review of Moody’s and Standard and Poor’s web sites show that the city remains unrated.

One reason that the ratings were withdrawn was that Compton could not produce audited financial statements on a timely basis. Normally, local governments must provide audited financial statements within nine months of their fiscal year end. According to a disclosure filed with the Municipal Securities Rulemaking Board, the city failed to file audited financial statements for its 2011 fiscal year, filed its 2012 statements 16 months late and filed its 2013 statements 21 months late.

The city’s audited financial statements for the fiscal year ended June 30, 2014 are dated November 17, 2016, which is 19-1/2 months after the March 30, 2016 filing deadline. The continual filing delays makes a rating restoration unlikely. Moreover, the city’s 2014 audit is qualified – which means that the independent auditor could not fully verify the amounts reported by the city.

The auditor’s letter notes that “the City could not provide documentation to support $6.3 million in additions to capital assets.” The auditor could also not determine whether the city had earned $2.9 million in federal grant revenues, raising the possibility that the grant money was not spent for the intended purpose.

According to the city’s unaudited 2015 financial report. Compton’s general fund revenues were $1.4 million greater than expenditures. However, the city general fund balance was negative $33.5 million, which is the equivalent of a huge overdraft on an individual’s checking account. Compton has other funds, some of which have positive balances, but its aggregate fund balances totaled negative $20.9 million – rendering the city essentially insolvent. (According to an email message I received from Compton’s financial manager, the general fund balance improved in 2016 and the recently approved sales tax will accelerate this trend.)

Compton can continue operating because it issues annual revenue anticipation notes. The most recent offering floated last July has a term of 11 months and carries an interest rate of 2%. This is quite a low borrowing cost for an unrated city with known financial problems. It is only possible because the revenue required to repay the bonds never passes through the city’s hands. Instead, property tax and vehicle license fee revenue collected by Los Angeles County on behalf of Compton is transferred directly to a bond trustee, who then pays bond investors.

While 2% may seem a small price to pay to keep the city going, Compton also has to pay underwriting, legal and financial advisor fees when issuing these bonds. For the June 2016 offering, these costs of issuance totaled 2.21% of principal according to the State Treasurer’s Debt Watch site, so the city’s overall borrowing cost was closer to 4%.

Aside from this short-term debt, Compton has other bond and loan obligations, as well as pension and OPEB liabilities. But as a proportion of city revenues, these obligations are in line with many other cities in California and across the country. Also, the city has had a special property tax dedicated to paying retirement obligations since 1947.

Compton also experienced lower unemployment and increasing property values in 2015, suggesting a positive revenue trend. Recent commercial developments including a new Amazon shipment/cargo center and a new Walmart should also brighten the city’s revenue picture.

Under the circumstances, it is likely that Compton can struggling along – rolling over and whittling down its short-term bond debt – as long as we don’t have another economic downturn. If a regional or national recession strikes however, the city will once again be at risk of bankruptcy.

Marysville

As a small, lower middle class city with few jobs outside of service and retail, Marysville fits the profile of many struggling cities in America. But unlike some other cities in our survey, Marysville’s revenue decline in the aftermath of the Great Recession was modest: total revenues fell from roughly $12 million in 2007 to $11 million in 2015. However, the city is burdened by a large amount of debt in relation to its limited revenue and small economic base. Marysville has a population of 12,216 and its median household income is only about $35,000 a year.

The city’s 2015 financial statements show a general fund balance of negative $10.5 million but most of this red ink is due to an incorrect accounting treatment. Marysville accounted for its $9 million Net Pension Liability in its general fund, but this amount is only supposed to appear in the Government-Wide financial statements. Removing the pension liability still leaves a significant amount of red ink: a negative $1.5 million balance.

Marysville is burdened with $32 million of long-term debts apart from its pension obligations, including sewer bonds and Certificates of Participation (COPs) – which are primarily serviced from tax revenues.  On the plus side, only one city employee and his spouse are eligible for retiree healthcare benefits.

In 2014, city leaders proposed Measure W, which would have authorized a 1% sales tax for ten years with revenues directed to the general fund. However, voters narrowly defeated the new tax. In September 2015, Moody’s Investors Service downgraded the city’s issuer rating to Baa3, and 2011 Taxable Refunding Certificates of Participation (COPs) to B2, reflecting the risk that tax revenues would be insufficient to service the COPs and fund public safety. A rating of B2 is five notches below Moody’s lowest investment grade rating, and is thus deep into “junk bond” territory.

In June 2016, voters were asked to approve a similar 1% sales tax hike under Measure C. This tax increase passed with a 55% majority. Moody’s responded by upgrading Marysville to Baa2 again.  The rating agency also upgraded the city’s COPs to Ba2, which is still two notches below investment grade. If the additional sales tax revenue reaches the forecast level of $1.6 million annually, and the new funds are not spent on new initiatives, the City should be able to reverse its negative general fund balance in the near future.

Maywood

Like its southeast Los Angeles County neighbor, the City of Bell, Maywood is a small municipality that has experienced chronic management problems. In 2015, the State Auditor identified Maywood as one of six high risk cities requiring special monitoring. The Auditor since deferred actions on four of the six cities, focusing on Hemet and Maywood. Although Hemet scored well in our model, Maywood was among the ten worst general purpose governments we evaluated in 2014 and again in our new survey.

After its review, the State Auditor concluded that “Maywood’s city council has failed to properly oversee the city’s operations and has allowed numerous financial and administrative problems to remain uncorrected, such as the city’s failure to maximize revenue and lack of the most rudimentary internal controls. Further, it has accepted flawed budgets and frequently ignored its municipal code when it approved non-competitively bid contracts.”

According to the auditor’s report, Maywood’s fiscal problems date back several years. In 2010, the city lost its general liability and workers compensation insurance, triggering the layoff of all municipal employees and the disbanding of its police force. Although Maywood no longer had employees, it was still obligated to fund pensions for its former workforce, but failed to pay the bills it received from CalPERS. Maywood has also suffered substantial turnover among mayors and City managers. It is also facing an investigation by the Los Angeles District Attorney for failing to abide by the Brown Act, a state law that sets standards of transparency for City Council meetings.

Maywood’s 2015 CAFR contains a going concern opinion from the city’s auditor reflecting doubts that the city could continue to operate as an independent entity. Triggering this opinion was the city’s negative $1 million general fund balance and its government-wide net unrestricted position of negative $27 million. On the plus side, the city only has $3 million in bonded debt.

Soledad

Located south of Salinas in Monterey County, Soledad’s economy is largely dependent on agriculture and two state prisons. While the city has a positive general fund balance, it received a low score due to a high ratio of debt to revenues. Most of the city’s debt takes the form of an interest-free loan from the state of California to finance the construction of a new sewer plant. Through 2010 Soledad borrowed $46 million, which it was supposed to pay in 20 annual installments. The city later negotiated an extension of the loan to 30 years reducing annual payments to $1.5 million.

This debt service burden is relatively large for a city that collected only $18 million of revenue in 2015. Soledad’s total revenues had exceeded $23 million before the recession in 2008. The city has already published its 2016 financial statements, which show higher revenue and lower debt – due to principal repayments. It should thus receive a higher score on our next survey.

Vernon

Vernon, located south of downtown Los Angeles, has only 210 residents but also plays host to 1800 mostly industrial businesses employing over 50,000 workers. In a previous report, we found that municipal employees outnumber residents and are paid, on average, $107,848 per year.

The city reported revenues of $249 million in 2015, mostly from power, light and water bills collected by municipal utilities. The general fund had $39 million in revenue and $53 million in expenditures. Its negative balance improved from negative $23 million to negative $16 million as a result of transfers from the utilities and the sale of property.

While city utilities were profitable, they are heavily encumbered by debt. As of June 30, 2015, the utilities had $383 million in outstanding bonds.

Victorville

Due to a depressed economy, Victorville has suffered poor revenue performance in the wake of the Great Recession. After peaking in 2008 at $130 million, governmental fund revenues cratered – falling to $70 million by 2013 – and have only recovered slightly thereafter, reaching $76 million in 2015. Total government revenues of $173 million are well below the $236 million recorded in 2008. With a shrinking to stagnant revenue base, the city will be challenged to service its large debt burden which includes over $300 million in bonds issued between 2005 and 2008 (however, as discussed below, city management considers much of this debt to not be the city’s responsibility). The city’s bonded debt dwarfs its $36 million net pension liability and $18 million OPEB liability.

Weak revenues have also been draining the city of cash. In fiscal year 2015, Victorville’s general fund balance declined from $4.8 million to $3.4 million – enough to cover only about 6% of annual spending. According to City Manager, Doug Robertson, the city’s general fund balance climbed back to nearly $4 million in fiscal year 2016.

Victorville has also been struggling with bonds issued by the Southern California Logistics Airport Authority (SCLAA). Because SCLAA is separate legal entity, Robertson disputes the inclusion of its debt in our calculations, however city officials have administrative control over this entity and its debt is consolidated with that of the city for financial reporting purposes.

The Authority has been defaulting on bond payments since 2011. The most recent default affected interest and principal payments on subordinated bonds due December 1, 2016, with some bondholders receiving as little as 12% of their promised payments.

In April 2013, the Securities and Exchange Commission sued Victorville, a city official, SCLAA and the bond underwriter for fraud in connection with the sale of the defaulted bonds. The SEC complaint alleges that the defendants inflated the value of an airport hangar used as collateral for the bonds and that they misappropriated a portion of the bond proceeds. The defendants tried unsuccessfully to have the case dismissed, but it has yet to come to trial – almost four years after the initial filing. (the case number is EDCV13-0776, US District Court, Central District of California).

Although the case does not relate to bonds issued by Victorville, officials claim that payments to lawyers and the costs of complying with SEC subpoenas have weighed on the city finances.

California’s Public Sector Compensation Trends

SUMMARY

This report calculates the average compensation and benefits for California’s full-time state, city and county government workers during 2015, using raw payroll data posted by the California state controller. It compares these findings to the results of a similar report issued three years ago using 2012 pay and benefit data from the California state controller. It then compares these trends to state and local government in the rest of the U.S. going back to 1995 using U.S. Census Bureau data. Using U.S. Census Bureau and California Employment Development Dept. data, it then compares state and local government pay in California to private sector pay, going back to 2000. Finally, it estimates how much the average state/local government worker pay and benefits would have to be if their pensions were adequately funded. This study focuses on California’s cities, counties and state agencies and does not examine pay and benefit data or trends for K-12 or college and university public employees.

Here is a summary of key findings:

(1) In 2012, the average pay and benefits for a full time employee in a California city was $124,058; county workers, $102,312; state agencies, $100,668.

(2) By 2015, these total compensation averages had increased as follows: Cities, $137,392, up 11% in three years; counties, $117,425, up 15%; state agencies, $116,887, up 16%. Adjusting for inflation of 3.02%, real compensation growth was 7.3% in cities, for counties it was 11.2%, and for state agencies it was 12.5%.

(3) Average 2015 total compensation for full-time state/local workers by category found the following:
–  Cities:  public safety $171,450, miscellaneous (all other employees) $121,431.
–  Counties:  public safety $170,728, miscellaneous $108,857.
–  State Agencies:  public safety $137,531, miscellaneous $104,867.

(4) Between 2012 and 2015 there was a strong correlation between growth in employer costs for overtime and growth in employer costs for pension contributions. Overtime pay was up in 2015 compared to three years ago by 35% for cities, 60% for counties, and 32% for state agencies. Similarly, pension contributions were up in 2015 compared to three years ago by 14% for cities, 26% for counties, and 42% for state agencies.

(5) In 2015, the pay (not including benefits) for California’s city and county employees exceeded pay for workers in cities and counties in the rest of the U.S. by 39%; California’s average public safety worker pay exceeded that of their counterparts across the U.S. by 78%; miscellaneous worker pay in California was 16% greater than in the rest of the U.S.

(6) In both California and in the rest of the U.S., between 1995 and 2015, pay for state, city and county workers grew by between 77% and 87%. The CPI (consumer price index) increased by 55% during that same period.

(7) Between 2000 and 2015, average private sector pay for full-time workers in California (not including benefits) increased 47%, from $37,012 in 2000 to $54,326 in 2015. During that same period, average pay for public employees in California increased by 59%, from $51,271 in 2000 to $81,549 in 2015.

(8) In 2015, the “benefits overhead” for the average private sector full-time worker in California is estimated at 15%; for state, city and county public employees, even when including overtime in the denominator, it is 40%.

(9) The composite average total compensation (pay and benefits) for a full-time city, county or state worker in California during 2015 was $121,843; for the average full-time private sector worker in California, including benefits, it was 62,475, which is 51% of what the public sector worker earned.

(10) If you take into account the necessary increases in contributions to California’s state and local pension funds in order to keep them solvent and keep promised retirement benefits intact, the average total compensation (pay and benefits) for a full-time city, county or state worker in California during 2015 was $139,691.

INTRODUCTION

Three years ago the California Policy Center published an analysis of public sector pay and benefits for the year 2012. Using the same sources and methods, this report is to provide updated 2015 numbers. Our source for this information is the State Controller’s “Government Compensation in California” website which provides information on employee pay and benefits for approximately 2 million positions at more than 5,000 state and local public employers.

What level of public employee pay and benefits are affordable and appropriate is a difficult but necessary discussion. The analysis we performed in 2012 may have been one of the earliest attempts to extract from the raw data the average pay and benefits for full-time employees of California’s cities, counties, and the state government.

One of the biggest weaknesses inherent in the State controller’s “Government Compensation in California” database is that the summary information by agency provides averages that include records for employees who only worked part-time, or who only worked for part of the fiscal year. As will be discussed in the next section, however, the State controller’s compensation website provides Excel spreadsheets on their “downloads” page that include a detailed annual pay record for literally every public employee working in state or local government. These spreadsheet records yield sufficient additional information to accurately estimate averages limited to full-time employees.

In this report we will compare compensation and benefits data from 2012 to 2015, separating the data by cities, counties, and state agencies. We will then isolate compensation and benefits data for public safety employees and miscellaneous (all other) employees and perform the same analysis with those subsets. We will conclude with a presentation of additional findings using data, where available, going back as far as 1995, comparing California’s public sector compensation trends to reported private sector compensation data, as well as to changes in the consumer price index. Along with the State Controller, our sources include the U.S. Census Bureau, the U.S. Bureau of Labor Statistics, and the California Employment Development Department.

*   *   *

METHODS AND ASSUMPTIONS TO ISOLATE FULL-TIME EMPLOYEE RECORDS

The method to remove part-time records from our analysis in order to develop compensation averages for full-time employees of California’s cities, counties, and state government, using the State controller’s raw data, rests on four assumptions. They are:

(1) A full-time employee would participate in a health insurance plan to which the employer would contribute some portion of the required payment, however minimal.

(2) A full-time employee would participate in a retirement benefit plan, usually a pension, to which the employer would contribute some portion of the required payment, however minimal.

(3) A full time employee would earn an amount in “regular pay” at least equal to the amount specified as the “minimum pay for job classification.”

(4)  To screen out interns, elected officials, and any other employee classifications that are not clearly full-time positions, we eliminate any records where the reported “regular pay” is less than $30,000 per year.

It is important to note that the pool of full time employees that is isolated using this analysis does not necessarily include all records of full-time employees. The third condition that must be met, for example, that requires a “full time” employee to have earned an amount in “regular pay” at least equal to the amount specified as the “minimum pay for job classification,” will exclude employees who only worked a partial year (typically because during the year they either were hired, retired, or transferred into or out of that job) and therefore earned less than the minimum. But “partial-year” employees must be excluded from the analysis because their lower earnings are not representative of what they would have earned if they’d been in the position the full year.

Another factor worth explaining are end of career payouts of, for example, accrued sick time, which could potentially skew averages upwards. In reality the opposite is probably true, because (1) this deferred compensation that occurs whenever an employee retires is an accurate reflection of what they were earning throughout their career, and so unless a disproportionate number of employees retire and collect payouts in the year under analysis, these payouts belong in the averages, and (2) a significant number of retirees do not work the full year and are therefore screened out based on condition #3 because their “regular pay” did not equal or exceed the “minimum pay for [their] job classification.

Because of the sheer size of the pool, even with the weaknesses noted, it is unlikely the results generated are not accurate. They draw from a database that literally includes every single employee under the payroll of any city, county, or state agency in California. In all, 291,011 city employee records were analyzed, 350,150 county employee records, and 239,860 state agency employee records. To verify the methods and the data, the reader is invited to download each of these Excel files, which were created by downloading the State controller’s raw data files and modifying them:

AVERAGE TOTAL COMPENSATION, FULL-TIME EMPLOYEES – 2015 vs 2012

Using data provided by the California state controller, Table 1 below displays 2012 average pay by category – regular pay, overtime, other pay, pension benefits, and other benefits. Subtotals are provided for total pay and total benefits, along with total compensation which represents all employer costs – pay and benefits – for the average full time worker. The columns provide data for California’s cities, counties, and state agencies.

Table 1 – Public Sector Pay in California
Average Pay and Benefits for Full-Time Workers, 2012
20170124-CompTrends-2012-SCO-pay

As can be seen, the average full-time city employee in California during 2012 earned $124,058, the average full-time county employee earned $102,312, and the average full-time state worker earned $100,668. How does this compare to 2015, three years later?

Table 2 – Public Sector Pay in California
Average Pay and Benefits for Full-Time Workers, 2015
20170124-CompTrends-revised-2

As can be seen on Table 2, over the past few years compensation for full-time state and local government workers has increased by about 16% across cities, counties and state agencies. If you adjust this for changes in the Consumer Price Index between December 2012 and December 2015, it doesn’t change much. The CPC in 12/2012 was 229.601, moving up to 236.525 in 12/2015, a move of 3.02% which compounded is less than 1.0% per year. Put another way, after adjusting for inflation, over the last three years the average full time city worker in California saw their pay and benefits increase by 7.3%, for counties it was 11.2%, and for state agencies it was 12.5%.

Table 3 depicts the percentage increase (not adjusting for inflation) by category of compensation. Predictably, much of this growth occurred in the amount of pension contributions, 20% in cities, 26% in counties, and 42% in state agencies. The other significant area of pay increases were in overtime, 42% in cities, a whopping 60% in counties, and 32% in state agencies. This is more than correlation – when the overtime rate of 1.5x regular pay exceeds the rate of employee benefits as a percent of pay, it is financially preferable to pay fewer workers overtime than to hire more workers.

Table 3 – Public Sector Pay in California
Percent Change in Average Pay for Full-Time Workers Between 2012 and 2015
20170124-CompTrends-revised-3

AVERAGE TOTAL COMPENSATION, PUBLIC SAFETY EMPLOYEES – 2015

The causal relationship between pension and other benefit costs and overtime becomes clearer on Table 4, which depicts the average full-time public sector worker’s pay and benefits when splitting the employees into public safety and miscellaneous (all other employees) categories. As can be seen, in 2015 all categories of public safety benefits overhead averaged in excess of 50%, in cities it was 53%, in counties it was 60%, and in state agencies it was 51%. By contrast, among miscellaneous employees where benefits overhead averaged closer to 40%, overtime expenses were relatively insignificant. This causation is further supported by the data showing that in California counties, where pension costs have driven the benefits overhead rate to the highest level, 60%, the increase to overtime charges between 2012 and 2015 (Table 3) was also the highest, at 60%.

Since only regular pay (and some categories of “other pay,” but not overtime) is considered pension eligible, if benefit overhead exceeds 50% of regular pay, it makes more financial sense to pay time-and-a-half than to hire more workers.

Table 4 – Public Sector Pay in California
Pay, Benefits, and Benefit Overhead for Public Safety and Miscellaneous Workers, 2015
20170124-CompTrends-revised-4

While evaluating public safety pay and benefits, it is interesting that a sharp disparity exists between the average pay and benefits earned by full-time police compared to full-time firefighters. As depicted in Table 5, it can be seen that full-time firefighters in California’s cities earned on average in 2015 a total compensation of $196,370; cities, $198,938; state agencies, $145,938. This compares with police in California’s cities who earned on average $161,617; counties, $165,628; state agencies, $136,827. This disparity between firefighter and police earnings is inexplicable or appropriate, depending on who you ask. Also of note is the fact that state agencies pay their police and firefighters much less than cities and counties.

Table 5 – Public Sector Pay in California
Pay, Benefits, and Benefit Overhead for Police and Firefighters, 2015
20170124-CompTrends-2015-police-and-fire-SCO-pay

TOTAL COMPENSATION TRENDS 1995-2015, CALIFORNIA VS. REST-OF-USA

Another way to assess public sector pay in California is to compare it to US Census Bureau data. Unfortunately the census bureau data is limited to payroll, which means we cannot track growth in costs for benefits. But the data does allow a comparison between payroll costs for miscellaneous employees vs. public safety employees, between payroll costs for local (cities and counties combined) agencies and state agencies, and between payroll costs between California’s agencies and their counterparts in the rest of the U.S.

Table 6 shows payroll trends for California’s local governments between 1995 and 2015, compared with the rest-of-the U.S. The bottom line of data indicates that in both California and the rest of the U.S., the rate of pay between 1995 and 2015 – with only slight variations – increased by around 80%. What can also be seen was that the overall average pay for California’s cities and counties exceeded the overall average for the rest of the U.S. by 40%, but with widely varying percentages between miscellaneous employees, whose pay only exceeded the national average by 13%, and public safety employees, whose pay exceeded the national average by 78%.

Table 6 – Public Sector Pay in California
Average Pay, California Local Governments vs. Rest-of-U.S., 1995-2015
20170124-CompTrends-2012-UScensus-local

Comparing rates of pay for California state agencies vs state agencies in the rest of the U.S. yields somewhat similar trends with one notable exception. As shown on Table 7, in the rest of the U.S., average pay overall, and within the subsets of public safety and miscellaneous employees, increased between 1995 and 2015 by 70% to 75%. In California, however, the amount of increase varied a great deal. While miscellaneous employees saw their average pay increase by 83% between 1995 and 2015, public safety employees saw their average pay increase by 118%.

As can be seen on the 2nd to last row of data on Table 7, the average annual pay for public safety employees in California’s state agencies now exceeds the average for their counterparts in the rest of the U.S. by 72%. For local governments in California (Table 6), public safety pay averages 78% greater than in the rest of the U.S. By contrast, miscellaneous employees are paid more than their counterparts in the rest of the U.S. – 16% more in local governments and 39% more in state agencies – but their advantage is less than half that of public safety employees.

Table 7 – Public Sector Pay in California
Average Pay, California State Agencies vs. Rest-of-U.S., 1995-2015
20170124-CompTrends-2012-UScensus-state

It is relevant to note that the Consumer Price Index between 1995 and 2015 increased by 55%, meaning that in real dollars, we are seeing public sector rates of pay increase – in both California and the rest of the U.S. – between 1995 and 2015 at around 25% in excess of the rate of inflation during that period.

TOTAL COMPENSATION TRENDS 1995-2015, CALIFORNIA PUBLIC VS. PRIVATE SECTOR

By relying on U.S. Census Bureau data for public sector salaries and wages, and California EDD (Employment Development Dept.) data for private sector salaries and wages, information is available starting in 2000 through 2015 for comparisons. Unfortunately, 1995 data was not available from the EDD for California workers. Table 8 depicts the wage growth trends for public and private sector workers in California between 2000 and 2015, including breakouts between miscellaneous government employees and public safety employees.

Table 8 – Public Sector Pay in California
Average Pay, California Public Sector vs. Private Sector, 2000-201520170124-CompTrends-2015-EDD-public-v-private

As depicted in the far right column on Table 8, average private sector salaries and wages increased by 47% between 2000 and 2015. By comparison, all public sector employee wages increased by 59% during that same period, with miscellaneous employee wages rising 56% and public safety employee wages rising 64%. As a consequence, as can be seen on the three rows “% > than private sector” (indicating the percent by which public sector pay exceeds private sector pay) beneath each category of government employee, the disparity between public sector and private sector wages became more pronounced over the past 15 years.

Because information on average private sector employee benefits was not available from the EDD, the U.S. Census Bureau, the Bureau of Labor Statistics, or any other source we could identify, it is necessary to impute this number. While the precision of this estimate will necessarily constitute a range of plausible amounts, this will nonetheless yield meaningful comparisons of average total compensation in the private sector vs. in the public sector. As it is, our exhaustive review of the detailed individual compensation records for every city, county, and state worker employed in 2015 in California, gives us a high level of confidence that our results for them as primarily reported on Tables 2 and 4 (and elsewhere) are very accurate.

In order to make a final comparison of total compensation averages between California’s public and private sector workers, estimates must be made of private sector benefit overhead. A practical range would be between zero – which applies to California’s more than 2.0 million independent contractors, and at least 7.65%, which is the sum of employer medicare payments (1.45%) and employer Social Security payments (6.2%). In addition, benefits must include the cost of employer paid health insurance, and the costs for employer contributions to a retirement account such as a 401K. At the high end of the range, therefore, one may impute 10% for health insurance, 3% for a matching 401K contribution, and 7.65% for the employer’s share of Social Security and Medicare, i.e., 20.65%. Insofar as it is unlikely more than half of California’s 18.3 million employed workers enjoy a full-time salaried job with this entire package of benefits, we believe it is a generous assumption to apply a 15% overhead cost to the average private sector worker in California.

As a result, we estimate that the average full-time private sector worker in California in 2015 earned total compensation of $62,475, compared to the average full-time state or local government worker earning $116,887 (state), $117,425 (counties), and $144,012 (cities). Overall, this analysis calculated the average pay and benefits for 154,570 full-time state employees, 223,420 full-time county employees, and 112,764 full-time city employees. The overall average pay for these 450,754 full time employees of California’s cities, counties and state agencies, was $86,977; average benefits, $34,867; average total compensation, $121,843. These calculations were based on a ground-up analysis of individual pay records submitted to the state controller’s office by every city, county and state agency in California. This is in contrast to our estimated total compensation for the average private sector worker in California, which at $62,475 in 2015, is a 51% of what government workers earned in that same year.

OBSERVATIONS AND CONCLUSIONS – THE IMPACT OF FUNDING THE PENSION SYSTEMS

Based on comprehensive review of available data, during 2015 it is clear that the pay and benefits for public sector workers in California’s cities, counties and state agencies make twice, on average, what private sector workers earn. It is important to note this analysis did not include any K-12 employees or higher education employees. Moreover, the methods we used to isolate full-time employees necessarily screened out not only obvious part-time workers, but also full-time workers who may not have occupied their position for a full year. This was necessary to avoid understating how much full-time workers actually earn in California’s public sector. Taking these two factors into account, it should be no surprise the actual employment rolls of California’s state and local agencies are far greater than the 450,754 records we analyzed. According to the U.S. Census Bureau, the “full-time equivalent” number of employees at local agencies in 2015 were 1,370,992; of that, 715,308 worked in public education and were not part of our analysis. Similarly, U.S. Census Bureau data show “full time equivalent” employment with the state in 2015 at 505,977; of that 254,391 worked in public education.

No discussion of current compensation and benefits for California’s public employees is complete without a discussion of the pension systems, because their solvency must be assured in order for these workers to collect in retirement the benefits they have been promised. During 2015 there were 88 public employee pension systems in California, serving nearly 2.5 million active and retired state and local public employees. Any increases to the employer contributions to these systems must be considered additional compensation to these employees.

Put another way, a fair way to estimate how much public employees in California are really making would be to estimate how much more needs to be contributed to their pension systems by their employers, and spread that increase among the 1,876,969 “full time equivalent” public employees. Table 9, drawn from a California Policy Center analysis performed in early 2016 using 2014 data from the U.S. Census Bureau, offers usable estimates:

Table 9, California State/Local Pension Funds Consolidated
2014 – Est. Funding Status and Required Contributions at Various ROI
20160516-CPC-Ring-pension-liabilities

What Table 9 offers is an opportunity for the reader to pick a number. Many studies on this topic will lead with a headline proclaiming the collective unfunded liability for California’s pension funds to be $1.0 trillion, or a “half trillion.” But as can be seen on Table 9, these proclamations merely depend on what rate of return is assumed. At what remains the official rate of return projection, California’s state/local government pension funds are about $250 billion underfunded. At a projected rate of return of 3.5%, they are nearly $900 billion underfunded. The lower portion of Table 9 offers actual cash payment projections based on collective assumptions (2.5% multiplier, eligibility at 57, 30 year level payments to reduce unfunded liability) that we consider best-case conservative. As can be seen, best case, $38.1 billion needed to be contributed to the pension funds in 2014 – in reality, in that year the collective contributions were only $30 billion (ref. The Coming Public Sector Pension Apocalypse, CPC April 2016).

Some relevant recent 2015 data has been compiled by Ballotpedia, showing that during 2015 the pension systems in California received $34.1 billion in contributions from government employers and paid out $48.5 billion to retirees. While the total required taxpayer contribution calculations on Table 9 are from a previous year, it is a reasonable assumption that they will not be lowered in 2015 compared to 2014. Therefore, at a 7.5%, best case rate of return, the pension funds should have received $38.1 billion in 2015, but actually only got $34.1 billion. That is, best case, they were $4.0 billion short.

In reality it is likely they needed to contribute far more than $38.1 billion, because many pension funds, including the largest, CalPERS, have already acknowledged they will have to lower their projected return to 6.5%. And the largest municipal credit analysis bureau in the U.S., Moody’s, has begun using the risk-free corporate bond rate of return when calculating pension liabilities for cities and counties, 5.5%. One may argue that a realistic rate-of-return projection belongs lower still, at 4.5% or even 3.5%. After all, 3.8% is the rate liabilities are valued at by the pension systems themselves when calculating how much an agency that wants to exit the system has to pay them. But sticking with a reasonable 5.5%, as can be seen on Table 9, the pension funds during 2015 should have received $67.6 billion and only got $34.1 billion. They were $33.5 billion short.

Applying this shortfall pro-rata to the amount paid California’s 1.8 million full-time-equivalent active state and local government workers is straightforward. $33.5 billion / 1.8 million = $17,848.

To be perfectly accurate, this average would obviously need to be applied unevenly. For example, the more generous pay and pension formulas offered to public safety employees means it would cost more than $17,848 in additional pension fund contributions each year to keep their pension funding solvent. Conversely, other employees would be able to shore up their pension funding ratios with less than a $17,848 per capital annual increase. But on average, this is a sound number. If anything, it remains low, because unfunded OPEP (other post employment benefits, typically supplemental health insurance) liabilities also require increasing contributions during the careers of active workers who expect to receive these benefits in retirement.

Therefore we can conclude that the average pay and benefits for California’s active state and local public employees totals at least $139,691 if they expect to collect their retirement benefits without reductions. What they currently make on average, $121,843 per year, almost certainly does not include sufficient pension fund contributions to allow them to actually get the benefits they were promised. So depending on which number you pick, the average private sector worker in California, whose pay and benefits are at best estimated to be $62,475 per year, makes between 45% and 51% of what their public servants make. Can greater levels of education and job risk account for this two-to-one disparity?

 *   *   *

Ed Ring is the vice president of policy research for the California Policy Center.

SOURCES

California’s Total State and Local Debt Totals $1.3 Trillion, 2017, California Policy Center

The Coming Public Pension Apocalypse, and What to Do About It, 2016, California Policy Center

Government Compensation in California, California State Controller

Government Employment & Payroll, U.S. Census Bureau

How Much Do California’s State, City and County Workers Really Make?, 2014, California Policy Center

California Labor Market Information, California Employment Development Dept.

Consumer Price Index Data from 1913 to 2017, U.S. Dept. of Labor

Employer Costs for Employee Compensation 1995, 2000, 2005, 2010, 2015, U.S. Dept. of Labor, Bureau of Labor Statistics

California Employment and Wages Data Tables (2011-2016), California Employment Development Dept.

California Employment and Wages Data Tables (2000-2010), California Employment Development Dept.

Public pensions in California, 2015, Ballotpedia

California’s Total State and Local Debt Totals $1.3 Trillion

We estimate that California state and local governments owe $1.3 trillion as of June 30, 2015. Our analysis is based on a review of federal, state and local financial disclosures. The total includes bonds, loans and other debt instruments as well as unfunded pension and other post-employment benefits promised to public sector employees. Our estimate of California government debt represents about 52% of California’s Gross State Product of $2.48 trillion. When added to the state’s share of the national debt, we find that California taxpayers are shouldering debt burdens on a par with residents of peripheral Eurozone states.

Not included are billions of dollars in deferred maintenance and upgrades to California’s infrastructure. To the extent California’s government has not maintained investment in infrastructure maintenance and upgrades to keep up with normal wear and to keep pace with an expanding population, it has passed this cost on to future generations who will have to issue additional debt to pay for this expense.

Components of California Government Debt

This is an update of a 2013 California Policy Center study entitled “Calculating California’s Total State and Local Government Debt.” That study reported total debt between $848 billion and $1.1 trillion. While we retain confidence in the findings of this earlier analysis, our new estimate incorporates a more comprehensive array of data sources and updated methodologies.

Our previous research relied primarily on official reports prepared by the State Controller and State Treasurer. Since 2013, some of this reporting has been altered or discontinued. Our current estimate supplements state provided data, with US Census data and information gathered from audited financial statements issued by state and local governments.

The latest U.S. Census Bureau estimate of California state and local government debt is $426 billion. Although this estimate is as of 2014, it is the most authoritative number available. Further, it appears to be reasonable based on our review of audited financial statements published by 300 of the state’s largest governmental entities. Although the state has over 4,000 government entities (and perhaps many more depending on one’s method of counting), most of these entities are relatively small and do not contribute significantly to state-wide totals.

We used the data collected from the audited financial statements to allocate the $426 billion total to the various categories of governments listed in the first section of the following table. State government is the largest borrower, but cities, counties, local educational authorities and special purpose governments also made large contributions to the total.


Special districts, authorities and agencies receive relatively limited attention, but some are large borrowers. For example, the Metropolitan Transportation Commission responsible for Bay Area Bridges, and to a lesser extent, area roads and public transit systems, has over $10 billion in liabilities, mostly in the form of bonds.

Table 1 also shows an estimated $148 billion of unfunded Other Post-Employment Benefits (primarily retiree health care). The state and county governments contribute the lion’s share of this total. Los Angeles County has the largest Unfunded Actuarially Accrued Liability (OPEB), at almost $27 billion. Our OPEB UAAL estimates are based on our review of the government audited financial statements for the 300 largest state government entities, which we believe account for 95% of statewide obligations.

The bond and OPEB obligations account for a total of $574 billion that we can attribute to governments by category. To this we add statewide unfunded pension obligations reported by 85 single and multi-employer pension plans, estimated at $258 billion. For most systems, we used a database posted by the State Controller, but for the largest systems, we obtained 2015 updated data from actuarial valuation reports.

Unfunded retirement obligations are considered long-term debt by any reasonable accounting standard. The principle behind this is clear: retirement benefits are earned during the years an employee works. To the extent the pension fund assets do not equal the present value of this future liability, a debt is created.

A large body of literature has arisen to question Unfunded Actuarially Accrued Liabilities (UAAL) reported by pension systems (see, for example, the work of Robert Novy-Marx and Joshua Rauh). The main concern is that most public pension systems discount the value of future benefit payments by unrealistically high rates of between 7% and 8% per year. Some authors contend that the discount rate employed should be a long-term risk free rate (of around 3%) because the benefits are almost certain to be paid. Others argue that a discount rate based on future asset returns may be used, but argue for adopting a more conservative rate given the fact that most systems have failed to achieve target returns in most recent years.

Moody’s, the credit rating agency, discounts pension liabilities with the Citigroup Pension Liability Index (CPLI), which is based on high grade corporate bond yields. When Moody’s first introduced its pension methodology a few years ago, we applied it to pension liabilities reported as of June 2011 when CPLI was 5.67%. More recently, CPLI has fallen: in June 2015, it was 4.44%. As a result, the increase in UAAL arising from the use of Moody’s methodology is much greater than it was when we first evaluated pension debts.

Using the CPLI discount rate, we estimate that the real UAAL is $713 billion, which is $455 billion more than the officially reported (the method for restating UAAL based on a different discount rate assumption is described here). An alternative approach used by the Stanford Institute for Economic Policy Research (SIEPR) is to discount the liabilities by a rate closer to the risk-free rate. In a recent report, Stanford researchers used a discount rate of 3.723%. Using Stanford’s methodology, we estimate a UAAL of $1.02 trillion.

It should be noted that this low rate is used by CalPERS to determine how much to charge a local government that chooses to leave the system. The logic in using this rate is probably that CalPERS would no longer be able to raise pension contribution levels after the agency has left the system and can’t depend upon local taxpayers to make up any shortfall in CalPERS’ future investment performance.

The following table shows liabilities by major pension system as reported, with the Moody’s adjustments and with the Stanford adjustments.


pensionunderfunding2015

Debt Continues to Increase

According to the State Treasurer’s Office Debt Watch website, $72 billion on new debt was issued in the year ending December 2016 as summarized below. This amounts to a debt increase of about $1,800 per citizen or about $4,600 per taxpayer in only one year (but this is partially offset by maturities and early repayments of exiting issues).

newissuance2016

California Debt in a National and International Context

The grand total of government borrowings, unfunded OPEB obligations and unfunded pension obligations is $1.28 trillion, or 52% of Gross State Product (GSP is a state’s share of the nation’s Gross Domestic Product and was $2.48 trillion in 2015). This represents a significant but not extraordinary debt burden by international standards.

But to more properly consider California debt in an international context, we should add federal debt for which California taxpayers may be responsible. In 2015, the ratio of publicly held federal debt to GDP was 73% (the national debt, which also includies debt securities held by the Social Security Administration and other federal agencies raises this proportion to 101% as of mid-2015).

Combining California’s debt with publicly held federal debt, we estimate a total debt-to-GDP ratio of 125% (or 153% using the broader definition of federal debt). This level places California distressingly close to peripheral Eurozone countries that faced financial crises in 2011 and 2012. Portugal’s 2015 debt-to-GDP ratio was 129% and Italy’s was 133%.

Implications at the Individual Level

The estimated California government debt of $1.3 trillion can be allocated back to all residents or just those that pay taxes. The state’s population is about 39 million. According to the IRS, about 17 million individual tax returns were filed in 2014. These levels imply California government debt burdens of $33,000 per resident and $74,000 per taxpayer – excluding their share of federal debt.

Further Research Needed

There are additional questions that remain to be addressed. The totals we report do not include the cost of addressing deferred maintenance of the state’s civil infrastructure. However, in 2015, California Forward estimated that the state faces a $358 billion infrastructure funding gap over the next ten years.

We have not looked at trends. How much faster has state and local debt grown compared to the state’s economy that supports the debt? We have not made any attempt to determine if the level of debt is beyond what the state can afford to service or what the impact of future interest rate increases may have on the ability of state and local government entities to service this level of debt in the future. Interest rates are at historic lows and are likely to rise in the future.

We have not estimated the impact of any possible increase in required pension payments on state and local government budgets. If CalPERS and other public employee pension systems reduce their discount rates to be consistent with recent investment performance and likely future investment returns, pension payments will increase substantially for state and local governments.

The State Treasurer’s office reports totals for debt issued on their Debt Watch website but does not estimate total debt outstanding. Some of the debt issued is retired or replaced by new debt. We understand that starting in 2018 the State Treasurer will start reporting debt outstanding as well as debt issued by various levels of government. This should improve the accuracy of future California Policy Center reports on total debt outstanding and eliminate the need to make estimates for some of the data.

About the Authors:

William Fletcher is a business executive with interests in public finance and national security. He retired as Senior Vice President at Rockwell International where most of his career was spent on international operations and business development for Rockwell Automation. Before joining Rockwell, he worked for Bechtel Corporation, McKinsey and Company, Inc., and Combustion Engineering’s Nuclear Power Division, and was an officer and engineer in the U.S. Navy’s nuclear program. His international experience includes expatriate assignments in Hong Kong, Europe, the Middle East, Africa and Canada. In addition to his interest in California’s finances, he is involved in organizations dealing with national security and international relations. Fletcher is a graduate of Tufts University with a BS degree in Engineering and a BA degree in Government. He also graduated from the U.S. Navy’s Bettis Reactor Engineering School.

Marc Joffe is the Director of Policy Research at the California Policy Center. In 2011, Joffe founded Public Sector Credit Solutions to educate policymakers, investors and citizens about government credit risk. His research has been published by the California State Treasurer’s Office, the Mercatus Center at George Mason University, the Reason Foundation, the Haas Institute for a Fair and Inclusive Society at UC Berkeley and the Macdonald-Laurier Institute among others. He is also a regular contributor to The Fiscal Times. Prior to starting PSCS, Marc was a Senior Director at Moody’s Analytics. He has an MBA from New York University and an MPA from San Francisco State University.

Rebuilding California’s Infrastructure – Introduction (Part 1 of 6)

20161123-cpc-infrastructure-cover

This is Part One of “Rebuilding California’s Infrastructure,” to access the other five sections, click on the links below. To access the entire six-part study in a single, printable PDF document, DOWNLOAD HERE.

Part One: Introduction
Part Two: Water Reuse
Part Three: Water Storage
Part Four: Desalination
Part Five: Energy and Transportation
Part Six: Financing Models and Policy Recommendations

EXECUTIVE SUMMARY

California’s water, energy and transportation infrastructure has not been adequately maintained. The state’s water infrastructure has not been expanded since the 1970’s and is designed to accommodate 20 million residents when California now has nearly 40 million residents. Its transportation infrastructure is considered one of the worst maintained in the U.S. Its energy infrastructure is increasingly oriented towards renewables, without a clear plan to realize the distribution and storage upgrades necessary to realize this dramatic shift.

Current policies in California embrace water and energy conservation and mass transit to balance demand with supply. While we don’t oppose conservation per se, we believe that current and future Californians deserve abundant and affordable water, power and mobility. Current state policies that enforce scarcity are ultimately inconsistent with a prosperous and growing California.

This study investigates California’s infrastructure challenges, focusing on projects to increase the supply of water, but also surveying opportunities in energy and transportation. We find that many infrastructure projects can yield viable returns to investors. With respect to water supply, the study finds cost effective solutions in the areas of storm runoff storage in aquifers and reservoirs, as well as in sewage treatment and reuse. The study finds desalination to also be a financially viable alternative, particularly as a way to ensure diverse and resilient sources of water to California’s large coastal urban centers.

As an alternative to funding new infrastructure through municipal bonds, we suggest the possibility of securing investments from California’s state and local public employee pension funds. Over 90 independent pension systems, led by CalPERS and CalSTRS, in aggregate have nearly $800 billion in assets under management. Deploying a significant percentage of these assets to fund revenue producing civil infrastructure could deliver to these pension funds safe and reasonable returns. These returns are comparable to the target earnings of the pension systems, while offering reliability during an era of uncertain stock market performance.

Encouraging pension investment in civil infrastructure not only serves the twin goals of rebuilding California’s water, energy and transportation assets and providing safe and lucrative investment opportunities for pension funds. It will create hundreds of thousands of good construction jobs along with tens of thousands of jobs operating these new facilities, enriching California’s economy. And having these new assets will greatly improve California’s quality of life, attracting new residents and businesses.

With respect to infrastructure, the conventional wisdom in California politics today is austerity – resource conservation and minimal financial wherewithal. Our study proposes an exciting alternative that embraces prosperity and abundance.

CONTENTS

Section One: Introduction – Why Now?, Objectives of this Study

Section Two: Water Reuse – Current Capacity, Costs to Build Water Reuse Capacity, Revenue Potential, Return on Investment

Section Three: Water Storage – Current Capacity, Proposed projects to expand surface water storage capacity, Developing groundwater storage capacity, Costs to Acquire Water Storage Capacity, Revenue Potential, Return On Investment

Section Four: Desalination – Introduction, The Carlsbad Desalination Plant, What’s Innovative about the Carlsbad Desalination Plant?, Cost for Customers of Water Produced by Carlsbad Desalination Plant, Financing and Plant Economics, Obstacles – Cost and Financial Risk, Other Seawater Desalination Plants in California, Controversy over the Huntington Beach Plant, Responding to the Cost-Based Arguments against Desalination, Brackish Groundwater and Surface Water Desalination, Desalination Elsewhere in the United States, International Cases, Desalination in Israel and its Relevance to California, Other Countries, Conclusion

Section Five: Energy and Transportation – Energy, Natural Gas Pipelines, Freight Rail, Oil Trains vs. Pipelines, Passenger Rail, High Speed Rail, High Occupancy Toll Lanes, Conclusion

Section Six: Financing Models and Policy Recommendations – Policy Recommendations: California, Policy Recommendations: Federal, Conclusion

INTRODUCTION

California’s civil infrastructure was once the envy of the nation. During the 1950’s and 1960’s the state wisely invested in transportation, water and power infrastructure, delivering capacity well in excess of the needs of the state’s population at the time. Even today, the scale of California’s network of aqueducts and pumping stations to transfer water from north to south, east to west, is one of the largest in the world, and California’s vast network of freeways has few rivals.

Policymakers of that era had planned to continue to expand these infrastructure assets to accommodate a growing population, but that all came to a halt in the 1970’s.[1] During the 1970’s not only were the plans for additional water storage and distribution assets abandoned, but state-owned rights-of-way and land acquisitions both for water and transportation were sold to private interests. As a result, California now has a population of 40 million people living in a state with civil infrastructure designed to accommodate 20 million people.[2]

California’s political leadership has avoided new investment in civil infrastructure by zoning ultra-high density infill in urban areas, transit villages, and light rail, by mandating energy efficiency and incentivizing decentralized renewable energy sources such as rooftop photovoltaics, and by mandating water conservation and incentivizing retrofits such as low-flow faucets and toilets. In effect, the new political alternative to infrastructure development is conservation.

The deliberate imposition of scarcity on Californians has artificially elevated the cost-of-living. Restrictions on land development, elevated prices for water and electricity, and monstrous commutes on congested freeways[3] take an inordinate toll on wallets and productivity. What’s more, it is not clear that these restrictions have been beneficial.

For example, restrictions on urban water reuse don’t have a significant impact on water availability – at a macro level. In a dry year, around 150 million acre feet (MAF) fall onto California’s watersheds in the form of rain or snow; in a wet year, we get almost twice that much.[4] Most of that precipitation either evaporates, percolates, or eventually runs into the ocean. In terms of net water withdrawals, each year around 31 MAF are diverted for the environment, such as to guarantee fresh water inflow into the delta, 27 MAF are diverted for agriculture, and 6.6 MAF are diverted for urban use. [5] Of the 6.6 MAF that is diverted for urban use, 3.7 MAF is used by residential customers, and the rest is used by industrial, commercial and government customers.[6] Put another way, 65 million acre feet of water is diverted each year in California for environmental, agricultural and urban uses, and a 25% reduction in water usage by residential customers will save exactly 0.9 million acre feet – 1.4% of our total statewide water diversions.

Figure 1: California Water Budget in a Dry Year (amounts in AF)
20161123-cpc-infrastructure-f1

Consumption of electricity is an area where considerable progress has been made towards conservation over the past few decades. But this progress, while impressive, puts an economic burden on low income families, small businesses, and energy-intensive large businesses. And the ambitious goals set forth in the Scoping Plan issued pursuant to the Global Warming Solutions Act of 2006 (Assembly Bill 32, commonly referred to as AB 32) cannot be achieved without imposing even greater economic burdens on Californians.

Conservation has been a convenient policy initiative in the face of shrinking budgets and reduced funding. It has given license to defer maintenance on existing infrastructure assets which has both eroded service delivery and shortened assets’ useful lives.  Neglected bridges on major freeways suddenly collapse in flash floods, roads plagued with potholes cause accidents and make commutes longer, aging water mains burst. To reverse this course will require over $700 billion.[7]

Conservation in lieu of investment has also resulted in decades of under-investment in new infrastructure assets to improve services and provide resiliency to weather droughts, to ride out market-price spikes, and to accommodate a growing population.  This approach has prevented California from benefitting from supply-producing infrastructure innovations in water reuse and energy generation, as well as service improvements via transportation modernization.

The premise of this study is that massive new investment in California’s infrastructure in the areas of water, energy, and transportation will lay the foundation for a prosperous 21st century in the Golden State. It goes beyond the scope of this study to offer a detailed critique of the many policies aimed at promoting conservation. Rather the purpose of this study is to offer balance to the discussion by surveying an assortment of civil infrastructure projects that would increase supply and improve services. While this challenges the conventional political wisdom, it is nonetheless consistent with the spirit of innovation that has made California great and continues to define its culture. We believe that designing policies to create abundance instead of scarcity is an idea whose time has come.

WHY NOW?

There is a convergence today of several trends that justify massive investment in new and upgraded civil infrastructure. California’s infrastructure assets have increasingly become liabilities to cash-strapped municipalities, with a significant percentage of them unable to supply goods and services to satisfy demand due to deferred maintenance and obsolescence. At the state level, the cost of repairing and replacing these assets is a long-term liability that could ultimately impact the California’s credit rating.[8]  At the same time, an ever-growing pool of institutional investment capital is seeking to invest in infrastructure assets that can generate returns and income no longer reliably available from stocks and bonds.[9] This presents an opportunity for California to capitalize on investor interest by creating policies and programs to encourage the creation of infrastructure that will provide more goods and services and that, collectively, will strengthen and sustain the state’s economy.

The scope of California’s deferred maintenance problem is quantified in the Governor’s 2016 Five-Year Infrastructure Plan for California. The report attributes 90% of the state government’s $77 billion in deferred maintenance costs to transportation and water infrastructure assets.[10] The Governor’s plan to address the $57 billion in deferred maintenance on roads, for example, calls for spending a one-time $1.7 billion on road fixes and improvements and an additional $36 billion over ten years. This approach, however, continues to fall far short of what’s needed to protect and improve the operation of Californian infrastructure assets and to meet the demands of its citizens.

While public finance officials grapple with the consequences of deferred maintenance and underinvestment, institutional investors struggle to adapt to lower return expectations for both the equity and fixed income markets.

A recent McKinsey report suggests that annual returns on US equities will fall from 7.9% to somewhere in the range of 4.0% to 6.5%, while US bond returns will fall from 5.0% to between 0.0% and 2.0%.[11] These less generous return expectations, borne of today’s low interest rates and limited GFP growth, is causing investment managers to consider alternatives to traditional equity and fixed income holdings. One such alternative investment is the universe of core infrastructure assets, particularly those assets with strong operating histories and contracted, inflation-linked cash flows, which could replace income traditionally generated by fixed income investments.

Long-term institutional investors are eager to deploy capital into US infrastructure yet struggle to do so because investment opportunities are limited and highly competitive. The recent auction of the Indiana Toll Road demonstrates the value of high-quality infrastructure assets to institutional investors. In 2015, a consortium of pension funds purchased the remaining 66 years of a lease on the Indiana Toll Road for $5.725 billion; this price was well above the $3.85 billion paid by the original investment group in 2006, and came despite the fact that this original concessionaire declared bankruptcy.[12]

The lack of infrastructure opportunities for US institutional investors is attributable to the fact that most infrastructure assets and systems are owned by government and operated as monopolies. It is very difficult for private-sector businesses to compete with government monopolies delivering subsidized goods, especially those protected by legislation from market forces that promote efficiency and competition. This restricts the investable universe for institutional investors.

By and large, California has ready and abundant access to tax-exempt financing through the municipal bond market. It does not make sense then for public agencies to pay institutional investors more for their capital than they pay in the municipal bond market—currently about 4 percent.

But while capital at 4 percent appears cheap, borrowing costs are only the starting point in public infrastructure projects. Other costs, such as operations and maintenance, ought to be considered—and too frequently are not—when undertaking projects that might stretch out over 30 years. Governments and taxpayers would potentially get far more value from institutional investors willing and able to finance total lifecycle costs than they do from a simple bond issuance.

In competing for opportunities to invest, institutional investors will need to differentiate themselves and demonstrate that they can add value beyond what is available in the municipal market. This may include providing: 1) the ability to provide a ready source of patient equity capital that is more interested in long-term dividends than up-front fees for advisory and/or construction services, 2) expedited contracting procurement for projects with time-sensitive and/or complex delivery requirements, 3) domain expertise and management resources, and, 4) a way to monetize non-essential assets without ceding public ownership.

For these reasons, encouraging institutional investment in California’s infrastructure now—when public agencies and institutional investors needs and interests are advantageously aligned—potentially provides a way to rebuild the backbone of the state’s economy.

OBJECTIVES OF THIS STUDY

This study aspires to identify opportunities for investment in civil infrastructure that have the potential to increase supply and improve services to Californians. We survey infrastructure with revenue-generating capacity that can repay taxpayers and investors in key project areas that we believe urgently require investment.

We begin with in-depth examinations of three opportunities for water infrastructure investment:

Water Supply Reuse:  Upgrade sewage treatment plants to produce potable water. California’s sewage treatment plants currently produce approximately 5 million acre feet of waste water per year. Less than 20% of this water is currently treated sufficiently to be reinjected into aquifers for reuse as potable water. Reusing sewage could replace up to 50% of California’s total urban water consumption.

Reservoirs:  Build reservoirs for runoff capture. The Sites reservoir proposal is a good example of a project with excellent return on investment potential that cannot get built primarily due to objections from environmentalists. As a project that diverts runoff, however, it is not nearly as objectionable as high dams. This section will survey what both of these types of water storage options cost, taking into account current best practices to minimize environmental impact.  This section will include an analysis of the parallel value of reservoirs as a means to store and distribute intermittent renewable energy.

Desalination:  Build desalination plants along the California coast. California currently has one major desalination plant operating, in Carlsbad, producing (by world standards) a relatively meagre 50,000 acre feet per year. Meanwhile, desalination technology and economies of scale elsewhere in the world prove that desalination is cost effective. Taking into account the cost to pump water through California’s extensive system of inter-basin aqueducts, desalination in Southern California is even an energy-neutral proposition.

For each of the above cases we will survey the most likely possible projects, many of them already proposed. We will discuss the costs to build them, their capacity, and the impact they will have in the context of total existing capacity. We will report on their estimated potential revenues, operating costs, and potential return on investment. Where possible, for comparison, we will also report on the cost, capacity, and returns for similar projects elsewhere in the developed world.

We also provide a survey of successful financing models and policy initiatives used in other countries to increase private investment in civil infrastructure. We will analyze these models and incentives to understand the benefits of their approach in contrast to the American method of investing on a transactional basis in a bond offering.

After addressing water infrastructure in depth, we survey energy and transportation investment opportunities at a higher level. We find evidence that new investments in solar/natural gas hybrid power generation, commuter rail and High Occupancy Toll (HOT) lanes would provide benefits in excess of cost.

We acknowledge that there are significant political challenges to investing in California’s infrastructure on a major scale including uncertainty about the state’s expiring public-private partnership legislation, balance in environmental reviews, debt capacity, and the utility of cost-for-services legislation. We have tried to factor these challenges into both our investment and policy recommendations.

The study will conclude with proposed policy recommendations aimed at improving the quality of life in California and strengthening its economy.

 *   *   *

FOOTNOTES

[1] Carson Bruno (April 13, 2016). California’s Crumbling Condition – The Past, Present, and Future of Infrastructure in California. Hoover Institution. http://www.hoover.org/research/californias-crumbling-condition-past-present-and-future-infrastructure-california.

[2] The state’s population was 20 million in 1970. For more on the stoppage of infrastructure development at that time, see Victor Davis Hanson (Winter 2015). The Scorching of California, City Journal. http://www.city-journal.org/html/scorching-california-13704.html.

[3] According to 2015 Census data, 24% of Los Angeles County commuters took 45 minutes or more to get to work. See http://factfinder.census.gov/faces/tableservices/jsf/pages/productview.xhtml?src=bkmk.

[4] Elizabeth A. Stanton and Ellen Fitzgerald (February 2011). California Water Supply and Demand: Technical Report. Stockholm Environment Institute. http://sei-us.org/Publications_PDF/SEI-WesternWater-CWSD-0211.pdf.

[5] Ellen Hanak, et. al. (2011). Managing California’s Water: From Conflict to Reconciliation. Public Policy Institute of California. Table 2.2, Page 86. http://www.ppic.org/content/pubs/report/R_211EHR.pdf.

[6] Author’s analysis of California Department of Water Resources (April 23, 2014). 2010 Urban Water Management Plan Data: DOST Tables 3, 4, 5, 6, 7a, 7b, & 7c: Water Deliveries – Actual and Projected, 2005-2035. http://www.water.ca.gov/urbanwatermanagement/docs/2014/T3_T4_T5_T6_T7_Water_Deliveries04-23-14post.xls.

[7] John Chiang (February 9, 2016). Building California’s Future Begins Today. http://www.treasurer.ca.gov/publications/biennial/2016.pdf. Page 2 quotes estimates from CA Forward of the state’s infrastructure needs and available funding. Water infrastructure is expected to require $200 billion of investment of which $24 billion is not yet available; transportation requires $535 billion of which $294 billion is not yet available.

[8] To the extent that the state relies on newly issued debt to fund infrastructure maintenance.

[9] Ed Ring (May 16, 2016). The Coming Pension Apocalypse, and What to Do About It? California Policy Center. http://californiapolicycenter.org/the-coming-public-pension-apocalypse/.

[10] Edmund G. Brown (2016). California’s Five Year Infrastructure Plan. http://www.ebudget.ca.gov/2016-Infrastructure-Plan.pdf.

[11] McKinsey Global Institute (May 2016). Diminishing Returns: Why Investors May Need to Lower Their Expectations. http://www.mckinsey.com/~/media/mckinsey/industries/private%20equity%20and%20principal%20investors/our%20insights/why%20investors%20may%20need%20to%20lower%20their%20sights/mgi-diminishing-returns-full-report-may-2016.ashx.

[12] Caitlin Devitt (March 11, 2015). Huge Indiana Toll Road Bid Seen Boosting P3 Sector. The Bond Buyer. http://www.bondbuyer.com/news/regionalnews/huge-indiana-toll-road-bid-seen-boosting-p3-sector-1071274-1.html. Bill Dolan (March 11, 2015). Down-under consortium claims victory in Toll Road bidding. Northwest Indiana Times. http://www.nwitimes.com/news/local/lake/down-under-consortium-claims-victory-in-toll-road-bidding/article_12703e55-f80e-5794-8480-0d65ae3781ff.html.

*   *   *

ABOUT THE AUTHORS

Marc Joffe is the Director of Policy Research at the California Policy Center. In 2011, Joffe founded Public Sector Credit Solutions to educate policymakers, investors and citizens about government credit risk. His research has been published by the California State Treasurer’s Office, the Mercatus Center at George Mason University, the Reason Foundation, the Haas Institute for a Fair and Inclusive Society at UC Berkeley and the Macdonald-Laurier Institute among others. He is also a regular contributor to The Fiscal Times. Prior to starting PSCS, Marc was a Senior Director at Moody’s Analytics. He has an MBA from New York University and an MPA from San Francisco State University.

Jill Eicher Jill Eicher is a researcher focusing on innovative financing models for public-sector agencies. Most recently, she was a Visiting Scholar at Stanford University’s Global Projects Center, working on the development of a cooperative investment model for public pension funds to deploy capital into U.S. infrastructure. She co-founded the Fiduciary Infrastructure Initiative, a research-driven venture focused on the applicability of international pension cooperatives making direct infrastructure investments as models for the U.S. A graduate of Wellesley College, Eicher did post-graduate work in mathematics and was issued a patent for her method for assessing investment risk.

Ed Ring is the Vice President of Policy Research at the California Policy Center. His work has been cited in the Los Angeles Times, Sacramento Bee, Wall Street Journal, Forbes, and other national and regional publications. Previously, as a CFO primarily for start-up companies in the Silicon Valley, he has done financial accounting for over 20 years, and brings this experience to his analysis and commentary on issues of public sector finance. From 1995 to 2009 he was the editor of EcoWorld, a website covering environmental issues from a free-market perspective. Between 2007 and 2010 he launched in partnership with AlwaysOn Media the highly successful “GoingGreen” clean technology investor conferences, held annually in San Francisco and Boston. He has an MBA in Finance from the University of Southern California, and a BA in Political Science from UC Davis.

Kevin Dayton is a policy analyst for the California Policy Center, a prolific writer, and the author of frequent postings about generally unreported California state and local policy issues on the California Policy Center’s Prosperity Forum and Union Watch. Major policy reports written by Kevin Dayton include For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction. Dayton spent more than 17 years in various federal, state, and local policy positions for Associated Builders and Contractors (ABC), including ABC of California State Government Affairs Director from 2005 to 2012. He was also a legislative assistant in the U.S. House of Representatives for Congressman Gary A. Franks (R-Connecticut) from 1992 through 1994. Dayton is a 1992 graduate of Yale University, where he majored in History.

ABOUT THE CALIFORNIA POLICY CENTER

The California Policy Center is a non-partisan public policy think tank providing information that elevates the public dialogue on vital issues facing Californians, with the goal of helping to foster constructive progress towards more equitable and sustainable management of California’s public institutions. Learn more at CaliforniaPolicyCenter.org.

 *   *   *

Rebuilding California’s Infrastructure – Water Reuse (Part 2 of 6)

20161123-cpc-infrastructure-cover

This is Part Two of “Rebuilding California’s Infrastructure,” to access the other five sections, click on the links below. To access the entire six-part study in a single, printable PDF document, DOWNLOAD HERE.

Part One: Introduction
Part Two: Water Reuse
Part Three: Water Storage
Part Four: Desalination
Part Five: Energy and Transportation
Part Six: Financing Models and Policy Recommendations

WATER REUSE

While water reclamation, or more commonly, water reuse, has been used primarily to achieve conservation goals, we examine its potential to increase water supply and to generate revenue. We will explore how water authorities[1] could use reclaimed water as a new source of revenue to accelerate efforts to build facilities and acquire greater water reuse capacity. We will also examine how this revenue could be used to repay taxpayers and investors committing capital to water reuse projects.

Water reclamation—the treatment of wastewater to produce water that meets increasing standards of water quality, specifically, non-potable reuse (NPR), indirect potable reuse (IPR), and direct potable reuse (DPR)—introduces new revenue potential to the business models of municipal water authorities and promises to expand water markets across California.

The table below describes the three categories of reclaimed water in terms of fundamental approved use as determined by progressively stricter water quality standards. The table also highlights dynamics fueling market activity.

Types of Reclaimed Water, Use and Market Dynamics
20161123-cpc-infrastructure-reuse1

The convergence of these market dynamics is driving the market for reclaimed water, particularly in local water markets where traditional suppliers are not able to meet demand and consumers’ tolerance for continued forbearance with conservation mandates and supply disruptions wanes. As we will show, there is a tension between policymakers’ efforts to encourage water recycling for conservation purposes and long-standing regulations that make it difficult for water authorities to finance such capital-intensive mandates.

According to California’s Department of Water Resources (DWR), recycled water has the potential to increase water supply by 1.8 million to 2.3 million acre-feet per year by 2030.[2] In 2013, DWR reported annual water reuse production of 670,000 acre-feet.[3] Applying current local rates of $208 per acre-foot for recycled water[4] and recent open market price observations of $1,000 per acre-foot[5] the midpoint of DWR’s 2030 projection levels would indicate a $426 million regulated-market value or a $2 billion value on the open market (although such a large increase in the amount of water available could lead to lower prices).

CURRENT CAPACITY

California continues to lead the country in water reclamation and was the first state to establish regulations for non-potable reuse. Water reclamation plants in California have been treating wastewater to produce non-potable water for irrigation and other commercial purposes since the mid-sixties. Today, there are roughly 250 water reclamation facilities statewide. The most recent survey of water reuse found that approximately 13 percent (or 669,000 acre-feet) of the total 5 million acre-feet of municipal wastewater produced each year is reused.[6]

We estimate the annual cost to treat California’s wastewater is more than $3.6 billion.[7] The water that is treated but not reused—some 4.3 million acre-feet—is then disposed of on an annual basis. With water selling for $1,000 per acre-foot on the open market, the value of this discarded water is about $4.3 billion per year, before treatment costs.

While most of California’s reclaimed water is for non-potable reuse, some water districts began acquiring advanced water purification technology to produce indirect potable water for recharging and/or replenishing groundwater beginning in the early 2000s. According to the Department of Water Resources, IPR production represents approximately 19% of wastewater reclaimed.[8] A few water districts have upgraded (or are considering upgrading) their advanced water purification facilities to be able to produce drinking-quality water (DPR) as policymakers work to establish quality standards.

To put California’s capacity to reuse water into context, we compare current and state-targeted levels for 2030 to total wastewater volume available in the chart below.

California Wastewater Volume – Current vs. Potential Capacity
20161123-cpc-infrastructure-reuse2

Local water districts are keenly interested in increasing water reuse capacity because of 1) uncertainty about the reliability of existing water supplies, 2) rising costs to import water, and 3) state policy guidelines on wastewater discharge requirements.  As they begin to produce more meaningful supplies of potable and non-potable water revenue potential increases, cost-saving opportunities emerge, and new customer segments develop.

Key legislation has encouraged water authorities to increase water reuse capacity and to study the feasibility of developing greater potable reuse capacity. At the same time however existing legislation such as Proposition 218, restricts water authorities’ ability to develop reuse capacity by requiring fees to be tied directly to services of a specific asset.

Examples of water reuse projects under development include the Montebello Forebay Groundwater Recharge Project, Orange County Water District’s Groundwater Replenishment Program, Eastern Municipal Water District’s Potable Reuse Program, San Diego Water Purification Project, Santa Clara Valley Water District’s IPR projects, with similar initiatives underway in Long Beach, El Segundo, and Chino.

COSTS TO BUILD WATER REUSE CAPACITY

A landmark study of water strategies designed to increase supply included an analysis of water reuse projects. Researchers calculated the cost of a representative recycling project with the capacity to produce both non-potable reuse and indirect potable reuse at $1,000 per acre-foot on an all-in basis over 30 years. This finding was based on capital costs of $480 million, annual operating costs of $30 million, and a yield of 72,000 acre-feet.[9]

The study’s methodology drew on three key variables—capital cost (cost to build), operating cost (annual cost to operate), and yield (the volume of water supplied)—and then factored in assumed debt financing costs over 30 years at 5 percent and some other qualitative metrics. The total annual cost was then divided by the project‘s yield per year to determine the all-in (unit) cost per acre-foot of water sourced from the project over the next 30 years.

As a comparison, the study calculated a $350 per acre-feet cost for a much smaller project producing a fifth of the volume—13,700 acre-feet per year—in a facility that cost only $49 million to build. The facility, however, was dependent on existing infrastructure for operational support and did not have the capacity to produce indirect potable reuse. This illustrates the challenge in evaluating the cost to acquire water reuse capacity, which varies widely due to the import of both project-specific and site-specific factors.

In the table below, financial information from proposed and completed projects provides additional perspective on cost variability in acquiring potable and non-potable water reuse capacity.

California Water Reuse Projects: Completed and Proposed
20161123-cpc-infrastructure-reuse3

Our analysis finds that multiple factors impact the cost of water reuse projects in both potable and non-potable strategies. These factors include the condition of the existing water treatment infrastructure, quality of the source water, treatment process methodology, conveyance requirements, storage needs, energy provisions, location complexities such as proximity to source and discharge points, environmental buffer suitability, and financing costs.

Recent estimates for proposed projects provide further evidence of the variability in the cost to produce water for reuse, which range from $300 to more than $1,300 per acre-foot.[10] The cost of reclaiming water is generally expected to continue to decline as emerging technologies improve the efficiency of treatment process and reduce energy requirements. Costs will fall further as water authorities progress from pursuing non-potable and indirect potable reuse capacity to acquiring direct potable reuse capacity.

REVENUE POTENTIAL

In addition to increasing water supply, water reuse introduces new sources of revenue to water authorities. This presents an opportunity for water managers to monetize wastewater treatment operations and the associated end products—i.e., non-potable and potable reuse—in ways that create value for ratepayers and potential investors. Key to realizing this opportunity is in pricing the new supply to better tie to the full cost of production and to market demand for water. Doing so will have the added benefit of opening California’s water markets to private investors.

By creating revenue streams from what otherwise would have been operational costs, municipal water authorities can adapt their cost-recovery mandates to become more profitable stewards going forward. Water districts spend over $850 per acre-foot to treat and dispose of wastewater while potential buyers are eagerly paying nearly $1,000 per acre-foot whenever scarce opportunities to purchase water appear.[11] Moreover, after incurring the cost of treating and disposing wastewater, water districts in many parts of California then spend over $750 per acre-foot to import water to satisfy customer needs.[12]

This translates into the opportunity to both reduce costs—potentially covering water treatment costs and eliminating imported water costs—and to earn revenue by selling excess capacity.

Capitalizing on the revenue potential of water reuse benefits water districts, ratepayers, and policymakers. New revenue streams strengthen the water district’s balance sheet and business model, easing the reliance on traditional debt financing. Tapping into new market segments diversifies the customer base, reducing the need for rate hikes and fee levies. Modernizing wastewater treatment operations with revenue-generating assets enhances the ability of water districts to comply with climate and conservation policy goals.

Current commercial opportunities for water managers include selling excess supplies of potable and non-potable reuse to 1) industrial businesses vying for more aligned pricing, 2) water districts seeking to replenish groundwater, augment surface water supply, and/or mitigate seawater barrier intrusion, and 3) agricultural concerns experiencing reduced allocations from water authorities.

Farmers are a good example of a new customer segment for water operators. Historically, the cost to convey water from urban water operators to farmers has been prohibitive. But recent water allocation policy decisions have left some farmers without enough water to irrigate their crops forcing them to let fields lie fallow. For these potential customers, making the capital investment necessary to establish water delivery channels from urban water facilities increasingly makes sense.

RETURN ON INVESTMENT

There are few, if any, private sector investments in California’s civil water reclamation assets or water reuse projects over the past twenty-five years.  Consequently, no investment-return data is available for analysis.

The market for recycled water in California is evolving as policymakers and ratepayers consider the long-term implications of water scarcity. In so doing, many are recognizing that water and wastewater services are a much more complex and capital-intensive proposition than selling a public good.

Similarly, the validity of the water sector’s cost recovery model has been called into question as concerns about water quality and supply issues, outdated infrastructure, deferred maintenance, climate change, and contaminants loom larger than the billions already borrowed to comply with regulatory-mandated remediation.[13]

Current pricing policies are challenging all constituencies as operations and maintenance costs rise and water sales revenue falls. Water pricing policies and municipal financing practices reveal often fail to fully capture the lifecycle costs of water delivery and wastewater treatment, further compromising the financial stability of water authorities.[14]

The convergence of these dynamics presents an opportunity for private investors to partner with municipal water authorities to unlock value in new revenue-generating services such as water reuse. Few water authorities can take the financial risks of building new infrastructure to deliver recycled water to customers or investing in emergent water purification technologies to lower costs. For private investors, these risks present an investment opportunity.

As the costs of public financing increase—whether due to using bonding capacity for projects that could otherwise be financed by the private sector or to investing in sub-optimal technologies because better alternatives are unproven and carry higher risk—the price of private financing becomes more attractive given the value created for the public. Moreover, these uncaptured values reveal the true cost of public financing especially when the impact of subsidized bond financing on market pricing is factored into decision-making. Returns for private investors can be captured in the value they offer water authorities that is not available from the capital markets and reduces uncompensated risks borne by taxpayers.

By partnering with the private sector to take risks that are not appropriate for the public sector, water authorities can offset the costs of water reuse capacity and increase water supply to Californians.

 *   *   *

FOOTNOTES

[1] Public sector water providers are often special districts or authorities. They may also be part of a municipal government. We will use the term “water authorities” to refer to all types of government entities that supply water either on a wholesale or retail basis.

[2] California Department of Water Resources (2013). California Water Plan Update 2013, Vol. 3, Chapter 1, Introduction, p. 1-9. http://www.water.ca.gov/waterplan/docs/cwpu2013/Final/Vol3_Ch01_Introduction.pdf.

[3] California Department of Water Resources (2013). California Water Plan Update 2013, Vol. 3, Chapter 12, Municipal Recycled Water, p. 12-11. http://www.water.ca.gov/waterplan/docs/cwpu2013/Final/Vol3_Ch12_Municpal-Recycled-Water.pdf.

[4] This is an average of current rates for recycled water reported in the 2015 Comprehensive Annual Financial Reports of the Eastern Municipal Water District (p. 97), the Orange County Water District (p. 63), and the Santa Clara Valley Water District (p. 141).

[5] See for example, Keith Schneider’s interview with Anthea Hansen, Del Puerto Water District manager in “One Way to Ease California Drought: Recycle Wastewater For Irrigation,” Circle of Blue, July 23, 2015, available at http://www.circleofblue.org/2015/world/one-way-to-ease-california-drought-recycle-wastewater-for-irrigation/ and Ryan Bradley’s interview with Earle Hartling, Recycling Coordinator for the Metropolitan Sanitation District in “To Fight the Drought, California Is Turning Sewage Into Drinking Water,” Take Part, December 8, 2015, available at http://www.takepart.com/article/2015/12/08/recycled-water.

[6] See State Water Resources Control Board and Department of Water Resources 2012 staff report. Results, Challenges, and Future Approaches to California’s Municipal Wastewater Recycling Survey (2009), p.1 available at http://waterboards.ca.gov/water_issues/programs/grants_loans/water_recycling/docs/article.pdf..

[7] This calculation uses an average cost of $721/AF to treat California’s wastewater [based on sewer operations costs and wastewater treated volumes reported in the 2015 Comprehensive Annual Financial Reports of the Eastern Municipal Wastewater District (p.29 and p.92), the Irvine Ranch Water District (p.95 and p.97) and the San Francisco Public Utilities Commission, (p.147 and p.221)] and applies it to the 5 million acre-feet of treated wastewater produced annually statewide as estimated in State Water Resources Control Board and Department of Water Resources 2012 staff report, Results, Challenges, and Future Approaches to California’s Municipal Wastewater Recycling Survey,p.1 available at http://waterboards.ca.gov/water_issues/programs/grants_loans/water_recycling/docs/article.pdf).

[8] State Water Resources Control Board and Department of Water Resources 2012 staff report, Results, Challenges, and Future Approaches to California’s Municipal Wastewater Recycling Survey (2009), p.7, available at http://waterboards.ca.gov/water_issues/programs/grants_loans/water_recycling/docs/article.pdf.

[9] Gregory Freeman, Myasnik Poghosyan, and Matthew Lee (2009). Where Will We Get the Water?
 Assessing Southern California’s Future Water Strategies. Los Angeles County Economic Development Corporation. http://www.laedc.org/reports/WhereWillWeGettheWater.pdf.

[10] California Department of Water Resources (2013). California Water Plan Update 2013, Vol. 3, Chapter 1, Introduction p. 1-12. http://www.water.ca.gov/waterplan/docs/cwpu2013/Final/Vol3_Ch12_Municpal-Recycled-Water.pdf.

[11] For example, in 2015 the Del Puerto Water District purchased 44,000 acre-feet of water from rice growers in northern California at $850 per acre-foot and 13,000 acre-feet from Merced County at $950 per acre-foot. Keith Schneider (July 23, 2015). One Way to Ease California Drought: Recycle Wastewater for Irrigation. Circle of Blue. http://www.circleofblue.org/2015/world/one-way-to-ease-california-drought-recycle-wastewater-for-irrigation/.

[12] The Irvine Ranch Water District currently reports a cost of $1,000 per acre-foot for imported water on its website. This compares to reported costs in 2015 of $1,424 per acre-foot by the Padre Dam Municipal Water District and $794 per acre-foot by the Santa Monica Water District. See also the Eastern Municipal Water District and Orange County Water District 2015 Comprehensive Annual Reports.

[13] Jarmo Hukka and Tapio Katko (2015). Appropriate Pricing Policy Needed Worldwide for Improving Water Services Infrastructure. Journal – American Water Works Association. Volume 107 Number 1. Pages E37-E46. http://www.awwa.org/publications/journal-awwa/abstract/articleid/48268706.aspx.

[14] Johnson Foundation at Wingspread (January 2012). Financing Sustainable Water Infrastructure. http://www.johnsonfdn.org/sites/default/files/reports_publications/WaterInfrastructure.pdf.

*   *   *

ABOUT THE AUTHORS

Marc Joffe is the Director of Policy Research at the California Policy Center. In 2011, Joffe founded Public Sector Credit Solutions to educate policymakers, investors and citizens about government credit risk. His research has been published by the California State Treasurer’s Office, the Mercatus Center at George Mason University, the Reason Foundation, the Haas Institute for a Fair and Inclusive Society at UC Berkeley and the Macdonald-Laurier Institute among others. He is also a regular contributor to The Fiscal Times. Prior to starting PSCS, Marc was a Senior Director at Moody’s Analytics. He has an MBA from New York University and an MPA from San Francisco State University.

Jill Eicher Jill Eicher is a researcher focusing on innovative financing models for public-sector agencies. Most recently, she was a Visiting Scholar at Stanford University’s Global Projects Center, working on the development of a cooperative investment model for public pension funds to deploy capital into U.S. infrastructure. She co-founded the Fiduciary Infrastructure Initiative, a research-driven venture focused on the applicability of international pension cooperatives making direct infrastructure investments as models for the U.S. A graduate of Wellesley College, Eicher did post-graduate work in mathematics and was issued a patent for her method for assessing investment risk.

Ed Ring is the Vice President of Policy Research at the California Policy Center. His work has been cited in the Los Angeles Times, Sacramento Bee, Wall Street Journal, Forbes, and other national and regional publications. Previously, as a CFO primarily for start-up companies in the Silicon Valley, he has done financial accounting for over 20 years, and brings this experience to his analysis and commentary on issues of public sector finance. From 1995 to 2009 he was the editor of EcoWorld, a website covering environmental issues from a free-market perspective. Between 2007 and 2010 he launched in partnership with AlwaysOn Media the highly successful “GoingGreen” clean technology investor conferences, held annually in San Francisco and Boston. He has an MBA in Finance from the University of Southern California, and a BA in Political Science from UC Davis.

Kevin Dayton is a policy analyst for the California Policy Center, a prolific writer, and the author of frequent postings about generally unreported California state and local policy issues on the California Policy Center’s Prosperity Forum and Union Watch. Major policy reports written by Kevin Dayton include For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction. Dayton spent more than 17 years in various federal, state, and local policy positions for Associated Builders and Contractors (ABC), including ABC of California State Government Affairs Director from 2005 to 2012. He was also a legislative assistant in the U.S. House of Representatives for Congressman Gary A. Franks (R-Connecticut) from 1992 through 1994. Dayton is a 1992 graduate of Yale University, where he majored in History.

ABOUT THE CALIFORNIA POLICY CENTER

The California Policy Center is a non-partisan public policy think tank providing information that elevates the public dialogue on vital issues facing Californians, with the goal of helping to foster constructive progress towards more equitable and sustainable management of California’s public institutions. Learn more at CaliforniaPolicyCenter.org.

 *   *   *

Rebuilding California’s Infrastructure – Water Storage (Part 3 of 6)

20161123-cpc-infrastructure-cover

This is Part Three of “Rebuilding California’s Infrastructure,” to access the other five sections, click on the links below. To access the entire six-part study in a single, printable PDF document, DOWNLOAD HERE.

Part One: Introduction
Part Two: Water Reuse
Part Three: Water Storage
Part Four: Desalination
Part Five: Energy and Transportation
Part Six: Financing Models and Policy Recommendations

WATER STORAGE

The cumulative impact of water-related regulatory actions in California has reduced water distribution to consumers thus calling into question the reliability of the state’s water supply. This has precipitated a sustained call for increased storage capacity for water developed for urban, agricultural, environmental, and management uses. This shift in the state’s perspective on water storage—from a mechanism to facilitate conservation objectives to a critical component of water supply and distribution—introduces potential investment opportunity for institutional investors.

State water authorities and legislators alike have called for private-sector capital to play a role in financing water storage projects. The Department of Water Resources, for example, cited public-private partnerships as potential financing options in the 2013 Water Plan Update, as did the 2016 State Treasurer’s Biennial Report. California’s long-standing use of joint powers authority offers institutional investors, and especially public pension funds as state agencies, even broader financing partnership opportunities.

Available funding further enhances policymakers’ appeals to institutional investors. California voters approved $2.7 billion in funding support for water storage projects in Proposition 1, the Water Quality, Supply and Infrastructure Improvement Act of 2014. Federal grants and funding provided by Title XVI for water projects seeks to attract capital from the private sector in hopes of leveraging public dollars. This confluence of funding from all levels of government decreases risk for institutional investors and commensurately increases value for taxpayers.

In this section, we examine the utility of water storage in improving water managers’ ability to deliver water services to customers for the purpose of discovering potential investment opportunities for private-sector investors. Although water storage technology does not increase the amount of water, it makes the supply of water for human use more reliable.

California stores water from two sources. Surface water, the water that runs into rivers, lakes, and reservoirs, and groundwater, which flows below ground in the permeable rock, gravel, sand, and silt of aquifers. Availability from stored water supplies can be thought of as a bank account. Surface water is like a checking account, offering short-term, seasonal water storage capabilities, and groundwater is more like a savings account for longer-term storage capacity.[1]

Academics, policymakers, and water managers agree that coordinating the management of surface and groundwater supplies optimizes overall yield and nets cost efficiencies.

The table below shows the state’s sources of water, storage repositories, and a summary of the key dynamics impacting market activity.

Water Sources, Types of Water Storage, and Market Dynamics
20161123-cpc-infrastructure-storage1

We believe there is potential investment opportunity for private-sector investors in market-driven surface water and groundwater water storage strategies, particularly in water banks. Opportunities for private-sector investors will expand as water districts increase their ability to form partnerships and aggregate projects.

CURRENT CAPACITY

Estimates of California’s total water storage capacity vary widely due to incomplete information about the state’s 515 groundwater basins. California’s Department of Water Resources approximates groundwater storage capacity to be somewhere between 850 million and 1.3 billion acre-feet but then further qualifies this statistic by assessing the volume of usable storage capacity—defined as groundwater that can be economically withdrawn, recharged, and meets potable or non-potable quality standards—at 143 to 450 million acre-feet.[2] Still, California has at least ten times more storage capacity below ground than above which the department estimates approaches some 41 million acre-feet contained in the state’s 1,400 reservoirs.[3]

California Surface and Ground Water Storage Capacity (million acre-feet)
20161123-cpc-infrastructure-storage2

Combined, these estimates indicate total water storage capacity statewide to be between 184 and 491 million acre-feet.

For context, in the most recent normal weather year, 2010, California used more than 40 million acre-feet of water, drawing roughly 22 million acre-feet (59%) from surface water and 17 million acre-feet (40%) from groundwater.[4] In drought years, groundwater can supply as much as 46 percent.[5] This illustrates how critical both surface water and groundwater storage capacity are to meeting California’s water needs.

PROPOSED PROJECTS TO EXPAND WATER STORAGE CAPACITY

Over the next two years, decisions will be made on four major projects to expand California’s surface water storage capacity by 10 percent.[6]  Irrespective of whether or not construction on these expanded or new reservoirs begins, the call to increase surface water storage capacity in the state will continue to intensify as long as the reliability of California’s water supply remains in question.

The four reservoir projects under consideration are detailed in the table below along with their corresponding potential increased capacity and current status:

Representative California Surface Water Projects
20161123-cpc-infrastructure-storage3

There are several additional projects proposed or in progress to increase water storage capacity. These include the Lake Del Valle Reservoir Water Supply Storage Expansion Project, the Blagen Mill Pond Restoration Project, and the Wilson Lake Rehabilitation and Meadow Restoration Plan.

While there is pitched interest in expanding surface water storage capacity, it is important to note that Proposition 1 funding cannot exceed more than half of a project’s total capital costs, nor can it be used for operation and maintenance costs. This requires water authorities to secure financing from other sources, including the private sector, in order to take advantage of available state funding.

DEVELOPING GROUNDWATER STORAGE CAPACITY

In contrast to the state’s well-documented efforts to expand surface water storage capacity, California policymakers encouraged 1 million acre-feet of groundwater storage expansion but they have not proposed, nor identified, any specific projects electing instead to have groundwater storage managed at the local level.

Local water managers are very interested in pursuing projects to expand groundwater storage capacity, particularly capacity that would increase supply reliability by facilitating conjunctive management with surface water storage. They are motivated by available funding and by the enactment of the Sustainable Groundwater Management Act. This legislation introduces the state’s first groundwater regulation and requires water districts to develop sustainable groundwater master plans.

A comprehensive study of groundwater management plans found that many water agencies are actively evaluating groundwater storage expansion options, including water banking. These include the Semitropic Water Storage District, Sacramento and San Joaquin counties, Orange County Water District, and Eastern Municipal Water District. The study’s researchers estimate these projects would lead to approximately 22 million acre-feet in expanded groundwater storage capacity. They cite potential advantages as drivers of these efforts, specifically local control, support, and use, which translate into lower conveyance costs due to the proximity of water consumers.[7]

A portion of the total groundwater storage capacity includes space created by the depletion of some of the state’s aquifers. To make use of the most strategically-located spaces, water managers have created water banks. Like financial banking institutions, water bank customers make deposits and withdrawals to their accounts although in a different currency: water. Experts calculate that water banks have been developed in less than one percent of Californian water basins.[8]

Major California Water Bank Expansion Projects
20161123-cpc-infrastructure-storage4

California has a significant amount of untapped groundwater storage capacity.

Experts calculate that approximately 250 million acre-feet is available for additional groundwater storage and banking.[9] Partnerships between water districts, storage engineers, and long-term institutional investors could accelerate the development of the state’s groundwater storage capacity.

COSTS TO ACQUIRE WATER STORAGE CAPACITY

Location is the key factor in the cost to develop water storage capacity, varying significantly according to site characteristics, water recharge supply, conveyance infrastructure, and the ability to integrate the management of surface, groundwater, and conveyance facilities.

The table below provides findings from studies which examined the comparative costs to develop water storage capacity.

Comparative Costs to Develop Water Storage (Average Costs $/AF)
20161123-cpc-infrastructure-storage5a

Our survey agrees with these studies finding that groundwater storage offers far greater water storage capacity at a lower cost than surface water projects. What’s more, groundwater storage projects have generally been developed and put into operation over shorter timeframes than those involving dams and reservoirs.

In testimony to the Hoover Commission in 2010 on water banking, a Kern Water Bank Authority representative illustrated the initial capital cost differential. He compared the $1.9 billion capital cost of the Diamond Valley Reservoir which stores 800,000 acre-feet to the Kern Water Bank which cost $75 million to construct and holds over 1,000,000 acre-feet.[10]

It is important to note, however, that water managers and industry experts agree that the advantages of groundwater storage are best realized when used in conjunction with surface water storage resources.

REVENUE POTENTIAL

While recent legislation and government funding have improved conditions for securing initial capital to expand water storage capacity, long-standing regulations remain that inhibit widespread development. As long as local water authorities are compelled to focus on cost recovery instead of revenue generation, capital-intensive projects like water storage will continue to take decades to conceive, evaluate, and finance.

Without revenue sources to repay investments made either by taxpayers or private-sector investors, progress in expanding California’s water storage capacity will be made only at the margin.

Water experts have advised that “the water sector has to fundamentally change the way it values water as a resource by adjusting the water rate structure and pricing policies in a way that captures the full cost of delivery, decouples revenue from the quantity of water sold, and reflects the marginal cost of consumption and scarcity.”[11] Moreover, they assert that, “having a functional water market, in which people with excess water can sell it to those who need it, is an important incentive for getting people to store water because they can profit from their conservation. From the state’s perspective, the market is an important tool to reallocate water to those who most need it now without harming anyone’s long- term water rights.”[12]

As a result, market pricing data on water storage revenue is not readily available and therefore has not been widely studied to date. Both surface and groundwater storage managers have three primary sources of revenue: fees for conveyance, pumping and storage; water sales from actual supplies and potential trading and exchange activities; and pumping rights. The lack of pricing data is a significant deterrent to private-sector investment.

Energy generated in the course of operation by surface water storage assets introduces potential revenue streams to capitalize on in the open markets.

Hydroelectric power, for example, is produced as gravity directs water flow from higher elevation to lower elevation, turning turbines to generate electricity that can be sold. In addition to using the basic downstream flow of rivers, a surface water supply system can generate additional hydroelectric power through pumped storage.

RETURN ON INVESTMENT

We find that the most compelling potential investment opportunity in water storage for the private sector is in groundwater, particularly in water banks. The Rio Bravo Water Storage District in Kern County, for example, is offering long-term equity ownership in its water bank in addition to the more traditional debt financing and contract or lease arrangements. Researchers foresee water banks serving as brokers, clearinghouses, and facilitators of trade. [13]

Water banks build on the sector’s experience in using partnership structures to achieve economies of scale, diversify risk, and increase influence. Examples of these partnership structures include informal consortiums, joint powers authorities, and public-private partnerships. This partnering capability is another key to securing private-sector investment.

Alliances between water districts to seek government grants and funding seeds a potential progression towards water storage project aggregation that would facilitate private-sector financing. This is attractive to investors because it diversifies project risk and improves return on investment.

 *   *   *

FOOTNOTES

[1] This concept was suggested by Robert Merrill (March 31, 2016), Groundwater Storage Isn’t Sexy, But It Beats Temperance Flat, The Fresno Bee. http://www.fresnobee.com/opinion/readers-opinion/article69096302.html.

[2] California Department of Water Resources (2003). California Groundwater Update, Bulletin 118, Chapter 6, Basic Groundwater Concepts, p. 95. http://www.water.ca.gov/pubs/groundwater/bulletin_118/california’s_groundwater__bulletin_118_-_update_2003_/bulletin118-chapter6.pdf.

[3] California Department of Water Resources (2013). California Water Plan Update 2013, Vol. 1, Chapter 3, California Water Today, p. 38. http://www.water.ca.gov/waterplan/docs/cwpu2013/Final/04_Vol1_Ch03_Ca_Water_Today.pdf.

[4] California Department of Water Resources (2013). California Water Plan Update 2013, Vol. 3, Chapter 9, Conjunctive Management and Groundwater Storage, p.9.

[5] California Department of Water Resources (2013). Compilation of Enhanced Content for California Water Plan Update 2013, p. 1.

[6] The Public Policy Institute of California calculates an additional 4 million acre-feet, increasing California’s total water storage capacity from 42 million acre-feet to 46 million acre-feet. See Storing Water, April 2015.

[7] Jay Lund, et. al. (November 2014). Integrating Storage in California’s Changing Water System, Center for Watershed Sciences, University of California Davis. https://watershed.ucdavis.edu/files/biblio/Storage_White_Paper_20Nov2014.pdf. .

[8] Erica Gies (May 7, 2015). Water in The Bank, Yale Environment 360. http://e360.yale.edu/feature/water_in_the_bank_one_solution_for_drought-stricken_california/2872/. Gies estimates “around 22 basins in California — mostly urban — are already storing and banking groundwater.” Of these only four are banking water, representing less than 1% of the state’s total water basins.

[9] Jay Lund, et. al. (November 2014). Integrating Storage in California’s Changing Water System, Center for Watershed Sciences, University of California Davis.

[10] This testimony is available at http://www.lhc.ca.gov/studies/201/watergovernance/ParkerJan10.pdf.

[11] Newsha Ajami and Barton Thompson (June 1, 2015). Investing in the Future of the Water Sector, Water Online. http://www.wateronline.com/doc/investing-in-the-future-of-california-s-water-sector-0001.

[12] Erica Gies (May 7, 2015). Water in The Bank, Yale Environment 360.

[13] Peter W. Culp, Robert Glennon and Gary Libecap (October 2014). Shopping for Water: How the Market Can Mitigate Water Shortages in the American West, The Hamilton Project-Brookings. http://www.hamiltonproject.org/assets/files/how_the_market_can_mitigate_water_shortage_in_west.pdf.

*   *   *

ABOUT THE AUTHORS

Marc Joffe is the Director of Policy Research at the California Policy Center. In 2011, Joffe founded Public Sector Credit Solutions to educate policymakers, investors and citizens about government credit risk. His research has been published by the California State Treasurer’s Office, the Mercatus Center at George Mason University, the Reason Foundation, the Haas Institute for a Fair and Inclusive Society at UC Berkeley and the Macdonald-Laurier Institute among others. He is also a regular contributor to The Fiscal Times. Prior to starting PSCS, Marc was a Senior Director at Moody’s Analytics. He has an MBA from New York University and an MPA from San Francisco State University.

Jill Eicher Jill Eicher is a researcher focusing on innovative financing models for public-sector agencies. Most recently, she was a Visiting Scholar at Stanford University’s Global Projects Center, working on the development of a cooperative investment model for public pension funds to deploy capital into U.S. infrastructure. She co-founded the Fiduciary Infrastructure Initiative, a research-driven venture focused on the applicability of international pension cooperatives making direct infrastructure investments as models for the U.S. A graduate of Wellesley College, Eicher did post-graduate work in mathematics and was issued a patent for her method for assessing investment risk.

Ed Ring is the Vice President of Policy Research at the California Policy Center. His work has been cited in the Los Angeles Times, Sacramento Bee, Wall Street Journal, Forbes, and other national and regional publications. Previously, as a CFO primarily for start-up companies in the Silicon Valley, he has done financial accounting for over 20 years, and brings this experience to his analysis and commentary on issues of public sector finance. From 1995 to 2009 he was the editor of EcoWorld, a website covering environmental issues from a free-market perspective. Between 2007 and 2010 he launched in partnership with AlwaysOn Media the highly successful “GoingGreen” clean technology investor conferences, held annually in San Francisco and Boston. He has an MBA in Finance from the University of Southern California, and a BA in Political Science from UC Davis.

Kevin Dayton is a policy analyst for the California Policy Center, a prolific writer, and the author of frequent postings about generally unreported California state and local policy issues on the California Policy Center’s Prosperity Forum and Union Watch. Major policy reports written by Kevin Dayton include For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction. Dayton spent more than 17 years in various federal, state, and local policy positions for Associated Builders and Contractors (ABC), including ABC of California State Government Affairs Director from 2005 to 2012. He was also a legislative assistant in the U.S. House of Representatives for Congressman Gary A. Franks (R-Connecticut) from 1992 through 1994. Dayton is a 1992 graduate of Yale University, where he majored in History.

ABOUT THE CALIFORNIA POLICY CENTER

The California Policy Center is a non-partisan public policy think tank providing information that elevates the public dialogue on vital issues facing Californians, with the goal of helping to foster constructive progress towards more equitable and sustainable management of California’s public institutions. Learn more at CaliforniaPolicyCenter.org.

 *   *   *

Rebuilding California’s Infrastructure – Desalination (Part 4 of 6)

20161123-cpc-infrastructure-cover

This is Part Four of “Rebuilding California’s Infrastructure,” to access the other five sections, click on the links below. To access the entire six-part study in a single, printable PDF document, DOWNLOAD HERE.

Part One: Introduction
Part Two: Water Reuse
Part Three: Water Storage
Part Four: Desalination
Part Five: Energy and Transportation
Part Six: Financing Models and Policy Recommendations

DESALINATION – INTRODUCTION

Desalination – converting salt water into drinking water – promises to free Southern California from water insecurity. Although desalinated water is more expensive than water from other sources, its supply is far more reliable. In this section we survey desalination plants in California, elsewhere in the US and abroad, we consider the economics of desalination and we address criticisms of this option.

California is facing a shortfall in water supply that seems to be only widening. Currently, California’s rivers are receiving about half of their natural flow. According to Mike Sweeney of the Nature Conservatory’s California chapter, taking more than 20% of a river’s natural flow can negatively impact its function and ecosystem.[1] While the last winter cycle has temporarily raised reservoir levels, climate scientists believe that the drought could continue for years to come.[2] Furthermore, the rainfall from El Niño was mostly in the northern part of the state, leaving Southern California more vulnerable to continued drought. For these reasons, local water suppliers have begun to consider various methods of increasing water supply in a way that is independent of weather.

Desalination is one such method that has now entered the implementation stage with the recent opening of a 50 Million Gallon Per Day (MGD) capacity plant in Carlsbad (San Diego County). A second plant of similar size in Huntington Beach (Orange County) is nearing final approval.[3]

The company behind these initiatives is Poseidon Water, founded in 1995. Poseidon is a unit of Brookfield Infrastructure Partners, a group that specializes in managing infrastructure projects. This chapter contains extended discussions of the Carlsbad and Huntington projects, and provides information on desalination projects elsewhere in California, the United States and globally. We find that while desalination is relatively costly, the extra expense may be justified by the supply security it brings.

THE CARLSBAD DESALINATION PLANT

It was a coincidence that the Carlsbad Desalination Plant was completed after four years of drought in California. Over 17 years, the primary argument of the San Diego County Water Authority for building the desalination plant was water supply reliability.

During a drought in the early 1990s, it became apparent that San Diego County was vulnerable – as it was 95% dependent on water supplied from Northern California and the Colorado River. The San Diego Water Authority adopted a deliberate strategy to diversify its supply sources and develop a local source for water. Desalination produced water locally, perpetually, and didn’t rely on water infrastructure to the north that could be damaged or destroyed by earthquakes.

Michael Lee, a spokesperson for the San Diego Water Authority, told us that San Diego County is consuming twelve per cent less water today than it was in 1990, even as its population has grown thirty per cent and its economy has grown eighty per cent. By 2035, the city of San Diego plans to obtain thirty per cent of its total water supply from another local source altogether—not from rivers, oceans, or aquifers but from sewers. As previously discussed, a process similar to desalination (known colloquially as “toilet to tap”) can be used to treat recycled wastewater.

After four years of drought, San Diego County has enough water to meet 99 percent of normal demand without conservation.[4] However, the state has not exempted the County from statewide conservation mandates.

WHAT’S INNOVATIVE ABOUT THE CARLSBAD DESALINATION PLANT

Traditionally, desalination has been accomplished through a thermal process: saltwater is boiled and the steam is captured, cooled, and condensed into water. But most desalination plants built today use “reverse osmosis” technology to remove material from water. The website for the Carlsbad Desalination Plant divides the desalination process into five stages:[5]

  1. Pretereatment. At full operation, 100 million gallons of ocean water per day enters the desalination plant from an intake pipe that was used by the adjacent NRG Energy’s Encina Power Station to cool turbines. The water is pumped through tanks that contain layers of coal, sand, and gravel. Organic material (such as algae) and suspended particles are filtered out. Dissolved salts remain.
  2. Secondary Pretreatment. “Microfiltration” removes very small suspended impurities. By the end of this process, material that could clog the membranes in reverse osmosis is removed.
  3. Reverse Osmosis. Pumps force water at high pressure (7000 horsepower of energy or 1100 pounds per square inch) through more than 2000 fiberglass tubes containing over 16,000 thin membrane filters. Dissolved salts, other minerals, viruses and bacteria are removed, leaving water molecules. Meanwhile, devices capture energy remaining from the high pressure stream and transfer it back to the intake of seawater. It is claimed these devices reduce the desalination plant’s power use by 146 million kilowatt-hours of energy per year.
  4. Post Treatment. For the half of the water to be supplied to customers, chlorine is added to disinfect it and some minerals are added. The other half of the water (salty brine) – 35,000 gallons of brine per minute – is pumped as discharge into the Agua Hedionda Lagoon (another legacy of the Encina Power Plant) for eventual return to the ocean. The high-salinity discharge from the Carlsbad plant must, by California law, be diluted before it hits the brine pit. Four gallons of seawater are mixed with each gallon of effluent, which means that the water returning to the ocean has no more than 20% higher salinity than the ocean water itself.
  5. Product Water Storage. Drinkable water is pumped through a 10-mile long 54-inch wide pipeline to an aqueduct owned by the San Diego County Water Authority’s Second Aqueduct in San Marcos and blended with other water supply.

Forcing seawater through thin membranes to remove dissolved material uses less energy than boiling the water to collect it as steam. Advances in reverse-osmosis technology have cut the total amount of energy used in desalination in recent decades. Carlsbad is expected to use 4,898 kilowatt/hours per acre-foot, to desalinate ocean water and deliver it to households, according to Poseidon’s report to the Department of Water Resources. Poseidon used state-of-the-art technology to reduce energy requirements and promised that plant operations would have a zero net carbon footprint. [6]

The plant can produce up to 50 million gallons a day, equivalent to 56,000 acre-feet of water per year, enough to meet the needs of approximately 400,000 people.[7] The plant is expected to provide 8% of the Authority’s drinking water.[8]

COST FOR CUSTOMERS OF WATER PRODUCED BY THE CARLSBAD DESALINATION PLANT

San Diego County Water Authority customers have already been paying a lot more for water because of infrastructure improvements and – ironically – because of successful water conservation campaigns that reduced revenue for the water district.  In May 2014, the San Diego County Water Authority projected that ratepayers would pay an extra $5.14 per household for the supply of desalinated water.[9]  That cost was incorporated into the 2016 water rates. [10]

For example, the average residential household bill for water in the City of San Diego at the end of 2015 was $70.81. It increased 9.1% to $77.25 in January 2016 (and increased another 6.9% in July 2016, with more scheduled increases thereafter).[11]  The additional $5.14 would have been 7.3% of the total bill for December 2015.

For the first fiscal year of desalinated water production, the Authority has projected a total cost of $113.6 million, including debt service, for the minimum amount of 48,000 acre feet.[12]  This is compared to $45.2 million for an equivalent amount of imported water.[13]

Water customers for most large American cities, including San Diego, have experienced gradually higher costs for water in the past 15 years.[14]  Recent increases in water costs in San Diego are a result of debt service on major infrastructure projects (such as the Capital Improvement Program and Emergency and Carryover Storage Project), planned infrastructure such as Pure Water San Diego, and conservation, which reduced usage, reduced revenue, and compelled rate increases.

San Diego County Water Authority defends the desalination plant as a way to diversify water sources and ensure supply regardless of droughts and earthquakes. But it also justifies desalination costs based on its long-term projections of the cost of imported water. The cost of the Authority’s imported water has doubled since 2008,[15] and the Authority projects that the cost of imported water from the Colorado River and the Delta will eventually exceed the cost of desalinated water, perhaps by 2030.[16] The Carlsbad plant is expected to operate for at least 30 years.

FINANCING AND PLANT ECONOMICS

The San Diego County Water Authority is the second water agency in the United States to build a large reverse osmosis seawater desalination plant, and therefore it was able to avoid some of the mistakes made in the development of the first US plant near Tampa, Florida. The Authority entered into a 30-year water purchase agreement with Poseidon Water – offloading construction and operational risk into a private company.

The San Diego County Water Authority agreed in 2012 to purchase between 48,000 and 56,000 acre-feet of desalinated seawater per year for 30 years. (An acre-foot is about the amount of water two average-sized families use in one year.) The agency will pay between $2,131 and $2,367 an acre-foot, more than double what it will pay to import water next year from the Metropolitan Water District of Southern California.

Plant construction costs were financed by a $167 million equity investment from Poseidon and $734 million of debt, taking the form of municipal bonds issued by the California Pollution Control Financing Authority.[17]  Premiums on the bond sale and interest income on bond proceeds provided an additional $24 million necessary to meet total construction costs of $925 million.

The bonds financed the desalination plant, a 10-mile pipeline connecting the plant to the San Diego County Water Authority’s distribution system and other pipeline improvements. Poseidon’s investment and bond servicing obligations apply only to the plant; the Water Authority services the pipeline bonds, whose face value was $203 million.

After 30 years of operation at the Carlsbad plant, the Water Authority has the option – but not the obligation – to purchase the plant for $1. The agency also has the right to buy the facility after 10 years.[18]

The official statement contains thirty years of projected revenue and operating cost data for a base case and four alternative scenarios. Although these projections are included to show debt service coverage ratios (i.e., the quotient of operating income and debt service), they can also be used to calculate the return of Poseidon’s $167 million equity investment. Those calculations are shown in Appendix 1. ROI under the five scenarios ranges from 7.78% to 12.35%.

Water officials say the authority’s backing saved ratepayers about $200 million in financing costs. Because the bonds were issued in the municipal bond market, interest payments are exempt from income taxes – enabling the issuer to attract investors at lower interest rates. In addition, “A large, modern technologically advanced desalination project like the one in Carlsbad is not financeable without a secure, financially viable customer for the water,” authority spokesman Michael Lee told the Los Angeles Times. “It is the take-or-pay contract with the water authority that made the project financially viable.”[19]

The Authority tapped relatively experienced companies to be partners for the project, including Poseidon Water, IDE Technologies, Stonepeak Infrastructure Partners and Kiewit-Shea Desalination. Perhaps as a result, the Carlsbad facility was named “International Plant of the Year” by Global Water Intelligence.[20]

OBSTACLES – COST AND FINANCIAL RISK

Environmental groups have spearheaded much of the criticism of the cost of the plant, the cost of the water it produces, and the terms of the 2012 agreement between The San Diego County Water Authority and Poseidon Resources. In particular, the agency has been criticized for agreeing to buy water from Poseidon whether they need it or not.

The City of Santa Barbara had negotiated a Water Purchase Agreement with its desalination plant developer Ionics Inc., but that agreement included a provision allowing the city to pay Ionics Inc. a “standby charge” much lower than the cost to operate the plant. The city paid the lower standby costs for five years and then bought the plant. It sold off the plant’s outdated technology to help cover costs, and has recently contracted to have it re-commissioned. It’s expected to be ready in October 2016. Santa Barbara’s new contract with IDE Americas Inc. to re-commission the plant also includes a provision to pay a standby charge.[21]

San Diego County Water Authority officials argue that a similar standby charge arrangement with Poseidon Water was not possible because their project was much larger and costlier. Officials told the San Diego Union Tribune that “Without long-term commitments to recoup expenses, the company (Poseidon Water) never could have justified taking on the debt to build the huge project.”.[22]

OTHER SEAWATER DESALINATION PLANTS IN CALIFORNIA

While the Carlsbad plant has a high profile, it is the not the first desalination initiative in California., Various local governments have adopted the process on a small scale during the past 25 years. A selection of California projects is listed in the following table.

Operating Desalination Plants in California
20161123-cpc-infrastructure-desal1

Sources for Table:

City of Santa Barbara (2016). Desalination Project Status. http://www.santabarbaraca.gov/gov/depts/pw/resources/system/sources/desalination.asp.

City of Santa Barbara (2016). Fiscal 2017 Water Rates. http://services.santabarbaraca.gov/CAP/MG132763/AS132767/AS132797/AI136571/DO136572/DO_136572.pdf

Sand City Coastal Desalination Plant (nd). Water Technology. http://www.water-technology.net/projects/sand-city-plant/.

California American Water (May 16, 2013). Advice Letter to California Public Utilities Commission. http://www.amwater.com/files/AL%201013%20-%20%20Monterey%20Sand%20City%20PW%20Surcharge%20-%20For%20CPUC.pdf.

Sand City (February 16, 2016). Council Minutes. http://sandcity.org/wp-content/uploads/2016/08/02.16.16-Minutes.pdf.

Jennifer Warren (June 25, 1991). Catalina Discovers the Ocean: Desalination to Supply a Reliable Water Source. Los Angeles Times. http://articles.latimes.com/1991-06-25/local/me-1319_1_water-supply.

Southern California Edison (June 8, 2015). Catalina Island Water System Fact Sheet. https://www.sce.com/wps/wcm/connect/9b85bcbc-a87f-4cf1-8e42-008090ff30be/Catalina+Water+System+Fact+Sheet_AA.pdf?MOD=AJPERES

Lauren Bartlett (November 23, 2015). New Desalination Plant Comes to Catalina Island. Inside Edison. http://insideedison.com/stories/new-desalination-plant-comes-to-catalina-island.

CONTROVERSY OVER THE HUNTINGTON BEACH PLANT

About a dozen other seawater plants are under consideration or construction elsewhere along the California coast.[23] Among these is the 50 MGD plant proposed for Huntington Beach.

Poseidon Water has sought to build a Huntington Beach desalination plant since 1998, the same year it began the process in Carlsbad.[24] In both cases, construction has been held up by environmental regulation and lawsuits. In 2013, it appeared that Poseidon would finally get its permit to build the plant approved by the California Coastal Commission after the International Scientific and Technical Advisory Panel, ISTAP, concluded that the proposed plant was feasible and prudent.[25]

However, the Coastal Commission unanimously voted to delay their decision until Poseidon conducted a study of the ocean floor to determine the feasibility of using subsurface intake pipes to bring water into the desalination plant.[26] Shortly afterwards, Poseidon withdrew its permit application to conduct the study. After an independent study determined that subsurface intake pipes were too expensive to be feasible, Poseidon re-submitted its application in September 2015. The new plan would reduce seawater intake to 106 million gallons of seawater to produce 50 million gallons of desalinated water daily, down from 127 million gallons in the previous proposal. The new proposal also added 1 millimeter screens to the intake pipes in order to protect marine wildlife.[27]

The Huntington Beach desalination plant would pump about 50 million gallons a day, increase water bills by 6%, or $3 per month, and would supply 15% of water for the Orange County Water District.[28] Poseidon would cap its price at 20% above the rate set by the Metropolitan Water District, which is a major supplier for the Orange County Water District, for the first ten years. The Coastal Commission has approved the plan on the condition that the plant will shut down if the environmental impact is worse than anticipated until the issues can be remedied, Poseidon says it will restore local wetlands to mitigate environmental impact.

The Orange County district buys untreated water from the Municipal Water District for $660 per untreated-acre foot. The Municipal Water District currently charges $1003 per acre-foot for treated water. A Los Angeles Times report estimated the cost of Huntington Beach desalinated water at $1812 per acre foot, before any water district subsidies.[29]

In February of 2016, the Municipal Water District of Orange County revised their projection for future water demand downwards by 17%[30], bringing into question the need for a $1 billion desalination plant in Huntington Beach and increasing criticism from environmental groups. Poseidon Water claimed that desalination was necessary despite the lower demand estimate. However desalination continues to offer the district important advantages including local control, greater supply reliability and protection from price spikes for imported water.

Orange County Coastkeeper argues that the proposed plant would spike local energy costs, pollute the ocean and kill large numbers of marine animals.[31] Poseidon counters that the plant will be 100% carbon neutral (like the Carlsbad facility), that it will protect ocean water quality and that sea life can adapt to the slightly elevated brine levels caused by plant discharges.[32]

While environmental concerns need to be evaluated during a plant approval process, they should be adjudicated more quickly. Thus far, Poseidon has been seeking approval for the Huntington Beach plant for 18 years. Although the plant has the support of most local residents, nearby cities, and government agencies, the proposal has been bogged down in 18 years of costly and redundant applications and studies that drive up prices and discourage future investment. The first step in promoting any sort of water infrastructure development, whether desalination or otherwise, would be untangle the regulatory knots and thereby unlock innovation.

RESPONDING TO THE COST-BASED ARGUMENTS AGAINST DESALINATION

In May 2016, a coalition of environmental-oriented organizations released a report summarizing current data about how seawater desalination plants in California would affect marine life.[33] Coming from an environmentalist perspective, the report was skeptical about seawater desalination as an appropriate and useful option for water supply in California. However, it identified some legitimate shortcomings in economic analysis and public knowledge of seawater desalination.

For example, the report noted that “costs, benefits and limitations of desalination are not well understood by the California public” and asserted that the public relied on “misinformation and sweeping generalizations” about the potential value of seawater desalination.

Criticisms of desalination’s expense often fail to take into account the concepts of marginal cost and marginal utility that underpin contemporary microeconomics.[34] In a free market, the supply of a product is based on its marginal cost of production, i.e. the cost of producing the very last and most expensive unit. An equilibrium is theoretically achieved when the marginal cost of supplying water equals its marginal benefit to consumers.

If a consumer captures rainwater directly, the price of his water is virtually zero. If a public utility captures rainwater and pipes it to the consumer, the cost per gallon is only slightly higher. These facts tend to anchor our view about what water should cost.

But this price opinion becomes less applicable when free or near-free sources are insufficient to meet consumer demand. In such cases, consumer utility may be optimized by using sources of water that are more expensive – even sources that are much more expensive.

Desalinated water produced by the Carlsbad plant is sold to the San Diego Water Authority for about $2,200 per acre foot. An acre foot of water is equal to 325,853 gallons, so the wholesale price per gallon of Carlsbad desalinated water is less than seven tenths of one cent per gallon.

Market prices offer evidence that demand for water exists at prices much higher than seven tenths of a penny per gallon. The International Bottled Water Association estimates that the wholesale cost of domestic non-sparkling bottled water was $1.20 in 2014 – more than 150 times the wholesale cost of Carlsbad desalinated water.[35] Despite the high price, nationwide bottled water consumption reached 11.7 billion gallons in 2015 and is expected to surpass carbonated soft drink sales in 2017.[36] (Although bottled water is normally intended for drinking, it has been used for broader purposes when the tap water supply becomes unreliable as it has in Flint, Michigan.[37])

Unlike bottled water, tap water is not typically supplied on a free market, and is not priced in accordance with consumer demand. Political considerations and the earlier observation about the free availability of rainwater push the price of tap water down to levels well below the marginal consumer value it provides.

The assumption that all water should be priced at or near the cost of obtaining our least costly supplies unnecessarily limits consumer welfare. If individuals are willing to pay extra to take longer showers or water their lawns, social utility is maximized by letting them pay the additional cost rather than compelling them to conserve.

Environmentalists may prefer to tackle water supply shortages through water restrictions, even if it means taking large swaths of land out of agricultural cultivation and encouraging population decline in areas with insecure water supply.[38] In contrast, we see seawater desalination as a potentially positive solution that allows for economic growth, job creation, and revenue generation that, in turn, facilitate further advances in infrastructure, programs, and services for the public. Opponents of seawater desalination may try to marginalize or vilify this perspective from an ideological viewpoint. That would be a disservice to current and future generations of Californians.

BRACKISH GROUNDWATER AND SURFACE WATER DESALINATION

Aside from seawater, desalination technology can also be applied to brackish (salty) water underground, in lakes and in rivers. Several brackish water desalination facilities already operate in California. The state’s potable water supply could be increased by expanding some of these facilities and adding new ones. Because brackish water sources typically contain less salt than seawater, less energy is required to desalinate it. As a result, desalination of brackish surface water and groundwater is usually less costly than seawater desalination. In this section, we briefly outline a number of brackish water desalination projects in California.

The Chino Basin Desalter Authority, a joint powers authority in the Inland Empire, began operation in 2000. In fiscal year 2015, it was contracted to provide 24,600 AFY (or about 21.9 MGD) of desalinated water to eight water agencies.[39] The authority is currently completing an expansion which will add 10,600 AFY (or about 9.5 MGD) of capacity at an expected cost of $143 million.[40] According to the Authority’s 2016/17 Budget, it is charging agencies an average of $871 per acre foot to cover both operating and capital costs.[41] In FY 2015, the authority incurred O&M costs of $12.8 million and delivered 25,795 acre feet of water.[42] This implies unit O&M costs of $496 per acre foot.

The Alameda County Water District opened its Newark Desalination Facility in 2003. This was the first large-scale brackish water desalination facility in Northern California. The plant’s initial capacity was 5 MGD but it was expanded to 10 MGD in 2010. Initial construction cost was $20.2 million and projected operating cost was $241 per acre foot.[43] Although the district does not publish costs per acre foot by source, it reported that the desalination facility saved customers $4.3 million in 2013 by replacing imports of more expensive water from the San Francisco Public Utilities Commission.[44]

The Mission Basin Groundwater Purification Facility provides 15% of the water supply in the City of Oceanside (San Diego County). The plant started operation in 1992 with a capacity of 2 MGD and was expanded to its current 6.4 MGD capacity in 2002.[45]

Also in San Diego County, the Richard A. Reynolds Groundwater Desalination Facility has been purifying brackish well-water for the Sweetwater Authority since 1999. Construction is currently underway on an expansion, which is expected to increase the facility’s production from 5 MGD to 10 MGD in 2017. The cost of the expansion project is $42 million, of which half is being provided by the state and a quarter by the US Bureau of Reclamation. The Authority expects that the facility will produce water at a cost of $510 per acre foot, much less than the $1,200 per acre foot cost of imported water.[46]

DESALINATION ELSEWHERE IN THE UNITED STATES

A number of desalination plants operate in other states. While most of these have been built and maintained by the public sector, we survey them to demonstrate the widespread application of desalination within the United States and to provide additional data points with respect to construction and operational costs.

In 1995, the City of Cape May, at the southern tip of New Jersey’s coastline decided to address a long-term decline in fresh well-water supplies by building a desalination plant. Three years later, a 2 MGD facility was completed and placed in service. Eighteen years later it continues to operate and the city is planning to expand its capacity.[47] Water from the Cape May desalination plant is the purest in New Jersey and the plant has allowed the city to become a net exporter of water after years of importing.[48]

More controversial is the Taunton River Desalination Plant in Southeast Massachusetts. The plant was authorized in 2002 as a response to chronic water shortages in the nearby city of Brockton.  By the time the plant opened in 2008, conservation measures had reduced Brockton’s water demand to the point that it no longer needed water from the facility. City officials were criticized for agreeing to pay the private operator – Aquaria Water – $120 million over 20 years to build and operate the plant. If and when the city consumes water from the facility, it must also pay $1.23 per thousand gallons (which equates to $401 per acre foot).[49] In June 2016, a drought resulted in declining water levels at Silver Lake, Brockton’s main water source. The city responded by drawing 3.8 million gallons per day from the Aquaria facility.[50]

Despite the controversy over the Taunton River plant, another desalination facility was built on nearby Palmer River by the Swansea Water District. The 1.2 MGD plant opened in 2013 and cost $18 million to build.[51]

Texas has 46 desalination plants[52] with aggregate capacity of 123 MGD. All of these plants process brackish groundwater or brackish surface water.[53] No seawater desalination plants are currently operating or under construction in the state, although the Laguna Madre Water District has voter approval to borrow $15.7 million to fund a seawater desalination plant on South Padre Island.[54]

Texas’ largest brackish water desalination facility is the Kay Bailey Hutchinson Desalination Plant in El Paso. The plant cost opened in 2007 and cost $91 million to build.[55] Although it has a capacity of 27.5 MGD it does not normally run at full capacity. According to the Texas State Controller, the plant produces 3.5 million gallons on an average day at an operating cost of $489 per acre foot.[56]

Another large brackish water desalination facility was built by the federal government in Yuma, Arizona. Under a 1944 treaty, the United States is obligated to provide Mexico with 1.5 million acre feet of water from the Colorado River (the River empties into the Gulf of California in the Mexican State of Baja California).[57] To ensure that Mexico received sufficient amounts of water without excess salinity, the Bureau of Reclamation opened a desalting plant in 1992 near the border to remove salts from irrigation return flows in Southern Arizona and supply the purified water to Mexico. The plant has generally remained in standby mode because the US was able to meet its annual water obligation without operating it. But, in 2010 and 2011, the Bureau conducted an extended pilot run of the facility. During the pilot run, the plant produced 22,666 acre feet of purified water at a cost of $10.22 million. While this implies an operating cost of $451 per acre foot, the Bureau forecasted much lower costs if the facility began continuous operation – in the range of $45 to $52 per acre foot. The much lower operating cost of this facility is the result of the lower salinity of its intake water:  water processed by the Yuma facility contained an average of 2,621 parts per million (ppm) of salt.[58] By contrast, seawater has a salinity of 35,000 ppm.[59]

The only large seawater desalination plant currently operating in the United States outside California is the Tampa Bay Seawater Desalination Plant in Florida. The 25 MGD facility was completed in 2007 at a cost of $158 million (substantially over the initial budget of $110 million but well below the cost of the Carlsbad facility). Since opening, the plant has operated at varying rates. In 2012, Cooley and Ajami estimated the unit cost of Tampa Bay desalinated water at $1,600 per acre foot assuming average production of 11 MGD. Their estimate includes both operating and debt service costs.[60] Based on data provided by Tampa Bay Water’s Budget Administrator, Lynda Vatter, we calculate that plant operating costs ranged from $1,097 to $1,121 per acre foot during the three most recent fiscal years in which production exceeded 9 MGD.[61]

The Tampa desalination site has an inherent advantage which contributes to its ability to operate at a lower cost than Carlsbad. It is located on an estuary where the water is somewhat less salty than ocean water. Like Carlsbad, the Tampa plant was built next to an already existing power station, and is able to take advantage of waste heat generated by this facility.[62]

Overall, Florida has over 140 desalination facilities producing 515 million gallons of potable water daily. The vast majority of Florida’s plants process brackish ground and surface waters. Aside from Tampa, the only other seawater desalination plants are smaller facilities in the Florida Keys.[63]

 

INTERNATIONAL CASES

In this section we discuss desalination in Israel at some length and then list notable facilities in other nations.

DESALINATION IN ISRAEL AND ITS RELEVANCE TO CALIFORNIA

Israel now obtains about half of its water supply from desalination plants built since 2004.[64] Those facilities are listed in the accompanying table.

Desalination Plants Operating in Israel
20161123-cpc-infrastructure-desal2

Sources for Table:

Israel Water Authority (2015). Water Sector in Israel. http://www.water.gov.il/Hebrew/ProfessionalInfoAndData/2012/05-Water%20Sector%20in%20Israel%20-%20Zoom%20on%20Desalination.pdf

Israel Water Authority (2016). Desalination in Israel (Hebrew).

http://www.water.gov.il/Hebrew/Planning-and-Development/Desalination/Pages/desalination-%20stractures.aspx.

Israel Ministry of Foreign Affairs (2011). Agreement signed for construction of desalination plant in Ashdod. http://mfa.gov.il/MFA/InnovativeIsrael/Economy/Pages/Agreement_signed_desalination_plant_Ashdod_11-Aug-2011.aspx.

Dalia Tal (2004). Construction of Palmachim desalination plant will begin at end of October. Globes. http://www.globes.co.il/en/article-843773.

Global Water Intel (2012). Palmachim expansion financing sealed https://www.globalwaterintel.com/global-water-intelligence-magazine/13/2/general/palmachim-expansion-financing-sealed.

Deltek Group (2016). Annual Report 2015. http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NjI1MTA2fENoaWxkSUQ9MzI5NTAxfFR5cGU9MQ==&t=1.

Water Desalination and Reuse (2011). Agreement at last on Ashdod water price. http://www.desalination.biz/news/0/Agreement-at-last-on-Ashdod-water-price/5774/.

Desalination has freed the nation of eight million from dependence on the Jordan River, which has suffered ecological damage from water consumption and has been a flashpoint of tension with neighboring countries.[65]

A similar initiative in California could also free the state of contested water supplies from the Sierras and Colorado River. Large numbers of California water users are concentrated near the Pacific Coast, especially in the southern part of the state. Three coastal counties – Los Angeles, San Diego and Orange – have over 16 million residents spread over roughly 9,000 square miles. Simply satisfying the water needs of these inhabitants would greatly diminish the state’s overall water security challenge; it is not necessary to pipe desalinated water to sparsely populated inland areas.

With coastal Southern California residents each consuming about 80 gallons of water per day[66], the implied regional demand for potable water is about 1.3 billion gallons. The Carlsbad plant has a capacity of 50 million gallons per day, representing 4% of total demand.  A similar sized plant in Huntington Beach would double the supply of desalinated water – covering 8% of regional requirements.

As Israel’s experience shows, individual plants can be scaled up and built within a short distance of one another, suggesting that desalination could put a very large dent in the amount of water Southern California needs to import. The Sorek plant has more than twice the capacity of the Carlsbad and proposed Huntington Beach facilities, and the Israel’s five major desalination plants are sited along less than 100 miles of the Mediterranean coast.

While environmentalists express concern about the energy used by desalination, it is worth noting that the process has become more energy efficient over time.. Israel’s Sorek plant which became operational in 2013 is more energy efficient than facilities built previously.[67] This may explain why the plant is able to sell water to Israel’s water authority for 52 cents per cubic meter, equating to $641 per acre foot – a small fraction of the costs for Tampa or Carlsbad water. A further investment in desalination technology research can continue the trend toward reducing its cost and environmental impact.

OTHER COUNTRIES

Most of the International Desalination Association’s list of the 50 largest seawater desalination plants are in the Middle East. Outside of Israel, in the Middle East there are desalination plants operating in Saudi Arabia and the United Arab Emirates. Other countries with unreliable water supplies such as Australia and Singapore operate seawater desalination plants. South Africa has also partnered with Iran to develop desalination plants.

A particularly notable plant is Ras al-Khair in Saudi Arabia, the world’s largest. Its capacity is five times that of the Carlsbad facility in California, proving that desalination technology can be readily scaled to meet growing water demand.

Desalination Plants Elsewhere in the World
20161123-cpc-infrastructure-desal3

Sources for Table:               

Colin Simpson (2013). UAE’s largest power and desalination plant opens at Jebel Ali. The National (UAE). http://www.thenational.ae/news/uae-news/uae-s-largest-power-and-desalination-plant-opens-at-jebel-ali

Deema Almahabi (2014). Saudi’s Start Production at World’s Biggest Desalination Plant. Bloomberg. http://www.bloomberg.com/news/articles/2014-04-23/saudis-start-production-at-world-s-biggest-desalination-plant

Water Technology (2015). Tuaspring Desalination and Integrated Power Plant, Singapore. http://www.water-technology.net/projects/tuaspring-desalination-and-integrated-power-plant/

Tom Freyberg (2013). Singapore’s Second Desalination Facility Set to Open with Combined Power Plant. WaterWorld. http://www.waterworld.com/articles/2013/09/singapore-s-second-desalination-facility-set-to-open-with-combined-power-plant.html
Wikipedia (2016). Victorian Desalination Plant. https://en.wikipedia.org/wiki/Victorian_Desalination_Plant
http://www.water-technology.net/projects/southern-seawater-desalination-plant/
Veolia Water (nd). South Africa’s largest seawater desalination plant. http://www.veoliawaterst.co.za/vwst-southafrica/ressources/files/1/32048,Mossel-Bay-Desalination.pdf

CONCLUSION

As this survey shows, a number of nations and two other US states have made strong commitments to desalination technology. Arguments that California is somehow different from all these other jurisdictions seem labored. Instead, California’s hesitant embrace of desalination is mostly attributable to environmental activism, regulatory complexity and politicized water pricing.

Southern California can achieve full water supply security by adding a water source, which while relatively expensive, is still at least 100 times less costly than bottled water. Recent declines in energy prices and continued improvements in desalination technology promise further economies in the process of removing salt from seawater as well as from brackish groundwater and river water. While environmental concerns deserve to be heard, the state should provide a more efficient path for private investors to get final decisions on their desalination project proposals.

 *   *   *

FOOTNOTES

[1] Justin Fredrickson (July 20, 2016). Commentary: Environmental Demands for Water Keep Expanding. AgAlert. http://agalert.com/story/?id=9984.

[2] Orlowski, Aaron (June 6, 2016). Due to La Niña, Drought Could Get Worse This Winter. The Orange County Register. 2016. http://www.ocregister.com/articles/water-718356-california-drought.html.

[3] Anthony Clark Caprio, (May 15, 2015). O.C. district to work toward water-purchase deal with proposed desalination plant. Los Angeles Times. http://www.latimes.com/tn-hbi-me-0521-ocwd-poseidon-20150515-story.html.

[4] San Diego County Water Authority (October 1, 2015). Regional Water Conservation Still Critical Despite Potential for Increased Rainfall. http://www.sdcwa.org/regional-water-conservation-still-critical-despite-potential-increased-rainfall.

[5] Carlsbad Desalination Plant Web Site (n.d.). http://carlsbaddesal.com/how-it-works.

[6] San Diego County Water Authority (December 10, 2008). Carlsbad Seawater Desalination Project: Energy Minimization and Greenhouse Gas Emission Plan. http://www.sdcwa.org/sites/default/files/files/environmental-docs/city-of-carlsbad/2-energy-minimization-greenhouse-gas-reduction-plan-Dec2008.pdf.

[7] San Diego County Water Authority (2016). Desal Process: Desalting the Sea. http://carlsbaddesal.sdcwa.org/desal-process/.

[8] San Diego County Water Authority (2016). Seawater Desalination. http://www.sdcwa.org/seawater-desalination.

[9] San Diego County Water Authority (May 19, 2014). Water Authority Proposes 2015 Rates to Maintain Reliable Water Supply. http://www.sdcwa.org/water-authority-proposes-2015-rates-maintain-reliable-water-supply

[10] Anne Stanko (December 14, 2015). Nation’s Largest Seawater Desalination Plant Enhances Water Supply Reliability for San Diego County. Carlsbad Desalination Plant web site. http://carlsbaddesal.com/nations-largest-seawater-desalination-plant-enhances-water-supply-reliability-for-san-diego-county

[11] City of San Diego (2015). Our Water System: Investing in Our Future. https://www.sandiego.gov/sites/default/files/legacy/water/pdf/rates/ratechangefacts.pdf

[12] San Diego County Water Authority (September 9, 2015). Water Revenue Refunding Bonds, Series 2015A Official Statement. http://www.sdcwa.org/sites/default/files/files/finance-investor/longtermDebt/2015A_OS.pdf

[13] Ben Bergman (December 14, 2015). San Diego water glut threatens to overshadow new desalination plant. KPCC web site. http://www.scpr.org/news/2015/12/14/56198/sd-water-glut-threatens-to-overshadow-new-desalina/

[14] Black and Veatch (2013). 50 Largest Cities Water/Wastewater Survey. http://www.saws.org/who_we_are/community/RAC/docs/2014/50-largest-cities-brochure-water-wastewater-rate-survey.pdf

[15] City of San Diego (2014). Frequently asked questions about the proposed water rate changes for 2014 and 2015. https://www.sandiego.gov/sites/default/files/legacy/water/pdf/rates/jan20142015faq.pdf.

[16] San Diego County Grand Jury (May 15, 2013). Reduce Dependence on Imported Water. http://www.sandiegocounty.gov/grandjury/reports/2012-2013/Reduce_Dependence_Imported_Water_Report.pdf.

[17] California Pollution Control Financing Authority (December 20, 2012). Official Statement: Water Furnishing Revenue Bonds. http://emma.msrb.org/EP726342-EP563548-EP964765.pdf.

[18] San Diego County Water Authority (September 27, 2012). Water Authority Releases Proposed Carlsbad Desalination Water Purchase Agreement. http://www.sdcwa.org/water-authority-releases-proposed-carlsbad-desalination-water-purchase-agreement.

[19] Morgan Cook (November 25, 2015). While other parts of California are bone dry, San Diego faces the opposite problem: too much water. Los Angeles Times. http://www.latimes.com/local/lanow/la-me-drought-watch-20151125-story.html.

[20] San Diego County Water Authority (April 22, 2016). Carlsbad Desalination Plant Named International Plant of the Year for 2016. http://carlsbaddesal.com/Websites/carlsbaddesal/images/Press_Release/PW_NR_Desal_PlantOfTheYear)04-21-16.pdf.

[21] Morgan Cook (November 21, 2015). Desal plant launches amid ample water. San Diego Union-Tribune. http://www.sandiegouniontribune.com/news/2015/nov/21/desal-plant-comes-online-amid-ample-water/.

[22] Ibid.

[23] California Water Boards (April 24, 2015). Proposed Desalination Amendment: Creating a Consistent Permitting Process. http://www.waterboards.ca.gov/publications_forms/publications/factsheets/docs/desal_fs.pdf.

[24] Jaimee Lynn Fletcher (November 7, 2013). Controversial H.B. Desalination Plant Seeks Final Approval. The Orange County Register. http://www.ocregister.com/articles/water-534924-project-poseidon.html.

[25] Shirley Detloff (August 22, 2015).  Study Confirms Prudence of H.B. Desalination Plant. The Orange County Register. http://www.ocregister.com/articles/water-678791-beach-huntington.html.

[26] Ed Joyce (November 14, 2013). Poseidon withdraws Huntington Beach desalination permit application; coastal commission tables vote (Update). Southern California Public Radio. http://www.scpr.org/news/2013/11/14/40366/poseidon-withdraws-huntington-beach-desalination-p/.

[27] Erika Agullar. (August 27, 2015).  Poseidon Plans to Reapply for permit to build Huntington Beach desalination plant. Southern California Public Radio. http://www.scpr.org/news/2015/08/27/54040/poseidon-water-plans-to-reapply-for-permit-to-buil/.

[28] Los Angeles Times (October 19, 2015). Editorial: In Huntington Beach, a desalination plant that makes sense. http://www.latimes.com/opinion/editorials/la-ed-desalination-huntington-beach-20151017-story.html.

[29] Anthony Clark Carpio (January 9, 2015). Will you be drinking ocean water? O.C. Water District to discuss buying from desalination plant. Los Angeles Times. http://www.latimes.com/tn-hbi-me-0115-poseidon-20150109-story.html.

[30] Aaron Orlowski (February 5, 2016). Orange County Will Demand Less Water in the Future, New Forecasts Say. The Orange County Register. http://www.ocregister.com/articles/water-703092-estimate-demand.html.

[31] Raymond Hiemstra (March 5, 2015). How Will the Huntington Beach Poseidon Desalination Plant Impact You? Orange County Coastkeeper. http://www.coastkeeper.org/huntington_beach_poseidon_desalination_plant_impact.

[32] Poseidon Water (2010). Protecting the Environment. Huntington Beach Freshwater. http://hbfreshwater.com/protecting-the-environment.

[33] Water in the West (May 2016). Marine and Coastal Impacts of Ocean Desalination in California. http://waterinthewest.stanford.edu/sites/default/files/Desal_Whitepaper_FINAL.pdf.

[34] Liberty Fund (2012). Margins and Thinking at the Margin. Library of Economics and Liberty. http://www.econlib.org/library/Topics/College/margins.html.

[35] International Bottled Water Association. How Much Does Bottled Water Cost? http://www.bottledwater.org/economics/real-cost-of-bottled-water. Accessed October 21, 2016.

[36] International Bottled Water Association. Bottled Water Market. http://www.bottledwater.org/economics/bottled-water-market. Accessed October 21, 2016.

[37] Christina Zdanowicz (March 7, 2016). Flint family uses 151 bottles of water per day. CNN. http://www.cnn.com/2016/03/05/us/flint-family-number-daily-bottles-of-water/.

[38] See, for example, Kathleen Parker (2010). Population, Immigration, and the Drying of the American Southwest. Center for Immigration Studies. http://cis.org/southwest-water-population-growth. And Dan Bacher (May 2, 2016). Tribunal Considers Rights of Nature in Imperiled San Francisco Bay-Delta. Daily Kos. http://www.dailykos.com/stories/2016/5/2/1522252/-Tribunal-Considers-Rights-of-Nature-in-Imperiled-San-Francisco-Bay-Delta.

[39] Chino Basin Desalter Authority (2016). Facilities. http://www.chinodesalter.org/index.aspx?nid=97.

[40] Chino Basin Desalter Authority (June 9, 2016). Official Statement: Desalter Revenue Refunding Bonds, Series 2016. http://emma.msrb.org/ES796378-ES626176-ES1021734.pdf. Page 12.

[41] Chino Basin Desalter Authority (2016). Adopted Budget Fiscal Year 2016/17. Exhibit A. http://chinodesalter.org/DocumentCenter/View/89.

[42] Chino Basin Desalter Authority 2016A Refunding Bonds Official Statement.  Pages 16 and Appendix A, Page III.

[43] Alameda County Water District (n.d.). Newark Desalination Facility. http://nbwatershed.org/prez/Piraino_Desal.ppt.

[44] Alameda County Water District (2014). Reliability by Design. http://www.acwd.org/DocumentCenter/View/585.

[45] City of Oceanside (n.d.). Mission Basin Groundwater Purification Facility. http://www.cityofoceanside.net/gov/water/div/missionfacility.asp.

[46] Sweetwater Authority (n.d.). Fast Facts: Richard A. Reynolds Groundwater Desalination Facility Expansion. http://www.sweetwater.org/Modules/ShowDocument.aspx?documentid=7643

[47] Mayor Edward J. Mahaney, Jr. (January 1, 2016). City of Cape May State of the City Address. Reprinted in Cape May County Herald. http://www.capemaycountyherald.com/news/government/article_37a811fc-b2ff-11e5-a8e3-af1614cf1954.html.

[48] Richard Denger (September 4, 2012). Desalination plant proved to be winning gamble for Cape May. The Press of Atlantic City. http://www.pressofatlanticcity.com/communities/lower_capemay/desalination-plant-proved-to-be-winning-gamble-for-cape-may/article_61eed314-f61b-11e1-9505-001a4bcf887a.html.

[49] Amy Crawford (June 2013). How Brockton’s Desalination Plant Cost Them Millions. Boston Magazine. http://www.bostonmagazine.com/news/article/2013/05/28/brockton-desalination-plant/2/.

[50] Marc Larocque (July 3, 2016). Brockton water board chair fights back in Silver Lake flap. The Enterprise. http://www.enterprisenews.com/news/20160703/brockton-water-board-chair-fights-back-in-silver-lake-flap.

[51] Bill Hall (April 18, 2014). Swansea desalination plant ranked third in world. http://www.southcoasttoday.com/article/20140428/scbulletin/404280306.

[52] Texas Water Development Board (2012). TWDB Desalination Plant Database. http://www2.twdb.texas.gov/apps/desal/DesalPlants.aspx.

[53] Texas Water Development Board (n.d.). Desalination Facts. http://www.twdb.texas.gov/innovativewater/desal/facts.asp.

[54] Texas Water Development Board (December 1, 2014). 2014 Biennial Report on Seawater Desalination. http://www.twdb.texas.gov/innovativewater/desal/doc/2014_TheFutureofDesalinationinTexas_Final.pdf.

[55] R. Alan Shubert (October 1, 2015). Overview of the El Paso Kay Bailey Hutchison Desalination Plant. Texas Desal Conference. http://www.texasdesal.com/wp-content/uploads/2016/02/Alan_Shubert.pdf.

[56] Texas State Comptroller (January 14, 2014). Texas Water Report: Going Deeper for a Solution. http://comptroller.texas.gov/specialrpt/water/gamechangers/desalination.php.

[57] Congressional Research Service (November 10, 2015). US Mexico Water Sharing: Background and Recent Developments. https://www.fas.org/sgp/crs/row/R43312.pdf.

[58] Bureau of Reclamation (July 2012). Yuma Desalting Plant Pilot Run Final Report. http://www.usbr.gov/lc/yuma/facilities/ydp/YDPPilotRunFinal072712.pdf.

[59] US Geological Survey (2016). Saline Water. http://water.usgs.gov/edu/saline.html.

[60] Heather Cooley and Newsha Ajami (November 2012). Key Issues for Desalination in California: Cost and Financing. Pacific Institute. http://pacinst.org/app/uploads/2013/02/financing_final_report3.pdf. Page 32.

[61] Lynda Vatter (September 13, 2016). Cost spreadsheet provided via email.

[62] Florida Department of Environmental Protection (April 2010). Desalination in Florida: Technology, Implementation and Environmental Issues. http://www.dep.state.fl.us/water/docs/desalination-in-florida-report.pdf.

[63] Florida Department of Environmental Protection (May 2014). Fact Sheet: Desalination. https://www.dep.state.fl.us/water/waterpolicy/docs/factsheets/wrfss-desalination.pdf.

[64] David Talbot (2015). Ten Breakthrough Technologies: Megascale Desalination. https://www.technologyreview.com/s/534996/megascale-desalination/.

[65] Brett Walton (July 25, 2016). Israel’s Mediterranean Desalination Plants Shift Regional Water Balance. Circle of Blue. http://www.circleofblue.org/2016/middle-east/israels-mediterranean-desalination-plants-shift-regional-water-balance/.

[66] South Coast water usage in April 2016 was 77 gallons per day per person and May 2016 usage was 81 gallons per pay per person. Southern California Public Radio (2016). Where is California water use decreasing? http://projects.scpr.org/applications/monthly-water-use/region/south-coast/.

[67] Talbot, MIT Technology Review.

*   *   *

ABOUT THE AUTHORS

Marc Joffe is the Director of Policy Research at the California Policy Center. In 2011, Joffe founded Public Sector Credit Solutions to educate policymakers, investors and citizens about government credit risk. His research has been published by the California State Treasurer’s Office, the Mercatus Center at George Mason University, the Reason Foundation, the Haas Institute for a Fair and Inclusive Society at UC Berkeley and the Macdonald-Laurier Institute among others. He is also a regular contributor to The Fiscal Times. Prior to starting PSCS, Marc was a Senior Director at Moody’s Analytics. He has an MBA from New York University and an MPA from San Francisco State University.

Jill Eicher Jill Eicher is a researcher focusing on innovative financing models for public-sector agencies. Most recently, she was a Visiting Scholar at Stanford University’s Global Projects Center, working on the development of a cooperative investment model for public pension funds to deploy capital into U.S. infrastructure. She co-founded the Fiduciary Infrastructure Initiative, a research-driven venture focused on the applicability of international pension cooperatives making direct infrastructure investments as models for the U.S. A graduate of Wellesley College, Eicher did post-graduate work in mathematics and was issued a patent for her method for assessing investment risk.

Ed Ring is the Vice President of Policy Research at the California Policy Center. His work has been cited in the Los Angeles Times, Sacramento Bee, Wall Street Journal, Forbes, and other national and regional publications. Previously, as a CFO primarily for start-up companies in the Silicon Valley, he has done financial accounting for over 20 years, and brings this experience to his analysis and commentary on issues of public sector finance. From 1995 to 2009 he was the editor of EcoWorld, a website covering environmental issues from a free-market perspective. Between 2007 and 2010 he launched in partnership with AlwaysOn Media the highly successful “GoingGreen” clean technology investor conferences, held annually in San Francisco and Boston. He has an MBA in Finance from the University of Southern California, and a BA in Political Science from UC Davis.

Kevin Dayton is a policy analyst for the California Policy Center, a prolific writer, and the author of frequent postings about generally unreported California state and local policy issues on the California Policy Center’s Prosperity Forum and Union Watch. Major policy reports written by Kevin Dayton include For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction. Dayton spent more than 17 years in various federal, state, and local policy positions for Associated Builders and Contractors (ABC), including ABC of California State Government Affairs Director from 2005 to 2012. He was also a legislative assistant in the U.S. House of Representatives for Congressman Gary A. Franks (R-Connecticut) from 1992 through 1994. Dayton is a 1992 graduate of Yale University, where he majored in History.

ABOUT THE CALIFORNIA POLICY CENTER

The California Policy Center is a non-partisan public policy think tank providing information that elevates the public dialogue on vital issues facing Californians, with the goal of helping to foster constructive progress towards more equitable and sustainable management of California’s public institutions. Learn more at CaliforniaPolicyCenter.org.

 *   *   *

Rebuilding California’s Infrastructure – Energy & Transportation (Part 5 of 6)

20161123-cpc-infrastructure-cover

This is Part Five of “Rebuilding California’s Infrastructure,” to access the other five sections, click on the links below. To access the entire six-part study in a single, printable PDF document, DOWNLOAD HERE.

Part One: Introduction
Part Two: Water Reuse
Part Three: Water Storage
Part Four: Desalination
Part Five: Energy and Transportation
Part Six: Financing Models and Policy Recommendations

ENERGY AND TRANSPORTATION

In this chapter, we survey infrastructure development opportunities in energy and transportation. Although current state policy leans heavily toward wind and solar power generation, we also see value in nuclear and hybrid gas/solar plants. On the transportation side, we find that expensive investments in high speed rail and new commuter light rail lines in Southern California may not be cost effective. Instead, targeted investments in freight rail, improvements to existing passenger rail systems and the creation of more High Occupancy Toll lanes will better facilitate the movement of goods and people around the State.

ENERGY

In 2000 and 2001, California suffered an electricity crisis characterized by rolling blackouts and sudden spikes in energy prices. Explanations for the electricity shortage are numerous, with many observers focusing on price manipulation by Enron energy traders. However, as James Sweeney points out in his review of the emergency, California’s energy supplies were tight and the state was heavily dependent on electricity imports from elsewhere in the West. In the months leading up to the crisis, the Pacific Northwest suffered a lack of rainfall, reducing its hydroelectric power generation, while Southwestern states saw increased demand for electric power.[1] These circumstances made less power available for importation, setting the stage for price manipulation and shortages.

In 1999, the last full year before the crisis, California imported 20% of its electricity from other states.  In 2015, the latest year for which figures are available, imports accounted for 34% of the state’s power use.[2] Although in-state electricity production has increased slightly since 1999, it has not kept up with increased demand.

In recent years, California’s electricity usage has been relatively flat – testimony to the success of conservation efforts. Total energy user per capita in California is lower than in 47 states; only New York and Rhode Island use less.[3] But as population increases and usage of chargeable devices such as electric cars and smartphones becomes more widespread, demand for electricity can be expected to rise in the future. To keep up with greater needs, replace aging plants and reduce reliance on uncertain imports from out-of-state, California will need more electric power.

Given concerns over climate change and other environmental impacts, it would be attractive to assume that California could meet all of its needs exclusively with new wind and solar power installations. Unfortunately, these green energy sources have limitations and environmental impacts of their own.

Wind turbines kill hundreds of thousands of birds across the US each year, and the number could reach 1.4 million if the nation meets an Obama administration goal of producing 20% of its electricity from wind.[4]

Solar farms require relatively large amounts of land per megawatt generated. Photovoltaic solar plants require 66,000 square meters per megawatt generated – more than six times the amount of land required by a nuclear plant.[5] Natural gas, biomass and coal plants have even smaller footprints.[6]

Further, some solar power plants use fossil fuels. For example, the Ivanpah plant in the Mojave Desert consists of 352,000 mirrors that collect sunlight needed to heat the facility’s three boilers, but relies on natural gas to preheat water going into the boilers and to run the plant when the sun is not shining. The natural gas burned at Ivanpah produced 46,000 metric tons of Carbon Dioxide in 2014, almost twice the rate at which a facility is required to participate in California’s cap-and-trade program. Had the natural gas used at Ivanpah been burned at a traditional power plant it would have produced enough electricity for 17,000 homes, or about one quarter of Ivanpah’s 2014 output. [7] Despite the fact that Ivanpah burns substantial amounts of natural gas, it received $1.6 billion of loan guarantees from the Department of Energy under its Title XVII clean energy program.[8]

The Ivanpah plant caught on fire in May 2016 when mirrors in the tower did not track the sun properly and did not focus sunlight onto the correct part of the tower.[9] The plant resumed operation by June 2016. The Ivanpah plant also runs into some other issues. 6,190 birds died at the plant in 2015.[10]

While Ivanpah was not positioned as a hybrid natural gas/solar facility, it effectively operates as one. A more cost-effective alternative is to build plants explicitly designed for hybrid operation. These facilities can maintain constant output throughout the day and under all weather conditions.

Relative to coal and oil, natural gas produces less greenhouse gases. According to the US Energy Information Administration (EIA), natural gas produces 26% less CO2 than gasoline and 43% less CO2 than coal to produce the same amount of energy.[11] Further, abundant supplies of natural gas are available domestically. According to EIA, the nation had technically recoverable natural gas reserves equal to 84 years of consumption at current rates.[12] Given its relative cleanliness and abundance, Joe Romm of the Center for American Progress characterized natural gas “as a plausible transition fuel for the next two to three decades as we aggressively ramp up wind, solar PV, concentrated solar thermal, biomass, geothermal, and other ultra-low-carbon energy sources.”[13]

Hybrid plants that supplement natural gas production with solar power date to 2010. In that year, Florida Power & Light brought the Martin Next Generation Clean Energy Center online. The plant has a total capacity of 1,225 megawatts (MW) of which 75 MW comes from solar. In New Mexico, Western Energy Partners is building a 750 MW hybrid plant expected to come online in 2019.[14]

If and when solar panels become substantially more efficient, these hybrid plants could be upgraded so that they produce a greater portion of their electrical output from renewable energy. The speed at which solar will improve is a matter of speculation and debate. The optimistic view was captured by futurist Ray Kurzweil, who recently said:

Solar panels are coming down dramatically in cost per watt. And as a result of that, the total amount of solar energy is growing, not linearly, but exponentially. It’s doubling every 2 years and has been for 20 years. And again, it’s a very smooth curve. There’s all these arguments, subsidies and political battles and companies going bankrupt, they’re raising billions of dollars, but behind all that chaos is this very smooth progression.[15]

On the other hand, environmentalist Michael Shellenberger told us that solar technology improvements have been linear rather than exponential and that recent cost declines were largely attributable to aggressive pricing by Chinese manufacturers of solar panels.[16] The last solar cell efficiency table published by the National Renewable Energy Laboratory supports Shellenberger’s view: maximum efficiencies reported for various solar technologies are rising gradually over time – and not accelerating.[17]

Improvements in Solar Cell Efficiency Over Time
20161123-cpc-infrastructure-energy1

A recent report from Lawrence Berkeley labs provides mixed signals: showing a steady decline in median prices for large scale photovoltaic projects through 2014, but a flattening of capacity-weighted average prices. In 2014, per-kWh costs for some larger PV projects were higher than similar projects coming online in 2013.[18]

Since the future direction of solar prices is uncertain and given the large footprint of today’s solar plants, California would be well served by a diversified energy policy. Insofar as California is using solar, policymakers should consider shifting additional solar power generation to cheaper photovoltaic solar panels (Ivanpah uses more expensive concentrated solar power [19]). Aside from wind, solar and hybrid projects incorporating natural gas, the state should consider maintaining and expanding its investment in nuclear power.

Currently, the state has only one nuclear facility: Diablo Canyon in San Luis Obispo County. Diablo Canyon’s two reactors produce about 8% of California’s in-state generated electricity. But the reactors may be forced to close in 2024 and 2025, if their federal licenses are not renewed.[20] While the decision to file a renewal application belongs to PG&E, the plant’s future may also be influenced by the state. Lt. Gov. Gavin Newsom, in his capacity as Chair of the State Lands Commission, is asking PG&E to conduct additional environmental reviews before the Commission approves an extension to a lease of state-owned tidelands required by Diablo Canyon. Newsom has also predicted that the plant won’t remain open another ten years.[21] In June 2015, facing political pressure, PG&E announced that it would close the Diablo Canyon nuclear facility in 2025. [22]

In January 2016, a group of scientists, conservationists and philanthropists called on PG&E and state leaders to keep the facility open. In an open letter, the group, Save Diablo Canyon, said:

Closing Diablo Canyon would make it far harder to meet the state’s climate goals. Already, the percentage of electricity California generates from clean energy declined from 53 percent in 2011 to 38 percent in 2014. Without Diablo, California’s clean electricity generation would decline to 26 percent while electricity from natural gas would rise to 70 percent.[23]

Signers of the letter included former Whole Earth Catalogue Founder, Stewart Brand; NASA climate scientist James Hansen; Santa Clara University conservation biologist Michelle Marvier; 1976 Nobel Prize winner Burton Richter; President Emeritus of the Missouri Botanical Center; Pulitzer-Prize winning historian Richard Rhodes; University of Wisconsin Nelson Center for the Environment Director, Paul Robbins; and environmentalist Michael Shellenberger, quoted above.

Shellenberger, a Time Magazine Hero of the Environment and spokesperson for the coalition, also told us that he would not oppose expanding Diablo Canyon and/or building additional nuclear facilities in California. Because nuclear power plants produce such high quantities of clean energy, the state could achieve its aggressive climate goals by preserving Diablo Canyon, and building a small number of additional nuclear facilities.

Nuclear accidents, although widely publicized, are rare. Further, fatalities directly caused by these accidents have been limited. For example, the International Atomic Energy Association confirmed that there were no deaths attributable to radiation in the immediate aftermath of the 2011 Fukushima accident. A substantial number of deaths in Fukushima resulted from a large scale evacuation ordered by the government following the meltdown, but scientists quoted by The New York Times concluded that this evacuation was unnecessary.[24] As Michael Shellenberger told us, the government should have instead told residents to shelter in place.

Diablo Canyon stores spent fuel rods – the most radioactive form of nuclear waste – on site. According to PG&E, the volume of this waste is minimal and that the methods of handling it are safe.[25] On the other hand, Mother’s for Peace, a group opposed to Diablo Canyon, reports that, by 2025, the facility will have generated 4,310 spent fuel assemblies, each containing 225 twelve-foot rods. The group reports that these rods will remain hazardous for 300 years, and that their storage casks could be breached in the event of a terrorist attack.[26]

Currently there is no central location for storing radioactive nuclear waste. In 2002, the US Department of Energy determined that Yucca Mountain, 100 miles northwest of Las Vegas, would be a suitable site for permanently storing spent fuel rods. The site was approved by President George W. Bush and the Congress, but eight years later, the Obama Administration killed efforts to prepare Yucca Mountain for this use. GAO concluded that the decision to halt the Yucca Mountain project was due to “social and political opposition to a permanent repository, not technical issues.”[27]

Ideally, either a future federal administration or the state government would identify a relatively safe location – away from populated areas – to permanently store radioactive nuclear waste before construction of additional nuclear power plants in California was completed.

NATURAL GAS PIPELINES

In this section, we consider natural gas pipelines and their effectiveness in meeting California’s energy needs.

Proposals to add natural gas pipeline capacity are likely to face stiff political opposition due to concerns about climate change and safety. As we explained above, natural gas produces less greenhouse gas than other fossil fuels and renewables will be insufficient to meet California’s energy needs for some time.

Natural gas is usually transported by pipeline. In order to be transported by truck or rail, it must be cooled to a temperature of -160° Celsius, at which point the fuel assumes a liquid form. Transport of Liquefied Natural Gas by train is a relatively new development. The Federal Railroad Administration approved the first application to carry LNG on an American railroad in late 2015.[28] Truck transportation of LNG is necessary for outlying areas not served by pipelines, but is considerably more expensive than pipeline transport[29] and thus not likely to be scalable.

With respect to safety, a couple of high profile disasters in recent memory are likely to play a role in any discussion about new pipeline projects.

On September 9, 2010, a natural gas pipeline under San Bruno (San Mateo County) exploded, killing eight people, injuring 58 others and destroying 38 homes. The section of pipe that failed was installed in 1956 before federal law mandated pressure testing to ensure the integrity of new segments. Subsequent investigations found that the pipeline’s owner Pacific Gas & Electric often had inadequate practices with respect to pipeline construction, inspection and recordkeeping.[30]

In late 2015 and early 2016, over 97,000 metric tons of methane leaked from a natural gas storage facility in Porter Ranch (Los Angeles County). The leak, which lasted 112 days, caused the evacuation of 6,000 residents. Because methane is a highly potent greenhouse gas, the leak is believed to have had serious climate change implications.[31] While this incident did not involve a pipeline, it could serve as a basis for opposition to natural gas storage and transportation projects generally.

According to the California Public Utilities Commission (CPUC), there were 57 pipeline incidents across the state in 2015 of which two were categorized as level 4 – causing injury or death.[32] Nationally, the federal Pipeline and Hazardous Material Safety Administration (PHMSA) reported 29 serious incidents in 2015. Since 2010, the number of these incidents has ranged from 24 to 34, with the number of deaths ranging from 9 to 19.[33]

While it would be ideal to have an energy distribution system that caused no deaths or injuries, the natural gas pipeline system should be regarded as quite safe overall given the size of the national system. The nation has nearly 320,000 miles of gas transmission pipelines and over 2 million miles of gas distribution pipelines.[34]

Southern California Gas has proposed to build a 63-mile gas pipeline between the cities of Adelanto and Moreno Valley in the inland empire. The pipeline, together with four pressure limiting stations and an upgrade to the Adelanto Compressor Station, is estimated to cost $621 million.[35] The new pipeline is intended to increase the reliability of supply for customers in the southern portion of the utility’s service area.[36] Construction of this system is expected to begin in September 2018 and take one year.[37] The actual construction phase will thus be much shorter than the permitting and approval process, which is estimated to contribute $16 million to the overall cost of the project.[38]

Nationally, the INGAA Foundation estimates that the required investment in natural gas pipeline infrastructure at $4 billion annually in constant dollars through 2035. Other natural gas infrastructure should require about $10 billion of additional annual investment.[39] While the report does not break down required investment to the state level, we do know that California represents about 9% of the nation’s natural gas consumption, suggesting that annual pipeline spending may be in vicinity of $400 million.

Investment at this level should be within the financial capability of the natural gas industry. According to American Gas Association data, Southern California Gas Company had $2.9 billion in revenues in 2014, while Pacific Gas and Electric had $2.1 billion in gas-related revenues during the same year. These companies should be able to finance several hundred million dollars of infrastructure investment each year from retained earnings and by issuing bonds or taking commercial bank loans.

From a public policy standpoint, it may not be necessary to make major changes to ensure that the necessary level of investment can be obtained. That said, policy changes that reduce the cost and increase the speed of the permitting process would ensure that energy companies can make the needed investments in a more cost effective manner. After discussing freight rail, we will consider oil pipelines as an alternative to oil trains.

FREIGHT RAIL

Three of the nation’s largest ports are located in California. In 2013, Los Angeles ranked first for the volume of goods handled, Long Beach was second and Oakland was sixth. San Diego and Port Hueneme (Ventura County) also ranked among the top 30.[40] With the rise of Asian manufacturing, California ports have played an increasingly important role in the nations’ goods movement system.

In June 2016, the Panama Canal Authority implemented a major expansion of the Central American waterway.[41]  The project doubles the canal’s capacity and allows much larger ships to use the waterway. As a result, shipping goods from Asia through the Canal to Eastern and Gulf ports will become a more cost-effective alternative to docking at ports in California and then shipping containers eastward via truck or freight rail. The $5.4 billion expansion was completed in June.[42]

Researchers at IMS Worldwide have estimated the location of a “cost equivalence line”. Points east of the line can be more cost effectively served by east coast ports, while those on the other side of the line are better served by goods shipped from west coast ports. In 2013, the line was about 700 miles inland from the east coast.  In other words, even for places as far east as Illinois and Mississippi, it was cheaper to bring in goods via West Coast ports.[43]

Transportation Cost Equivalence Line
20161123-cpc-infrastructure-energy2

Now with the Panama Canal expansion completed, this line will move to the West. How far it will move is yet to be determined. Researchers at CBRE suggested that the shift will not be that dramatic,[44] but there will no certainty until a few years after the Canal expansion opens.

Although the desirability of retaining California’s share of national shipping volume can be criticized by economists, we assume that this goal is attractive to state policymakers.

California can limit the westward movement of the cost equivalence line, and thus the loss of shipping traffic at our major ports, by investing in transportation infrastructure. While more and better highways would benefit trucking, freight rail infrastructure upgrades may be a better option.

During periods of high energy prices, freight rail can have substantial cost advantages over trucking, especially over longer distances.[45] Also, because rail is more fuel efficient, it produces much lower emissions per ton-mile of cargo shipped.[46] According to Congressional Budget Office analysis, shipping by truck produces social costs eight times greater than shipping the same volume by freight rail.[47]

In April 2016, the Southern California Association of Governments (SCAG) adopted a 25-year Regional Transportation Plan[48] which calls for over $246 billion in transportation capital improvements. Because SCAG’s region includes the nation’s two largest seaports, this plan is especially relevant to California’s freight infrastructure development. An appendix[49] to the plan lists numerous projects that would enhance the Southern California region’s freight rail capacity and reliability. These initiatives – which are estimated to cost $11 billion in all – include capacity expansions, grade separations, installation of positive train control systems (to prevent accidents) and improved dock connections.

Shipping becomes more efficient when containers can be offloaded directly from ships to railcars. In Southern California, about 27% of cargo is transferred on dock. This proportion would increase to 35% if the goods movement plan is implemented. The plan also expands “near dock” transfers in which containers are trucked a short distance (five miles or less) from the dock to a railyard.

Other regions that host major ports have identified potential freight rail upgrades. The Alameda County Goods Movement Plan[50] which includes the Port of Oakland lists a number of potential investments that would speed freight rail movement, including construction of a new rail bridge and double tracking (which eliminates delays caused when a single track is used by trains going in both directions). The port does not currently have any on dock rail terminals, but does have two near dock facilities.[51]

The Port of San Diego is also considering improved on dock rail facilities, but the timing, nature and cost of the upgrades have not been specified.[52] Further inland, the Port of Stockton also has freight connections. A number of upgrades for this port are recommended in the San Joaquin Valley Interregional Goods Movement Plan.[53]

Because US freight railroads are privately owned, a substantial proportion of infrastructure funding can and does come from the private sector. In 2013, railroad companies in the US invested $13 billion in track and equipment.[54]

OIL TRAINS VS. PIPELINES

One variety of freight has proved controversial in recent years is oil. In the aftermath of a number of oil train explosions, objections to rail transportation of petroleum have increased.

In 2013, an oil train accident in Lac-Mégantic, Quebec, Canada killed 47 people, destroyed the downtown core and resulted in the release of 1.5 gallons of petroleum.[55] In early 2015, trains carrying oil from North Dakota’s Bakken formation derailed in Mount Carbon, West Virginia[56] and Galena, Illinois.[57] Although neither incident caused fatalities, they both resulted in large releases of oil due to the failure of tank cars.

These incidents have triggered opposition to new oil train projects. For example, the Benicia City Council has deferred action on Valero Oil’s proposal to construct a new rail line to its refinery.[58] A similar proposal by Phillips 66 in San Luis Obispo has also met with opposition.[59]

Two types of infrastructure investments can address safety issues arising from oil trains: (1) build stronger tank cars that are less likely to spill oil or catch fire during a derailment, or (2) add pipelines as an alternative to rail transport.

In July 2015, the federal government imposed stricter standards for tank cars. All new cars must have thicker shells, shields along the front and back, electronic breaking systems and other improvements. Older cars must be retired or retrofitted to meet the new standards by 2020.[60] California cities could approve new rail extensions for oil trains, while requiring oil companies to adhere to the new standards earlier. Such an approach would balance safety concerns with the need to maintain a stable oil supply in California.

Another alternative is to move oil via pipelines rather than trains. Earlier, we saw that pipelines are the best solution for moving natural gas. Although oil does not need to be liquefied, movement of oil by pipeline is still much less expensive than rail transport.[61] In 2014, the nation’s 67,000 miles of crude oil pipelines carried 9.29 billion barrels of unrefined petroleum products.[62]

The recent battle over the Keystone XL pipeline at the federal level suggests that there would be strong environmentalist opposition to new pipelines in California. And there is some reason for concern. While pipeline spills are less frequent than spills arising from train derailments, the amount of oil released during a pipeline rupture can be much larger.[63] A 2010 pipeline spill in Michigan involved 850,000 gallons of oil, contaminated a local creek and will cost $1.2 billion to remediate. One reason for the high cost is that the spill involved diluted bitumen from the Alberta tar sands, which has more serious environmental impacts than the conventional crude oil that normally flows through California pipelines.[64]

PASSENGER RAIL

The case for investment in passenger rail is mixed. In the Southern California, mass transit ridership has declined despite the availability of new rail lines. For example, the Los Angeles County Metropolitan transportation Authority has seen a 10% drop in boardings since 2006 despite a $9 billion investment in light rail and subway lines.[65]

By contrast, the Bay Area Rapid Transit (BART) system is experiencing record ridership and bumping up against capacity limitations. Between FY 2010 and FY 2015, average weekday exits rose from 101 million to 126 million.[66] BART’s most congested section, the tube between San Francisco and Oakland is operating near capacity during rush hours, causing frequent delays. An influential Bay Area think-tank, SPUR has proposed the creation of a second cross-bay tube and suggested the possibility of using a Public-Private partnership to build the project.[67] According to BART officials quoted by the San Francisco Chronicle, the cost of such a project may be around $12 billion.[68]

Meanwhile, the BART system is also struggling with aging cars, tracks and other components. The November 2016 ballot contained a $3.5 billion bond measure to fund system maintenance projects. The bond contains $1.225 billion to replace electrical systems, $625 million to replace worn rails, $570 million to fix leaking tunnel structures, and $400 million to upgrade the central control computer system and run trains closer together.[69]

Another rail system in the Bay Area that has experienced substantial ridership growth is Caltrain which provides service between San Jose and San Francisco. Between 2010 and 2015, average weekday ridership grew from 34,120 to 58,245, with most rush hour trains now exceeding their seated capacity.[70]

The system is currently implementing a $1.7 billion modification plan that includes electrifying the entire line and improved signaling.[71] These improvements will speed trains and thus increase the system’s seated capacity.

Caltrain’s longer term capital plan is linked to the buildout of California High Speed Rail (HSR), since the San Jose to San Francisco portion of the proposed intercity bullet train would run along Caltrain’s right of way. Under this so-called blended system, HSR trains would generally run on Caltrain tracks, but may use passing tracks at certain points to allow the faster HSR trains to overtake Caltrain vehicles making more frequent local stops.[72]

It does not appear that the blended system proposal calls for the elimination of Caltrain’s forty grade crossings, at which the tracks intersect with roads. Grade crossings are associated with frequent fatal accidents[73] and they can impose significant delays on motorists waiting for trains to pass. If HSR service does eventually begin on an electrified Caltrain system, maximum train frequencies would rise to as many as ten per hour, substantially increasing gate downtime and accompanying delays for local drivers and pedestrians.[74] Safety and mobility along Caltrain’s right of way could be improved by replacing all grade crossings with underpasses or overpasses. The Palo Alto City Council has offered a proposal along these lines, suggesting that revenue from a Santa Clara County transportation sales tax measure be used to replace grade crossings in that city. The Palo Alto proposal lists two grade costing replacement projects estimated to cost a total of $700 million.[75] Replacing all 40 grade crossings system-wide could thus be expected to require several billion dollars.

A third major Bay Area transit system, the San Francisco Municipal Railroad (SF Muni) has seen much slower ridership growth. According to data provided to the authors by SF Muni in response to a Public Records Act request, passenger volume rose from 216 million in FY 2010 and to 219 million in FY 2015. Like many other mass transit systems serving compact geographic areas, SF Muni is facing headwinds from the growth of ride sharing services and bicycle commuting.

Randall O’Toole, a Cato Institute Senior Fellow, argues that the impending introduction of self-driving vehicles will render commuter and light rail transportation unnecessary in most parts of the country. O’Toole contends that self-driving cars will greatly increase the effective capacity of highways during rush hours because autonomous vehicles can react more smoothly to changing speeds of cars ahead of them. By not overreacting to slowing traffic, driverless vehicles will minimize chain reaction slowdowns that often cause traffic jams. In cities, shared autonomous vehicles will give people who cannot or do not want to drive a low cost alternative to buses and passenger rail.[76]

O’Toole’s predictions appear to be borne out by strategic actions being taken by ride-sharing companies and auto manufacturers. In January 2016, Lyft and General Motors announced a partnership to build a fleet of self-driving cars,[77] although General Motors had made clear that these cars will not be on the market in the near future.[78] More recently, Uber began tests of self-driving rideshare vehicles in Pittsburgh and announced plans to work with several manufacturers on autonomous vehicle technology.[79] The intention in both cases appears to be to use self-driving cars to provide taxi services.

In a computer simulation, Daniel Fagnant and his collaborators found that a network of self-driving taxis in Austin, Texas could substantially reduce the number of cars in the downtown area as well as the need for parking spaces. The researchers estimate that each autonomous vehicle could replace as many as nine cars downtown.[80] Parking spaces could be converted to other land uses, including extra driving lanes in congested areas.

Another growing alternative to mass transit in urban areas is bicycling. The US Census reported that the proportion of commutes by bicycle in the nation’s largest cities rose from 0.6% to 1.0% between 2000 and 2012.[81] There are indications that the trend toward biking has accelerated more recently in some California cities.  In San Francisco, bike trips rose 8.5% between 2014 and 2015.[82] In San Diego, bike traffic on two major Uptown thoroughfares increased 346% between 2012 and 2014, with the change largely attributed to the installation of buffered bike lanes.[83] Although bicycle commuting is most often marketed by activists and local governments as an alternative to driving, biking is also replacing mass transit use especially for shorter trips.

A recent Los Angeles Times op-ed attributed declining transit ridership to increased bicycling and greater use of ride-sharing services among other factors. But, rather than celebrate these trends, the author suggested increased housing density near transit lines and other measures to entice commuters onto rail and bus systems.[84] Perhaps a better alternative is to curtail investment in expensive mass transit infrastructure and instead implement policies to encourage bicycling,ride-sharing and jitneys.

HIGH SPEED RAIL

Earlier, we discussed the linkage between Caltrain and California High Speed Rail (HSR) capital plans. Given the fact that Caltrain is operating above its seated capacity and that the main highway between San Jose and San Francisco is heavily congested[85], an investment in accelerating passenger rail transport along this route appears reasonable. It is less obvious, however, that the rest of the HSR system can be cost justified.

The High Speed Rail Authority’s (HSRA) latest business plan shows a greater than 99% chance that the system will break even by 2040. In that year, the plan projects annual ridership of between 33.2 million and 56.8 million and fare box revenue of between $1.9 billion and $3.1 billion (in current dollars).[86]

However, independent observers have expressed skepticism of HSRA’s past estimates. For example, the Reason Foundation argued that HSRA’s ridership projections are inflated because of unrealistic travel time assumptions, implausible expectations about the number of passengers from outside the HSR corridor that will travel to an HSR station, and improper estimates of automobile travel costs that riders will use when choosing between car and rail alternatives. After adjusting for these factors, Reason projects that ridership will only be a small fraction of the HSRA estimates.[87]

Ridership statistics for an existing US high speed train service support Reason’s analysis. The Acela Express carried 3.5 million passengers during FY 2015. When slower trains are included, a total of 11.7 million passengers travelled Amtrak’s Northeast corridor between Boston and Washington,[88] in a region more densely populated than that served by the planned High Speed Rail line.[89] Northeast corridor ridership levels are a small fraction of those projected for HSR.

Long term ridership forecasts may also be impacted by unpredictable business and technology developments. In early 2016, a startup company named Sleepbus inaugurated overnight bus service between Los Angeles and San Francisco for $48. Passengers are provided with a bunk bed for the duration of the seven-hour ride. The service is proving attractive to millennials who welcome the opportunity to save on lodging expenses by sleeping on the bus.[90] This advantage would seem resistant to a faster, but costlier alternative such as high speed rail. HSRA’s business plan assumes a fare of $86 between Los Angeles and San Francisco.[91]

Meanwhile, a larger startup is trying to implement Elon Musk’s vision of travel by hyperloop. If Hyperloop Tech is successful, passengers will be able to travel in relatively small vehicles suspended electromagnetically within a tube. The technology is theoretically capable of speeds exceeding 700 miles per hours with very frequent departures. Hyperloop Tech has raised $37 million, employs a staff of 72 and plans to complete a working prototype in the near future.[92] More recently, the firm has experienced turmoil,[93] but the potential of its technology remains.

HIGH OCCUPANCY TOLL LANES

While self-driving cars will reduce congestion over the long term, specific highway choke points can be addressed sooner with additional lanes. In certain cases, new lanes can be financed with toll revenue, thereby opening the door to private infrastructure investment.

California has over two decades of experience with High Occupancy Toll (HOT) lanes that are shared by vehicles with multiple passengers and single-occupant cars paying a variable toll to enter the lane. Tolls are collected electronically by means of FasTrak transponders in each car. Drivers who use HOT lanes as both sole occupants and carpoolers at different times can use a “switchable FasTrak” device to indicate how many people are in the car for any given trip.[94]

The nation’s first HOT lanes were built in the median of California State Route 91 in Orange County, and began operation in December 1995.[95]  These lanes continue to operate today, serving over 37,000 paying riders each day and generating $42 million in toll revenue during the year ended June 30, 2016.[96] The lanes were built and originally operated by a privately-owned corporation, the California Private Transportation Company (CPTC), which borrowed $126 million and provided $19 million in equity to finance construction.[97]

Unfortunately, an issue with CPTC’s contract undermined the public-private partnership. A non-compete clause prevented the Orange County Transportation Authority from adding other highway capacity within 1.5 miles of SR-91.[98] Continued growth in the area led to increased congestion. In 2002, the Authority bought out CPTC’s contract for $207.5 million and took over operation of the lanes.[99]

While the SR-91 express lanes proved very profitable for CPTC, another corporation found private highway operation to be a losing proposition. In 2007, California Transportation Ventures (CTV) opened a 9.3-mile extension to the South Bay Expressway (SR-125) in San Diego. The project required $130 million in equity and $480 million in debt financing. Litigation with construction contractors and disappointing toll revenues forced CTV into bankruptcy in 2010; the San Diego Association of Governments (SANDAG), assumed operational control the following year.[100] In 2013, SANDAG reported higher than expected toll revenues and that the road was on a firm financial footing,[101] suggesting that over the long-run, the extension was cost-justified.

SR-125 is one of several successful toll roads in Southern California. In Orange County, two Joint Powers Authorities operate four toll roads. Both of these authorities received operating revenue in excess of both operating and non-operating expense in Fiscal Year 2016.[102]

Since the inauguration of the SR-91 express lanes, additional HOT lanes have opened in Alameda, Los Angeles, San Diego and Santa Clara Counties. All of these arteries were built and are operated by government agencies.  Although enabling legislation for privately-built HOT lanes remains on the books, local transportation authorities have not used the PPP option.

High levels of congestion on several stretches of freeway in the Southern California and the San Francisco Bay Areas suggest that more opportunities for HOT lane construction are available. According to the American Highway Users Alliance, 13 of the nation’s 30 worst traffic bottlenecks are in California. The Alliance estimates that these bottlenecks cost motorists an estimated 48 million lost hours annually.[103]

The reintroduction of private capital into HOT-lane and toll road finance could reduce the number of lost hours. The size of the potential revenue opportunity, which CalTrans has estimated to be $2.3 billion over a ten year period[104] should be compelling. Private contractors and governing agencies will have to fashion agreements that enable profitable operation while maximizing public benefit.

CONCLUSION

California needs additional power plants to reduce its dependency on imported electricity and keep up with population growth. Wind and solar can only make a limited contribution to the state’s power generation needs. These sources should be supplemented by the construction of new hybrid natural gas/solar plants and, assuming a waste storage solution is in place, new nuclear power plants.

Centrally generated energy resources need to be transported.  Although energy pipelines and oil trains engender strong opposition, the overall safety record of pipelines looks good when one considers the enormous number of miles of pipelines we have in the US versus the relatively small number of incidents that have occurred.

Investments in freight rail can solidify California’s leadership in goods movement despite the expansion of the Panama Canal. Freight rail is cost effective and environmentally friendly, and much of the investment in freight rail is already undertaken by private companies. Although they will continue to face environmental objections, oil tanker cars built to newer federal standards would be a good choice for transporting crude to California refineries.

The case for passenger rail investment is nuanced. Systems that serve heavily populated areas where road-based alternatives are congested and costly to expand may be attractive candidates for investment. The BART system which takes traffic off Bay Area bridges is a good example.[105] But systems that replace shorter trips that have multiple route choices may not generate sufficient ridership gains given competition from bicycles, ride sharing services and autonomous vehicles (in the years ahead). Beyond the Bay Area, high speed rail development appears dubious from a cost-benefit perspective. In some cases, the addition of HOT lanes to existing freeways may prove to be more cost-effective than adding new passenger rail capacity.

Finally, it is worth noting that investments in freight and passenger rail often overlap. When passenger and freight trains share the same rights of way, signaling improvements, grade crossing replacements and additional tracks benefit both uses. This is reflected in San Diego Forward’s 2015 Regional Plan which included $4.6 billion in rail enhancements that would benefit both types of traffic.[106]

 *   *   *

FOOTNOTES

[1] James L. Sweeney (Summer 2002). The California Electric Crisis: Lessons for the Future. The Bridge, Vol. 32, No. 2. 24-31. http://www.nae.edu/File.aspx?id=7375

[2] California Energy Commission. California Electrical Energy Generation. http://energyalmanac.ca.gov/electricity/electricity_generation.html. Accessed August 8, 2016.

[3] US Energy Information Administration. Rankings: Total Energy Consumed per Capita, 2013 (million Btu). http://www.eia.gov/state/rankings/?sid=CA#series/12. Accessed August 8, 2016.

[4] Bird-Smart Wind Energy: Protecting Birds from Poorly Sited Wind Turbines (n.d.). American Bird Conservancy. http://abcbirds.org/program/wind-energy/.

[5] Massachusetts Institute of Technology (2006). The Future of Geothermal Energy. http://geothermal.inel.gov/publications/future_of_geothermal_energy.pdf.

[6] Natural Gas: Smallest Footprint of All Energy Sources (n.d.). Natural Gas Supply Association. http://www.ngsa.org/download/analysis_studies/footprint%20comparison%20april%202013.pdf.

[7] David Danelski (October 21, 2015). It’s not easy being green: Ivanpah solar plant near Nevada burns a lot of natural gas, making it a greenhouse gas emitter under state law. Orange County Register. http://www.ocregister.com/articles/plant-688596-gas-energy.html.

[8] Ivanpah. Energy.Gov: Loan Programs Office. http://energy.gov/lpo/ivanpah. Accessed March 4, 2016.

[9] Joseph Bebon (May 25, 2016). Update: NRG Confirms Cause of Fire at Ivanpah Solar Plant. Solar Industry.

[10] Phil Taylor (July 29, 2016). Sharp rise in estimated bird deaths at Calif. ‘power tower’. http://www.eenews.net/stories/1060040984

[11] US Energy Information Administration (June 18, 2015). Frequently Asked Questions: How much carbon dioxide is produced when different fuels are burned? https://www.eia.gov/tools/faqs/faq.cfm?id=73&t=11.

[12] US Energy Information Administration (November 18, 2015). Frequently Asked Questions: How much natural gas does the United States have, and how long will it last? http://www.eia.gov/tools/faqs/faq.cfm?id=58&t=8.

[13] Joe Romm (June 3, 2009). Climate action game changer, Part 1: Is there a lot more natural gas than previously thought? Center for American Progress web-site. http://thinkprogress.org/climate/2009/06/03/204193/climate-action-game-changer-unconventional-natural-gas-shale/.

[14] Herman K. Trabish (April 9, 2015). $1B, 750 MW hybrid natural gas-solar facility to be built in New Mexico. Utility Drive. http://www.utilitydive.com/news/1b-750-mw-hybrid-natural-gas-solar-facility-to-be-built-in-new-mexico/384717/

[15] Max Miller (2011). Ray Kurzweil: Solar Will Power the World in 16 Years. The Big Think. http://bigthink.com/think-tank/ray-kurzweil-solar-will-power-the-world-in-16-years.

[16] Chinese solar panel dumping led to the imposition of steep US tariffs in 2014. See Diane Cardwell (December 16, 2014). U.S. Imposes Steep Tariffs on Chinese Solar Panels, The New York Times. http://www.nytimes.com/2014/12/17/business/energy-environment/-us-imposes-steep-tariffs-on-chinese-solar-panels.html?_r=0

[17] National Renewable Energy Laboratory (2015). Best Research-Cell Efficiencies. http://www.nrel.gov/ncpv/images/efficiency_chart.jpg (A discussion of this chart is available at http://www.nrel.gov/about/community/news/2016/24867.

[18] Mark Bolinger and Joachim Seel (September 2015). Utility-Scale Solar 2014. Lawrence Berkeley National Laboratory. https://emp.lbl.gov/sites/all/files/lbnl-1000917.pdf.

[19] Sarah Zhang (May 23, 2016). A Huge Solar Plant Caught on Fire, and That’s the Least of Its Problems. Wired. http://www.wired.com/2016/05/huge-solar-plant-caught-fire-thats-least-problems/.

[20] David R. Baker (November 14, 2015). Nuclear power’s last stand in California: Will Diablo Canyon die? San Francisco Chronicle. http://www.sfchronicle.com/business/article/Nuclear-power-s-last-stand-in-California-Will-6630933.php.

[21] David R, Baker (January 3, 2016). Can Gavin Newsom close California’s last nuclear plant? San Francisco Chronicle. http://www.sfchronicle.com/business/article/Can-Gavin-Newsom-close-California-s-last-6734454.php.

[22] David Sneed (June 21, 2016). PG&E Agrees to Close Diablo Canyon in 2025. The San Luis Obispo Tribune. http://www.sanluisobispo.com/news/local/article84993992.html

[23] Save Diablo Canyon (2016). Open Letter. http://www.savediablocanyon.org/open-letter/.

[24] George Johnson (September 21, 2015).  When Radiation Isn’t the Real Risk. New York Times.  http://www.nytimes.com/2015/09/22/science/when-radiation-isnt-the-real-risk.html?_r=0.

[25] PG&E Corporate Affairs. Diablo Canyon Power Plant: Safely storing used nuclear fuel. https://www.pge.com/includes/docs/pdfs/shared/edusafety/systemworks/dcpp/PGE_FactSheet_safestorage.pdf. Accessed March 23, 2016.

[26] Klaus Schumann and Fred Frank (2014). High-Level Radioactive Waste at Diablo Canyon. Mothers for Peace. https://mothersforpeace.org/data/archive/2014-05-01-high-level-radioactive-waste-at-diablo-canyon.

[27] Government Accountability Office (April 2011). Commercial Nuclear Waste: Effects of a Termination of the Yucca Mountain Repository Program and Lessons Learned. http://www.gao.gov/assets/320/317627.pdf.

[28] Matt Buxton (October 13, 2015). Alaska Railroad OK’d for LNG Transport. Newsminer. http://www.newsminer.com/news/local_news/alaska-railroad-ok-d-for-lng-transport/article_da2e37c8-7248-11e5-b9f9-abc9a0a52711.html.

[29] Lonnie Shekhtman (September 26, 2014). Companies providing ‘virtual pipeline’ for natural gas. https://www.bostonglobe.com/business/2014/09/25/companies-providing-virtual-pipeline-for-natural-gas/wFsLxTTNE4lyko463dPfGL/story.html.

[30] Rebecca Bowe and Lisa Pickoff-White (September 8, 2015). Five Years After Deadly San Bruno Explosion: Are We Safer? The California Report. http://ww2.kqed.org/news/2015/09/08/five-years-after-deadly-san-bruno-explosion-are-we-safer

[31] Alejandro Davila Fragoso (February 26, 2016). The Massive Methane Blowout in Aliso Canyon Was the Largest in U.S. History. Climate Progress. http://thinkprogress.org/climate/2016/02/26/3754378/gas-leak-largest-ever/.

[32] California Public Utilities Division (February 2016). Safety and Enforcement Division: Monthly Performance Report. http://www.cpuc.ca.gov/uploadedFiles/CPUC_Website/Content/Transparency/Safety_Reports_and_Presentations/SED_Monthly_Performance_Reports/SED%20Monthly%20Report%20February%202016%20Final.pdf

[33] PHMSA (2016). Pipeline Serious Incident 20 Year Trend. https://hip.phmsa.dot.gov/analyticsSOAP/saw.dll?Portalpages.

[34] Pipeline 101 (2013). Why do we need pipelines? http://www.pipeline101.com/Why-Do-We-Need-Pipelines.

[35] Southern California Gas Company (November 2014). North-South Project: Updated Report. https://www.socalgas.com/regulatory/documents/a-13-12-013/Attachment%20A_%20Updated%20Buczkowski%20Supplemental%20Testimony%20Final%20Redacted.pdf.

[36] Southern California Gas (2016). North-South Project. https://www.socalgas.com/stay-safe/north-south.

[37] CPUC (2016). Southern California Gas Company and San Diego Gas & Electric North-South Project

(Application No. 13-12-013) http://cpuc.ca.gov/environment/info/ene/n-s/northsouth.html.

[38] North-South Project: Updated Report. Attachment XIV.

[39] The INGAA Foundation (March 18, 2014). North American Midstream Infrastructure through 2035: Capitalizing on Our Energy Abundance. http://www.ingaa.org/File.aspx?id=21498&v=598452af.

[40] Patrick Burnson (May 1, 2014). Top 30 US Ports: Digging Deep. Logistics Management. http://www.logisticsmgmt.com/article/top_30_us_ports_digging_deep.

[41] http://micanaldepanama.com/expansion/2016/03/panama-canal-inaugurates-scale-model-training-facility-announces-expansion-inauguration-date/.Rick Jervis (June 27, 2016). Bigger ships: Panama celebrates opening its expanded canal. USA Today. http://www.usatoday.com/story/news/world/2016/06/26/bigger-ships-panama-celebrates-opening-its-expanded-canal/86403210/.

[42] Panama Canal Expansion: Contractor’s Cost Overruns Case Dismissed. Reuters. https://gcaptain.com/panama-canal-expansion-contractors-cost-overruns-claim-dismissed/.

[43] CBRE (2016). Seaports and Logistics: 2016 North America Annual Report. https://www.boma.org/research/Documents/CBRE_2016_Seaports_and_Logistics_Annual_Report.pdf. An earlier CBRE report showed the cost-equivalence line much farther to the East. See CBRE (2014). Transportation Cost Equivalence Line: East Coast vs. West Coast Ports. http://www.cbre.us/o/washingtondcmarket/AssetLibrary/Transportation-Cost-Equivalence-Line-July-2014.pdf.

[44] CBRE (2016).

[45] Chris Nelder (October 22, 2012). Rising Energy Costs May Usher in U.S. Freight Rail Revival. Scientific American. http://www.scientificamerican.com/article/freight-rail-back-to-the-future/.

[46] C. Jake Haulk (1997). Inland Waterways as Vital National Infrastructure. Allegheny Institute for Public Policy. http://www.port.pittsburgh.pa.us/modules/showdocument.aspx?documentid=340.

[47] Congressional Budget Office (December 11, 2014). Social-Cost Pricing in Freight Transportation. https://www.cbo.gov/sites/default/files/113th-congress-2013-2014/presentation/49838-socialcost-pricingfreighttransportation_0.pdf.

[48] Southern California Association of Governments (April 2016). The 2016-2040 Regional Transportation Plan/Sustainable Communities Strategy. http://scagrtpscs.net/Documents/2016/final/f2016RTPSCS.pdf.

[49] Southern California Association of Governments (April 2016). Goods Movement Appendix to the RTP/SCS. http://scagrtpscs.net/Documents/2016/final/f2016RTPSCS_GoodsMovement.pdf.

[50] Alameda County Transportation Commission (February 2016). Alameda County Goods Movement Plan. http://www.alamedactc.org/files/managed/Document/18249/AlamedaCTC_GoodsMovementPlan_FINAL.pdf.

[51] California Department of Transportation (May 2013). 2013 California State Rail Plan. http://www.dot.ca.gov/californiarail/docs/Final_Copy_2013_CSRP.pdf.

[52] San Diego Unified Port District (December 2015). Tenth Avenue Terminal Redevelopment Plan Draft Environmental Impact Report. Provided to us via email.

[53] San Joaquin Council of Governments, et. al. (August 2013). The San Joaquin Valley Interregional Goods Movement Plan. http://dot.ca.gov/hq/tpp/offices/ogm/CFAC/Stockton_08_16_2013/SJV_Goods_Movement_Exec_Sum.pdf.

[54] American Association of Railroads (2014). Total Annual Spending: 2013 Data. https://www.aar.org/Fact%20Sheets/Safety/2013-AAR_spending-graphic-fact-sheet.pdf.

[55] Transportation Safety Board of Canada (2014). Lac-Mégantic runaway train and derailment investigation summary. http://www.tsb.gc.ca/eng/rapports-reports/rail/2013/r13d0054/r13d0054-r-es.pdf.

[56] Federal Rail Administration (October 2015). Accient Findings Report for Derailment of CSX Transportation, Inc.’s Unit Crude Oil Train K08014. https://www.fra.dot.gov/Elib/Document/15369.

[57] Associated Press (March 9, 2015). Galena train-derailment recovery nearly complete. Quad-City Times. http://qctimes.com/news/local/galena-train-derailment-recovery-nearly-complete/article_cfb80f04-c63f-11e4-906c-8fc85743afa0.html.

[58] Tony Bizjak (April 19, 2016). Benicia City Council delays decision on oil trains. Sacramento Bee. http://www.sacbee.com/news/local/transportation/article72799142.html.

[59] Cynthia Lambert (February 4, 2016). Hundreds condemn Phillips 66 oil-by-rail proposal in first day of two-day hearing. The Tribune. http://www.sanluisobispo.com/news/local/article58417963.html.

[60] Ari Phillips (May 4, 2015). The U.S. Is Getting Serious About Oil Train Explosions. Here’s How It Plans to Stop Them. Think Progress. http://thinkprogress.org/climate/2015/05/04/3654319/oil-by-rail-rules-address-explosion-in-traffic/.

[61] Association of Oil Pipelines (2014). About Pipelines. http://www.aopl.org/pipeline-basics/about-pipelines/. Page quotes rates provided by Argus Media.

[62] Association of Oil Pipelines (November 2015). U.S. Liquids Pipeline Usage and Mileage Report. http://www.api.org/~/media/files/oil-and-natural-gas/pipeline/whats-new/2015-aopl-api-pipeline-usage-mileage-report.pdf?la=en.

[63] Emily Atkin (February 18, 2015). Data: Oil Trains Spill More Often, But Pipeline Spill Bigger. ThinkProgress. http://thinkprogress.org/climate/2015/02/18/3624116/how-would-you-like-your-oil-spilled-today-sir/.

[64] John Frittelli, et. al. (December 4, 2014). U.S. Rail Transportation of Crude Oil: Background and Issues for Congress. Congressional Research Service. https://www.fas.org/sgp/crs/misc/R43390.pdf.

[65] Laura J. Nelson and Dan Weikel (January 27, 2016). Billions spent, but fewer people are using public transportation in Southern California. Los Angeles Times. http://www.latimes.com/local/california/la-me-ridership-slump-20160127-story.html.

[66] Bay Area Rapid Transit (2016). Ridership Reports. http://www.bart.gov/about/reports/ridership.

[67] Ratna Amin and Brian Stolke (February 10, 2016). Designing the Bay Area’s Second Transbay Rail Crossing. SPUR White Paper. http://www.spur.org/sites/default/files/publications_pdfs/SPUR_Designing_the_Bay_Area%27s_Second_Transbay_Rail_Crossing.pdf.

[68] Michael Cabanatuan (January 31, 2015). Prospects for 2nd BART tube gain momentum, but wait could be long. San Francisco Chronicle. http://www.sfgate.com/bayarea/article/Prospects-for-2nd-BART-tube-gain-momentum-but-6054215.php.

[69] Dan Brekke (June 9, 2016). $3.5 Billion BART Bond Measure Headed to November Ballot. KQED News. http://ww2.kqed.org/news/2016/06/09/BART-bond-measure-november-3-point-5-billion/.

[70] Caltrain (2015). Caltrain 2015 Annual Passenger Count Key Findings. http://www.Caltrain.com/Assets/_Marketing/pdf/2015+Annual+Passenger+Counts.pdf.

[71] Caltrain (2016). Caltrain Modernization Capital Projects. http://www.Caltrain.com/projectsplans/CaltrainModernization/Modernization.html.

[72] LTK Engineering Services (2012). Caltrain/California HSR Blended System Analysis. http://www.caltrain.com/Assets/Caltrain+Modernization+Program/Documents/Final-Caltrain-California+HSR+Blended+Operations+Analysis.pdf.

[73] US Department of Transportation (2015). Federal Railroad Administration Ramps up Campaign to Enhance Safety at Nation’s Grade Crossings. https://www.transportation.gov/briefing-room/federal-railroad-administration-ramps-campaign-enhance-safety-nation%E2%80%99s-grade-crossings.

[74] Caltrain (May 2013). Caltrain / HSR Blended System: Grade Crossing and Traffic Analysis http://www.caltrain.com/Assets/Caltrain+Modernization+Program/Presentations/Caltrain-HSR+Blended+System+Grade+Crossing+$!26+Traffic+Analysis.pdf.

[75] City of Palo Alto (August 17, 2015). City Council Staff Report: VTA Call for Projects. http://www.cityofpaloalto.org/civicax/filebank/documents/48467.

[76] Randall O’Toole (September 18, 2014). Policy Implications of Autonomous Vehicles. Cato Institute Policy Analysis Number 758. http://object.cato.org/sites/cato.org/files/pubs/pdf/pa758_1.pdf

[77] Davey Alba (January 5, 2016). The Lyft-GM Deal and Why You Probably Won’t Buy a Self-Driving Car. Wired. http://www.wired.com/2016/01/the-lyft-gm-deal-and-why-you-probably-wont-buy-a-self-driving-car/.

[78] John Rosevear (August 4, 2016). Why Did General Motors Delay Its Self-Driving Cars?  http://host.madison.com/business/investment/markets-and-stocks/why-did-general-motors-delay-its-self-driving-cars/article_35625a95-866d-5315-9db5-25095e9dec9c.html.

[79] Max Chafkin (August 18, 2016). Uber’s first self0driving fleet arrives in Pittsburg this month. Bloomberg News, http://www.bloomberg.com/news/features/2016-08-18/uber-s-first-self-driving-fleet-arrives-in-pittsburgh-this-month-is06r7on.

[80] Daniel J. Fagnant, Kara M. Kockelman, and Prateek Bansal (2015). Operations of Shared Autonomous Vehicle Fleet for Austin, Texas, Market. Transportation Research Record. Volume 2536: Pages 98-106.

[81] Brian McKenzie (May 2014). Modes Less Traveled—Bicycling and Walking to

Work in the United States: 2008–2012. US Census. http://www.census.gov/hhes/commuting/files/2014/acs-25.pdf.

[82] Joe Fitzgerald Rodriguez (April 15, 2016). Annual bike count shows commutes in SF up nearly 9 percent. San Francisco Examiner. http://www.sfexaminer.com/annual-bike-count-shows-commutes-sf-nearly-9-percent/.

[83] Bike San Diego (April 2, 2015). In Uptown: Bike Traffic On Fourth and Fifth Avenues up by an Average of 346% Since 2012. http://bikesd.org/2015/04/in-uptown-bike-traffic-on-fourth-and-fifth-avenues-up-by-an-average-of-71-since-2012/.

[84] Ethan N. Elkind (February 1, 2016). How to Boost L.A.’s sinking transit ridership. Los Angeles Times. http://www.latimes.com/opinion/livable-city/la-oe-0201-elkind-transit-ridership-decline-20160201-story.html.

[85] Matthew Artz (December 17, 2015). Bay Area’s worst commutes: Highway 101 in South Bay at No. 3. The Mercury News. http://www.mercurynews.com/news/ci_29269888/bay-area-freeways-last-year-were-most-congested.

[86] California High Speed Rail (February 18, 2016). Draft 2016 Business Plan. http://www.hsr.ca.gov/docs/about/business_plans/DRAFT_2016_Business_Plan_0201816.pdf.

[87] Joseph Vranich and Wendell Cox (April 2015). California High Speed Rail: An Updated Due Diligence Report. Reason Foundation Policy Study 415. http://www.hsr.ca.gov/docs/about/business_plans/DRAFT_2016_Business_Plan_0201816.pdf.

[88] Amtrak FY15 Ridership and Revenue (November 2015). http://media.amtrak.com/wp-content/uploads/2015/10/FY15Ridership_Revenue_Fact_Sheet_11-5-15.pdf

[89] According to Wikipedia, the Northeast Megalopolis is the most urbanized region of the US with a population density of 931 people per square mile. https://en.wikipedia.org/wiki/Northeast_megalopolis

[90] Tess Townsend (April 19, 2016). How this startup is disrupting long-distance transportation right now. Wired. http://www.inc.com/tess-townsend/sleepbus-gets-you-from-sf-to-la-for-50.html.

[91] Cambridge Systematics (2014). California High Speed Rail 2014 Business Plan: Ridership and Revenue Forecasting. http://www.hsr.ca.gov/docs/about/business_plans/BPlan_2014drft__Ridership_Revenue.pdf.

[92] Hyperloop Tech (December 7, 2015). Propulsion Open Air Test. http://hyperlooptech.com/blog/This%20morning%20we%20are%20announcing%20one%20of%20the%20many%20steps%20that%20move%20us%20closer%20to%20achieving%20our%20%22Kitty%20Hawk%22%20moment%20in%202016.

[93] Benjamin Wallace (October 18, 2016). A Kink in the Hyperloop. New York Magazine. http://nymag.com/selectall/2016/10/the-kink-in-elon-musks-hyperloop.html.

[94] The Toll Roads of California (2016). FasTrak Throughout California. http://www.thetollroads.com/accounts/fastrak/california.

[95] Robert Poole and C. Kenneth Orski (2000). HOT Lanes: A Better Way to Attack Urban Highway Congestion. Regulation, Volume 23 Number 1. http://object.cato.org/sites/cato.org/files/serials/files/regulation/2000/4/poole.pdf.

[96] 91 Express Lanes (2016). Traffic Revenue. Orange County Transportation Authority. https://www.91expresslanes.com/revenue.asp.

[97] US Department of Transportation (2014). SR-91 Express Lanes, Orange County, CA. https://www.transportation.gov/policy-initiatives/build-america/sr-91-express-lanes-orange-county-ca.

[98] Corridor Watch (2007). State Route 91 (California). http://www.corridorwatch.org/ttc_2007/CW00000091.htm.

[99] US Department of Transportation (2014). SR-91 Express Lanes.

[100] US Department of Transportation (2014). South Bay Expressway (SR-125), San Diego, CA. https://www.transportation.gov/policy-initiatives/build-america/south-bay-expressway-sr-125-san-diego-ca

[101] San Diego Association of Governments (2013). SANDAG exceeds goals for operating toll road. http://www.sandag.org/enewsletter/archives/june2013/feature_1.html.

[102] Foothill/Eastern Transportation Corridor Agency and San Joaquin Hill Transportation Corridor Agency 2016 audited financial statements available at https://www.thetollroads.com/about/investor/financial-reports.

[103] American Highway Users Alliance (2015). Unclogging America’s Arteries 2015. http://www.highways.org/wp-content/uploads/2015/11/unclogging-study2015-low-res.pdf

[104] California Transportation Commission (2012). Toll Roads/High Occupancy Toll Lanes. http://www.catc.ca.gov/reports/2012NeedsAssess/10232012/revopt12_tollHOT_10312012update.pdf.

[105] This was illustrated by the severe traffic congestion experiences in San Francisco’s East Bay suburbs during the 2013 BART strike.  See, for example, Carolyn Jones, et.al. (October 21, 2013). Traffic is worst yet on Day 4 of BART strike. San Francisco Chronicle. http://www.sfgate.com/news/article/Traffic-is-worst-yet-on-Day-4-of-BART-strike-4913005.php.

[106] San Diego Forward (2015). Regional Transportation Plan Appendix A. http://www.sdforward.com/pdfs/RP_final/AppendixA_B_C.pdf.

*   *   *

ABOUT THE AUTHORS

Marc Joffe is the Director of Policy Research at the California Policy Center. In 2011, Joffe founded Public Sector Credit Solutions to educate policymakers, investors and citizens about government credit risk. His research has been published by the California State Treasurer’s Office, the Mercatus Center at George Mason University, the Reason Foundation, the Haas Institute for a Fair and Inclusive Society at UC Berkeley and the Macdonald-Laurier Institute among others. He is also a regular contributor to The Fiscal Times. Prior to starting PSCS, Marc was a Senior Director at Moody’s Analytics. He has an MBA from New York University and an MPA from San Francisco State University.

Jill Eicher Jill Eicher is a researcher focusing on innovative financing models for public-sector agencies. Most recently, she was a Visiting Scholar at Stanford University’s Global Projects Center, working on the development of a cooperative investment model for public pension funds to deploy capital into U.S. infrastructure. She co-founded the Fiduciary Infrastructure Initiative, a research-driven venture focused on the applicability of international pension cooperatives making direct infrastructure investments as models for the U.S. A graduate of Wellesley College, Eicher did post-graduate work in mathematics and was issued a patent for her method for assessing investment risk.

Ed Ring is the Vice President of Policy Research at the California Policy Center. His work has been cited in the Los Angeles Times, Sacramento Bee, Wall Street Journal, Forbes, and other national and regional publications. Previously, as a CFO primarily for start-up companies in the Silicon Valley, he has done financial accounting for over 20 years, and brings this experience to his analysis and commentary on issues of public sector finance. From 1995 to 2009 he was the editor of EcoWorld, a website covering environmental issues from a free-market perspective. Between 2007 and 2010 he launched in partnership with AlwaysOn Media the highly successful “GoingGreen” clean technology investor conferences, held annually in San Francisco and Boston. He has an MBA in Finance from the University of Southern California, and a BA in Political Science from UC Davis.

Kevin Dayton is a policy analyst for the California Policy Center, a prolific writer, and the author of frequent postings about generally unreported California state and local policy issues on the California Policy Center’s Prosperity Forum and Union Watch. Major policy reports written by Kevin Dayton include For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction. Dayton spent more than 17 years in various federal, state, and local policy positions for Associated Builders and Contractors (ABC), including ABC of California State Government Affairs Director from 2005 to 2012. He was also a legislative assistant in the U.S. House of Representatives for Congressman Gary A. Franks (R-Connecticut) from 1992 through 1994. Dayton is a 1992 graduate of Yale University, where he majored in History.

ABOUT THE CALIFORNIA POLICY CENTER

The California Policy Center is a non-partisan public policy think tank providing information that elevates the public dialogue on vital issues facing Californians, with the goal of helping to foster constructive progress towards more equitable and sustainable management of California’s public institutions. Learn more at CaliforniaPolicyCenter.org.

 *   *   *

Rebuilding California’s Infrastructure – Financing Models & Recommendations (Part 6 of 6)

20161123-cpc-infrastructure-cover

This is Part Six of “Rebuilding California’s Infrastructure,” to access the other five sections, click on the links below. To access the entire six-part study in a single, printable PDF document, DOWNLOAD HERE.

Part One: Introduction
Part Two: Water Reuse
Part Three: Water Storage
Part Four: Desalination
Part Five: Energy and Transportation
Part Six: Financing Models and Policy Recommendations

FINANCING MODELS AND POLICY RECOMMENDATIONS

California is not alone among states that find their infrastructure in need of modernization and their sources of funding constrained. The United States is decades behind several other countries in building its infrastructure for the 21st century. Policy changes will be required at both the state and federal levels to enable California to make up its infrastructure investment deficit.

California and other US states have not relied on private capital to finance infrastructure, as the $3.7 trillion municipal bond market makes borrowing by state and local governments affordable by virtue of the exemption of interest from federal income taxation. But a reliance on this tax-exempt debt financing mechanism has produced a legacy of underinvestment and delayed maintenance in infrastructure assets all across America. As a result, infrastructure assets—bridges, drinking water distribution pipes, transit systems—have become liabilities to state and local governments.

This has led public finance officials to re-examine their approach to financing infrastructure, including California State Treasurer John Chiang who proposed in his 2016 State Treasurer’s Biennial Report, “to rethink our reliance on bond debt to fund infrastructure.” He stated:

“The issuance of debt can be seen as a Trojan horse carrying with it transaction and interest costs that require repayment of two to three times, or more, of what was actually borrowed. These costs are expected to grow as the debt markets emerge from the sustained period of historically low interest rates. As rates increase, more of every infrastructure dollar will be used to pay interest, leaving less for the concrete, steel, equipment, and labor.” [1]

State Treasurer Chiang suggests, “developing finance plans that draw on a variety of capital sources.” The idea to leverage public funding with private financing from long-term institutional investors like pension funds has been articulated by many governments around the world, including the U.S. Department of the Treasury.

The intrinsic problem in financing infrastructure, however—from Sacramento to Queensland—is not a lack of capital but a lack of revenue-generating infrastructure assets to repay investors. While private investors have not participated much in financing public infrastructure, they have spurred money-making innovation in private-sector infrastructure, such as electrical power and telecommunications. These investors are increasingly as sought after for their expertise as for their capital.

To speed private investment in public infrastructure, some governments have developed policy incentives and financing mechanisms expressly to attract long-term institutional investors. We will look at five of these programs with any eye towards how they might be adapted by California policymakers, specifically, project guarantees, inflation protection mechanisms, pension governance reform, project bundling and in-kind contributions.

Advocates of laissez faire may question some of the policies described here, regarding them as a form of crony capitalism. For the purposes of this study, we assume that some types of civil infrastructure have public goods characteristics:  they would be under-supplied in the absence of government intervention.[2] Assuming the government must be involved, we believe that incenting private actors to supply public goods is usually preferable to public provision. It is also worth noting that there is international competition for infrastructure capital; if California and the US don’t offer policies to attract this capital, it will be invested in Australia, Canada and Europe.

United Kingdom: Guarantees

As part of the 2012 UK Guarantees Scheme, the UK government offered financial guarantees on money loaned to fund infrastructure projects in an effort to make the projects more attractive to private investors. The program was intended to “avoid delays to investment in UK infrastructure because of adverse credit conditions making it difficult to secure private finance.” By providing guarantees to lenders, the investment risk was transferred from the lenders to the government in hopes of encouraging more lending for infrastructure projects. The program was funded by an annual fee paid to the government by sponsoring infrastructure companies, based on the level of risk associated with the project. As of December 2015, the program has generated 39 projects valued at approximately $669 billion; there have been no calls on government to pay out on any government guarantees.[3]

For California policymakers, this financing mechanism may have the potential to be adapted by state infrastructure banks and economic development commissions to reduce project-financing risk for private investors in California infrastructure.

Netherlands: Inflation Protection

In the 2012 N33 road-widening transportation project, the Dutch government created an inflation-linked financing mechanism expressly to secure senior debt financing from the local pension fund, APG. In this $167 million transaction, APG provided $107 million in debt, at a lower fixed rate than offered by the commercial banks to the government, in return for inflation-proof payments on its capital, which was guaranteed by the Dutch government. This enabled APG to reduce inflation risk in its $461 billion portfolio and provided the government with cheaper debt by taking inflation risk.[4]

Typically, infrastructure project financing is fixed and not indexed to inflation. By indexing project loan payments to the country’s consumer product index, the Dutch government saved APG the significant costs associated with buying similar inflation protection.

Like APG, US pension funds need inflation protection. Policymakers might be able to use the Dutch government’s inflation-linked financing mechanism as a model to structure similar instruments. This is especially relevant since California has the two largest public pension funds in the United States. Such a financing mechanism might mitigate the geographic and concentration risks that would otherwise impede the California pension funds from investing in California infrastructure.

Canada: Controlling Interest Legislation and Pension Governance Reform

The Quebec government entered into an operating partnership with La Caisse de dépôt et placement du Québec, a local, $215 billion pension fund, to take over responsibility for planning, financing, developing and operating certain public infrastructure assets. To do this, the provincial government needed to amend procurement regulations and pension governance laws to allow the pension fund to have a controlling interest in public assets. The government continues to protect the public interest by retaining approval authority for projects developed by the pension fund.[5]

This financing model might offer California policymakers an additional option for building and operating infrastructure projects with limited impact on public balance sheets.

Europe and Canada: Project Bundling

Because it does not make sense for long-term institutional investors to finance small infrastructure projects—the average municipal financing in the US is $25 million—or to invest in projects in economically-challenged locations—project sponsors in Europe and Canada developed methods to group or consolidate projects into single procurements.[6]

By bundling similar small projects into one deal, a scale can be achieved that justifies the costs of due diligence for private investors, reduces transaction costs for both investors and sponsors, and diversifies the risk of the underlying individual projects.

Project-bundling financings have funneled over $800 billion in international infrastructure investment over the past five years.[7] We propose them because of the broad application they may offer California policymakers as they confront a $358 billion gap in needed infrastructure financing over the coming decade.[8]

Australia: In-Kind Contribution

The state government of Queensland conveyed the Queensland Motorway—a highway, bridge, and tunnel network—to QIC, a local pension fund, to satisfy pension liabilities in 2011. This in-kind contribution benefitted from both political support and public acceptance because of the shared responsibility for pension liabilities between the government, the pension fund, and the taxpayers. QIC’s management of, and subsequent investments in, the motorway resulted in an increase in its value so great that the asset had to be sold because of its overweight position in QIC’s portfolio. This resulted in a multi-million-dollar profit for the pension fund in less than five years[9] and a much-improved roadway for the state.

US corporations have made in-kind contributions to their pension funds, but state and local governments have not made them to public pensions. California policymakers might explore the potential of in-kind contributions as a tool to address distressed assets on balance sheets and to reduce unfunded pension liabilities.

In addition to these five approaches to increase private-sector investment in public infrastructure, some governments have encouraged pension funds to pool assets to more efficiently deploy capital into infrastructure projects. Pooling can be thought of as the aggregation of assets into a collective investment vehicle to enhance investment performance.

Pooled-Asset Structures

Australia introduced pooled-asset structures in the early 1990s. More recently, in 2011, the United Kingdom launched an initiative to establish a pooled-asset vehicle, stating: “The current investment model and structure of UK pension funds does not allow the vast majority of UK pension funds to efficiently invest in infrastructure.”[10]

The 2012 Moreau Report, commissioned by the Canadian government, echoes the UK’s rationale, specifically finding that pooling would facilitate pensions’ access to infrastructure investments.[11]

After the collapse of a Minnesota bridge in 2007, Kathleen Sebelius, then governor of Kansas, proposed that “pension funds pool their assets and invest directly in projects to build new roads and bridges in multiple states, bypassing the Wall Street firms that want to siphon off profits.”  She suggested that public pensions funds, with assets in excess of $3 trillion, could “create a multiplier effect, generating jobs, economic activity, and new tax revenue for states.[12]

US pension plans—to date—have not pooled assets to invest in infrastructure.

One of the earliest Australian pooled-asset structures, Industry Funds Management (IFM), is recognized as an exemplar of the genre. Created in 1994 by 30 Australian pension (or superannuation) funds, IFM operates as an institutional fund manager with an independent board to oversee the business, and with a dedicated in-house investment team to make investment decisions and manage the assets.

According to CEO Brett Himbury, the $20 billion IFM has generated an average annual return of 11.5 percent over the past 20 years.[13] IFM’s recent investment in the Indiana Toll Road is its 30th infrastructure asset and the fourth toll road in IFM’s infrastructure portfolio.[14]

IFM uses its organizational structure to align investors’ interests by facilitating follow-on investments. This optimizes both cash yield and the long-term value of assets in which they have an equity ownership interest. The ability to reinvest in owned assets is a competitive advantage that generates, on average, a 15 percent return according to IFM Executive Director Brian Clarke.[15]

This investment approach differs from discrete, US debt financings in which the focus is on obtaining the lowest cost of capital, not on enhancing the long-term value of the asset.

Direct-Investment Capacity

The “secret sauce” of IFM, and many other pooled-asset structures, is the ability to make direct investments in infrastructure assets and projects. This capacity enables investors to draw on in-house expertise to make investment decisions internally and to have equity ownership interests in assets. This lowers costs and increases control over their investments. US institutional investors generally do not have the capacity to make direct investments and therefore must outsource the investment process to fund managers at much greater expense.[16]

Pioneered by the Ontario Teachers’ Pension Plan, most of the large Canadian pension funds also have the capacity to make direct investments in infrastructure assets and projects. Like the Australian pension funds, they acquired the capacity to make direct investments in infrastructure by investing cooperatively in pooled-asset structures developed expressly to invest in infrastructure. These structures range from formally organized legal entities to opportunistic syndicates.

Borealis Infrastructure is one of the Canadian direct-investment platforms formed expressly to invest in infrastructure on behalf of its sponsoring pension fund, Ontario Municipal Employees Retirement System (OMERS). OMERS operates Borealis Infrastructure as one of three investment captives, much like a subsidiary company that is structured to balance accountability and autonomy. Each captive has a dedicated chief investment officer to oversee an in-house investment team; all are employees of OMERS. Borealis Infrastructure manages over $12.7 billion in infrastructure investments for OMERS and other institutional investors. Its 10-year average annual rate of return, according to its 2014 annual report, is 12.33 percent, which almost doubles the MSCI World Infrastructure Index return for the same period.[17]

The sustained outperformance of these Australian and Canadian infrastructure investors can be attributed to organizational structures, which align long-term interests and financing mechanisms that realize cost efficiencies.

Few of the nearly 4,000 pension plans spread across the United States—227 managed by states, and 3,771 managed by local governments—have an efficient way to invest in infrastructure. Even the two largest American pension funds, both in California, have not yet been able to institutionalize direct investment capacity.

Barriers to Adaptability of International Models

It is important to note that there have been numerous examples in the United States of political attempts—mostly by state governors—to tap institutional investors, particularly pension funds, to secure private capital to finance infrastructure needs, yet no policy initiatives have been advanced to overcome the structural impediments of US fiscal policy that discourage private investment in infrastructure.

Public pensions have a fiduciary duty to provide a secure retirement for their beneficiaries—not to build bridges, create jobs, or finance businesses started by women or minorities. Nonetheless, political leaders pressure them to support pet projects. New York Governor Mario Cuomo proposed financing a new Tappan Zee Bridge with public pension capital in 2011; California Governor Jerry Brown called for pension capital to build a high-speed rail project in 2012.[18]

As convenient and logical as these calls for local, in-state investments would appear, they run counter to the tenets of prudent investing. Just as insurance companies spread out policies in hurricane and flood areas to mitigate geographic risk and employees do not invest all their money in the stock of their employers to avoid concentration risk, pension funds should limit investments in their local economies unless there are compelling offsets to mitigate the inherent geographic and concentration risks. If public pensions were to expose themselves to such risks, they would be putting taxpayers—who are ultimately responsible for pension funding shortfalls—at risk as well.

Life-Cycle Costs

Public finance officials—California State Treasurer John Chiang is an example—are increasingly recognizing that borrowing costs are only the starting point in financing infrastructure assets and projects. These policymakers acknowledge that other costs, such as operations and maintenance, need to be considered—and too frequently are not in the United States—when underwriting projects that might stretch out over several decades. They are also challenging the conventional wisdom that tax-exempt municipal financing is lower in cost once the cost of the tax subsidy is factored into the calculation.

A 2014 report on lifecycle cost analysis by the American Society of Civil Engineers and the Eno Center for Transportation provided the foundation for this thinking, which shows that including lifecycle costs in financing projects shifts the emphasis from up-front costs to the long-term value of the infrastructure asset.[19]

The objectives of many public finance officials seem to be in opposition to those of private investors—and for that matter, taxpayers. Governments seek to obtain the lowest cost of capital—to preserve borrowing capacity and minimize the cost of service to taxpayers—while private investors seek to realize the highest risk-adjusted return for their capital by increasing long-term asset value. Where these constituencies intersect is on the cash yield derived from high-performing infrastructure assets.

Long-term institutional investors like IFM and Borealis, invest—and reinvest—not for short-term gains but to receive steady, predictable cash flows for as long as possible. It follows that governments and taxpayers would get more value by financing total lifecycle costs than they do from a simple bond issuance based on the current cost of subsidized debt service that finances construction only.

By adopting a lifecycle approach to financing infrastructure, California policymakers could shift the focus from cost-of-service to asset preservation. This would enhance the sustainability of infrastructure assets, optimize the delivery of infrastructure services to taxpayers, and encourage private investment.

POLICY RECOMMENDATIONS – CALIFORNIA

We offer the following nine recommendations, noting that additional study needs to be done to determine both their adaptability and their feasibility for California.

  1. Identify projects which would be better financed by private capital to preserve state and local governments’ credit and funding resources for projects that can only be financed by the public sector.

California government agencies—such as the transportation and water state agencies, the California Energy Commission, and the California Public Utilities Commission—might begin by estimating the real lifecycle risks and costs of their infrastructure assets to identify those that could be better shared with, or transferred to, private partners. In addition to risk-sharing and possible cost-savings, this would allow governments to preserve credit capacity and funds for infrastructure needs unsuited to private sector financing.

  1. Aggregate projects to create financially viable project pools.

California infrastructure procurement agencies might mount a cooperative effort to investigate whether small, discrete projects with similar structural design and deficiencies could be bundled into single procurements. According to the 2016 State Treasurer’s Biennial Report, California has more than 2,700 bridges that are structurally deficient. Some of these bridges might need similar remediation, which could be done on a mass-production basis with greater efficiency. This would allow governments to reduce costs, increase competition, and accelerate delivery.

  1. Develop guarantees and credit-enhancement mechanisms to plug project-financing gaps.

For projects with insufficient user fees to produce a level of return necessary to attract private investors, state investment banks and economic development commissions could provide project-completion guarantees, contract assurances, and other credit enhancements. These financing mechanisms would provide project-viability gap funding. While funded by public-sector dollars, they would enable government to leverage its resources much further than by borrowing the full amount of financing.

  1. Facilitate the development of a multi-state, pooled-asset structure for public pensions to develop direct investment capacity in infrastructure.

This would introduce a competitive source of long-term capital to complement subsidized capital sources available to state and local governments. A pooled source of public pension capital would also preserve the ability of governments to utilize municipal bond financing by virtue of the public interest they share as state agencies.

  1. Adopt a lifecycle approach to financing California infrastructure.

This would quell the temptation to proceed with expensive, short-term-oriented financings at the expense of choosing the best option in the long run. It would also ensure that operation and maintenance costs are factored into financial decision-making. Most importantly, it would signal to private investors a commitment to long-term asset preservation.

  1. Encourage more efficient water markets.

More private capital would be available to finance water infrastructure, if water products were more consistently sold and exchanged at market prices. As discussed in the water storage chapter, California has the opportunity to greatly increase its use of water banking. More efficient pricing of different grades of water would both encourage the development of water banking and provide more consistent information about the returns available for reuse, storage and desalination projects.

  1. Streamline approval processes for key infrastructure projects.

As we mentioned in the desalination chapter, both the Carlsbad and Huntington Beach projects were proposed in 1998. The Carlsbad plant was completed 17 years later, while the Huntington Beach plant is still under review.  The state could accelerate infrastructure development and attract more private capital by reducing the number of public agencies reviewing proposals and capping the length of time a given agency can take to reach a final decision.

  1. Increase energy production using a greater variety of clean energy options.

The addition of solar and wind power production alone will be insufficient to keep up with the state’s growing population and energy needs. Regulators should be more open to nuclear energy and natural gas – which can be used together with solar in hybrid power stations.

  1. Reduce congestion by encouraging private capital to finance more High Occupancy Toll lanes.

HOT lanes have been successful is Orange County, elsewhere in Southern California and the Bay Area. Yet California still has the majority of the nation’s most crowded stretches of highway. State and local leaders should redouble their efforts to attract investors to finance more HOT projects rather than waiting for public sector agencies to accumulate enough funding to build these lanes.

POLICY RECOMMENDATIONS – FEDERAL

In the 2016 election cycle both major candidates called for increased federal infrastructure investment. But with its persistent deficits, high debt burden and rising entitlement costs, it is unclear that the federal government has the fiscal capacity to undertake the necessary investment. As an alternative, Congress should consider regulatory and tax code changes that would encourage banks, corporations and pension funds to invest in state and local infrastructure projects.

  1. Encourage banks to hold more municipal bonds by deeming them to be High Quality Liquid Assets.

In 2014, the Federal Reserve and the Federal Deposit Insurance Corporation implemented a new rule requiring large banks to hold a minimum amount of High Quality Liquid Assets (HQLA) to act as a buffer in case of a liquidity crisis like the one that disrupted financial markets in September 2008. The regulator included equities and corporate bonds in its definition of HQLA but excluded all municipal bonds.[20] More recently, bank regulators allowed some general obligation bonds to be treated as HQLA but continued to exclude revenue bonds.[21] Meanwhile the House of Representatives passed HR 2209 which directs the Fed and other financial regulators to include liquid, investment grade municipal bonds in their definitions of HQLA.[22] At this writing it was unclear whether this bill would become law. Highly publicized bankruptcies notwithstanding, municipal bonds have had very low default rates over the last 75 years[23] and should not face discriminatory regulatory treatment.

  1. Replace the federal tax exemption on municipal bond interest with an issuer subsidy.

Even if HQLA restrictions are eased, banks and other institutional investors will continue to limit their municipal bond holdings due to the tax treatment of these securities. Since the individual income tax was instituted in 1913, municipal bond interest has been exempt from federal taxation; it is also exempt from state income tax in California and elsewhere. As a result, municipal bonds are generally perceived as an investment for high income individuals who either hold them directly or through mutual funds.

Elimination of the tax exemption has been proposed by Simpson-Bowles Commission[24] and former Senator Tom Coburn (R-Oklahoma).[25]  While such a change would increase municipal market liquidity by bringing more categories of investors into the market, it would also reduce demand among today’s investors who are willing to take lower interest rates in exchange for the tax exemption.

A deficit-neutral solution promoting municipal market liquidity would be to replace the federal tax exemption on municipal bond interest with an interest subsidy to municipal bond issuers. Such an approach has a precedent: as part of the 2009 American Recovery and Reinvestment Act, the Obama Administration and a Democratic Congress created a new type of taxable municipal security known as Build America Bonds (BABs).[26] Although BABs pay higher interest rates than tax exempt municipals, the federal government pays issuers an interest subsidy that offsets the extra costs. Once ARRA funding was exhausted, no new BABs could be issued because Treasury lacked budgetary authority to continue offering the subsidies.

The Administration has proposed replacements for BABs in recent budgets,[27] but these suggestions have not been acted upon by the Republican Congress. One way to restore BABs in a divided government context would be to couple new BAB subsidy authority with elimination of the municipal bond interest tax exemption. If implemented, this reform would have the effect of forcing all new municipal bond issuance into the taxable sector.

A potential risk of this proposal is that Congress would restrict the level of available subsidies, and thereby create a disincentive for local government bond issuance. In the absence of the tax exemption, interest cost on new municipal bond issuances will be higher once funding for subsidies is exhausted. If the subsidy was instead implemented as an entitlement, Treasury could provide them to any eligible bond issuer that applies. While the word “entitlement” may seem scary, it is essential to realize that this does not represent a material change from the status quo. Today, individual investors have an unlimited ability to reduce their tax liability by purchasing municipal bonds; the proposed entitlement simply shifts the benefit from taxpayers to state and local bond issuers.

CONCLUSION

Pension funds and other institutional investors have large amounts of capital that could be deployed to California infrastructure assets. Meanwhile, California public agencies have been unable or unwilling to raise enough money to build and maintain infrastructure commensurate with the needs of a growing population.

By implementing policies that facilitate private investment in civil infrastructure, California can eliminate water shortages, dramatically reduce highway congestion and avoid a repeat of the brown-outs that ushered in the current millennium. We hope this study will trigger a discussion among policymakers and institutional investors about how to deploy private capital to public benefit in our state.

 *   *   *

FOOTNOTES

[1] John Chiang (February 9, 2016). Building California’s Future Begins Today. http://www.treasurer.ca.gov/publications/biennial/2016.pdf. Page 6.

[2] Public goods are typically services from which individual users cannot be excluded and thus cannot be priced. In the case of roads and tap water, it is physically possible to exclude users, but doing so may be considered unacceptable from a normative standpoint.

[3] Chris Rhodes, (Infrastructure Policy Briefing Paper, London, House of Commons Library, December 23, 2015), p. 20-22.

[4] Michael Bennon, Ashby H.B. Monk, Caroline Nowacki (Summer 2015), Dutch Pensions Paving Way for Infrastructure Development. Journal of Structured Finance. Vol. 21 No, 2 Pages 45-54. http://www.iijournals.com/doi/abs/10.3905/jsf.2015.21.2.045?journalCode=jsf.

[5] La Caisse de dépôt et placement du Québec. (Press Release, Montreal, January 13, 2015), http://www.prnewswire.com/news-releases/la-caisse-unveils-agreement-with-quebec-government-to-carry-out-infrastructure-projects-288407561.html.

[6] As described in a 2014 Brookings Institution paper: “… in a given state, projects need to be large enough in dollar terms to merit private sector attention. As a rule of thumb, the private sector is interested in projects in the $100 million range to make the investment of their time and resources worth the effort. For some straightforward projects, notably parking garages, this number can be as low as $50 million.” See Patrick Sabol and Robert Puentes (December 2014), Private Capital, Public Good. Brookings Metropolitan Infrastructure Initiative, Washington, DC, p. 16.

[7] Ibid., p. 17

[8] John Chiang, Building California’s Future Begins Today, p. 6.

[9] Ross Israel, Leisel Moorhead, and Trent Carmichael (2015). The Commercialisation of Queensland Motorways in Australia. Infrastructure Risk Management PEI Report, London, pp. 274-279.

[10] Her Majesty’s Treasury (November 1, 2011). Memorandum of Understanding Between HM Treasury and the National Association of Pension Funds and its Member Pension Funds and the Pension Protection Fund. https://www.gov.uk/government/publications/memorandum-of-understanding-between-hm-treasury-and-the-national-association-of-pension-funds-napf

[11] William Morneau (November 16, 2012). Facilitating Asset Management for Ontario’s Public-Sector Institutions. Ontario Ministry of Finance. http://www.fin.gov.on.ca/en/consultations/pension/recommendations-report.pdf

[12] Kathleen Sebelius and Andy Stern (May 7, 2008). Main Street Not Wall Street Should Fix Crumbling U.S. Infrastructure. Christian Science Monitor. http://www.csmonitor.com/Commentary/Opinion/2008/0507/p09s02-coop.html

[13] Scott Deveau (November 13, 2015). Canadian Pension Funds Buy Indiana Toll Road for $2.8B.  Bloomberg News. http://www.bloomberg.com/news/articles/2015-11-13/canadian-pension-funds-buy-chicago-s-toll-road-for-2-8-billion.

[14] Industry Funds Management (May 27, 2015). IFM Investors Completes Acquisition of Indiana Toll Road Concession Company. Press Release. http://www.businesswire.com/news/home/20150527006535/en/IFM-Investors-completes-acquisition-Indiana-Toll-Road.

[15] McKinsey & Company (March 2013). Rethinking Infrastructure: An Investor’s View. McKinsey Insights & Publications., http://www.mckinsey.com/industries/infrastructure/our-insights/mark-wiseman

[16] Studies have shown that the cost differential between internal and external management is significant, and that outsourcing can cost ten to fourteen times more than internal management.  See Keith P. Ambachtsheer, The Future of Pension Management: Integrating Design, Governance and Investing, (Hoboken, NJ: John Wiley & Sons, 2016), 104. See also, Frederick Funston, “Management and Operations Study and Best Practice Review for the City of New York Office of the Comptroller’s Asset Management Function,” (Report, Funston Advisory Services, Bloomfield Hills, MI, December 2015), 367. See in addition, Canada Pension Plan Investment Board, frequently asked questions about operating costs,  http://www.cppib.com/en/public-media/faq.html.

[17] This figure is calculated from averaging the annual rates of return reported for infrastructure investments in the annual reports of the Ontario Municipal Employees Retirement System for the years 2006-2014, http://www.omers.com/corporate/corporate_annual_report.aspx and compared to an average of the annual rates of return of the MSCI World Infrastructure Index for the years 2006-2014, https://www.msci.com/resources/factsheets/index_fact_sheet/msci-world-infrastructure-index.pdf.

[18] Martin Braun, Freeman Klopott, and Henry Goldman (November 22, 2011, Cuomo Considers Pension Funds to Help Finance New Tappan Zee. Bloomberg News, http://www.bloomberg.com/news/articles/2011-11-22/cuomo-weighs-pension-funds-to-help-finance-tappan-zee-bridge-replacement. James Nash (December 3, 2012), Brown Seeks Sovereign Wealth to Back High-Speed Rail Line,” Bloomberg News. http://www.bloomberg.com/news/articles/2012-12-03/brown-seeks-sovereign-wealth-to-back-high-speed-rail-line

[19] American Society of Civil Engineers and the Eno Center for Transportation (2014). Life Cycle Cost Analysis. https://www.enotrans.org/etl-material/maximizing-the-value-of-investments-using-life-cycle-cost-analysis/.

[20] Kyle Glazer (September 3, 2014). Fed: Some Munis May Become HQLA in Liquidity Rule. The Bond Buyer. http://www.bondbuyer.com/news/washington-securities-law/fed-some-munis-may-become-hqla-in-liquidity-rule-1065794-1.html

[21] Jack Casey (April 1, 2016). Fed Rule Treating More Munis as HQLA Seen as Too Restrictive. The Bond Buyer. http://www.bondbuyer.com/news/washington-securities-law/fed-rule-treating-more-munis-as-hqla-seen-as-too-restrictive-1100310-1.html

[22] US House of Representatives (2016). H.R.2209 – To require the appropriate Federal banking agencies to treat certain municipal obligations as level 2A liquid assets, and for other purposes. https://www.congress.gov/bill/114th-congress/house-bill/2209/actions

[23] Matthew Holian and Marc Joffe (2013). Assessing Municipal Bond Default Probabilities. California Debt and Investment Advisory Commission. http://www.treasurer.ca.gov/cdiac/publications/probabilities.pdf.

[24] The National Commission on Fiscal Responsibility and Reform (December 2010). The Moment of Truth. https://www.fiscalcommission.gov/sites/fiscalcommission.gov/files/documents/TheMomentofTruth12_1_2010.pdf

[25] Naomi Jagoda (December 9, 2014). Sen. Coburn: Eliminate the Muni Tax Exemption. The Bond Buyer. http://www.bondbuyer.com/news/washington-taxation/sen-coburn-eliminate-the-muni-tax-exemption-1068624-1.html

[26] SIFMA (2016). Build America Bonds Resource Center. http://www.sifma.org/issues/capital-markets/municipal-securities/build-america-bonds/overview/

[27] Robert Puentes and Patrick Sabol (April 22, 2015). Building better infrastructure with better bonds. Brookings. http://www.brookings.edu/research/papers/2015/04/22-building-better-infrastructure-with-better-bonds-sabol-puentes

*   *   *

ABOUT THE AUTHORS

Marc Joffe is the Director of Policy Research at the California Policy Center. In 2011, Joffe founded Public Sector Credit Solutions to educate policymakers, investors and citizens about government credit risk. His research has been published by the California State Treasurer’s Office, the Mercatus Center at George Mason University, the Reason Foundation, the Haas Institute for a Fair and Inclusive Society at UC Berkeley and the Macdonald-Laurier Institute among others. He is also a regular contributor to The Fiscal Times. Prior to starting PSCS, Marc was a Senior Director at Moody’s Analytics. He has an MBA from New York University and an MPA from San Francisco State University.

Jill Eicher Jill Eicher is a researcher focusing on innovative financing models for public-sector agencies. Most recently, she was a Visiting Scholar at Stanford University’s Global Projects Center, working on the development of a cooperative investment model for public pension funds to deploy capital into U.S. infrastructure. She co-founded the Fiduciary Infrastructure Initiative, a research-driven venture focused on the applicability of international pension cooperatives making direct infrastructure investments as models for the U.S. A graduate of Wellesley College, Eicher did post-graduate work in mathematics and was issued a patent for her method for assessing investment risk.

Ed Ring is the Vice President of Policy Research at the California Policy Center. His work has been cited in the Los Angeles Times, Sacramento Bee, Wall Street Journal, Forbes, and other national and regional publications. Previously, as a CFO primarily for start-up companies in the Silicon Valley, he has done financial accounting for over 20 years, and brings this experience to his analysis and commentary on issues of public sector finance. From 1995 to 2009 he was the editor of EcoWorld, a website covering environmental issues from a free-market perspective. Between 2007 and 2010 he launched in partnership with AlwaysOn Media the highly successful “GoingGreen” clean technology investor conferences, held annually in San Francisco and Boston. He has an MBA in Finance from the University of Southern California, and a BA in Political Science from UC Davis.

Kevin Dayton is a policy analyst for the California Policy Center, a prolific writer, and the author of frequent postings about generally unreported California state and local policy issues on the California Policy Center’s Prosperity Forum and Union Watch. Major policy reports written by Kevin Dayton include For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction. Dayton spent more than 17 years in various federal, state, and local policy positions for Associated Builders and Contractors (ABC), including ABC of California State Government Affairs Director from 2005 to 2012. He was also a legislative assistant in the U.S. House of Representatives for Congressman Gary A. Franks (R-Connecticut) from 1992 through 1994. Dayton is a 1992 graduate of Yale University, where he majored in History.

ABOUT THE CALIFORNIA POLICY CENTER

The California Policy Center is a non-partisan public policy think tank providing information that elevates the public dialogue on vital issues facing Californians, with the goal of helping to foster constructive progress towards more equitable and sustainable management of California’s public institutions. Learn more at CaliforniaPolicyCenter.org.

 *   *   *

California Cities Facing Huge Pension Increases from CalPERS

In their most recent actuarial reports CalPERS for the first time provided pension cost estimates for the next 8 years, from 2015 to 2023.

How high are these costs going for California’s cities who retroactively increased their pensions at CalPERS urging over the past 15 years? To answer that question I looked at the largest city in my county, Santa Rosa and this is what I found.

Data Sources for this Report

The data used to develop the spreadsheet analysis done as part of this report are NOT numbers that I calculated. The past numbers for 2002 to 2015 are taken directly from the City of Santa Rosa’s Comprehensive Annual Financial Reports found on the City’s website (This page has the links to Santa Rosa’s CAFRs from 2001 through 2015. In each of these CAFRs, the pension information is found in the section entitled “Notes to Basic Financial Statements” under the heading “Employees Retirement Plan.”). The projected growth of certain costs – such as retiree healthcare benefits (also known as “other post employment benefits,” or OPEB), the payroll and sales and property tax revenues – use inflation rates or growth rates similar to what CalPERS uses.

The future pension costs were obtained directly from the 2013 and 2015 Actuarial Reports prepared by CalPERS and found on the CalPERS website. Since the future costs are based upon CalPERS achieving a 7.5% net rate of investment return, I believe their costs are understated, but I used them anyway. But since the pension plan has $804 million worth of assets if the pension fund returns 6.5%, in a single year it will add $8 million to the City’s pension debt and a 5% return would add $20 million.

Looking at the data going back 16 years what I found is that in 2000, Santa Rosa’s pension contribution was $1.8 million and the plan was 122% funded, meaning there were $1.22 worth of invested assets in the fund for every $1.00 worth of benefits earned.

With CalPERS wholehearted support and assistance, on August 6, 2002, the Santa Rosa City Council passed a board resolution to enact a new contract with CalPERS that changed formulas from 2% per year of service at 55 years of age for non-safety Miscellaneous employees to a 3% at 60 formula.  The new formula was provided prospectively, meaning it only applied to future years of service, not past years.

For Police and Fire employees, the new contract was adopted retroactively so it applied to past and future years of service. Their formula went from 2% per year of service at 55 years of age to 3% at 50. This represents a more than 50% increase in the benefit, since along with the “multiplier” increasing from 2% to 3%, the age of eligibility dropped from 55 to 50. But it was the retroactive granting of this benefit that caused even more significant financial liability. This is because the multiplier was increased by 50% even for years already worked and raised pensions from 60% of salary to 90% of salary for 30 years of service.

These changes ended up having a serious impact on the pension costs and the unfunded liability because CalPERS used an overly optimistic rate of investment return of 8.25% compounded per year in their cost analysis. Over the past 15 years since the increase, CalPERS has only achieved a 5% compound rate of return. Many experts believe in this current low interest rate environment returns will remain at the 5% return level for the foreseeable future.

In July of 2003 the City took on $53 million worth of new debt by selling Pension Obligation Bonds (POB) and giving the proceeds to CalPERS to pay down the unfunded liability that was created by the new formulas. With interest these bonds will divert over $100 million from government services to debt service.

CalPERS Flawed Cost Analysis and Lack of Proper Disclosure

CalPERS cost analysis provided to the City in 2002 stated the cost for the new 3% at 50 formula for Safety members would be 13.27% of salary and the cost for the 3% at 60 formula for Miscellaneous members would be 9.87% of salary. However, as previously stated, these estimates were calculated assuming that pension assets would grow at 8.25% per year into the future. Since CalPERS investments have only averaged 5% over the past 15 years the increases have created $287 million in unfunded pension liabilities for the City as of 2015.

In addition, the analysis did not provide the City with any warning or disclosure regarding what would happen if the 8.25% investment return was not achieved. CalPERS simply wrote “For many plans at CalPERS the financial soundness of the plan will not be jeopardized regardless of the new formula choice made by the employer.”

The Growth of Pension Costs Since the Increase

In 2001, the City’s pension contribution was $1.5 million and in the first 4 years following the increase it grew to $11.5 million. In addition, the funding ratio dropped from 122% in 2001 to 70% in 2005 meaning the fund, instead of $63 million in excess assets now had $128 million in unfunded liabilities.

In 2006, the annual cost grew by another $5 million hitting $16.6 million and by 2015 had grown to $21 million. However, this was a very modest growth considering CalPERS lost 29% of its assets during the Great Recession in 2008 and 2009. CalPERS lowered contributions in order to help cities and counties who saw their tax revenues during the recession drop. So CalPERS extended the amortization period on the unfunded liabilities from 9 to 20 years and smoothed their investment gains and losses from 4 to 15 years into the future. Basically, these were accounting gimmicks that resulted in severe underfunding of the pension plan and these changes exist today. The chart below shows the growth of Santa Rosa public employee retirement costs (click here to see the underlying calculations).

Santa Rosa Retirement Cost Growth

However, now CalPERS is worried that the plans are not being properly funded and pension contributions need to be doubled over the next 9 years.

Projected Future Costs

In their 2015 actuarial reports, CalPERS provided the City with their normal employer contribution as a percentage of payroll and the unfunded actuarial liability (UAL) as a total cost each year from 2015 to 2023. Using a 3% payroll growth assumption and their UAL numbers, I calculated the annual costs going forward. In addition, I added the pension obligation bond debt service each year going forward along with the cost of retiree healthcare benefits using a 5% annual cost increase assumption as CalPERS does.

My analysis indicates that during the next 8 years, the cost for retiree benefits will increase from $31.0 million or 33.7% of payroll in 2015 to $59.1 million or 48% of payroll in 2023.

The nearly doubling of pension and retiree healthcare costs means the City will need to cut salaries, benefits, services and/or increase taxes each and every year going forward by $3.2 million per year to meet their retiree benefit costs.

Pension and Healthcare Costs as a Percentage of Tax Revenues

More important than pension costs as a percentage of payroll are pension costs as a percentage of tax revenues because tax revenues are what enables the City to pay for its benefits. Once retiree benefit costs exceed the City’s ability to pay them, they will no longer be able to be fully paid and at that point either they will need to be reduced in bankruptcy or through significant pension reductions. The chart below shows the growth of pension costs relative to that of general fund property tax and sales tax revenues.

churchill-2016-10-31-chart

The results of my analysis are staggering. Over the past 15 years’ sales and property tax revenues have climbed an average of 3% per year, while employee retirement costs have increased an average of 19% per year. This has led to a growth of retiree benefit costs from 3.5% of major tax revenues in 2001 to 47% in 2015 and an estimated growth to 70% of major tax revenues by 2023 (Editor’s note:  the city receives other revenues which may also be available to finance pension costs).

Growth of the Unfunded Liability

The unfunded liability of the pension plan is calculated by taking the assets in the plan minus the present value of the benefits already earned by current employees and retirees, considered the plan’s liability. The funding ratio is determined by dividing the market value of assets in the plan by the liability.

CalPERS discounts the long term liability by assuming before the money is paid to retirees, it will earn investment income. CalPERS currently uses an assumed 7.5% rate of investment return to calculate the liability and payments to the plan. So if the assumed investment return is lowered, the unfunded liability of the plan increases along with the cost of paying off the liability. Unfunded liability costs are borne by taxpayers and are not a shared expense with the employees.

Currently, using a 7.5% assumed rate of return, the pension fund has $287 million worth of unfunded liabilities and pension bond debt and is 74% funded. However, many experts believe in this low interest rate environment a lower investment return assumption should be used. Many experts think that a 5.5% to 6.5% rate should be used. Other experts believe a 3.5% rate should be used since this is about the rate private pension plans are required to use and what CalPERS uses if a City wanted to buy their way out of the CalPERS system. I won’t guess what the future investment returns will be, but here is what happens to the unfunded liability at various rates of investment return assumptions:

  • At 6.5% the unfunded liability would increase to $426 million and $19.6 million per year to would be added to the City’s pension costs.
  • At 5.5% the unfunded liability would increase to $585 million and $31.6 million per year would be added to the City’s pension costs.
  • At 4.5% the unfunded liability would increase to $755 million and $43 million per year would be added to the City’s pension costs.
  • At 3.5% the unfunded liability would increase to $967 million and $53.5 million

Santa Rosa Analysis of Unfunded Liability at Various Rates of Investment Return

20161028-cpc-churchill1

City Pension Plan Status Using ERISA Standards

Under the Federal ERISA rules for private pensions, a high quality bond rate of return is used to determine the assumed rate of investment return. Today that is around 3.5%. ERISA also defines the health of a pension plan as follows:

  • Less than 80% funded is considered “seriously endangered”
  • Less than 70% funded is considered “at risk”
  • Less than 65% funded is considered “critical status”

So under ERISA standards, the City of Santa Rosa’s pension plan at 45% funded when assuming a 3.5% return is 20 percentage points below what ERISA would consider “critical status”. So one could more accurately describe the pension system as being on “life support”.  Also, under ERISA rules the pension benefits each year would stop being accrued until the plan becomes 60% funded to keep the hole from going deeper.

ERISA also requires the plan sponsor pay off their unfunded liabilities over 7 years. CalPERS currently allows public agencies to pay off their liability over up to 30 years. If the City was required to pay off its unfunded liability over the next 7 years, their annual contribution to the pension fund would grow from $28 million to $146 million in 2015 alone. So under ERISA rules pension costs would increase by $120 million per year and take them to 145% of payroll.

Conclusion

The City of Santa Rosa and all cities in California who retroactively increased pensions need to restructure their pension systems. Otherwise it is increasingly unlikely they will be able to afford the benefits that have already been earned and provide taxpayers with the services they deserve for their tax dollars.

City officials can no longer pretend a crisis does not exist. They would be well advised to form a Pension Advisory Committee and bring all the stakeholders to the table to look at all the options, have an actuary determine the savings for each option and make informed decisions to save the pension plan and benefits people are counting on to fund their retirement.

 *   *   *

About the author:  Ken Churchill is the author of numerous studies on the pension crisis in California and is also the Director of New Sonoma, an organization of financial experts and citizens concerned about Sonoma County’s finances and governance.

REFERENCES AND RELATED ARTICLES

California Court Ruling Allows Pension Changes, August 26, 2016

How CalPERS has Created a Ticking Time Bomb, November 30, 2015

The Devastating Impact of Retroactive Pension Increases in California, April 27, 2015

Evaluating Total Unfunded Public Employee Retirement Liabilities in 20 California Counties, May 6, 2014

Sonoma County’s Pension Crisis – Analysis and Recommendations, January 12, 2014

The Sonoma County Retroactive Pension Increase: Gross Incompetence or Billion Dollar Scam?, April 15, 2012

How Retroactive Benefit Increases and Lower Returns Blew Up Sonoma County’s Pensions, April 5, 2012

 

California’s Misguided Water Conservation Priorities

If you’ve recently driven on most any California freeway, you’ve seen the default message on the government-owned electronic billboards, “Severe Drought Conditions – Reduce Outdoor Water Use.”

The message seems reasonable enough. Several years of lower-than-average rainfall have left the state’s reservoirs depleted, so why should households be wasting water, indoor or outdoor? And if you think that reducing residential water consumption will make a difference, the solutions seem reasonable as well:  Let your lawn die, install drip irrigation to keep your perennials alive, plant “drought tolerant” plants, buy a side-loading washer, a low flow toilet, put a flow restrictor on your shower, etc., etc., etc. But will all of this make any difference?

20160817-CPC-water-quote

To answer this question it is necessary to determine just how much water is available to Californians, and how much of that water is being consumed by residential households in California. When making this analysis, we will not only estimate how much water California’s households purchase from their utility, but how much water is embodied in the food they eat.

TOTAL ANNUAL WATER SUPPLY AND USAGE IN CALIFORNIA

Here’s a rough summary of California’s annual water use. In a dry year, around 150 million acre feet (MAF) fall onto California’s watersheds in the form of rain or snow, in a wet year, we get about twice that much. [1] Most of that water either evaporates, percolates, or eventually runs into the ocean. In terms of net water withdrawals, each year around 31 MAF are diverted for the environment, such as to guarantee fresh water inflow into the delta, 27 MAF are diverted for agriculture, and 6.6 MAF are diverted for urban use. [2] Of the 6.6 MAF that is diverted for urban use, 3.7 MAF is used by residential customers, and the rest is used by industrial, commercial and government customers. [3]

Put another way, we divert 65 million acre feet of water each year in California for environmental, agricultural and urban uses, and the recommended 25% reduction in water usage by residential customers will save exactly 0.9 million acre feet – or 1.4% of our total statewide water usage. One good storm easily dumps ten times as much water onto California’s watersheds as we’ll save via a 25% reduction in annual residential water consumption.

#1 – Total Annual Water Supply and Usage in California20160817-CPC-CA-total-water-usage1

Armed with these facts, there’s a strong argument that cutting back on residential water consumption will not make a significant difference in California’s overall water use. And there are additional facts that can put this argument into an even sharper context: How much water do California’s households consume in terms of the water that was required to grow the food they eat, and how does that amount compare to the water they purchase from their utility for indoor/outdoor use?

THE “WATER FOOTPRINT” OF FOOD PER OUNCE AND PER CALORIE

While the information to determine this is readily available, it isn’t typically compiled in this context, so here goes. The best source of comprehensive data on the “water footprint” for various types of food comes from the Water Footprint Network [4], a project initially funded by UNESCO. An excellent distillation of that information was produced in April 2015 by Kyle Kim, John Schleuss, and Priya Krishnakumar, writing for the Los Angeles Times [5]. Information on calories per ounce was found on the website “fatsecret.com” [6]. That information is summarized on the following table.

#2 – Water “Footprint” per Ounce and per Calorie of Food20160817-CPC-water-footprint-per-food-category

As can be seen on the above chart, when evaluating the water efficiency of various food sources, it is misleading to rely only on gallons per ounce, since the number of calories per ounce are highly variable. But putting these two variables together to calculate a gallons per calorie measurement is quite useful. Clearly, meat products require a huge amount of water per calorie. The most efficient sources of meat protein are found in chicken, which at 0.37 gallons per calorie is around four times as water-efficient as red meat. Some sources of protein from vegetables are surprisingly efficient, including avocados at 0.20 gallons per calorie, and the almond – much maligned as a water waster – at 0.15 gallons per calorie. But we digress. How much water does it take to feed the average household in California, and how does that compare to the amount of water they buy from the utility for indoor/outdoor use?

TOTAL ANNUAL CONSUMPTION OF WATER-IN-FOOD PER HOUSEHOLD

The next table, below, provides this estimate based on a typical diet. The estimate of 2,000 calories necessary to sustain the average human (men, women, children) comes from WebMD [7]. The breakout of food consumption by category, while somewhat arbitrary, relies on data on “the average American diet” [8] compiled by researcher Mike Barrett, writing for the Natural Society website. In turn, Barrett relied on USDA and other government sources for most of his data, which is reflected here.

#3 – Total Annual Consumption of Water-in-Food per Household
20160817-CPC-water-in-food-consumption-per-capita

In one year, the average American consumes a quantity of food that required 1.3 acre feet of water to grow. In turn, at 2.91 people per household in California [9], the average household consumes a quantity of food per year that requires 3.9 acre feet of water to grow.

AVERAGE ANNUAL WATER USE PER CALIFORNIA HOUSEHOLD

Putting all of this together yields a revealing table, below, that shows that the average household purchases a relatively trivial amount of water from their utility, when compared to how much water they purchase in the form of the food they eat. By dividing the 3.7 million acre feet of water used by residences each year in California by the 12.8 million households in California [10], the average annual water consumption per household is 0.289 acre feet. By contrast, the amount of water that is eaten, so to speak, by the average California household is 3.9 acre feet, thirteen and a half times as much. By the way, it is irresistible to point out that drinking water, that quantity each human requires for their daily hydration, based on the 0.5 gallon per day recommendation from AuthorityNutrition.com [11], comes out to a paltry 0.0016 acre feet per year per household – not even a rounding error when compared to the other uses. Think about that the next time you have to ask for your water at a California restaurant.

#4 – Average Annual Water Use per California Household
20160817-CPC-average-water-use-per-household

OBSERVATIONS AND RECOMMENDATIONS

(1)  Projects that increase water supply via sewage reuse, runoff storage via reservoirs or aquifers, and desalination, are options that benefit all users, urban and agricultural.

(2)  Increasing the supply of water from diverse sources creates system resiliency which can be of critical benefit not only in the face of persistent drought, but also against catastrophes that may, for example, disable a pumping station on a major aqueduct.

(3)  The energy costs to desalinate seawater, approximately 4.0 kilowatt-hours per cubic meter, are overstated. Desalination plants can be co-located with power plants, eliminating power loss through transmission lines, whereas far-flung pumping stations consume significant amounts of electricity. Depending on transmission loss and desalination plant efficiency, the amount of lift beyond which desalination consumes less power than pumping is about 1,500 feet.

(4)  Public investment in water saving home appliances, for example via tax rebates to consumers to purchase them, by contrast, do not increase the overall supply of water.

(5)  It is nearly impossible to engage in excessive use of indoor water in a household, because 100% of the sewage is treated and released as clean outfall to the environment. Moreover, sewage is increasingly treated and reused as potable water, and eventually 100% of indoor water waste will be cycled immediately back for reuse by households.

(6)  One preferred way to reuse household sewage is referred to as “indirect potable reuse,” where the treated water is percolated into aquifers where it is eventually pumped back for household reuse. This practice has the virtue of banking the water against supply disruptions, recharging the aquifer which is especially beneficial in coastal areas where there can be salt water intrusion, and even, as water is repeatedly cycled through the aquifer, causing an ongoing improvement to the quality of the water in the aquifer as treatment progressively reduces levels of undesirable residual toxins.

(7)  While achieving 100% reuse of sewage will render indoor water conservation pointless, the virtues of outdoor water use are understated. Healthy landscaping, consisting of abundant vegetation including lawns, reduce the incidence of dust-borne pathogens, reduce the incidence of asthma, and clean and moisturize the air. Replacing grass playing fields with artificial turf introduces toxins, causes more ACL and other sports injuries, and retains heat – often to the point of making these faux fields unplayable unless they are, ironically, watered.

(8)  Simply giving up consumption of red meat would reduce the average household’s water consumption by nearly 2.0 acre feet per year. By comparison, the average Californian household’s total water consumption from the utility averages 0.29 acre feet per year. That is, just replacing consumption of red meat with an equivalent caloric intake of chicken will save the average household seven times as much water as they buy from the utility for all uses, indoor and outdoor.

Policies designed to reduce household water use are a good idea, but must be kept in perspective. Perhaps what has already been done is more than enough, and priorities might now shift towards investment in infrastructure to increase the supply of water. Nearly all water diversions in California, about 90%, are either to preserve ecosystem health or to supply agriculture. Indoor water overuse is becoming a myth, and will become entirely irrelevant as soon as 100% sewage reuse capacities are achieved. Outdoor water use should not be thoughtless, but allowing grass and perennials to die, or converting landscaping to “desert foliage,” is a cultural shift that is not necessary or desirable.

Along with investing in infrastructure to increase the supply of water, public education to help Californians adopt healthier diets would have the significant side benefit of being sound water policy. A trivial change in patterns of food consumption yields a major reduction in water required for food. For example, a public education campaign that caused a voluntary 10% reduction in red meat consumption (from 25.0% of all calories to 22.5% of all calories) would reduce California’s water consumption by 2.5 million acre feet per year. By comparison, total outdoor residential water consumption in California is estimated at only 1.8 million acre feet per year.

Perhaps, in lieu of renouncing escalating and entirely unnecessary mandates to reduce household water use, those of us who love our lawns might at least be granted a waiver if we were to present an annual affidavit to document our below-average consumption of red meat. Our smart refrigerators might actually submit the report to the utility, sparing us the paperwork.

 *   *   *

Ed Ring is the president of the California Policy Center

 

 

FOOTNOTES

(1) Total Precipitation in California during wet, average, and dry years:
California Water Supply and Demand: Technical Report
Stockholm Environment Institute
Table 2: Baseline Annual Values by Water Year Type and Climate-Scenario (MAF)
http://sei-us.org/Publications_PDF/SEI-WesternWater-CWSD-0211.pdf

(2) California water use by sector:
California Water Today
Public Policy Institute of California
Table 2.2, Average annual water use by sector, 1998–2005
http://www.ppic.org/content/pubs/report/R_211EHChapter2R.pdf

(3) California urban water use by sector:
California Dept. of Water Resources
2010 Urban Water Management Plan Data – Tables
Download spreadsheet “DOST Tables 3, 4, 5, 6, 7a, 7b, & 7c: Water Deliveries – Actual and Projected, 2005-2035”
http://www.water.ca.gov/urbanwatermanagement/2010_Urban_Water_Management_Plan_Data.cfm

(4) Water required to grow food – comprehensive resource:
The Water Footprint Network
http://waterfootprint.org/en/resources/water-footprint-statistics/
Their study explaining the data (downloadable PDF):
http://waterfootprint.org/media/downloads/Mekonnen-Hoekstra-2011-WaterFootprintCrops.pdf
The raw data (downloadable spreadsheet):
http://waterfootprint.org/media/downloads/Report47-Appendix-II.xlsx

(5) Graphic explaining water required to grow 1.0 ounces of various common types of food:
Los Angeles Times, April 2015
http://graphics.latimes.com/food-water-footprint/

(6) Tables showing calories per ounce of food:
Meat:
Lamb – https://www.fatsecret.com/calories-nutrition/generic/lamb-cooked
Pork – https://www.fatsecret.com/calories-nutrition/generic/pork-cooked-ns-as-to-fat-eaten
Beef – https://www.fatsecret.com/calories-nutrition/generic/beef-cooked-ns-as-to-fat-eaten
Chicken – https://www.fatsecret.com/calories-nutrition/generic/chicken-rotisserie-ns-as-to-skin-eaten
Starch:
Rice – https://www.fatsecret.com/calories-nutrition/generic/rice-white-cooked-regular
Pasta – https://www.fatsecret.com/calories-nutrition/generic/spaghetti-cooked
Wheat bread – http://www.fatsecret.com/calories-nutrition/usda/whole-wheat-bread
Potatoes – https://www.fatsecret.com/calories-nutrition/generic/white-potato-roasted
Vegetables & Fruit:
Broccoli – https://www.fatsecret.com/calories-nutrition/usda/broccoli
Asparagus – https://www.fatsecret.com/calories-nutrition/usda/asparagus
Cucumber – https://www.fatsecret.com/calories-nutrition/usda/cucumber-(with-peel)
Avocado – https://www.fatsecret.com/calories-nutrition/usda/avocados
Banana – https://www.fatsecret.com/calories-nutrition/generic/banana-raw
Spinach – https://www.fatsecret.com/calories-nutrition/usda/spinach
Peaches – https://www.fatsecret.com/calories-nutrition/usda/peaches
Tomatoes – https://www.fatsecret.com/calories-nutrition/generic/tomatoes-raw
Fluids:
Milk – https://www.fatsecret.com/calories-nutrition/generic/milk-cows-fluid-whole
Wine – https://www.fatsecret.com/calories-nutrition/usda/white-table-wine
Beer – https://www.fatsecret.com/calories-nutrition/generic/beer
Orange juice – https://www.fatsecret.com/calories-nutrition/usda/orange-juice
Nuts:
Almonds – http://flowingdata.com/2015/04/07/gallons-of-water-to-produce-foods/

(7) Daily calorie requirement for the average American:
WebMD
http://www.webmd.com/diet/features/estimated-calorie-requirement

(8) Average American diet by food category:
Mike Barrett, Natural Society
http://naturalsociety.com/average-american-diet-infographic/

(9) Average number of residents per household in California:
Point2Homes.com
http://www.point2homes.com/US/Neighborhood/CA-Demographics.html

(10) Total number of households in California:
Point2Homes.com
http://www.point2homes.com/US/Neighborhood/CA-Demographics.html

(11) How much water should the average human drink per day:
AuthorityNutrition.com
https://authoritynutrition.com/how-much-water-should-you-drink-per-day/

How a Major Market Correction Will Affect Pension Systems, and How to Cope

Summary:  Based on historical trends, three key aggregated stock market ratios – price/earnings, price/sales, and price as a percent of GDP – all show that publicly traded U.S. stock are overvalued by approximately 50%. This article explains the significance of these ratios, then, using a financial model developed specifically for this purpose, evaluates the impact of a major stock market correction on the funded status of California’s pension funds.

For all of California’s pension funds consolidated, the analysis finds that if the market corrects downwards by 50%, then recovers to grow at 5% per year, without benefit reductions, the required annual contribution will rise to 80% of pension eligible payroll. This will cost California’s taxpayers an additional $50 billion per year. If the market corrects by 50% then recovers to grow at 4% per year, without benefit reductions, the required annual contribution will rise to 113% of pension eligible payroll. This scenario will cost California’s taxpayers an additional $86 billion per year. The study evaluates the impact of benefit reductions, exploring cases where only new employees are affected, as well as cases where benefits earned for future work by existing employees are also affected.

When evaluating what level of benefit reductions can preserve pension systems without increasing employer contributions – which currently average about 33% of pension-eligible payroll – the study found the following:

In the case of a stock market negative correction of 50% followed by 5% annual growth, if the annual multiplier (the amount that is multiplied by years work times final salary to calculate an initial pension) is cut by 40% for new employees, the annual retiree cost-of-living adjustment is cut by 40% for new employees, the retirement eligibility age is raised by five years for new employees, AND the annual multiplier is cut by 20% for existing employees for future work, the current level of payments – approx. 33% – would be sufficient to bring the systems to 100% funded status by 2050.

In the case of a stock market negative correction of 50% followed by 4% annual growth, if the annual multiplier is cut by 40% for new employees AND existing employees for future work, and the annual retiree cost-of-living adjustment is cut by 40% for new employees AND existing employees, and the retirement eligibility age is raised by five years for new employees AND existing employees, the current level of payments – approx 33% – would be sufficient to bring the systems to 100% funded status by 2050.

The article concludes by recommending policymakers and stakeholders negotiate contingency plans to handle a major stock market correction that strikes an appropriate balance between costly tax increases and benefit reductions. The model used for this analysis can be downloaded here. Researchers at the California Policy Center may be available to assist those interested in using this model to analyze their particular pension system. 

INTRODUCTION

Pension systems rely on investment returns to ensure their ability to pay retired participants far more in retirement benefits than they, along with their employers, ever contributed into those funds during the times they were working. Public employee pension systems are particularly dependent on strong investment returns, because they are exempt from ERISA guidelines that mandate conservative, low-risk investments. Pension systems subject to ERISA are forced by its rules to make modest return-on-investment projections, and as a result they collect relatively more from their participants and their employers during their working years, and pay out relatively less in retirement benefits.

Because public employee pension systems make higher risk investments and depend on higher returns – in order to collect less from their participants and pay out more in retirement benefits – they are unusually vulnerable to sustained downturns in the stock markets. These pension funds typically have 70% or more of their assets invested in publicly traded stocks, and these investments are typically where they expect to earn the bulk of their high returns.

California’s public employee pension systems currently project between 7.0% and 7.5% per year on their investments. Some of the major funds have announced that over the next 20 years they intend to drop that projection to 6.5%. They adhere to this rather bullish long-term projection despite a stock market that in aggregate has returned almost nothing to its investors for nearly two years. Because public sector pension funds are so big, managing in aggregate over $4.0 trillion in assets nationwide, they cannot reasonably expect to beat the market. One of the premises of this article is that the historical performance of the stock market over the past 60 years, and especially over the past 30 years, is not an indication of similar returns from now on, and may in fact be counter-indicative.

This article will discuss the probability of a major market correction in part one. It will present a financial model to analyze the impact of this correction in part two, and it will present various options to policymakers in part three. It is important to emphasize from the outset, however, that there are no easy solutions to public pensions in the face of major downward correction in the market followed by a recovery that takes several years.

Last month we released a related article entitled “The Coming Public Pension Apocalypse, and What to Do About It.” That article is recommended reading for anyone interested in this topic. The format of this article parallels the earlier work but uses a different but complementary analysis in part one, and then relies on a comprehensive pension analysis model – prepared over the past two months and publicly introduced here – as a framework for discussion in parts two and three.

PART ONE:  USING KEY RATIOS TO ESTIMATE HOW MUCH THE MARKETS ARE OVERVALUED

In the previous article, part one surveyed the reasons why pension fund rates of return will fall dramatically. The emphasis was on causes, which can be briefly summarized in two categories, demographics and debt.

Causes of unsustainable stock market appreciation: Demographics and Debt

The challenge demographics poses to pension funds is based on the rapidly changing ratio of retirees to workers. According to the Federal Administration on Aging, using Census Bureau data, in 1970, 9.9% of the US population was over the age of 65. By 2030 that percentage is projected to more than double, to 19.3% of the U.S. population. This means that twice as many people, as a percent of the total population, will be retired and living on their savings. Simply put, this means they will be sellers instead of buyers in the market, driving down prices. Pension funds, where you would not expect such a dramatic change in the ratio of workers to retirees since their demographics are based on growth of the government workforce, not birth-rates, have also recently become net sellers in the markets, because the benefit enhancements they lobbied for starting around 1999 are now translating into a retired population of who are people retiring earlier with larger pensions compared to older pensioners.

The challenge rising levels of debt poses to pension funds is based on three related trends – interest rates, total market debt as a percent of GDP, and stock market appreciation. What has happened since 1980 has been a long-term downward trend in interest rates, a long-term upward trend in the stock market, and a long term upward trend in total debt as a percent of GDP. These trends are connected: Lowering interest rates stimulates borrowing which increases consumer debt and creates an incentive (fully realized) for increasing government debt. Each time interest rates are lowered, two things happen to the stock market, (1) corporate profits rise because new rounds of borrowing stimulate consumer and government spending, which in turn makes their stock worth more, and (2) more people are buying stock since the return they can get on loans has just gone down – also driving up stock prices. The problem with this model however is that it is unsustainable. Ever since the last stock market low in February 2009, interest rates have remained at or near zero, and debt as a percent of GDP has plateaued at roughly 350%. Lowering interest rates can no longer stimulate economic activity or stock market appreciation.

Evidence of unsustainable stock market appreciation: Three Key Ratios

(1) Aggregate Price/Earnings Ratio

The first table illustrates the historical trend for the price-to-earnings ratio for the S&P 500. The historical average price earnings ratio for publicly traded stocks in the U.S., as can be seen from looking at the trend line, is about 16x. Currently it is about 25x. It should be noted that while earnings are considered too volatile to serve as the most reliable indicator of whether or not a stock is overvalued or undervalued, the table here, developed by economist Robert Shiller, presents a “cyclically adjusted price to earnings ratio.” Using this technique, a rolling ten-year average earnings is calculated, and that is what is being depicted on the chart.

As can be seen, the stock market crash of 1929 was preceded by an aggregate P/E of 30. The overvalued stock market before the correction of 2000, soaring on internet IPOs for companies that, in many cases had no earnings, achieved a P/E of nearly 45 before the fall. And the overvalued stock market before the correction of 2009 had a P/E of just over 25. These high P/Es are not sustainable. The S&P 500 closed on July 8th, 2016 at a value of 2,129. If the P/E of the S&P 500 were to revert to a sustainable historical average of 16, the S&P index would fall by 36% to 1,362. And while that’s a usable projection, in reality when corrections occur, the P/E ratio falls below the average for a time, i.e., a correction to 1,362 might be a best-case scenario for the S&P 500.

Aggregate Price/Earnings Ratio, S&P 500
Last 136 years through 2016 

20160630 Schiller price earnings ratio

(2) Aggregate Price/Sales Ratio

If the price/earnings ratio, even smoothed to a ten year rolling average, is considered unreliable because earnings are volatile, then the lesser known price/sales ratio is a good way to take a second look. A price/sales ratio is relatively easy to grasp intuitively – it measures the annual revenue of the company divided by the value of the company. An aggregate price/sales ratio for the entire S&P 500 would simply be the total annual revenues of all 500 companies, divided by the total market value (expressed in their stock price x number of shares outstanding) of all 500 companies. The sustainable historical average price/sales ratio for the S&P 500 is 0.9x.

The next chart, going back to 1965, shows that aggregate price/sales ratios for the S&P 500 are at 50 year highs. As can be seen, at the 2000 peak the price/sales ratio was around 1.6x, and back in 2008 it moved just over 1.8x. Today the aggregate price/sales ratio for the S&P 500 is about 2.1x. If the P/S of the S&P 500 were to revert to a sustainable historical average of 0.9x, the S&P index would fall by 57% to 912.

Aggregate Price/Sales Ratio, S&P 500
Last 51 years through 2016
20150228_S&P-price-sales-ratio

(3) Market value of all publicly traded U.S. stocks/GDP

Another way, using ratios, to assess whether or not the U.S. stock market is overvalued is to compare the market value of all publicly traded U.S. stocks to the gross domestic product for the U.S. economy. The chart depicting the trends for this ratio since 1955 shows that it is just off a 60 year high. Before the 2000 correction the market cap/GDP ratio was 204%. Before the correction of 2009 it got up to 183%. And at the end of 2015 it was just under 200%. After both the 2000 and the 2009 correction the market cap/GDP ratio dove to around 100%. If public stocks in the U.S. were to revert to a market cap/GDP ratio of 100%, the S&P 500 would fall 50% to 1,064.

Market Value of all Publicly Traded U.S. Stocks / GDP
Last 60 years through 2015

20160416_Stock Market percent of GDP

The conclusion of this section, using the average of the three ratios just considered, is that if stock prices were to return to sustainable levels, the indexes would fall by 47%. This is consistent with the findings of the previous article, which demonstrated that debt formation can no longer be used to stimulate the economy and the markets because interest rates have been stuck at or near zero for the last seven years. The next section will examine the impact of a 47% correction on the pension funds.

PART TWO:  THE IMPACT OF A MAJOR MARKET CORRECTION ON CALIFORNIA’S PENSION FUNDS

To evaluate the impact of a major market correction on California’s state/local pension systems, we have created a model to perform “Pension System Long-Range Financial Analysis.” As will be demonstrated, this model projects the annual cash flow for a pension system through 2075 under a variety of assumptions. It also shows the assets, liabilities (NPV) and funding status for a pension system by year through 2075. Readers are invited to download this model, evaluate its internal logic, view the assumptions underlying the baseline case, and experiment with various scenarios.

Download model for “Pension System Long-Range Financial Analysis.”

Baseline Case: No change to pension benefits, no reduction in return on investments

As a starting point for comparisons, the model projects the future cash flow and funding status for all of California’s state and local government worker pension systems combined under the following assumptions:

  • Contributions are not increased.
  • Benefits are not reduced.
  • Annual returns on invested assets, with the exception of 2015 which we optimistically estimate yielded 2.0%, continue from 2016 through 2075 at 7.5% per year without exception.

Key cash flow and benefit assumptions input in this baseline case include the following:

  • The average participant works 25 years, and there is a five year gap, on average, between when the average participant retires, and when they become eligible for pension benefits.
  • The average benefit multiplier (amount that is multiplied by years worked times final salary to calculate the initial amount of a pension) for retirees through 1999 is 1.8%.
  • The average benefit multiplier for post 1999 retirees is 2.5%, to reflect the retroactive benefit enhancements that began in that year.
  • The average pension cost-of-living increase per year is 2.5%.

The model permits variations to the inputs that are beyond the scope of this report to describe in full, but retains sufficient simplicity that anyone downloading it with a reasonable understanding of spreadsheets and pension finance can examine them in detail. Comments and criticisms on the efficacy of this model are most welcome. To summarize a few of these features, the user can:

  • Vary the life expectancy – we have assumed a life expectancy increase of 0.15% per year,
  • Vary the number of workers according to the birth year of each participant – we have used Census Bureau data on California’s state/local workforce and state/local retirees to assume a roughly accurate total of 1.8 million pension “full-time equivalent” eligible workers and 1.8 million “full career” retirees, straight-lined at 60,000 participants per year of birth.
  • Vary the amount that the beginning salary of a worker increases each year – we have assumed 2.75% per year which translates into an average starting salary of $15,000 in 1960 becomes an average starting salary of $66K in 2015.
  • Change the amount of annual salary increase (promotion, “step increases,” and COLAs) – we have assumed 3.0% per year which translates into an average salary of $71K in 2015 for a worker hired in 1990. US Census estimates place the average salary for a state/local government worker in California at $72K. Our average pension eligible salary, using the above-noted assumptions, is $69K, which assumes an average overtime payment (not pension eligible) of 5%.

By inputting these assumptions and others into the model, it calculates the following results for California’s consolidated state/local pension systems at the end of 2015:  A funded ratio of 65%, total assets of $756 billion, total liabilities (NPV) of $1.16 trillion, incoming contributions of $34 billion, and contributions as a percent of payroll of 32%. These results are almost exactly consistent with the consolidated estimates as provided by the U.S. Census Bureau for 2014 and 2015. Those references are footnoted on the “data” tab of the model.

The results calculated by the model, based on this “business as usual” are surprisingly positive. They show the unfunded liability being consistently whittled away, such that by 2020 the consolidated systems are 72% funded, by 2025 they are 81% funded, by 2030 they are 91% funded, and by 2040 they are 118% funded.

All of that assumes, however, that from 2016 on, the consolidated system assets earn 7.5%. Every year without exception.

First Set of Downturn Cases:  The markets fall 47% in 2017, and earn 5% per year thereafter.

This set of cases is to show the impact of a severe market correction, followed by modest returns from then on. This set of cases assumes a 7.5% return in 2016, followed by the crash in 2017, followed by modest 5% returns from then on. The five cases depicted here reflect escalating reductions to benefits. In all cases, what is solved for is the contribution – as a percent of payroll – required for the systems to achieve 100% funding by 2030. The baseline, by the way, under this earnings scenario – that is, if no changes are made to benefits or contributions in the face of this market correction – has the pension systems completely out of funds by 2041.

In the chart depicted below, five cases are presented. The first one makes no changes to benefits, solving for what contribution as a percent of payroll is necessary to restore 100% funding to the pension systems by 2050. As can be seen, the required contribution “$ Contr” is 80% of payroll. Recall that the consolidated average for California’s state/local pension systems is currently 32%, which equates to $34 billion per year. Put another way, it would cost California’s taxpayers another $51 billion per year if the market corrects by 47%, recovers at an earnings rate of 5% per year, and no changes are made to pension benefits.

The next three cases in the chart below consider changes to new hire benefits starting in 2020. Case #2 lowers the pension multiplier for new hires from 2.5% to 2.0%; a significant change that goes further than any pension reforms being seriously considered. As can be seen, it results in a lowering of the required contribution for these systems to restore 100% funding by 2050 to 66% of payroll, still more than twice what it is today.

Case #3 shows the impact of lowering the annual multiplier for new hires from 2.5% to 2.0%, combined with raising the eligible retirement age by five years. This results in a lowering of the required contribution for these systems to restore 100% funding by 2050 to 52% of payroll. Case 3 is highlighted because it probably represents the extreme limit of what current discussions indicate might eventually be negotiable.

In an attempt however to establish parameters for what additional reforms might yield, Case #4 shows the impact of lowering the pension multiplier for new hires still further, to 1.5%. The result is significant, bringing the required contribution for these systems to restore 100% funding by 2050 to 43% of payroll. Case #5 delves into territory that some would consider reasonable; it lowers the pension multiplier for existing employees to 2.0% per year – but only from now on, not retroactively. This yields significant savings, lowering the required contribution to 35% of payroll in order to achieve 100% funding by 2050. This scenario represents a viable way to preserve defined benefits without costing taxpayers tens of billions per year.

Contributions Required as Percent of Payroll to Achieve 100% Funding by 2050
Assume -47% Market Correction in 2017, Followed by 5.0% Annual Returns1 - 5 percent results

Second Set of Downturn Cases: The markets fall 47% in 2017, and earn 4% per year thereafter.

It is possible however that 5% returns per year after a severe market correction may be too much. After the last major stock market crash, in 1929, it took several decades before the cumulative average returns post-1929 reached 5% per year. The next set of cases examines the results of a 47% market downturn in 2017, followed by four percent returns from then on. The results are dramatically different from the 5% return scenario in the first set of cases, and illustrates the extraordinary sensitivity of pension fund solvency to the long-term rates of return.

In Case #6, just as in Case #1, no change has been made to the benefits either for new or existing employees. As can be seen, going from a 5% post crash annual average return to a 4% post crash annual average return causes the required contribution as a percent of payroll to jump from 80% (Case #1) to 113% (Case #6). This translates into an increase to taxpayers of $85 billion per year.

The next four cases in this 4% earnings scenario depict the same set of benefit reductions as in the previous 5% earnings scenario. But in this case, by the time you get to Case #10 (4% post crash earnings), which has the same set of reductions as Case #5 (5% post crash earnings), instead of whittling the required annual contribution (to achieve 100% funding by 2050) down to 35%, it is still at 48%. For this reason, additional cases are considered.

Cases #11 and #12 impose additional reductions to benefits on existing employees. By lowering the pension multiplier to 1.5% for existing employees – again, only from now on – the required contribution drops to 41%. By raising the age of eligibility for benefits by five years for existing employees, the required contribution drops to a manageable 37%.

Contributions Required as Percent of Payroll to Achieve 100% Funding by 2050
Assume -47% Market Correction in 2017, Followed by 4.0% Annual Returns2 - 4 percent results

PART THREE:  CONCLUSION AND RECOMMENDATIONS

Based on historical trends, three key aggregated stock market ratios – price/earnings, price/sales, and price as a percent of GDP – all show that publicly traded U.S. stock are overvalued by approximately 50%. These indicators are supported by evidence that debt accumulation can no longer be useful as a tool to stimulate the economy or the stock markets, and that demographic trends – where an aging population is introducing more sellers into the markets – creates additional downward pressure on the stock markets.

It is easy enough to step back and claim that the rules have changed, that these unusually high stock market multiples can be sustained for additional decades, and that productivity improvements will enable the U.S. economy to support both massive debt and an aging population. Those who argue this position are betting that the U.S. economy, because of its diversity, sheer size, relatively lower levels of total market debt as a percent of GDP, relatively higher interest rates (i.e. still positive), stability and security, will become a refuge for wealth fleeing far more tumultuous economies elsewhere in the world. Staking the future of pension fund systems on this argument is a dangerous gamble. For more on why conservative rates-of-return may be inevitable, and imminent, read Michael Lebowitz’s two-part series, recently published by the California Policy Center, “The Death of the Virtuous Cycle,” and “The Fifteenth of August.”

For all of California’s pension funds consolidated, the analysis finds that if the market corrects downwards by 50%, then recovers to grow at 5% per year, without benefit reductions, the required annual contribution will rise to 80% of pension eligible payroll. This will cost California’s taxpayers an additional $50 billion per year. If the market corrects by 50% then recovers to grow at 4% per year, without benefit reductions, the required annual contribution will rise to 113% of pension eligible payroll. This scenario will cost California’s taxpayers an additional $86 billion per year. This analysis has also evaluated the impact of benefit reductions, exploring cases where only new employees are affected, as well as cases where benefits earned for future work by existing employees are also affected.

When evaluating what level of benefit reductions can preserve pension systems without increasing employer contributions, the study found the following:

In the case of a stock market negative correction of 50% followed by 5% annual growth, if the annual multiplier (the amount that is multiplied by years work times final salary to calculate an initial pension) is cut by 40% for new employees, and the annual retiree cost-of-living adjustment is cut by 40% for new employees, the retirement eligibility age is raised by five years for new employees, AND the annual multiplier is cut by 20% for existing employees for future work, the current level of payments would be sufficient to bring the systems to 100% funded status by 2050.

In the case of a stock market negative correction of 50% followed by 4% annual growth, if the annual multiplier (the amount that is multiplied by years work times final salary to calculate an initial pension) is cut by 40% for new employees AND existing employees for future work, and the annual retiree cost-of-living adjustment is cut by 40% for new employees AND existing employees, the retirement eligibility age is raised by five years for new employees AND existing employees, the current level of payments would be sufficient to bring the systems to 100% funded status by 2050.

Preserving defined benefit pensions in the face of a prolonged period of low investment returns will require the stakeholders in public employee pension funds to make hard choices. For example, lowering benefit accruals – just for future work by existing employees –  can have a significant impact on reducing the required contribution. Reducing benefits for new employees is helpful, but the savings to be realized are decades in the future and are therefore heavily discounted when calculating a current pension system liability. For this reason, only restricting benefit reductions to new employees means they must be severe indeed. Balancing benefit reductions between existing employees (for future work) and new employees yields far less severe overall reductions – although as demonstrated, if the average market returns dip below 5% in the long-term – there is no incremental way to preserve system solvency without also dramatically increasing the required contributions.

Policymakers and stakeholders should plan now. They should negotiate, at the least, contingency plans to handle a major stock market correction that strikes an appropriate balance between costly tax increases and benefit reductions. Should there be a significant stock market downturn, taxpayers themselves will have depleted savings. They should not have to endure higher taxes to maintain public sector retirement accounts, when their own retirement accounts have been equally affected.

 *   *   *

Ed Ring is the president of the California Policy Center.

 

UC Berkeley’s ‘income inequality’ critics earn in top 2%

 

Photo by Policy Network via Wikimedia Commons

REICH: Despite calls for income equality, the University of California Berkeley professor earned at least $263,592 in 2014. (Photo by Policy Network via Wikimedia Commons.)

 

Scholars from the University of California at Berkeley have played a pivotal role in making income inequality a major political issue. But while they decry the inequities of the American capitalist system, Berkeley professors are near the top of a very lopsided income distribution prevailing at the nation’s leading public university.

Among the most prominent of these scholars is Robert Reich, Chancellor’s Professor of Public Policy at the University of California at Berkeley. Reich’s 2013 film, Inequality for All, is an indictment of a rigged U.S. economy that makes a select few richer while consigning the middle class to stagnation. A review of the film and Reich’s other work suggests that the economist and former Clinton-era Labor Secretary provided numerous talking points for Bernie Sanders’ high-profile – though ultimately unsuccessful – presidential campaign.

While Reich helped popularize the income inequality theme, much of the intellectual heavy lifting has been done by UC Berkeley economist Edward Saez and his colleagues at the university’s Center for Equitable Growth (CEG). Saez has been researching income inequality since 2003, when he co-authored a paper on the topic with Thomas Piketty, the French economist whose book Capital in the Twenty-First Century also played a key role in popularizing the income inequality issue. The pair continue to collaborate.

Since these Berkeley academics preaches, we wondered whether the university community also practices greater equality. To answer this question, we examined distributional equity at the university, relying on publicly available data.

Statistical Comparisons of Inequality

Social science researchers often measure income inequality with the Gini Coefficient – a calculated value that can range between zero and one. The higher the Gini Coefficient, the more unequal the country, municipality or community. If everyone in a population has exactly the same income, that group’s Gini Coefficient is zero.  By contrast, if one individual receives all of a community’s income (and everyone else receives nothing), the Gini Coefficient is 1.

According to World Bank statistics, the average country had a Gini Coefficient of around 0.36 in 2012, when data for 68 countries were available. In 2013, the coefficient for the U.S. was 0.4106 – roughly the same as it was under Bill Clinton in 1997. The country with the lowest reported Gini was Ukraine (at 0.2474) and the highest was Haiti (at 0.6079). Scandinavian countries are among the most equal (between 0.26 and 0.29), while Latin American nations dominate the high Gini countries (with several over 0.50).

Within the United States, the Census Bureau reports Gini coefficients for over 500 cities.  The latest data available are for 2014. The city of Berkeley’s Gini score of 0.5356 places it in the top 5% of U.S. cities for income inequality. In California, it ranks third of 133 – behind Davis (another city dominated by a UC campus) and Los Angeles. Internationally, city of Berkeley’s score is virtually identical to that of Colombia.

Public employee compensation data allows us to measure income inequality on campus. The State Controller’s Public Pay database contains salaries for all UC employees, indicating which campus each employee is on. The Gini coefficient for the 35,000 UC Berkeley employees in the data set is 0.6600 – higher than that of Haiti.

Getting Rich from Researching and Critiquing Inequality

Income inequality at Cal extends to the university’s inequality research arm, the Center for Equitable Growth mentioned earlier. According to 2014 data from Transparent California, Center Director Emmanuel Saez received total wages of $349,350. Its three advisory board members are also highly compensated Cal professors: David Card (making $336,367 in 2014), Gerard Roland ($304,608) and Alan Auerbach ($291,782). Aside from their high wages, all four professors are eligible for a defined-benefit pension equal to 2.5% times final average salary times number of years employed. It is also worth noting that all four are in the top 2% of UC Berkeley’s salary distribution, and that Saez is in the top 1%. It could be that an effective researcher has to know his or her subject: thus to the study the top 1%, we suppose one has to be in the top 1%.

Pricey Textbook

BOOK CLUB: Cal economics students are pounded by high-priced textbooks.

Robert Reich receives somewhat lower compensation than the four CEG economists, collecting $263,592 in pay during 2014. But Reich’s salary was likely not his only source of income in 2014. Reich makes himself available to give paid speeches through a number of speaking bureaus, charging a fee estimated at $40,000 per talk. He is also likely to receive some income from his books, movies and pensions from previous employers.

Reich is not the only senior academic who can avail himself of significant income aside from that provided by his university employer. Because teaching and publication demands on tenured professors are relatively modest, there’s time to earn extra income from consulting and writing textbooks. The latter can be surprisingly lucrative, since many college textbooks sell for over $200 per copy. Last September, the Cal bookstore offered an introductory economics textbook for $294. Lucrative opportunities to supplement one’s income with consulting fees and royalties are typically unavailable to a college’s administrative staff.

Highly Paid Coaches and Administrators

Aside from tenured professors, UC Berkeley also provides generous compensation for athletic coaches and administrators. The highest paid UC Berkeley employee in 2014 was Daniel Dykes who received $1,805,400 for coaching the California Golden Bears football team, which went 5-7 that year and did not make a bowl appearance. Dykes was followed closely by Jeff Tedford (at $1,800,000), the Bears’ former coach who was still on the payroll in 2014 despite having been relieved of his coaching responsibilities. The next five highest paid UC Berkeley employees were also coaches.

UC Berkeley Chancellor Nicholas Dirks was paid $532,226 in 2014, but a unique perk substantially boosted his effective compensation.

Dirks House

HE BUILT A WALL AND YOU PAID FOR IT: Chancellor Dirks’ residence with new $700k fence.

Like all UC Chancellors, Dirks is provided with a free residence. According to the San Francisco Chronicle, University House – now occupied by Dirks – contains 15,850 square feet of living and meeting space. Living on campus has not been an unalloyed benefit for Chancellor Dirks, however. The home has been attacked on numerous occasions by student activists. In response, the university recently completed a metal fence around the home at a cost of $699,000 – two and a half times over budget.

Dirks’ cash compensation was slightly lower than that of former UC President Mark Yudof, who co-instructed one class at Cal’s Law School in 2014, receiving $546,057 for his time. According to the Sacramento Bee, “Yudof benefited from a UC policy that allows high-ranking administrators to receive a year of pay if they are preparing to teach again.” After stepping down as president, Yudof took a one-year sabbatical, co-taught one class in Fall 2014 and another in Spring 2015, and then retired.

Tenured faculty and administrators at Cal have also been shielded from harsh discipline, even when they engage in sexual harassment. According to a recent report in the San Jose Mercury News:

Astronomer Geoff Marcy received a warning last year despite the university’s finding that he had serially harassed students over nearly a decade. Former law school dean Sujit Choudhry received a 10 percent pay cut but was initially allowed to keep his position after he was found to have sexually harassed his executive assistant. And former Vice Chancellor Graham Fleming — who stepped down last April amid allegations he had sexually harassed a staff member — quickly landed an administrative job as ambassador for UC Berkeley’s new Global Campus, a satellite campus in Richmond.

The three Cal employees cited received generous compensation in 2014. Marcy collected $217,861; Choudhry made $472,917 and Fleming received $404,625. More recently, Berkeley has taken stronger disciplinary measures in response to media attention and pressure from UC’s system President Janet Napolitano. Fleming was fired and Choudhry resigned in March.

Life for the Other 99%

High compensation for tenured faculty does not necessarily come with a heavy teaching workload. Instead, most of the teaching burden appears to fall on junior faculty and teaching assistants.

Introductory classes at UC Berkeley often have several hundred students. Although a faculty member gives the lectures and designs the syllabus, students functioning as teaching assistants, readers and graders handle most live interaction with course participants, review their homework and score their exams. Students fulfilling these roles may be in a graduate program, but are often juniors or seniors.

In Fall 2013, Cal’s Intro to Computer Science – CS 61A – had 1,098 registered students, exceeding the capacity of the lecture hall. The assistant professor conducting the course, John DeNero, recorded lecture videos for those who could not fit into the room. He told the student newspaper: “Almost all of the learning in computer science courses happens in the lab and when they’re working on projects. So if you don’t fit in the room, you can definitely still participate in all the important parts of the course.” Students taking the class had access to 19 teaching assistants and 15 readers. DeNero was paid $46,643 in 2014 – likely exceeding the amounts paid to the enormous assistant and reading staff who now receive around $14 per hour. Thus, one of the university’s most important services – orienting new students to the fast-growing field of computer science – was delivered by poorly paid staff, without any input from its highly compensated senior faculty.

Although the City of Berkeley has a higher minimum wage than the rest of the state, Cal is exempt from this municipal minimum. In late 2014, The East Bay Express reported that the university was paying hundreds of student workers less than the $10 per hour city minimum.  More recently, the university implemented a UC-wide Fair Wage/Fair Work Plan under which the minimum wage rose to $13 per hour in October 2015 with subsequent increases to $14 per hour in October 2016 and $15 per hour in October 2017. It should be noted that, unlike other minimum wage requirements, UC’s minimums apply only to employees working more than 20 hours per week, so it is possible that some student workers will remain below the City of Berkeley minimum, currently set at $12.53.

It is difficult to assess how little of the teaching burden falls on the shoulders of tenured faculty.  The University of California’s Annual Accountability Report (covering all 10 UC campuses) indicates that most instruction is provided by “full-time permanent faculty.” This designation includes assistant and associate professors who have yet to obtain tenure. Further, the university employs a misleading metric for reporting relative instructional burdens between full-time permanent faculty, lecturers, visitors, adjuncts and others. Teaching loads are shown in “student credit hours (SCH),” which is the number of students enrolled in a given course times the number of credits earned from that course. If a permanent faculty member gives the lectures for a 4-credit course attended by 1000 students, 4000 SCH are added to the full-time permanent faculty total even though most instructional activities in the course are performed by juniors, seniors and graduate students.

Relatively low-paid and heavily worked staff also keep many of Cal’s core functions running. Administrative staff faced a round of layoffs in 2011 and are now undergoing a further workforce reduction despite increasing enrollment numbers. Meanwhile, unrepresented staff (those not unionized) have seen minimal salary growth in recent years. Although administrative tasks – such as managing financial aid applications, administering grants applications and maintaining university software platforms – may seem less glamorous than research, individuals performing these functions often work much harder than tenured faculty while earning far less.

Conclusion

The University of California at Berkeley has a great reputation, and the school continues to earn its high standing with a mixture of world-class scholars, outstanding students and (at least some) great facilities.

To attract excellent academics and administrators, the university must offer competitive compensation packages. In some cases, these packages will draw truly outstanding people who go on to do excellent work for the university. In other instances, these packages amount to sinecures enabling high-status individuals to receive compensation disproportionate to their contributions.

In this respect, Cal is no different from a large, publicly held corporation. Companies offer big salaries to CEOs and other high-level professionals, sometimes getting their money’s worth and other times not. Just as it isn’t reasonable to expect a tenured professor or senior administrator to be paid in line with entry-level employees, we shouldn’t expect senior university administrators and tenured professors to be paid the same as work-study students.

While it is true that the compensation ratios between the highest- and lowest-paid employees are greater at many large corporations than at universities, there is an offsetting consideration. A very large portion of compensation at UC Berkeley and other public universities is paid by federal and state taxpayers through grants and financial aid. This is not the case for private companies – at least those that don’t sell to the government.

The hefty salaries and generous pensions awarded to Berkeley administrators, professors and coaches are funded by taxpayers – most of whom earn far less than these academic luminaries. So if UC Berkeley economists are really opposed to income inequality and are concerned about low-paid workers, they might consider sharing some of their compensation with the teaching assistants, graders, readers and administrative staff at the bottom of Cal’s income distribution.

We’re not saying income inequality is a bad thing; we’re not saying that Reich, Saez and other Berkeley professors should make less than they do, or that student teachers ought to make much, much more. In fact, there are reasonable arguments that income inequality is not only inevitable and even ethical, but that it’s also a generally positive feature of advanced economies.

We are saying there’s something unusual in the Berkeley phenomenon – the high-profile role of high-income earners in criticizing income inequality.

ABOUT THE AUTHOR
Study author Marc Joffe is the founder of Public Sector Credit Solutions and a policy analyst with the California Policy Center. Joffe founded Public Sector Credit Solutions in 2011 to educate policymakers, investors and citizens about government credit risk. PSCS research has been published by the California State Treasurer’s Office, the Mercatus Center and the Macdonald-Laurier Institute among others. Before starting PSCS, Marc was a senior director at Moody’s Analytics. He earned his MBA from New York University and his MPA from San Francisco State University.

ABOUT THE CALIFORNIA POLICY CENTER
The California Policy Center is a non-partisan public policy think tank providing information that elevates the public dialogue on vital issues facing Californians, with the goal of helping to foster constructive progress towards more equitable and sustainable management of California’s public institutions. Learn more at CaliforniaPolicyCenter.org.

 

Comparing Federal and California State Retirement Exposures

Californians may be accustomed to living with the specter of a public pension crisis. But the federal government’s problem with its retirement system – including Social Security – is far worse, and yet none of the three remaining major-party candidates for president has a plan to do anything about it.

The California Policy Center generally focuses on state and local issues. But with just days left before California’s June 7, we offer this comparison of California and federal exposure to pension liability.

State Retirement Expenditures

According to the governor’s May Budget Revision, the state will make a total of $8.1 billion in pension contributions during the 2016-2017 fiscal year. This amount represents a sharp increase from the current fiscal year level of $7.1 billion and fiscal 2014-2015 contributions of $6.3 billion. (These numbers exclude Other Post Employment Benefit payments.)

The rapid increase is attributable to lackluster stock market performance, more conservative actuarial assumptions implemented by CalPERS and a teacher’s pension reform that increased the state’s responsibility for CalSTRS. However, even the newly increased contribution levels are unlikely to resolve chronic underfunding in both CalPERS and CalSTRS because these two systems assume a 7.5% annual rate of return, which seems unrealistic in today’s slow growth, low interest rate economy.

Figures 1 and 2 provide a longer term perspective on the growth of state pension costs. These graphs go back to the 1999-2000 budget year when the governor signed SB 400, a bill that provided a large, retroactive increase in pension benefits. In that year, pension contributions were only $1.2 billion.

StateVFed-Chart1

Figure 1

StateVFed-Chart2

Figure 2

Because of inflation and the growth of the state economy, it may be more helpful to look at state pension contributions in relation to some broader economic indicator. In previous CPC studies, we have shown pension costs as a percentage of overall government revenue – identifying a number of California cities and counties that devote over 10% of their income to retirement plan contributions.

The state’s position is much better than that of the most burdened counties and cities. In 2014-2015 (the last year for which audited financial statements are available), $6.3 billion of pension contributions represented 2.29% of total state revenues – including general fund revenue, other governmental fund revenue and business type activity revenue – which totaled $276 billion. We project that this ratio will rise to about 2.76% in 2016-2017.

For those interested in general fund statistics only, pension contributions accounted for 5.57% of general fund revenue (on a budgetary basis) in 2014-2015 and are projected to rise to 6.49% in 2016-2017. These ratios overstate California’s pension burden, because many employees are compensated with resources outside the general fund.

On the other hand, some California state spending effectively subsidizes pension costs incurred by city, county, school districts and special districts. For example, most of the state’s $87.6 billion education budget for 2016-2017 will be distributed to local educational authorities, which will use some of these funds to make employer contributions to public employee pension systems.

As Ed Ring reported in a recent CPC study, total California government employer pension contributions in 2013-2014 were $21.2 billion. While only one quarter of this total was directly paid by the state government, some portion of the local government share would not have been made in the absence of state aid payments.

Ring’s report also offers some insight into how much state pension contributions would have to rise if more realistic return assumptions were used.  For example, if pension funds used a 5.5% return assumption, pension fund contributions would have to triple from current levels.

Social Security

The vast majority of federal retirement expenditures take the form of Social Security benefits. Because most American workers are eligibility for Social Security, the program is quite large. In the current federal fiscal year, Social Security expenditures are projected to be $911 billion or just over 27% of federal revenues. About 83% of these costs take the form of retiree and survivor benefits, 16% goes to disabled workers and under 1% covers administrative expenses.

Each year, the Social Security Board of Trustees publishes an actuarial report. The report includes short- and long-term projections, with an emphasis on the status of the Social Security trust fund. The latest report shows that the trust fund contained about $2.8 trillion in assets at the end of calendar year 2014. The report also projects that the trust fund will be exhausted in 2034 based on a set of intermediate cost assumptions. The report also includes projections based on two alternative scenarios: one reflecting higher-cost assumptions (such as greater longevity) and lower cost assumptions. Under the high-cost scenario, the trust fund would be exhausted by 2030, while under the low-cost scenario the trust fund maintains a positive balance throughout the report’s 75-year projection horizon.

Although discussion of Social Security often revolves around the trust fund, this emphasis is misplaced. Unlike CalPERS or CalSTRS, the Social Security trust fund does not contain real assets. Instead, it holds special-issue U.S. Treasury bonds. Since the trust fund is part of the federal government, its assets are merely IOUs issued by its owner. The situation is analogous to an individual removing money from his piggy bank and replacing it with a note showing the amount he plans eventually to put back.  This may be a good commitment device, but any financially knowledgeable third party would not consider the note a meaningful asset.

One might argue that the Treasury bonds in the trust fund represent a claim on federal assets, but as shown in its latest audited financial statements, the federal government has a negative net position. Total federal assets of $3.2 trillion are easily exceeded by $13.2 trillion of federal debt securities held by the public and $8.2 trillion of other liabilities. So the IOUs held by the Social Security trust fund compete with claims held by many external parties for a relatively small pool of federal assets.

While the trust fund assets are not economically meaningful, they do have a legal significance – but even that is less than meets the eye. Under current law, if the trust fund is exhausted, benefit payments must be immediately reduced so that they are equivalent to Social Security revenues, which mostly derive from Federal Insurance Contribution Act (FICA) taxes paid by employees and employers. Under the trustee’s intermediate scenario, benefits would fall to 79% of the then-current level when the trust fund is exhausted in 2034.

However, this sudden, sharp reduction is extremely unlikely. Given the large number of Social Security recipients, the high voting propensity of older voters and the power of AARP, the benefit cut would almost inevitably be reversed, with additional costs borne by the general fund. There is a recent precedent for general fund transfers of this type: when Congress temporarily reduced FICA taxes in 2011 and 2012, the loss of trust fund income was offset by general fund transfers.

Rather than view Social Security through the trust fund prism, its fiscal impact is better understood in terms of its net impact on the consolidated federal budget. In other words, we should look at the difference between Social Security revenues and expenditures. The trustee report includes interest on the Treasury bonds held by the Social Security trust fund, but this notional income should be disregarded: the interest is paid and received by the same entity, the federal government.

Figure 3 shows Social Security’s net cash flow in constant dollars back to 1957. Projected revenues are depicted by three lines, with shaded areas in between. The middle line reflects the trustee’s intermediate assumptions, with the low cost and high cost scenarios shown by the lowest and highest lines respectively. As the chart shows, program revenues and expenditures were roughly equal for the first three decades. Between the late 1980s and the last decade, revenues exceeded expenditures, often by large margins. In the late 1990s, this surplus helped balance the federal budget; later, it offset budget deficits that developed under the George W. Bush Administration.

StateVFed-Chart3

Figure 3

Increased disability insurance claims associated with the Great Recession and the beginning of baby boomer retirements ushered in a series of negative net balances beginning in 2010. These deficits are expected to continue under all three trustee scenarios, and to become quite large under the intermediate and high cost assumptions. By 2040, the shortfall reaches $371 billion under the intermediate scenario and $610 billion under the high cost scenario – in 2015 constant dollars.

Unprecedented deficits of this magnitude have very serious implications for the federal budget, especially when combined with escalating Medicare and Medicaid costs. Last year, the Congressional Budget Office projected that the ratio of publicly held debt to GDP will increase from 74% currently to 107% by 2040.

Federal Employee Retirement Programs

The federal government also has a large number of employees and retirees eligible for defined pension benefits. According to its latest annual report, the Civil Service Retirement and Disability Fund, paid $81 billion of retirement benefits in fiscal year 2015, or 2.49% of federal revenues. The system reported an Unfunded Actuarial Liability of $804.3 billion and Assets of $858.6 billion, implying a funded ratio of only 51.6%. Further, the fund’s assets are almost entirely invested in U.S. Treasury securities. Similar to the Social Security Trust Fund, the economic meaning of these investments is questionable.

The Defense Department also provides retirement benefits. The latest available actuarial report shows $54.8 billion of benefits paid in fiscal year 2013 and a 35% funded ratio. Last year, President Obama signed a Defense Authorization Bill containing a military pension reform. Instead of a straight defined-benefit plan, new recruits joining the armed forces after January 1, 2018 will be placed in a hybrid plan containing a 401(k)-style component with an employer match. The defined benefit component will remain, but will be reduced by 20%. This reform should improve the program’s funded ratio, but won’t reduce military pension costs by very much – if at all. Under the current system, service members must remain in the military for 20 years to become eligible for pension benefits. Vesting in federal matching payments under the new defined contribution plan will begin after two years.

Comparing the Federal and State Governments

Overall, the federal government has much greater exposure to pension costs that does the state of California. Civilian and military pension benefits consume a proportionately larger amount of the federal revenue than the share of total state revenue absorbed by CalPERS and CalSTRS contributions. Further, the federal government is responsible for providing most American workers pension benefits through Social Security, which absorbs more than a quarter of federal revenue and has an inadequate level of pre-funding, even if one considers Treasury securities to be an acceptable investment vehicle for a federal retirement system.

That said, it is worth considering some advantages the federal government has relative to the state in dealing with pension costs. First, the U.S. constitution does not provide a right to accrued benefits. In an emergency, Congress and the president could cut or terminate benefits to Social Security recipients, federal civilian retirees or veterans. This is not the case for the state of California.

As Alexander Volokh points out: “In California, when a public employee begins work, he not only acquires a right to the pension accumulated so far — presumably zero on the first day, and increasing as he works longer — but also the right to continue to earn a pension on terms that are at least as generous as the ones then in effect, for as long as he works. And if pension rules become more generous in the future, then those more generous terms are the ones that are protected.”

As I discussed earlier, I do not expect Social Security benefits to be reduced when the trust fund runs out, so the fact the Social Security recipients do not have access to the courts may be a distinction without a difference.  But it is still true that the federal government has a tool for reducing benefit costs – especially during a fiscal emergency – that is not available to the state.

Further, there is a widespread belief that the federal government is less vulnerable to a fiscal emergency than California because it has access to the printing press. In other words, if the federal government cannot obtain enough tax revenue to pay retirement benefits, it could do so with newly created money.

While this is a fair distinction, it comes with a couple of caveats. First, at the national level, money creation has become the role of the Federal Reserve, which has some degree of political independence.  Strictly speaking, the president cannot order the Fed Chair to create money. Second, U.S. state and local governments have been able to create circulating IOUs in the past. During the Depression, numerous cities issued scrip, while, in 2009 the state issued IOUs to vendors amidst a budget crisis. These IOUs were eventually traded on a secondary market.

These caveats notwithstanding, it is true that a central government controlling an international reserve currency does have more fiscal flexibility than a state which is legally obligated to balance its budget each year. So the federal government’s ability to absorb pension obligations is greater than California’s. This is fortunate, because the federal governments exposure is so much greater.

Solutions

We have seen that both California and the federal government face high and rising pension costs, and that each has not fully accounted for these obligations. The drivers of these problems are similar, and are duplicated throughout much of the developed world:  retirement of the large baby-boom generation, increased longevity and a failure of political institutions to deal effectively with long-term problems.

While the specific policies to improve pension sustainability differ across jurisdictions, the basic ideas are similar. These include:

  • Paring back benefit levels, especially for the most highly paid, most affluent beneficiaries.
  • Increasing retirement ages and then indexing them to longevity.
  • Increasing employee contributions.
  • Replacing deceptive accounting techniques and rosy actuarial assumptions, with conservative, fact-based financial reporting.

Finally, libertarians and fiscal conservatives working on these issues should re-evaluate their tactics. In 2005, George W. Bush’s strategy of using the impending Social Security crisis to justify a partial switch to personal accounts was roundly rejected by Democrats and Republicans alike. While many of us in the public-sector pension reform community like the idea of 401ks, we need to understand that employees – especially those who are risk-averse or financially unsophisticated – prefer defined benefits. Rather than attacking defined-benefit plans, we should try to fix these plans so that they don’t bankrupt the governments that offer them.

Comparing Fresno City and County Pension Systems

As the Fresno Bee recently reported, the city of Fresno’s pension systems are in much better financial shape than the Fresno County Employees’ Retirement Association (FCERA). As of June 30, 2015, the city’s two systems reported a combined $349 million of assets (at market value) in excess of actuarially accrued liabilities. By contrast, FCERA’s assets were $1.043 billion below its liabilities. Actuarial surpluses are rare in California, and the discrepancy between the city and county is so great that we thought it would be worth diving into the finances of Fresno’s retirement system to explain the contrast.

The systems provide extensive financial reports on their websites. The two most useful are Comprehensive Annual Financial Report (which includes financial statements and 10-year histories for many data points) and the Actuarial Valuation Study (which provides in-depth data about system assets, contributions and benefit payments). FCERA posts its reports at http://www.fcera.org. The two city systems – one for Fire and Police, and one for non-public safety employees – publish their reports at http://www.cfrs-ca.org/.

Table 1 below compares some key metrics across the plans.

The Valuation Value of Assets (VVA) is used by system actuaries to determine future contributions. But for our purposes, VVA is less useful than the Market Value of Assets (MVA). While MVA is simply the total market value of all the bonds, stocks and other investments the system holds, VVA includes various smoothing adjustments – reporting practices, some of them legitimate, that can mask liabilities.

Benefits

Contributing to the difference in the financial health of Fresno’s city and county systems is the difference in benefit levels. For example, the City of Fresno limits public safety pensions to no more than 75% of final average salary (as per Section 3-333 of the municipal code). The county imposes no similar cap and also provides very generous benefit accrual rates, in some cases exceeding 3% per year of service. According to calculations we performed using the county system’s Benefit Calculator, a Tier 1 public safety employee retiring at age 60 with 30 years of service would get a pension equal to 97% of final salary. Tier 1 employees were hired before 2007; newer county employees receive less generous benefits.

The city does not cap miscellaneous employee benefits, but its employees earn substantially less credit for each year of service. According to the city’s Benefit Calculator, a miscellaneous employee retiring at age 65 with 30 years of service would receive 72% of final compensation, compared to 97% for a county employee retiring at the same age and the same number of service years.

 

Asset Returns

Another potential distinction between the city and county systems is investment performance. A pension plan can improve its actuarial balance by achieving higher asset returns. Over the five years ended June 30, 2015, the city’s investments outperformed the county’s. FCERA generated annualized investment returns net of fees of 9.8%. The two Fresno city systems, whose assets are jointly managed, achieved net returns of 10.9% over the same period. This 1.1% difference compounded over five years is fairly significant. One billion dollars growing at the county’s rate of 9.8% becomes $1.596 billion after five years, while the same amount growing at the city’s 10.9% annual rate becomes $1.677 billion – $81 million more.

However, when we look at the 10-year period that includes the Great Recession, the performance numbers reverse. Over the 10 years ended June 30, 2015, county assets grew at an annual rate of 6.8% versus 6.4% for the city. Both of these return rates are below the annual asset return rates assumed by each system (more on this below).

Further, it’s worth noting that funding levels for all systems declined over the 10-year period. Between June 30, 2005 and June 30, 2015, FCSERA’s funded ratio based on VVA declined from 91.5% to 80.7%. The Fresno Fire & Police plan saw a decline from 126.4% to 119.6%, while the city’s Employee Retirement System witnessed a funded ratio decline from 139.8% to 109.2%.

 

Discount Rates

In general, the market value of a plan’s assets is fairly easy to determine and is not subject to substantial estimation error. Most plan assets are invested in stocks and bonds that trade frequently and whose values are easy to establish independently.

By contrast, plan liabilities are based on numerous assumptions. How much a plan will have to pay in the future depends upon when employees retire and when they pass away. Expressing these future benefit payments in current dollars requires the choice of a discount rate – a choice subject to controversy.

Fresno city plans use a higher discount rate than FCERA. The city’s ERS and Fire & Police plans both assume annual returns of 7.50% and then use that rate to discount future benefit payments. FCERA uses a slightly more conservative rate of 7.25%. Both of these assumptions exceed the actual 10-year returns experienced by the city and county pension systems, and thus should arguably be reduced.

But to compare the systems, we don’t need to determine the ideal discount rate; we simply need to apply the same rate to each system. If we reduce the city’s discount rate from 7.5% to 7.25%, pension liabilities across the two city systems would increase about $61 billion and their funded ratio would fall by about 3.5%. (These estimates are discussed in an appendix at the end of this study). While significant, this fact only explains a small portion of the 38.3% gap in funded ratios between the city and county systems.

 

Mortality Assumptions

While the pension literature includes much discussion of discount rates, less has been written about mortality assumptions. But good death rate estimates are important: if beneficiaries live a lot longer than expected, pension payments will be much greater than forecast. This recently became clear in Detroit, where city officials faced a sudden spike in projected retirement payments after its pensions actuary switched to a new mortality table.

Mortality tables are produced by the Society of Actuaries. Most public pension plans use a table from the Society’s RP-2000 Mortality Tables Report produced in the year 2000. The large increase in Detroit’s projected pension costs occurred after actuarial firm Gabriel Roeder switched to the Society’s new RP-2014 Mortality Tables.

The RP-2000 report included a supplemental schedule that can be used to scale mortality rates to future years. The scaling procedure assumes a steady improvement in longevity, and thus a steady decrease in mortality rates over time. By applying the adjustment factor from the scaling schedule multiple times, an actuary can approximate what a future mortality table might look like. For example, by applying the scaling factors to the 2000 mortality rates 15 times an actuary can approximate 2015 mortality rates. In Detroit, Gabriel Roeder did not apply the scaling factor, thereby causing the big change when it transitioned to the newer mortality table.

Both the Fresno city plans and FCERA use the RP-2000 Combined Healthy Mortality Table and then scale the death rates from this table with factors in Mortality Projection Scale AA. However, there is an important difference. The city performs the scaling six extra times: it uses mortality rates scaled to 2021, while FCERA uses death rates scaled to 2015. This means that the city plans are projecting fewer deaths at any given retiree age – and therefore greater liability – than does FCERA.

The county’s mortality projections are thus more “optimistic” than those of the city plans, in the sense that its approach anticipates shorter-lived recipients – and that translates into lower expected benefit payments. The sooner an employee is assumed to pass away the less he or she is projected to receive from the system. If FCERA performed the same scaling as the city plans, its reported funding level would be worse. Without more data, we cannot say how much worse.

Finally, it ‘s worth noting that retirement rate assumptions differ between the city and county systems. The difference may be justified, and the impact is unclear. Since the plans have different benefit structures, they present different incentives to workers timing their retirements. When an employee retires early, he or she will receive benefits for more years but generally at a lower rate. So a change in retirement-age assumptions, may raise or lower projected system costs.

 

Conclusion

Overall, our conclusion is mixed. Fresno’s Employee Retirement System and Fire & Police Retirement System offer less generous benefits that the Fresno County Employees’ Retirement Association. This difference in benefit levels makes a substantial contribution to funding disparities between the systems.

FCERA uses a more conservative discount rate, while the city plans use more (financially) conservative mortality assumptions. These modeling differences affect the disparity between reported city and county funding levels, but they do not represent real differences and simply muddy our understanding of relative system performance. Ideally, all California pension systems would use the same actuarial assumptions (unless there are real demographic differences between workforces) so that we would be able to perform accurate comparisons.

 

Appendix: Recalculating AAL Using a Different Discount Rate

A pension system’s AAL is the discounted amount of future benefit payments. Unless one has a table of projected future benefit payments, it is impossible to precisely calculate AAL using another discount rate.

In 2013, Moody’s adjusted pension liabilities by using more conservative discount rate assumptions. The rating agency’s method of restating liabilities involves projecting forward the system’s reported liability for 13 years and then discounting the result back for 13 years using the more conservative rate. Moody’s refers to the 13-year re-discounting period as a “common duration” and recognizes that applying the same duration to all plans could be a source of estimation error.

Moody’s also noted at the time that more precise estimates would be possible once pension plans implemented enhanced reporting required under Government Accounting Standards Board Statements 67 and 68.

Under these new rules, pension systems must report the “Sensitivity of Net Pension Liability to Changes in the Discount Rate.” This new schedule shows the Net Pension Liability calculated using the current discount rate, a rate 1% higher and another rate 1% lower. For the Fresno city systems, we have Net Pension Liabilities based on rates of 6.5%, 7.5% and 8.5%.

We can estimate the impact on Net Pension Liability by linearly interpolating between the 6.5% and 7.5% values. For the two Fresno systems combined, the estimated impact of a change in discount rate from 7.5% to 7.25% is $69 billion.

Net Pension Liability as reported under GASB Statement 67 is higher than each system’s Actuarially Accrued Liability. In the case of the Fresno city systems, the difference is about 11.5%. If we reduce the Net Pension Liability difference of $68 billion by 11.5%, we arrive at the $61 billion estimate presented in the main text.

The author wishes to thank Lisa Schilling at the Society of Actuaries and Bill Bergman of Truth in Accounting for their assistance with some technical points in this study. Any errors are my responsibility.

The Coming Public Pension Apocalypse, and What to Do About It

When the next market downturn hits, every public employee pension fund in the United States will face severe challenges. Because public employee pension funds are not subject to the same rules that private pension funds have to adhere to – namely, the restrictions on risky investments as specified in the federal Employee Retirement Income Security Act of 1974 – they will be hit much harder in a downturn than private pension funds. Some states will face more significant challenges than others. California is destined to be one of the hardest hit.

This discussion of California’s coming public pension apocalypse has three sections. Part one will make the case, yet again, that public employee pension funds cannot possibly hope to earn the rates of return over the next 20 years that they earned over the past 20 years. Part two will show the precise impact that lower rates of return will have on the unfunded liability, the normal contribution, and the unfunded contribution – using projections that show all of California’s state and local public employee pension funds in a consolidated report. Those who are already convinced that pension funds are headed for trouble are encouraged to skip immediately to part two, to see exactly how many hundreds of billions we’re talking about.

Finally, this discussion will offer recommendations to mitigate the impact of the coming public employee pension apocalypse, and pave the way for more sustainable programs in the future. These recommendations are in three parts – how to restore the pension funds, how to restore economic vitality to Californians, and policies to advocate at the federal level.

PART ONE: WHY PENSION FUND RATES OF RETURN WILL FALL DRAMATICALLY

“For the first time in the pension fund’s history, we paid out more in retirement benefits than we took in contributions.”
–  Anne Stausboll, Chief Executive Officer, CalPERS, 2014-2015 Comprehensive Annual Financial Report

There are few examples of a seemingly innocuous statement with more significance than Anne Stausboll’s admission, buried in her “CEO’s Letter of Transmittal,” summarizing the performance of CalPERS, the largest public employee retirement system in the United States. Because what’s happening at CalPERS – they now pay more in benefits than they collect in contributions – is happening everywhere in America.

For the first time in history, America’s public employee pension funds, managing well over $4.0 trillion in assets, are becoming net sellers, not buyers. And as any attentive student of economics will tell you, when there are more sellers than buyers, prices drop. Behind this mega economic trend is a mega demographic trend: across the developed world, certainly including the United States, an increasing percentage of the population is retired. The result? An increasing proportion of people who are retired and slowly liquidating their lifetime savings – also driving down asset values and investment returns.

Current events create volatility in the market and returns have been flat for the past 18 months. Turmoil in the Middle East. A long overdue slowdown to China’s overheated economy. Depressed energy prices. But there are two long-term trends that will keep investment returns down. Demographics is one of them: The more retirees, the more sellers in the market. The other mega-trend, equally troubling to investors, is that debt accumulation, which stimulates spending, has reached its limit. We are at the end of a long-term, decades-long credit cycle. The next three charts will illustrate the relationship between interest rates, debt formation, and the stock market during two critical periods – the first one following the stock market peak in December 1999, and the second following the stock market peak in September 2007.

The first chart, showing the federal funds rate over the past 30 years, shows that when the stock market peaked in December 1999, the federal funds rate was 6.5%. Within three years, in order to stimulate borrowing that would put more cash into the economy, that rate was dropped to 1.0%. Once the stock market recovered, the rate went back up to 4.25% until the stock market peaked again in the summer of 2007. Then as the market declined precipitously for the next 18 months through February 2009, the federal funds rate was lowered to 0.15% and has stayed near that low ever since.

The point? As the stock market has recovered since February 2009 to the present, unlike during the earlier recoveries, the federal funds rate was never raised. This time, there’s no elbow room left.

Table 1-A
Effective Federal Funds Rate – 1985 to 2015

20160111-UW-ER-fedrate

To put these low interest rates in context requires the next chart which shows total U.S. credit market debt as a percent of GDP over the past 30 years. Consumer debt, commercial debt, financial debt, state and federal debt (not including unfunded liabilities, by the way), is now estimated at 340% of U.S. GDP. The last time it was this high was 1929, and we know how that ended. As it is, even though interest rates have stayed at nearly zero for just over seven years, total debt accumulation topped out at 366.5% of GDP in February 2009 and has slightly declined since then. The point here? Even low interest rates, this time at or near zero, no longer stimulate a net increase in total borrowing, which in turn puts cash into the economy.

Table 1-B
Total U.S. Credit Market Debt – 1985 to 2015

20160111-UW-ER-debtGDP

Which brings us to the Dow Jones Industrial Average, a stock index that tracks nearly in lockstep with the S&P 500 and the Nasdaq, and is therefore an accurate representation of the historical performance of U.S. equities over the past 30 years. As you can see from this graph and the preceding graphs, the market downturn between December 1999 and September 2002 was countered by lowering the federal funds rate from 6.5% to 1.0%. Later in the aughts, the market downturn between September 2007 to February 2009 was countered by lowering the federal funds rate from 5.25% to 0.15%. But during the sustained market rise for the seven years since then, the federal funds lending rate has remained at near zero, and total market debt as a percent of GDP has actually declined slightly.

Table 1-C
Dow Jones Industrial Average – 1985 to 2015

20160111-UW-ER-DJIA

It doesn’t take a trained economist to understand that the investment landscape has fundamentally changed. The trend is clear. Over the past 30 years, debt as a percent of GDP has doubled (from 150% to over 350%), then remained flat for the past seven years. At the same time, over the past 30 years the federal lending rate has dropped from high single digits in the 1980s to pretty much zero by early 2009, and has remained there ever since. The conclusion? Interest rates can no longer be used as a tool to stimulate the economy or the stock market, and the capacity of the American economy to grow through debt accumulation has reached its limit.

For these reasons, achieving annual investment returns of 7.5%, or even 6.5%, for the next several years or more, is much harder, if not impossible. Conditions that produced stock market growth over the past 30 years no longer exist. Public employee pension funds, starting with CalPERS, need to face this new reality. Debt and demographics create headwinds that have changed the big picture.

PART TWO: THE IMPACT OF LOWER RETURNS ON CALIFORNIA’S PENSION FUNDS

“Pension-change advocates failed to find funding for a measure during the depths of the 2008 recession and the havoc it wreaked on government budgets, so they won’t pass (a measure) when the economy is doing well.”
–  Steve Maviglio, political consultant and union coalition spokesperson, Sacramento Bee, January 18, 2016

It’s hard to argue with Mr. Maviglio’s logic. If the economy is healthy and the stock market is roaring, fixing the long-term financial challenges facing California’s state/local government employee pensions systems will not be a top political priority. But that doesn’t mean those challenges have gone away.

One of the biggest problems pension reformers face is communicating just how serious the problem is getting, and one of the biggest reasons for that is the lack of good financial information about California’s government worker pension systems.

The California State Controller used to release a “Public Retirement Systems Annual Report,” that consolidated all of California’s 80 independent state and local public employee pension systems into one set of financials, but they discontinued the practice in 2013. The most recent one issued, released in May, 2013, was itself almost two years behind with financial data – using FYE 6-30-2011 financial statements, and it was almost three years behind with actuarial data – used to report funding ratios – using FYE 6-30-2010 actuarial analysis. Now the state controller has created a “By the Numbers” website, but it’s hard to use and does not provide summaries.

No wonder it’s so easy to assert that nothing is wrong with California’s pension systems!

The best source of easily understood compiled data on California’s pensions comes from the U.S. Census Bureau. Since that data is better than nothing, here are some critical areas where roughly accurate numbers can be reported.

The Cash Flow, Money In vs. Money Out

What is the net cash flow of these pensions funds? How much are they collecting in contributions and how much are they distributing in pension benefits? This information, especially if it can be compiled over a period of years, determines whether or not pension funds are net buyers or sellers in the markets. The reason this matters is because if America’s pension funds, with over $4.0 trillion in assets, are net sellers, they put downward pressure on stock prices. They’re that big.

Table 2-A
California State/Local Pension Funds Consolidated

2014 – Cash Flow

20160201-UW-Ring-1

This cash flow (above) shows that during 2014, California’s state/local pension funds, combined, collected 30.1 billion from state and local agencies, and paid out $46.1 billion to pensioners. They are paying out 50% more than they’re taking in, and this is a relatively recent phenomenon. Historically, pension funds have been net buyers in the market. Now, pension funds across the U.S., along with retiring baby boomers, are sellers in the market. This is one reason it is difficult to be optimistic about securing a 7.5% average annual return in the future, despite historical results. And as for that healthy 15.4% return on investments in 2014? That was offset in 2015 and 2016 so far, when the markets were flat. It is also noteworthy that employee contributions of $8.9 billion are greatly exceeded by the $21.2 billion in employer (taxpayer) contributions. How many 401K recipients get a 2.5 to 1.0 matching from their employer?

The Asset Distribution and Portfolio Risk

What is the asset distribution of these pension funds? How much have they invested in relatively risk free, fixed income bonds, vs. their investments in stocks and other variable return assets?

Table 2-B
California State/Local Pension Funds Consolidated

2014 – Asset Distribution

20160201-UW-Ring-2

This asset distribution table (above) indicates that the ratio of riskier, variable return investments to fixed return investments is nearly four-to-one. What if stocks fail to appreciate for a few years? What if real estate values don’t continue to soar? What if there simply aren’t enough high-yield investments out there to allow these assets, valued at a staggering $751 billion in 2014, to throw off a 7.5% annual return? This is a precarious situation. If these projected 7.5% returns were truly “risk free,” the ratios on this table would be reversed, with most of the money in fixed return investments.

The Effect of Lower ROI on the Unfunded Liability and Required Contributions

What is the amount of the unfunded liability for these pension funds? And of the total amount collected and invested each year in these funds, how much is the “unfunded contribution” – the amount allocated to pay down the unfunded liability and eventually restore the systems to 100% funding – and how much is the “normal contribution” – the amount required to fund future pension benefits just earned in that particular year by active workers?

This question, for which neither the State Controller, nor the U.S. Census Bureau, can provide timely and accurate answers, is the most complex and also the most important. While consolidated data is not readily obtainable for these variables, by assuming these pension systems, in aggregate, are officially recognized as 75% funded, we can compile useful data:

Table 2-C
California State/Local Pension Funds Consolidated

2014 – Est. Funding Status and Required Contributions at Various ROI

20160516-CPC-Ring-pension-liabilities

The above table, column one, estimates that at a 75% funded ratio, at the end of 2014 the total pension fund liabilities for all of California’s state and local government pension funds was just over $1.0 trillion, with unfunded liabilities at $250 billion. The second column in the table shows, using conventional formulas adopted by Moody’s investor services for analyzing public pensions, that if the annual rate-of-return projection is lowered to a slightly more realistic 6.5% (already being phased in by CalPERS), the unfunded liability jumps to $380.1 billion, and the funded ratio drops to 66%. For a detailed discussion of these formulas, refer to the California Policy Center study “A Method to Estimate the Pension Contribution and Pension Liability for Your City or County.”

The lower portion of the table spells out the consequences of lower rates-of-return in terms of required annual payments. The first row shows the required normal contribution as a percent of payroll, based on an average retirement age of 57 and an average annual pension multiplier of 2.5%. To evaluate the methods used to arrive at these percentages, refer to the California Policy Center study “A Pension Analysis Tool for Everyone.” The second row shows the taxpayer’s share of the normal contribution, in billions, under the assumption the employees are paying one-third of the normal contribution via payroll withholding.

The final row in the lower portion of the table shows the required unfunded contribution under various ROI assumptions. Using standard amortization formulas, and a 20 year payback term, at a 6.5% rate-of-return assumption, it would take a payment of $34.5 billion per year to return California’s pension funds to 100% funded status by 2036. Since the total taxpayer payments into California’s pension funds – refer back to table 1 – were only 21.2 billion in 2014, it is pertinent to wonder just how much the official numbers would report for the normal contribution, in aggregate, in 2014, vs. the unfunded contribution.

The significance of these numbers can’t be overstated. Even if pension funds earn 7.5% per year, taxpayers should be putting $38.1 billion into them each year, instead of only $21.2 billion. That’s a shortfall of $16.9 billion per year. If pension funds earn 6.5%, it will cost taxpayers $52.3 billion per year. That is an increase of 150% over what is currently being paid. And if they earn 5.5% per year – a return for which most ordinary savers would invest every spare penny they have – it will require a taxpayer contribution of $67.6 billion per year, over three times what is currently being paid.

The implications of this are staggering. A city that pays 10% of their total revenues into the pension funds, and there are plenty of them, at an ROI of 7.5% and an honest repayment plan for the unfunded liability, should be paying 17% of their revenues into the pension systems. At a ROI of 6.5%, these cities would pay 24% of their revenue to pensions. At 5.5%, 32%. And so on. It is impossible for these levels of payments to be sustained, but that’s exactly what will be necessary if the markets drop, and reforms are not implemented.

PART THREE: HOW TO MITIGATE THE IMPACT OF THE PUBLIC PENSION APOCALYPSE

Recommended Pension System Reforms to Maintain Solvency

(1) Make it possible to increase employee contributions. Social Security withholding can be increased or decreased at the option of the federal government. If collections into public employee pension funds are inadequate, increase the withholding from employee paychecks – not only for the normal contribution, but also to help pay the unfunded contribution.

(2) Make it possible to decrease benefits. Nothing in Social Security is guaranteed. Benefits can be cut at any time to preserve solvency. Decreasing benefits may be the only way to preserve defined benefit pensions. Equitable ways to do this must be spread over as many participant classes as possible. For example, the reform passed by voters in San Jose (severely reduced in scope after union litigation) called for suspending cost-of-living increases for retirees, and prospectively lowering the annual rates of benefit accruals for existing workers.

(3) Increase the retirement age. This has already been done several times with Social Security. Pension reforms to-date have also increased the age of eligibility for benefits.

(4) Calculate benefits based on lifetime earnings. Social Security calculates a participant’s benefit based on the 35 years during which they made the most. Public sector pensions, inexplicably, apply benefit formulas to the final year of earnings, or the final few years. These pension benefits should be calculated based on lifetime earnings.

(5) Make the benefit progressive. The more you make and contribute into Social Security, the less you get back. At the least, applying a ceiling to pension benefits should be considered. But it would serve both the goals of solvency and social justice to implement a comprehensive system of tiers whereby highly compensated public servants, who make enough to save themselves for retirement, get progressively less back in the form of a pension depending on how much they make.

Recommended Policy Initiatives to Increase Economic Vitality

(1) Massive Public/Private Investment in Infrastructure

(a) Rebuild California’s aqueducts and develop additional aquifer and surface storage for runoff harvesting. Build desalination plants on the southern California coast. Upgrade existing dams and pumping stations. Permit farmers to contract with California’s urban water districts to sell their water allocations. Build the Sites and Temperance Flat reservoirs. Create water abundance and make water cheap.

(b) Build new power stations. Whether these are 5th generation nuclear power stations, or new natural gas fired power plants, the immediate establishment of an additional 20%+ of generating capacity in California would result in significant lowering of utility rates and make California a net exporter of electricity.

(c) Permit development of offshore oil and gas using slant drilling from land. It is no longer necessary to develop offshore drilling rigs to extract energy reserves. There are cost-effective ways to bring this energy onshore without the risk of an oil spill from an offshore platform.

(d) Permit development of natural gas and shale oil reserves in California.

(e) Permit development of new mines and quarries in California.

(f) Build additional pipeline capacity into California to import and export natural gas to and from elsewhere in North America.

(g) Permit development of a liquid natural gas terminal off the California coast. Get California onto the global LNG grid to import and export natural gas and further diversify sources of energy and income. Create energy abundance and make energy cheap.

(h) Upgrade existing roads, bridges, and freeways. Begin working on “smart lanes” that will facilitate cars and mass transit vehicles driving on autopilot.

(i) Upgrade California’s existing freight and passenger rail infrastructure. When practical, integrate passenger and freight service on common rail corridors in large cities where high population densities make passenger rail economically viable. Increase the speed of intercity passenger rail to 100+ MPH, which can be done on upgraded but already existing track. Improve the interstate rail links emanating from California’s major seaports, to help them remain competitive.

(2) Balance State and Local Government Budgets

(a) Lower the wages of all state and local government workers by 20% of whatever amount they make in excess of $50,000 per year. Lower the wages of all state and local government workers by 50% of whatever amount they make in excess of $100,000 per year. Include in “wages” ALL forms of compensation.

(b) In addition to the steps recommended in the previous section, solve the financial crisis facing pensions by imposing special tax assessments on state and local government pensions in the amount of 50% of all pension payments in excess of $60,000 per year and 75% of all pension payments in excess of $100,000 per year (in 2016 dollars). Adopt the same reformed financial rules governing pension liability estimates that already apply to private sector pension plans.

(c) Require 75% of all K-12 and Community College employees to be teachers in a classroom.

(d) Faithfully implement the federal welfare reforms already adopted by most other states in 1996 during the Clinton administration.

(3) Change the Rules in Sacramento

(a) Implement fundamental curbs on the rights of public sector unions, including: Grant all public sector workers the right to opt-out of union membership and payment of any union dues including agency fees. Prohibit government payroll departments from collecting union dues. Allow all public sector employees to negotiate their own wages and benefits and not be bound by collective bargaining terms if they wish. Prohibit public sector unions from negotiating over long term benefits, and require all current wage and benefit agreements to expire at the end of the term for the elected officials who approved the agreements. Prohibit public sector unions from engaging in political activity of any kind.

(b) Discontinue California’s “CO2 auctions,” which have devolved into a redistribution scheme, taking money from middle class ratepayers and giving it to bankers, politically connected green entrepreneurs, and public sector payroll departments. Repeal AB32. Crucially, lift the crippling burden of land use regulations that keep the prices of homes and commercial property artificially high in California.

(c) Revisit all business-friendly recommendations made by business associations such as the bipartisan California Chamber of Commerce. This would not include compromise positions in support of public sector unions and crony capitalist environmental regulations. This would include banning mandatory project labor agreements or requiring union only contractors on government funded projects.

Recommended Policies to Advocate at the Federal Level

(1)  Balance the Federal Budget. Until the federal government limits its spending to what it collects in tax revenue, it will continue to push for lower interest rates to help fund the deficits. This will stimulate borrowing and consumption instead of savings and production. The cycle of using debt accumulation to finance growth must be broken.

(2)  Restore Partner Liability to Banks. If consumer banks and investment banks were managed by partners who would be personally liable for losses, they would not engage in speculative activity, shielded from personal accountability. As it is, today’s financial firms are not only managed by officers who carry minimal personal liability for their actions, but they are publicly traded entities despite being nothing more than financial intermediaries.

(3)  Reintroduce the Provisions of Glass Steagall. Which the Clinton administration eviscerated in the 1990’s. In brief, this post-depression reform prevented banks from using consumer deposits for speculative investments. Consumer banks and investment banks were required to operate as separate entities.

(4)  End the War on Short Sellers and Harmonize Regulations. Short selling financial assets is one way that financial bubbles are identified and popped before they get too big. Short sales keep valuations realistic and expose financial charades. They should be properly regulated with a uniform set of international rules, but they play a vital role in a healthy market.

(5)  Increase Required Reserve Ratios. Banks are currently permitted to use customer deposits to advance loans to borrowers. Currently they are only required to hold cash equivalent to 10% of their total deposits. Increasing this ratio would increase the financial resiliency of banks.

 *   *   *

Ed Ring is the executive director of the California Policy Center.

Pension burden in 5 California counties now over 10%

Years after the Great Recession slammed their Wall Street investments, at least five California counties have broken through the 10 percent ceiling, spending at least one of out of every $10 to fund their government-employee retirement programs.

The resulting strain on local budgets, called the pension burden, is revealed in California Policy Center’s latest analysis of county reports.

Five California counties reported that their pension contributions now exceed 10 percent of total revenues: Santa Barbara County (13.1 percent), Kern County (11 percent), Fresno County (10.7 percent), San Diego County (10.4 percent) and San Mateo County (10 percent). We will consider each below.

A sixth county, Merced, is also expected to report that its required contributions topped 10 percent of 2015 revenue when it files its audit. We estimate Merced’s payments at slightly over 11 percent of revenue.

CPC’s review of audited financial statements filed by 30 California counties shows pension contributions accounting for between 3 percent and 13 percent of total county revenue.

“For years, public employee union leaders denied the pension burden was even close to 10 percent,” my colleague Ed Ring notes. “This study shows the burden is now approaching 15 percent of revenues.”

The surveyed counties, which account for more than 95 percent of California’s population, made over $5.4 billion in pension contributions during the fiscal year. These counties also made $660 million of debt service payments on pension obligation bonds, raising total pension costs to over $6 billion last year.

That figure accounts for about one-sixth of all California state and local pension contributions (not including payments on pension obligation bonds), estimated at $30.1 billion in 2014.

As investment markets remain relatively flat, it seems likely that many California counties will bow to pressure to cut government services or to raise cash through debt instruments or taxes.

METHODOLOGY

In 25 of 30 counties, we used 2015 audits. Five other counties had yet to file their 2015 reports; in these instances, we estimated revenues and pension contributions from 2014 audits, 2015 budgets and actuarial valuation reports.

Most large counties operate their own pension systems, rather than relying on CalPERS. These county systems often also serve special districts and even cities in the county. Our survey was limited to pension contributions made by the county governments themselves, and excluded separately reporting units – that is, entities that participate in county systems but produce their own financial statements.

In 2015, state and local governments implemented new accounting standards promulgated by the Government Accounting Standards Board (GASB). Aside from reporting net pension obligations as a liability on the government’s balance sheet, GASB Statement Number 67 requires filers to report “Actuarially Determined Contributions” and actual contributions made to their defined benefit plans. The Actuarially Determined Contribution (ADC), previously known as the Actuarially Required Contribution, is calculated by an independent actuary. The ADC is supposed to be the amount sufficient to finance pensions for current and future retirees while gradually closing any gaps in pension funding.

For the 25 larger counties that had released 2015 audits by late February, we recorded ADCs and total revenue, and calculated the quotient of these two values in order to get a rough idea of the relative burden that public employee contributions place on county finances. Because pension systems usually require their actuaries to assume high rates of return on their investments (typically 7.25 percent or more), it’s arguable that reported ADCs understate actual pension burdens.

That said, the reported ADCs provide a reasonable basis for comparison across counties. Further, California public agencies generally make pension contributions roughly equivalent to their ADCs, so the ADC is at least a good gauge of near-term pension burdens.

Total county revenues, ADCs and pension cost ratios appear in the following table:

California County Pension Burden
Total Annual Pension Payments As Percent of Total Annual Revenue
20160312-CPC-Joffe-County-Pensions2

  1. Santa Barbara County

Despite its strong economic performance, Santa Barbara County had the highest pension cost burden among the 25 counties we reviewed – by a considerable margin. Employer contribution rates ranged from 20.8 percent to 59.5 percent, and have risen substantially since 2007. Employer contribution rates represent the percentage of public employee salaries a public agency contributes to its pension plan; they are generally higher for public safety employees, who receive more generous retirement benefits.

In the fiscal year ended June 30, 2015, the Santa Barbara County Employees’ Retirement System (SBCERS) suffered a decline in its funded ratio, from 81.1 percent to 78.4 percent. The drop was largely due to a disappointing 0.83 percent return on plan assets, compared to an assumed 7.5 percent annual asset return.

Despite the decline, SBCERS is still on somewhat stronger footing than the state’s CalPERS – which was about 73.3 percent funded on June 30, 2015. SBCERS is also amortizing its unfunded liabilities faster than CalPERS, using a 17-year timeframe versus 30 years for CalPERS.

SBCERS ended the fiscal year with an unfunded liability of $698 million, about 93 percent of which was the responsibility of county government (the rest belongs to courts and special districts). The system was last fully funded in 2000.

According to a 2007 report commissioned by the county auditor, the system’s position deteriorated for a variety of reasons including poor investment performance and benefit improvements granted by elected officials. The report does not detail these benefit improvements, but they included a change to the final average salary calculation used to determine benefit levels. Liberalizing final average salary calculations can enable pension spiking – a practice under which employees work extra overtime or get last-minute promotions at the end of their careers to maximize pension benefits.

  1. Kern County

Although Kern County’s ADC/revenue ratio is two points lower than that of Santa Barbara County, its situation is worse in a variety of ways. According to the most recent Kern County Employees’ Retirement Association (KCERA) actuarial valuation report, the system was only 64.08 percent funded as of June 30, 2015 – down from 65.11 percent the previous year.

Also, as of June 30, 2015, the county had $284 million in outstanding pension obligation bonds. If the $51 million in scheduled debt service on these bonds is added to the $201 million in Actuarially Determined Contributions the county was required to make, its pension cost burden would exceed that of Santa Barbara County – which has not issued pension obligation bonds.

KCERA’s funded ratio reflects an assumption of 7.5 percent annual returns on its portfolio. This contrasts with an actual fiscal year 2015 return of only 2.3 percent. On the other hand, KCERA is trying to amortize its unfunded liabilities more rapidly than CalPERS – employing an 18-year amortization period versus 30 years for CalPERS. KCERA’s severe underfunding and rapid amortization help drive relatively high pension contribution rates, which range from 37.8 percent for Kern’s court employees to 63 percent for public safety employees.

Kern County shows other signs of fiscal distress. In January 2015, county supervisors declared a financial emergency, prompted by the precipitous decline in oil prices. When the emergency was declared, oil companies paid about 30 percent of the county’s property taxes. That said, it is worth noting that property taxes accounted for just 15 percent of the county’s total 2015 revenue. Counties receive a substantial portion of their revenue from state and federal grants, so declines in a major source of county tax revenue are often less damaging than they are for cities.

After the emergency declaration, Standard and Poor’s affirmed the county’s A+ rating (four notches below the agency’s top AAA rating) and changed its outlook to negative. No downgrade has followed.

Kern County’s liabilities exceed its assets, leaving it with a negative Net Position – another sign of fiscal stress. Since most of a government’s assets are already committed to specific requirements (like paying debt service) or tied up in capital assets that are difficult to sell, analysts often focus on its Unrestricted Net Position – a measure of reserves that could be freely allocated by elected officials. Kern County has a negative Unrestricted Net Position of almost $2.3 billion – suggesting a serious fiscal problem.

On the other hand, the county has a strong general fund balance – equal to more than six months of general fund expenditures. As we have reported elsewhere, low or negative general fund balances have been the best predictor of municipal bankruptcy in recent years.

More recently, the county made further budget cuts which could result in closures of fire stations, jails and other facilities. If the county was not paying over $1 in every $8 for pension contributions and pension obligation bond debt service, these reductions might not have been necessary.

  1. Fresno County

Like Kern County, Fresno County has used pension obligation bonds (POBs) to address pension underfunding. As of June 30, 2015, the county had $454 million in POBs outstanding. This balance actually exceeds the $402 million principal amount of the POBs when they were issued in 2004, because much of the 2004 offering consisted of capital appreciation bonds (CABs). Interest on CABs is added to principal over the life of the bond and then paid at maturity.

In fiscal year 2015, Fresno was scheduled to pay over $37 million in debt service on its POBs. If this is added to the $153.5 million in Actuarially Determined Contributions the county was obliged to make, its pension-cost-to-revenue ratio would (like Kern County’s) exceed that of Santa Barbara County’s, which did not issue POBs.

Fresno County has the highest employer contribution rates as a percentage of payroll of the counties discussed here. In fiscal year 2015, contribution rates range from 37.4 percent to 74.6 percent for certain public safety employees. The county’s retirement program provisions are relatively generous. According to the system’s actuarial report, most plans allow members to retire at age 50. If they remain on the payroll after 55, many classes of employees accrue additional benefits at accelerated rates.

On the plus side, the Fresno County Employees’ Retirement Association is amortizing its unfunded liabilities over a 15-year period and has a relatively strong funded ratio – 79.4 percent (down from 83 percent at the end of 2014).

Illustrating that optimistic investment forecasts plague local government financials, Fresno County assumes annual asset returns of 7.25 percent. Its actual return in fiscal 2015 was a dismal -0.10 percent.

  1. San Mateo County

Like Santa Barbara County, San Mateo County has a strong economy, so it’s surprising to see it near the top of our list. One driver of the county’s pension burden appears to be high employee salaries. Since pension benefits are based on final average salaries, high employee compensation translates into high pension benefits.

A San Jose Mercury News story revealed that San Mateo County had 78 employees paid over $200,000 in the 2013 fiscal year. More recent data available on Transparent California shows that number grew to 90 employees in 2014.

Employee contribution rates ranged from 28.3 percent to 65.5 percent. For a single employee earning $200,000, the county’s annual pension contribution could be as a high as $130,940.

A 2012 San Mateo Civil Grand Jury report noted that county pension contributions had grown from $78 million in fiscal 2006 to $150 million in fiscal 2012, but the plan continued to generate substantial unfunded liabilities. The jury made a number of recommendations including “significantly decreasing the number of county employees through outsourcing and/or reducing services, and by attrition.”

The county’s board of supervisors agreed with most of the Grand Jury’s findings but did not specifically respond to the call for headcount reductions.

In late 2013, the board of supervisors decided to make extra contributions to SamCERA (the San Mateo County Employees Retirement Association) in order to more rapidly cut its unfunded liability. The supervisors authorized a one-time payment of $50 million in fiscal 2014 followed by annual $10 million payments in each of the next nine fiscal years. These payments, totaling $140 million over 10 years, are above the county’s Actuarially Determined Contribution.

The extra contributions have improved SamCERA’s funded ratio despite lackluster stock market performance in the most recent fiscal year. The system’s funded ratio rose from 73.3 percent in 2013, to 78.8 percent in 2014 and to 82.6 percent in 2015. The system achieved portfolio returns of 3.5 percent in fiscal 2015 as opposed to a 7.5 percent projected return rate.

Since 2013, the system’s unfunded liability has fallen from $954 million to $702 million. SamCERA amortizes unfunded liabilities over a 15-year period. Given the improvement in SamCERA’s funded ratio, it seems likely that San Mateo County will fall off the list of highly burdened counties in future years.

CONCLUSION

Generous benefits, aggressive return assumptions and (in some cases) high employee pay have left a number of California counties heavily burdened with pension costs. This year’s poor stock market performance will likely mean additional stress.

Over the longer term, the state’s 2013 pension reform should provide some relief, as newly hired employees receive less generous benefits. But if the stock market continues to be weak or if county systems make poor investment choices, asset returns will remain below the 7.25 percent-7.50 percent typically anticipated in actuarial valuations. Under those circumstances, employer contributions and overall pension burdens may continue to rise. The result will likely be ballooning public debt, pressure to raise taxes and cuts in government services.

 *   *   *

About the author:  Marc Joffe is the founder of Public Sector Credit Solutions and a policy analyst with the California Policy Center. Joffe founded Public Sector Credit Solutions in 2011 to educate policymakers, investors and citizens about government credit risk. PSCS research has been published by the California State Treasurer’s Office, the Mercatus Center and the Macdonald-Laurier Institute among others. Prior to starting PSCS, Marc was a Senior Director at Moody’s Analytics. He has an MBA from New York University and an MPA from San Francisco State University.

How CalPERS has Created a Ticking Time Bomb

During the Stockton bankruptcy Judge Klein called CalPERS the “bully with a glass jaw.” Klein meant that CalPERS, as a servicing company, has no standing in the bankruptcy because the pension obligation is between the public agency and their employees and retirees.
Read more

California Ranks 50th in State Spending Transparency: What We Can Do About It

Although many California political leaders espouse their support for transparency, the state lags behind most others in opening its spending data to public scrutiny.  So while Lieutenant Governor Gavin Newsom, has called on governments to “lean into [the] notion of openness and transparency,” the state he may soon lead is leaning in quite the opposite direction.

In its March 2015 report card, the US Public Interest Research Group (US PIRG) gave California a grade of “F” for its efforts to provide spending transparency – a distinction shared only by two other states, Alaska and Idaho.  US PIRG also assigned each state a more granular numerical score on a 0-100 scale. California’s score of 34 placed it last among the fifty states – 9 points below Alaska.  US PIRG notes:

California…is weighed down by the bureaucratic fragmentation of its information. While the state has made some interesting and useful data sets available to the general public … California does not succeed in providing a “one-stop” transparency portal.

Bureaucratic fragmentation has also frustrated private efforts to elicit the state’s checkbook. In 2013, American Transparency – a not-for-profit that operates openthebooks.com – filed a Public Records Act with the State Controller’s Office (SCO) requesting detailed state spending data. SCO’s legal counsel rebuffed the request on the grounds that the controller does not hold all the spending records, and is not required under the Public Records Act to create records not already in its possession. Apparently state spending data is scattered across roughly 500 agencies, departments and commissions which pay some or all of their vendors directly.

The fragmentation issue might be resolved by Senate Bill 573 which would require the governor to hire a Chief Data Officer, who would then be tasked with creating a state-wide open data portal leveraging information from all state agencies. The bill, proposed by Dr. Richard Pan (D-Sacramento), received favorable publicity but was tabled by the Senate Appropriations Committee on August 27. Pan would have to re-introduce the bill next year if he wants it to pass before the next legislature is seated.

In the meantime, it will be up to civil society organizations to advance state spending transparency. As a part of our state’s civil society, we at the California Policy Center are eager to help.

Starting with Medi-Cal Reimbursements

Ideally, a state checkbook should contain all vendor payments. It need not include employee salaries because these are already published by both SCO and by Transparent California. While it would be extremely challenging for one or more outside organizations to compile all of this spending, a large portion of it can be assembled by examining a few of California’s largest agencies.

The entity that makes the most vendor payments is the Department of Healthcare Services which administers the state Medi-Cal program. In the last fiscal year, Medi-Ca106191228-20140630-Audl payments totaled $87 billion, including $17 billion from the General Fund, $14 billion from Special Funds and $56 billion in Federal Funds.

So just getting our hands around the payments made by this one department would go a very long way toward documenting the state’s overall spending.  Over the next few weeks, the California Policy Center will compile a DHCS checkbook to demonstrate the benefits of state spending transparency.

Our preliminary review suggests that the number one recipient of Medi-Cal funding is Los Angeles County USC Medical Center, known locally as LAC+USC. The 664-bed county hospital received over $700 million in Medi-Cal funds during the fiscal year ended June 30, 2014. LAC+USC is one of three LA County public medical centers. The two other county hospitals together received an additional $700 million in Medi-Cal funding during the same fiscal year, yielding a total of over $1.4 billion in state and federal Medi-Cal funds devoted to LA County hospitals. Medi-Cal reimbursements accounted for over 70% of all three hospitals’ patient revenues.

The prevailing view is that Medi-Cal payments are too low to adequately compensate providers. But, in the case of LAC+USC, the hospital reported $77 million of “Net Income”, i.e. revenues in excess of expenses, also known as “profit” in the private sector.  That said, it should be noted that the hospital suffered a loss on operations, and was profitable because it received $284 million in non-operating revenue.

Most of LAC+USC’s expenditures take the form of employee compensation and benefits, as well as physician fees. These three categories accounted for over $900 million of the hospital’s $1.375 billion in total operating expenses.

A review of 2013 Transparent California data shows that nine out of the ten highest paid Los Angeles County employees are physicians – apparently affiliated with one or more of the three County hospitals. All nine of these doctors received total compensation from the County in excess of $500,000 during calendar year 2013.

It appears that at least a couple of these individuals received compensation from other medical facilities. For example, Dr. John Peter Gruen, a neurosurgeon who received a total of $628,001 in County compensation is also affiliated with Huntington Memorial Hospital in Pasadena and Keck Medical Center of USC.

As this brief analysis suggests, the ability to obtain state spending details and juxtapose this information with other data sets should yield new insights into how our tax dollars are being managed. Next month, look to this space for much more information about California Medi-Cal spending.

 *   *   *

About the author:  Marc Joffe is a policy analyst for the California Policy Center. He is also the founder Public Sector Credit Solutions, established in 2011 to educate policymakers, investors and citizens about government credit risk. PSCS research has been published by the California State Treasurer’s Office, the Mercatus Center and the Macdonald-Laurier Institute among others. Prior to starting PSCS, Marc was a Senior Director at Moody’s Analytics. He has an MBA from New York University and an MPA from San Francisco State University.

Will California Voters Support Pension Reform?

A bipartisan coalition led by former San Jose Mayor Chuck Reed and former City Councilman Carl DeMaio have filed a pension reform ballot measure in California. The group seeks to qualify the measure for a possible November 2016 vote by California voters.

The California Policy Center examined polling conducted by a variety of sources and CPC also commissioned its own polling study through the polling firm Penn Schoen Berland. CPC’s poll utilized online interviews in English and Spanish from August 17-21, 2015 among n=1,002 likely voters in California.

Overwhelming Public Support for Pension Reform

CPC’s review of a number of statewide polls conducted in recent years confirms that California voters have shown overwhelming support for pension reform.

A statewide poll issued by the Public Policy Institute of California in September found that 72 percent of likely voters say public pension costs are a problem and 70 percent say voters should make decisions about retirement benefits. As in previous PPIC polls, 70 percent favor giving new government employees a 401(k)-style plan rather than a pension. The change has strong bipartisan support: Republicans 74 percent, independents 69 percent, and Democrats 65 percent.

The CPC poll used several questions to examine voters knowledge of and assessment of issues facing state and local government pension funds – as well as the level of compensation and benefit packages provided to government employees.

(1) Would you say the financial health of the pension funds for state and local government employees in California are in a better place, worse place, or about the same place as they were ten years ago?

(%) California
Likely Voters
Better place 14
Worse place 46
About the same place 25
Don’t know 15

(2)  As far as you know, are CalPERS and CalSTRS in debt or do they have a surplus?

(%) California
Likely Voters
In debt 30
Have a surplus 16
Don’t know / unsure 55

(3)  As far as you know, on average, are state and local government employees…?

(%) California
Likely Voters
Paid more than employees in the private sector 41
Paid less than employees in the private sector 34
About the same 25

(4)  As far as you know, on average, do state and local government employees…?

(%) California
Likely Voters
Get bigger pensions than employees in the private sector 60
Get smaller pensions than employees in the private sector 19
About the same 21

 *   *   *

Attorney General’s Title and Summary Impacts Support

In August, the DeMaio and Reed blasted Attorney General Kamala Harris for issuing what they called a “biased” Title and Summary of the pension reform measure the coalition filed. The Title and Summary is what voters actually see on the ballot and the Attorney General has a Constitutional obligation to provide a fair and accurate description.

Putting aside the debate over whether the Title and Summary is fair and accurate, the polling shows the Attorney General’s Title and Summary from a polling perspective does indeed have a major negative impact on the ballot proposal.

In March 2015, the coalition conducted its own poll of California voters that demonstrated solid support for the concepts contained in the ballot proposal – specifically asking this question:

Would you vote yes – in favor of, or no – against a ballot measure that would give voters the right to reform pension benefits for state and local government workers, would require voter approval before obligating taxpayers to guarantee lifetime pensions benefits for new state and local government employees, and would require new government employees to contribute at least half the cost of their retirement benefits?

California Voter Support for Pension Reform

20151116-CPC-DeMaio

CPC’s poll used the Title and Summary provided by the Attorney General – with the Title and Summary crafted by the AG resulting in less support for the measure.

PUBLIC EMPLOYEES. PENSION AND RETIREE HEALTHCARE BENEFITS. INITIATIVE CONSTITUTIONAL AMENDMENT. Eliminates constitutional protections for vested pension and retiree healthcare benefits for current public employees, including those working in K-12 schools, higher education, hospitals, and police protection, for future work performed. Adds initiative/referendum powers to Constitution, for determining public employee compensation and retirement benefits. Bars government employers from enrolling new employees in defined benefit plans, paying more than one-half cost of new employees’ retirement benefits, or enhancing retirement benefits, unless first approved by voters. Limits placement of financial conditions upon government employers closing defined benefit plans to new employees. Summary of estimate by Legislative Analyst and Director of Finance of fiscal impact on state and local government: Significant effects—savings and costs—on state and local governments relating to compensation for governmental employees. The magnitude and timing of these effects would depend heavily on future decisions made by voters, governmental employers, and the courts.

California Voter Support for Pension Reform
Using Attorney General’s Title & Summary

(%) California
Likely Voters
Vote yes to support 36
Vote no to oppose 33
Undecided 32

 *   *   *

Many Arguments in Favor of Pension Reform Poll Well

After testing the Title and Summary, CPC polled arguments that might be used by proponents of pension reform to justify major changes in state and local pension benefits.

(%) California Likely Voters

 

Much more likely Somewhat more likely Somewhat less

likely

Much less

likely

Many government employees are abusing the system to spike their pensions. In 2013, one former assistant fire chief in Los Angeles collected a government pension of $983,000. In San Diego, a former city librarian now collects $234,000 annually, and a politician in that same city started cashing full-pay pension checks at age 32. Last year alone, over 41,000 retired state and local government employees cashed pension checks of $100,000 or more! This proposal would end abuses like these. 52 27 12 9
This proposal does not take away any pension benefits lawfully earned by government employees. The proposal simply prevents any spiking of pensions going forward and also reforms benefits for any newly hired government employees going forward. It will not affect current retirees. In this way, we are fixing our pension problem while protecting the seniors and families who depend on current benefits. 47 40 8 5
Backroom deals by politicians created the California pension crisis. Politicians take campaign contributions and support from powerful government unions and in return, politicians give the unions sweetheart deals that mean bigger pension benefits. Politicians have even voted to spike their own pensions. This proposal provides a “check” on state and local politicians by requiring voter approval of any future pension deals. With this proposal, voters will be able to stop the politicians from doing backroom pension deals that taxpayers can’t afford. 47 31 13 9
If you are concerned about public safety you should support this pension reform proposal. If we don’t reform government pensions now, many cities and counties will be forced to cut police and fire services to divert our tax dollars to bail out government pension funds. For example, the Oakland Police Department no longer responds to 44 different crimes as a result of cutbacks that were necessary to fund pensions. Elsewhere in the state, fire stations have had to scale back hours of operation and in some cases close in order to pay rapidly rising pension costs. 44 40 8 8
Pension debt has grown exponentially in California, rising from $6.3 billion in 2003 to $198 billion in 2013. And when combined with unfunded liabilities for retiree healthcare programs, taxpayers owe almost $350 billion to fund future retirements for government employees. Without immediate action, the cost of government pensions will double in the next five years alone. This proposal will shrink the debt and save taxpayers billions. 44 34 14 7
Politicians and bureaucrats who run the government pension program are cooking the books and misleading the public. Last year the head of the pension program pled guilty to taking bribes and helping friends collect millions in a fraudulent investment scheme. The situation is getting worse as taxpayers lose billions from dubious investment decisions made by a board with significant conflicts of interest. This proposal would reform the government pension program, which is why the powerful elites who profit from the government pension program are opposing it. 44 30 15 11
Many government employees contribute nothing at all towards the costs of their pension benefits, leaving taxpayers to pick up the whole tab. This proposal would require new government employees to contribute at least half the cost of their retirement plans, similar to what most private sector employees have to contribute. 43 32 17 8
If you are concerned about quality education for our children you should support this pension reform proposal. If we don’t reform government pensions now, many cities and counties will be forced to cut after school programs, close libraries, and parks and recreation in order to divert our tax dollars to bail out government pension funds. For example, cities like San Jose had to restrict library hours of operation in order to pay for rapidly rising pension costs. 40 34 17 9
Mounting government pension debts have forced major cuts in important services. For example, pension contributions in Los Angeles have grown from 3% of the city’s overall budget to nearly 20% in just the last decade, crowding out other public needs. Already in cities and counties across California, higher pensions costs have meant cuts to after school programs, closures and brownouts at fire stations and cancellations of road repairs. With this pension reform proposal, we can generate savings to restore these important services. 39 34 20 7
Voters should take a close look at who opposes this pension reform proposal. One Sacramento union boss leading the charge against reform collects a pension of $183,690 annually. He says government employees trade off pay for a secure retirement. However, according to the Sacramento Bee newspaper, the average salary for employees like him is $163,000 annually plus health care and retirement at age 55. Those same union leaders are lying about this pension reform proposal because they want to keep their taxpayer-funded gravy train going. 39 29 18 15
Cities across California are being crushed under the weight of mounting pension debt. Because of pensions, major cities such as Vallejo, Stockton, and San Bernardino have already gone bankrupt, which resulted in massive cuts in important services such as police and fire protection. Unless we approve this pension reform proposal, many more cities throughout California will be forced to declare bankruptcy and make similar extreme cuts in our services. 38 36 16 9
Voters should take a close look who opposes this pension reform proposal. In 2012, the teachers unions blocked legislation that would have given local officials the power to fire teachers convicted of sexually abusing their own students even though this meant that sexually abusive teachers got to keep their jobs. Those same unions are lying about this pension reform proposal because they want to block the common-sense reform it would bring. 38 27 22 13
The pension reforms in this proposal are fair. The new benefits provided to government employees would be no better, and no worse, than the benefits provided to workers in the private and non-profit sectors. For police and fire, the measure provides a guarantee of death and disability benefits mirroring exactly what the US Military receives. 37 41 14 9
 

 *   *   *

Arguments in Opposition to Pension Reform Offer Mixed Bag of Results

(%) California Likely Voters
(among those who saw “anti” messaging first)
Much less

likely

Somewhat less

likely

Somewhat more likely Much more likely
This pension proposal is promoted and funded by Tea Party Republicans including a young billionaire Texan who is spending $50+ million dollars to take away from school bus drivers, teachers, nurses, and firefighters their hard-earned retirement benefits. He hates government so much that he wants to strip millions of middle and working class Californians of their retirement security. 53 19 17 11
This proposal to eliminate public pensions in California is led and funded by a Texas wheeler-dealer billionaire named John Arnold. Arnold is spending $50+ million dollars of his fortune to dismantle retirement plans for firefighters, nurses, and teachers. Moving California state and local government employees to 401(k) accounts would mean billions more for Arnold and his cronies to split in higher Wall Street fees. 48 21 19 13
Many public employees like teachers, police, and fire fighters do not receive Social Security or have very limited benefits. This proposal would eliminate their pensions and would undermine their ability to retire with dignity, as they will have no safety net if their 401(k) investments lose their value before or during their retirement through no fault of their own. 47 25 19 9
This pension reform proposal would likely eliminate the current death and disability benefits for new police, firefighters, and other public employees. It would be disgraceful to take these important protections away from families of police and fire fighters who make the ultimate sacrifice to protect Californians. 47 24 20 9
If enacted, this ballot measure will cost the taxpayers millions, or even billions for extra elections. Every contract at all levels of government could be on the ballot, costing school districts, cities, and counties millions of dollars to hold these elections. And it will unleash expensive lawsuits which will be litigated in the courts, with taxpayers footing the bill. 45 34 14 7
This proposal would eliminate state constitutional protections for current and future employees, breaking promises made to teachers, nurses, and firefighters by rewriting their pension benefits without negotiation. This would devastate middle class families who have contributed to these pension plans and have made long-term financial planning decisions based on the promises made to them when they were hired. 45 25 19 11
This proposal to eliminate public pensions in California is led and funded by greedy investors including America’s youngest Wall Street billionaire who made his stash out of the collapse of Enron. If a statewide pension-gutting proposal is passed in California, public sector employees will be moved to 401(k) plans, which would mean a windfall in investment fees for Wall Street. It’s as bad as when George W. Bush tried to privatize Social Security. 44 27 19 10
Pensions are important compensation for public employees, including those who work in K-12 schools, higher education, hospitals, and police protection.  Public employees earn an average of 7% less than their private sector counterparts. Adequate pensions also serve as valuable recruitment and retention tool. If we approve this proposal’s massive cuts in pension benefits, we will need to either pay government employees more or risk hiring less-qualified government employees, which will lead to lower-quality services. 38 26 20 16
This measure is part of an extreme agenda to eliminate collective bargaining for government employees in California. The proposal allows voters to increase or decrease compensation and retirement benefits of government employees without any negotiation or collective bargaining. This undermines the ability of the government and employees to negotiate and agree on contracts. These complex issues should be settled at a bargaining table, not the ballot box. 38 24 24 14
This proposal would take away vested benefits that were promised to current public employees. For example, a state employee with 8 years of service could lose retiree healthcare benefits she would have earned after 10 years under her current employment contract. This is unfair to workers and their middle-class families, especially single mothers, because many accepted lower as a tradeoff better retirement and healthcare plans. 37 32 20 11
This proposal exaggerates the pension problem. Public employees are not retiring to lavish and luxurious pensions. In 2012, California passed extensive pension changes that raised the retirement age for new workers and require all employees to pay half of their pension costs. Thanks to Governor Brown’s reforms, $100,000 plus pension payments have all but been eliminated. The average public employee pension is just $2,500 a month – hardly the gold-plated plan overhaul that the other side claims. 31 29 28 11

 *   *   *

Significant Support for Pension Reform After Title and Summary Is Explained

Among voters who were exposed to the case for pension reform immediately after the Title and Summary was provided, support shifted dramatically back in favor of the pension reform proposal.  CPC concludes that the Title and Summary as currently written confuses and scares voters, but once the proposal is clearly explained to voters, confident support returns.

(%) CA Likely Voters
Vote yes to support 63
Vote no to oppose 18
Undecided 19

 *   *   *

Pension Reform Likely to Have Major Impact on 2016 Elections

The presence of a pension reform issue in the midst of the 2016 elections in California could have a profound effect on both candidate races and the debate over a variety of tax increase measures being considered for the 2016 ballot.

(1)  In the November 2016 election, which of the following types of candidate would you be most likely to vote for?

(%) California
Likely Voters
A Democrat who opposes the proposal 24
A Democrat who supports the proposal 18
A Republican who opposes the proposal 12
A Republican who supports the proposal 20
None of the above 5
Not sure 22

(2)  If a candidate from a political party different from your own supported this proposal, would that make you…?

(%) California
Likely Voters
Much more likely to support that candidate 9
Somewhat more likely to support that candidate 23
Somewhat less likely to support that candidate 11
Much less likely to support that candidate 17
No difference 41

(3)  Some people say that we should approve tax increases on the wealthy and extend the temporary sales tax enacted in 2012, because the state still need that money to close the budget deficit. Without these funds, we will have to cut funding for schools and for other important public services.

Other people say that the politicians are only raising taxes to pump more money into these failing state and local government pension systems to continue unsustainable government pension payouts (including their own) with our tax dollars. None of this money will go to school funding. We should enact pension reform first before considering any more tax increases.

Which of the following comes closer to your view?

(%) California
Likely Voters
Approve tax increases  on the wealthy and extend 2012 tax increases 37
Enact pension reform first 32
Neither of the above 15
Unsure 17

 *   *   *

Voters Not Swayed Significantly By Groups on Pro and Con Side of Pension Reform

CPC evaluated voter views of a variety of groups that are likely to take positions both for and against pension reform proposals.

As it related to this proposal, how much would you trust the information you might receive from the following organizations or institutions?

(%) California Likely Voters A lot of trust /

very credible

Somewhat trust / somewhat credible Trust just a little / not very credible Do not trust at all / not at all credible
Police and firefighter unions 22 39 25 14
Teachers’ unions 18 35 23 23
CalPERS 13 35 33 19
Government employees’ unions 11 31 27 31
Public sector unions 11 30 34 25
California Chamber of Commerce 10 41 33 16

 *   *   *

About the Author:  Former San Diego city councilman and lifelong entrepreneur Carl DeMaio is now tackling state-wide fiscal reform policy. While on the City Council, DeMaio led the effort to cut red tape on small businesses, reform the city’s contracting processes to expedite infrastructure projects, and enact some of the toughest “Sunshine Law” open government requirements in the nation. In 2012, DeMaio crafted and led a citizens campaign to qualify and pass the “Comprehensive Pension Reform” Initiative – the first-of-its kind measure to switch San Diego from a Defined Benefit Pension Plan to a 401(k) retirement program. In 2003, DeMaio founded the American Strategic Management Institute (ASMI), which provides training and education in corporate financial and performance management. In late 2007, DeMaio sold both of his companies to Thompson Publishing Group. DeMaio holds a BA in International Politics and Business from Georgetown University.

“For the Kids” – Comprehensive Review of California School Bonds, Executive Summary (Section 1 of 9)

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
You are Here: Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
More Borrowing for California Educational Construction in 2016 (2 of 9)
Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
How California School and College Districts Acquire and Manage Debt (4 of 9)
Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
The System Is Skewed to Pass Bond Measures (7 of 9)
More Trouble with Bond Finance for Educational Construction (8 of 9)
Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
Guide to all Tables and Appendices – Comprehensive Reference for Researchers


Executive Summary 

Few Californians realize how much debt they’ve imposed on future generations with their votes for bond measures meant to fund the construction of new and modernized school facilities.

From 2001 to 2014, California voters considered 1147 ballot measures proposed by K-12 school districts and community college districts to borrow money for construction via bond sales. Voters approved 911 of these bond measures, giving 642 school and college districts authority to borrow a total of $110.4 billion.

California voters also approved three statewide ballot measures during that time to authorize the state to borrow $35.8 billion. That money has supplemented local borrowing for construction projects at school and college districts, and the state has spent all but $195 million of it.

That’s a total of $146.1 billion authorized during the last 14 years for state and local educational districts to obtain and spend on construction projects. All of it has been borrowed or will be borrowed from wealthy investors, who buy state and local government bonds as a relatively safe investment that generates tax-exempt income through interest payments.

Current and future generations of Californians are already committed to paying these investors about $200 billion in principal and interest — a number that will grow as school and college districts continue to borrow by selling bonds already authorized by voters but not yet sold.

And more borrowing is coming.

In 2016 California voters may be asked to authorize the state to borrow as much as $9 billion for school construction. More than 100 school and college districts may ask voters to approve borrowing a total of several billion more dollars. Officials at the country’s second largest school district, the Los Angeles Unified School District, claim they need more than $40 billion for additional construction and plan to ask voters to approve borrowing several billion in 2016.

It is time to be wary. The California Policy Center believes that most Californians are unaware and uninformed about this relentless borrowing and the amount of debt already accumulated to pay for school construction. Most voters cannot explain how a bond measure works and do not get enough information to make an educated decision about the wisdom of a bond measure.

California voters who want to learn more before voting will have difficulty finding relevant information. Where does an ordinary Californian find out how much money a school or college district has already been authorized to borrow from past bond measures, or the principal and interest owed from past bond sales that still needs to be repaid, or the projected changes in assessed property valuation and how they affect tax and debt limits, or the past and projected student enrollment? The state does not offer a clearinghouse of information for the public to research and compare data about bond measures and bond debt for educational districts. Much of the information available about debt finance for educational districts is oriented toward interests of bond investors rather than people who pay the debt.

Californians who recognize a need for their own local educational districts to refrain from accumulating additional debt have significant obstacles to overcome. State law gives supporters of bond measures a systematic strategic advantage when local districts develop bond measures and put them before voters for approval. Campaigns to support bond measures are funded and even managed by financial and construction industry interests that will profit after passage. And after voters approve a bond measure, educational districts are tempted to take advantage of ambiguities in state law and use bond proceeds for items and activities not typically regarded by the public as construction.

To help to fix these deficiencies, this report encourages the California legislature and the executive branch to adopt five sets of recommendations:

Five Categories of Recommendations
1Provide Adequate and Effective Oversight and Accountability for Bond Measures
2Enable Voters to Make a Reasonably Informed Decision on Bond Measures
3Eliminate or Mitigate Conflicts of Interest in Contracting Related to Bond Measures
4Reduce Inappropriate, Excessive, or Unnecessary Spending of Bond Proceeds
5Improve Understanding of Bond Measures Through Public Education Campaigns

At a time of low interest rates, California school and community college districts may benefit in some circumstances from borrowing money to fund school construction, just like households benefit from home mortgages and car loans. But California voters — and their elected representatives — need to become much more informed about the debt legacy they are leaving to their children and grandchildren.

Emotional sentiment, lobbying pressure from interest groups, and eagerness to circumvent frustrating tax and debt limits in state law can overwhelm a prudent sense of caution. Irrational decisions that burden future generations cannot necessarily be fixed after the public finds out about them.


Section Summaries

Section 2. Why This Report Matters: More Borrowing in 2016

Californians will be asked in 2016 to continue taking on debt for construction of educational facilities, but one elected official is leery. Governor Jerry Brown wants to change the funding system for school construction. He is concerned about debt that Californians have accumulated from years of allowing the state and local educational districts to relentlessly borrow.

That money borrowed through bond sales will have to be paid back — with interest — to the investors who bought them. Voters have limited understanding of bonds and how bonds provide funds for construction, and elections focus on what voters will get rather than how they will pay for it. To the detriment of future generations, few Californians realize the huge amount educational districts have been authorized to borrow and the huge amount of debt accumulated.

Section 3. Quantifying and Explaining California’s Educational Construction Debt

Whatever voters are asked to approve in 2016 will not launch a new program to fix long-neglected schools to serve a rapidly expanding state population while providing smaller class sizes. That thinking is a legacy of the 1990s that seems to endure today despite 14 years of most bond measures passing at a 55 percent threshold for voter approval. Arguments for another state bond measure in 2016 ignore or downplay how local school and college districts and the state obtained authority in the past 14 years to borrow $146.1 billion for educational construction.

If voters are not told or reminded of recent borrowing patterns, how can they make an informed decision on future borrowing? To rectify the lack of availability of statistics on total bond debt in California for educational facility construction, the California Policy Center collected, synthesized, and analyzed data regarding California educational construction finance. The California Policy Center believes it is the first and only entity to painstakingly research and present an accurate and comprehensive record of all state and local educational construction bond measures considered by voters from 2001 through 2014.

Section 4. How Educational Districts Acquire and Manage Debt

It’s likely that most California voters have limited familiarity with the organization and governance of their local school and community college districts. When voters authorize their local educational districts to borrow money for construction by selling bonds, presumably they trust that the local school or college district will exercise prudence in managing the process. Sometimes their trust is betrayed.

To discourage abuse of the school construction finance system, voters need to be aware of how their local government is organized and managed. They also need to realize that state law does not explicitly give Independent Citizens’ Bond Oversight Committees broad authority to review construction programs funded by bond measures.

How can voters become informed about bonds and the process of borrowing money for educational construction through bond sales? Is there a way to explain in clear plain language what actually happens after voters approve a bond measure and authorize a school or college district to borrow money via bond sales?

Section 5. Capital Appreciation Bonds: Disturbing Repayment Terms

In 1993, California law was changed so that school and college districts could use an innovative form of debt finance called zero-coupon bonds, also known as Capital Appreciation Bonds. These bonds allow school and college districts to borrow now for construction and pay it back — with compounded interest — many years later. The borrowing strategy has been a tempting and dangerous lure for elected school and college boards.

Some people think Capital Appreciation Bonds are a “ticking time bomb” or the “creation of a toxic waste dump.” Others regard critics as uninformed and contend that these debt finance instruments are beneficial for school and college districts. Since the people who will be paying off many of these Capital Appreciation Bonds are now children or not even born yet, there isn’t much incentive to stop the flow of borrowed money that doesn’t need to be paid back for a generation or two.

Section 6. Tricks of the Trade: Questionable Behavior with Bonds

Californians who want more spending on educational construction often express their resentment of a 2000 law limiting taxes and debt resulting from bond sales. It was passed in order to strengthen campaign arguments to voters in support of Proposition 39, which lowered the approval threshold for local bond measures from two-thirds to 55%. School districts have adopted several strategies to get around these limits in state law. One of them is very obscure but 100% successful: obtaining waivers from the State Board of Education.

Meanwhile, some districts are stretching legal definitions to use proceeds from bond sales to pay for items that resemble instructional material more than construction. One example is personal portable electronics such as iPads. Some of the state’s largest districts are purchasing this kind of technology while giving little assurance to the public that long term bonds aren’t the source of the money. This equipment may be obsolete well before the bonds mature, meaning that future generations will pay for these devices long after they are outdated and discarded.

Section 7. The System Is Skewed to Pass Bond Measures

Considering the advantages that supporters have in preparing and campaigning for a bond measure, perhaps it’s noteworthy that voters reject about 20% of local bond measures for educational construction. At every stage of the process, interests that will benefit from bond sales can take advantage of a system that favors passage of a bond measure. Some issues of concern include use of public funds to develop campaigns to pass bond measures, significant political contributions to campaigns from interests likely to benefit from construction, involvement of college foundations as intermediaries for campaign contributions, and conflicts of interest and alleged pay-to-play contracts.

Section 8. More Trouble with Bond Finance for Educational Construction

While compiling the comprehensive information provided in this study, California Policy Center researchers identified numerous other troubling aspects of bond finance. School and college districts are evading compliance with the law and making irresponsible decisions. Ordinary voters lack enough data to make an informed vote. Community activists who seek deeper understanding find themselves stymied.

Section 9. Improving Oversight, Accountability, and Fiscal Responsibility

This report encourages the California legislature and the executive branch to adopt five sets of recommendations that will help to fix these deficiencies.

Five Categories of Recommendations
1Provide Adequate and Effective Oversight and Accountability for Bond Measures
2Enable Voters to Make a Reasonably Informed Decision on Bond Measures
3Eliminate or Mitigate Conflicts of Interest in Contracting Related to Bond Measures
4Reduce Inappropriate, Excessive, or Unnecessary Spending of Bond Proceeds
5Improve Understanding of Bond Measures Through Public Education Campaigns

The California Policy Center rejects the idea that additional oversight and accountability isn’t needed or desirable. Some legislative reforms and education programs (both public and private) can overcome voter cynicism, frustration, apathy, and ignorance.

Tables and Appendices of “For the Kids: California Voters Must Become Wary…”

Tables A1 to A6

Table A-1 California K-12 School Districts 2013-2014 – Ranked by Enrollment

Table A-2 California Community College District Enrollment Fall 2014 Ranked by Number of Students

Table A-3 Details of Bond Indebtedness Waiver Requests from California School Districts to State Board of Education 2002 through March 2015

Table A-4 California School Construction & Finance History

Table A-5 Arguments for Capital Appreciation Bonds

Table A-6 Arguments Against Capital Appreciation Bonds

Appendices A to L

Appendix A – All California Educational Bond Measures Pass and Fail – 2001-2014 Ranked by Percentage of Voter Approval

Appendix B – All California Educational Bond Measures Approved by Voters – 2001-2014 Ranked by Amount Authorized to Borrow

Appendix C – All California Educational Bond Measures Rejected 2001-2014 – Ranked by Amount NOT Authorized to Borrow

Appendix D – All California Educational Bond Measures Approved With a Two-Thirds Threshold Since November 2000 Enactment of Proposition 39 – Listed By Election Year

Appendix E – All California Educational Bond Measures 55 Percent – 2001-2014

Appendix F – All California Educational Bond Measures Repurposed or Reauthorized Since November 2000 Enactment of Proposition 39 – Listed by Election Year

Appendix G – All California Educational Bond Measures Approved by Voters with 55 Percent Threshold Since November 2000 – Results if Prop 39 Had Not Been Law

Appendix H – All California Educational Bond Measures Approved by Voters Under 55 Percent Threshold Since November 2000 Enactment of Proposition 39 – Failures Under 2:3 Threshold

Appendix I – All California Educational Bond Measures Approved by Voters – 2001-2014 Ranked by Amount of Debt Service

Appendix J – All Educational Districts in Which Voters Authorized Borrowing Via Bond Sales Since Proposition 39 – Ratio of Current Debt Service to Amount Authorized

Appendix K – All Educational Districts in Which Voters Authorized Borrowing Via Bond Sales Since November 2000 Enactment of Prop 39 – Ratio of Current Debt Service to Total Yes Votes

Appendix L – All Educational Districts in Which Voters Authorized Borrowing Via Bond Sales Since November 2000 Enactment of Prop 39 – Ranked by Amount Authorized Per Yes Vote

###

More Borrowing for California Educational Construction in 2016 (Section 2 of 9)

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
You are here: More Borrowing for California Educational Construction in 2016 (2 of 9)
Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
How California School and College Districts Acquire and Manage Debt (4 of 9)
Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
The System Is Skewed to Pass Bond Measures (7 of 9)
More Trouble with Bond Finance for Educational Construction (8 of 9)
Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
Guide to all Tables and Appendices – Comprehensive Reference for Researchers


Why This Report Matters: More Borrowing in 2016

Californians will be asked in 2016 to continue taking on debt for construction of educational facilities, but one elected official is leery. Governor Jerry Brown wants to change the funding system for school construction. He is concerned about debt that Californians have accumulated from years of allowing the state and local educational districts to relentlessly borrow.

That money borrowed through bond sales will have to be paid back — with interest — to the investors who bought them. Voters have limited understanding of bonds and how bonds provide funds for construction, and elections focus on what voters will get rather than how they will pay for it. To the detriment of future generations, few Californians realize the huge amount educational districts have been authorized to borrow and the huge amount of debt accumulated.

Interest Groups Want Voters to Consider Another State Bond Measure

When the California Policy Center published this report, the California Attorney General had approved circulation of petitions through September 21, 2015 for a proposed statewide ballot initiative entitled the “Kindergarten Through Community College Public Education Facilities Bond Act of 2016.” Professional signature gatherers set up tables at grocery stores and other public locations trying to cajole citizens into signing petitions to “help the kids” by putting the measure on the ballot.

If this proposal qualifies for the ballot and voters approve it, the State of California will have the authority to borrow $9 billion through selling bonds to investors. According to the petition, this $9 billion will ensure that “K-14 facilities are constructed and maintained in safe, secure and peaceful conditions.” As reported in the Sacramento Bee, school construction interests and residential housing developers want this bond measure, or one like it, on the ballot in 2016.

Proponents point out, accurately, that most of the money that voters authorized the state to borrow in 1998, 2002, 2004, and 2006 has been distributed as matching grants to local educational districts. As of April 15, 2015, $195.4 million remains3 from $35.4 billion approved to borrow as a result of three statewide ballot propositions in the 2000s.

The petition for the Kindergarten Through Community College Public Education Facilities Bond Act of 2016 lists four “findings” explaining what the state could do if it borrowed $9 billion:

1. Career technical education facilities to provide job training for many Californians and veterans who face challenges in completing their education and re-entering the workforce.

The history of recent bond measures on the state and local level shows that voters are inclined to support more government spending when veterans are cited as beneficiaries. Poll results confirm this. A “State of California School Bond Measure Feasibility Survey” of likely voters conducted January 30 to February 9, 2014 for California’s Coalition for Adequate School Housing (C.A.S.H.) indicated that “more than six-in-ten are highly concerned about unemployment among veterans.”

2. Upgrade aging facilities to meet current health and safety standards, including retrofitting for earthquake safety and the removal of lead paint, asbestos and other hazardous materials.

Again, the “State of California School Bond Measure Feasibility Survey” concluded that “more than two-thirds agree that many California public schools need significant health and safety improvements,” specifically the statement that “many schools and community colleges throughout California are old, outdated and need upgrades to meet current health and safety standards, including retrofitting for earthquake safety and the removal of lead paint, asbestos and other hazardous materials.”

3. Studies show that 13,000 jobs are created for each $1 billion of state infrastructure investment. These jobs include building and construction trades jobs throughout the state.

Influential construction interests are part of the coalition supporting this statewide bond measure. This statement acknowledges their pivotal role in the campaign to pass it.

4. Academic goals cannot be achieved without 21st Century school facilities designed to provide improved school technology and teaching facilities.

Once again, the “State of California School Bond Measure Feasibility Survey” concludes that “in particular, voters believe that funds must be directed towards upgrading vocational/career education programs, repairing classrooms and science labs and upgrading technology.”

These are deliberately chosen arguments to justify borrowing another $9 billion for community college and K-12 school district construction projects. In fact, these were the same arguments used in newspaper opinion pieces and position papers in 2014 to support Assembly Bill 2235, which if signed into law would have asked state voters in the November 2014 election to authorize borrowing $4.3 billion for school construction through bond sales.

Regardless of whether the four arguments listed above for a statewide bond measure are factually valid, they have been tested through polling and other voter research and shown to be effective in winning voter support. Surely a 2016 campaign for a state bond measure will use them.

How do these arguments stand in the larger context of bond indebtedness for the State of California and its community college districts and K-12 school districts? This report provides some of that context and introduces information never before available to the public.

Governor Brown Worries About Debt and Seeks Change in School Construction Finance

Governor Jerry Brown has used his executive power to thwart legislative efforts to place a statewide bond measure for educational construction on the 2016 ballot. Assembly Bill 2235 never received an opposition vote as it passed the Assembly and moved through Senate committees with support from numerous interest groups. Voters didn’t get to consider it in the November 2014 election only because Governor Brown didn’t want it on the ballot. As reported by a Capitol Public Radio reporter, the bill author issued a statement explaining its abandonment: “The governor has made it clear that he does not want a school bond on the same ballot as the water bond and rainy day fund. We do not expect the legislature to send the bill on him.”

Meanwhile, the Governor is taking a leading role in calling for change in how state and local governments fund California school construction. He submitted a state budget proposal to the California legislature in January 2015 with an introduction stating that funding commitments “must be honestly confronted so that they are properly accounted for and funded.” It warned that “budget challenges over the past decade have also resulted in a greater reliance on debt financing, rather than pay-as-you-go spending…From 1974 to 1999, California voters authorized $38.4 billion of general obligation bonds. Since 2000, voters authorized more than $103.2 billion of general obligation bonds”

Table 1: All General Obligation Bonds to Be Paid Off Through
California’s General Fund
Amount Authorized to Borrow$135.2 billion
Amount Borrowed$105.7 billion
Amount Authorized But Not Borrowed$29.5 billion
Amount Owed in Principal (June 1, 2015)$72.4 billion
Amount of Debt Service Owed (June 1, 2015)$131.8 billion
Amount of Debt Service to Be Paid 2015-2016$6 billion
Sources: “Schedule of Debt Service Requirements for General Fund Non-Self Liquidating Bonds (Fixed Rate),” California State Treasurer, June 1, 2015, accessed June 28, 2015, www.treasurer.ca.gov/bonds/debt/201506/general-fixed.pdf and “Authorized and Outstanding General Obligation Bonds,” California State Treasurer, June 1, 2015, accessed June 28, 2015, www.treasurer.ca.gov/bonds/debt/201506/authorized.pdf

Concern About Debt Growing from State Matching Grants for Local Educational Districts

One funding commitment Governor Brown “confronted” in his proposed fiscal year 2015-16 budget was the State of California’s debt accumulated from funding construction of facilities for local school districts. California voters approved bond measures in 2002, 2004, and 2006 authorizing the state to borrow $35.4 billion via bond sales for school and college construction, and only $195 million remains to be borrowed. According to internal California State Treasurer documents, debt service on those three state bond measures is $56.7 billion.

According to the Governor’s 2015-16 Budget Summary, “the Administration has noted the following significant shortcomings” related to school bond finance over the past two years:

The current program does not compel districts to consider facilities funding within the context of other educational costs and priorities. For example, districts can generate and retain state facility program eligibility based on outdated or inconsistent enrollment projections. This often results in financial incentives for districts to build new schools to accommodate what is actually modest and absorbable enrollment growth. These incentives are exacerbated by the fact that general obligation bond debt is funded outside of Proposition 98. These bonds cost the General Fund approximately $2.4 billion in debt service annually.

This statement is surprising and controversial recognition that some school districts spend money on new school construction that perhaps isn’t needed. The proposed budget summary also notes that large school districts have in-house professional facilities departments that can take advantage of the first-come, first-serve application system to get funding from the State Allocation Board for local school construction.

Another surprising admission in the Governor’s budget proposal is acknowledgement that voters approve four out of five proposed local bond measures, thus providing a relatively easy flow of money for school construction: “The current program was developed before the passage of Proposition 39 (which reduced the local bond vote threshold from a two-thirds supermajority to 55 percent) in 2000, which has since allowed local school bonds to pass upwards of 80 percent of the time.”

The budget summary also reported that the California Department of Finance had met with parties interested in educational construction and developed a set of recommendations, including three related to bond finance:

1. Increase Tools for Local Control: Expand Local Funding Capacity

While school districts can pass local bonds with 55% percent approval, assessed valuation caps for specific bond measures and total caps on local bonded indebtedness have not been adjusted since 2000. In order to provide greater access to local financing, these caps should be increased at minimum by the rate of inflation since 2000.

Based on the Consumer Price Index of the U.S. Bureau of Labor Statistics, the inflation rate from November 2000 (when voters approved Proposition 39) to May 2015 was 36.6%. Therefore, under this proposal the California legislature would increase tax and debt limits at least 36.6% above existing amounts. However, the flaw in this proposal is that it does not account for increases in property value or total assessed property valuation in California since 2000. (See Section 5 of this report for background on tax and debt limits.)

2. Expand Allowable Uses of Routine Restricted Maintenance Funding

Current law requires schools to deposit a percentage of their general fund expenditures into a restricted account for use in maintaining their facilities. Rather than requiring that these funds be used solely for routine maintenance, districts should have the ability to pool these funds over multiple years for modernization and new construction projects. Expanding the use of these funds will provide school districts with yet another funding stream to maintain, modernize, and construct new facilities.

This proposal injects a bit of “pay-as-you-go” from district general funds into educational facilities construction — a departure from the bond debt financing that has driven school construction since the enactment of Senate Bill 50, the Leroy F. Greene School Facilities Act of 1998.

3. Target State Funding for Districts Most in Need

State funding for a new program should be targeted in a way that: (1) limits eligibility to districts with such low per-student assessed value they cannot issue bonds at the local level in amounts that allow them to meet student needs, (2) prioritizes funding for health and safety and severe overcrowding projects, and (3) establishes a sliding scale to determine the state share of project costs based on local capacity to finance projects.

This recommendation is based on the perception that the current first-come, first-served funding system allows certain school and college districts to win a disproportionate amount of state matching grants at the expense of other districts that may have a more legitimate need but lack the resources and wherewithal to take advantage of opportunities.

Finally, the list of recommendations concludes with a message:

…it is the intent of the Administration to advance the dialogue on the future of school facilities funding. School districts and developers should have a clear understanding of which limited circumstances will qualify for state assistance. Over the course of the coming months, the Administration is prepared to engage with the Legislature and education stakeholders to shape a future state program that is focused on districts with the greatest need, while providing substantial new flexibility for local districts to raise the necessary resources for school facilities needs.

These proposals are not new ideas. A 2003 report from the Public Policy Institute of California analyzed school bond measures and identified disparities among districts based on wealth and region. In response to these findings, the report suggested raising state debt limits for bond measures to reduce the impact of changes in assessed property valuation. It also recommended adoption of a plan that would give deserving school and college districts access to state construction funds without having to match these grants with local funding.

State Legislative Initiatives

The stage is set for change in California school construction financing. Subsequent to the release of the proposed budget from the Governor, state legislators introduced bills such as Senate Bill 114 and Assembly Bill 148. These bills would make some mild changes to the state’s school construction program, while at the same time placing a statewide bond measure on the November 2016 ballot to borrow money (for a yet unidentified amount) via bond sales for school construction.

The author of Senate Bill 114 explained the purpose of the bill:

Funding for the School Facilities Program is virtually gone and there is a backlog in applications for state assistance…while the state’s growing debt service is of concern, it is unclear whether local districts have the capacity to generate sufficient revenue at the local level to meet their specific facility needs. The “winding down” of the current program, and the Governor’s call for change, present an opportunity to rethink the administrative and programmatic structure of the State Facilities Program…

Supporting one or both of these bills are the California School Boards Association, the California Faculty Association, the California Association of School Business Officials, the American Federation of State, County, and Municipal Employees union (AFSCME); the Los Angeles Unified School District, and the Riverside County Superintendent of Schools. Further debate will reveal if these groups are willing to withhold potential objections to some of the Department of Finance proposed changes to educational construction finance in exchange for having another statewide bond measure on the 2016 Presidential general election ballot.

No formal opposition to these bills has yet emerged, but at this time the bills are just a frame, to be expanded with more detailed proposals.

Sources

“Request for Title and Summary for Proposed Initiative: Kindergarten Through Community College Public Education Facilities Bond Act of 2016,” Office of the California Attorney General, January 12, 2015, accessed June 28, 2015, https://oag.ca.gov/system/files/initiatives/pdfs/15-0005%20(Education%20Bond%20Act).pdf

“California School Builders, Others to Gather Signatures for November 2016 Bond Measure,” Sacramento Bee, January 12, 2015, accessed June 28, 2015, www.sacbee.com/news/politics-government/capitol-alert/article6143364.html

“AB 148 School Facilities: K–14 School Investment Bond Act of 2016 – California State Assembly Education Committee Analysis,” California Legislative Information, April 28, 2015, accessed June 28, 2015, https://leginfo.legislature.ca.gov/faces/billAnalysisClient.xhtml?bill_id=201520160AB148#

“State of California School Bond Measure Feasibility Survey,” California’s Coalition for Adequate School Housing, Date, accessed June 28, 2015, https://www.cashnet.org/meetings/2014_Annual_Conference/documents/38_LegislativeUpdate_Bond_Feasibility.pdf

“Text – AB 2235 Education Facilities: Kindergarten-University Public Education Facilities Bond Act of 2014,” California Legislative Information, accessed June 28, 2015, https://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201320140AB2235

“No School Bond, Lawmaker Suspension Measures On November Ballot,” Capitol Public Radio, August 19, 2014, accessed June 28, 2015, www.capradio.org/articles/2014/08/19/no-school-bond,-lawmaker-suspension-measures-on-november-ballot/

“2015-16 Governor’s Budget Summary,” Department of Finance – California Budget, January 9, 2015, accessed June 28, 2015, www.ebudget.ca.gov/2015-16/pdf/BudgetSummary/FullBudgetSummary.pdf

“2015 California’s Five-Year Infrastructure Plan,” Department of Finance – California Budget, January 9, 2015, accessed June 28, 2015, www.ebudget.ca.gov/2015-Infrastructure-Plan.pdf

“Governor’s Budget Summary 2015-16: K Thru 12 Education,” Department of Finance – California Budget, January 9, 2015, accessed June 28, 2015, www.ebudget.ca.gov/2015-16/pdf/BudgetSummary/Kthru12Education.pdf

“SB 50 – Chaptered. Leroy F. Greene School Facilities Act of 1998: Class Size Reduction – Kindergarten University Public Education Facilities Bond Act of 1998,” Official California Legislative Information, August 27, 1998, accessed June 28, 2015, www.leginfo.ca.gov/pub/97-98/bill/sen/sb_0001-0050/sb_50_bill_19980827_chaptered.html

“Fiscal Effects of Voter Approval Requirements on Local Governments,” Public Policy Institute of California, January 27, 2003, accessed June 28, 2015, www.ppic.org/content/pubs/report/R_103KRR.pdf

“Text – SB 114 Education Facilities: Kindergarten Through Grade 12 Public Education Facilities Bond Act of 2016,” California Legislative Information, June 3, 2015, accessed June 28, 2015, leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201520160SB114&search_keywords=

“Text – AB 148 School Facilities: K–14 School Investment Bond Act of 2016,” California Legislative Information, May 6, 2015, accessed June 28, 2015, leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201520160SB114&search_keywords=

“Senate Education Committee Legislative Analysis – AB 148 School Facilities: K–14 School Investment Bond Act of 2016,” California Legislative Information, March 25, 2015, accessed June 28, 2015, http://leginfo.legislature.ca.gov/faces/billAnalysisClient.xhtml?bill_id=201520160SB114#

###

Quantifying and Explaining California’s Educational Construction Debt (Section 3 of 9)

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
More Borrowing for California Educational Construction in 2016 (2 of 9)
You are here: Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
How California School and College Districts Acquire and Manage Debt (4 of 9)
Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
The System Is Skewed to Pass Bond Measures (7 of 9)
More Trouble with Bond Finance for Educational Construction (8 of 9)
Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
Guide to all Tables and Appendices – Comprehensive Reference for Researchers


Quantifying and Explaining California’s Educational Construction Debt

Whatever voters are asked to approve in 2016 will not launch a new program to fix long-neglected schools to serve a rapidly expanding state population while providing smaller class sizes. That thinking is a legacy of the 1990s that still seems to endure today despite 14 years of most bond measures passing at a 55 percent threshold for voter approval. Arguments for another state bond measure in 2016 ignore or downplay how local school and college districts and the state obtained authority in the past 14 years to borrow $146.1 billion for educational construction.

If voters are not told or reminded of recent borrowing patterns, how can voters make an informed decision on future borrowing? To rectify the lack of availability of statistics on total bond debt in California for educational facility construction, the California Policy Center collected, synthesized, and analyzed data regarding California educational construction finance. The California Policy Center believes it is the first and only entity to painstakingly research and present an accurate and comprehensive record of all state and local educational construction bond measures considered by voters from 2001 through 2014.

The amount of authority approved by voters is a higher percentage than the percentage of the number of bond measures approved by voters because larger bond measures proposed by larger districts passed at a higher rate than smaller bond measures proposed by smaller districts.

Table 2: Local Educational Bond Measures Considered by California Voters After Passage of Proposition 39 in November 2000
Number on Ballot1147
Number Approved911
Number Rejected236
Percentage Approved79.42%
Percentage Rejected20.58%
Amount Proposed to Authorize$124,350,056,744
Amount Proposed to Authorize (including 16 reauthorizations)$125,080,421,744
Amount Authorized$109,620,418,737
Amount Authorized (including 16 reauthorizations)$110,350,783,737
Amount Rejected$14,729,638,007
Percentage of Authority Approved (including 16 reauthorizations)88.22%
Percentage of Authority Rejected (including 16 reauthorizations)11.78%
Amount Authorized Through Three Statewide Bond Measures$35,766,000,000
Total Amount Proposed to Authorize (State and Local Bond Measures)$160,116,056,744
Total Amount Proposed to Authorize (State and Local Bond Measures) (including 16 reauthorizations)$160,846,421,744
Total Amount Authorized (State and Local Bond Measures)
(including 16 reauthorizations)
$146,116,783,737

How Did It Become So Easy to Pass Bond Measures?

A new era of generous borrowing for educational construction in California was inaugurated by the enactment of Proposition 39. Approved by 53.4% of voters in the November 7, 2000 election, it reduced the voter approval threshold for most educational construction bond measures from two-thirds to 55 percent. (Because the measure imposes restrictions on districts using the new 55 percent threshold, a minority of districts have continued to propose measures requiring a two-thirds vote.)

This lowered obstacle apparently encouraged local educational districts to take the risk of proposing many more bond measures at much higher amounts for voters to approve. As shown in Tables 3 and 4, dropping the voter threshold from 66.67% to 55% transformed the approval of educational bond measures from a 50-50 chance to a commonplace outcome.

As shown in Table 5, between now and 2055, California’s taxpayers will pay about $200 billion in principal and interest payments to investors who have bought bonds issued by the state and by local educational districts in order to get funding for facility construction.

Table 3: Local Educational Bond Measures Considered by California Voters After Passage of Proposition 39 in November 2000
55% ApprovalTwo-Thirds
Approval
Total
Number on Ballot10371101147
Number Approved85754911
Number Rejected18056236
Percentage Approved82.64%49.09%79.42%
Percentage Rejected17.36%50.91%20.58%
Table 4: Local Educational Bond Measures: Results If Proposition 39 Wasn't Law
Under Prop 39
(55% and 2/3)
If Prop 39 Wasn’t Enacted (2/3)
Total Number of Bond Measures on Ballot11471147
Number of Bond Measures Approved911423
Percentage of Bond Measures Approved79.42%36.88%
Total Amount Authorized to Borrow
(includes reauthorizations)
$125,080,421,744$52,712,273,012
Percentage of Authorization Amount Approved88.22%42.15%
Table 5: Total Amount of Debt Service for Educational Facility Construction
Amount for 642 School and College Districts for Which Voters Approved Bond Measures Since Proposition 39 Passed in 2000$136,867,456,924
Amount for Three Bond Measures That Voters Approved for State of California Since Proposition 39 Passed in 2000$56,668,673,695
Estimate for Several Dozen School Districts Where Voters Approved Bond Measures Only Before Enactment of Proposition 39 or Lack Data$2,000,000,000
Estimated Amount for Several Bond Measures That Voters Approved for State of California Before Proposition 39 Passed in 2000$4,500,000,000
Approximate Total$200,000,000,000

How Was Debt Service Determined?

California Policy Center researchers identified, calculated, and tallied aggregate debt service for almost all of the 642 California local educational districts in which voters approved borrowing money for construction through bond sales after the election of November 7, 2000. On that date, California voters approved Proposition 39 and reduced the threshold for voter approval of most bond measures for construction from two-thirds to 55 percent.

This debt service data was obtained using tables included in about 650 “Official Statements” posted on a publicly-accessible and free-to-use Electronic Municipal Market Access (EMMA) website administered by the Municipal Securities Rulemaking Board (MSRB).

Example of Official StatementWhat are these statements? Federal law generally requires underwriters in a primary offering of municipal bonds of $1 million or more to obtain and review an Official Statement from the issuer of those bonds. (Many smaller bond offerings also have Official Statements.) In a dense report of more than 200 pages, these statements disclose financial information meant to inform a potential buyer and reduce the chance of “fraudulent, deceptive, or manipulative acts or practices.”

Official Statements include a chart that indicates how much aggregate principal and interest the issuer of the bonds would owe each year if the bonds weren’t refunded (“called in” or redeemed so that new bonds can be issued at a lower interest rate) or paid off early. California Policy Center researchers entered each district name into the EMMA system, identified the most recent bond offering or bond refunding from the list of bond issues, downloaded the associated Official Statement, located the aggregate debt service chart, and calculated the total debt service for 2015 and/or later years.

Using these Official Statements to extract data required diligence. Firms that produce the statements do not use a specific standard format, so the aggregate debt service table appears in different places. Tables differ in title, format, or details of content. Older Official Statements are not optimized for word searches. A few tables do not total up the annual debt service, thus forcing the user to convert the table into a spreadsheet and calculate the total using a formula. A handful of Official Statements outright lacked aggregate debt service tables.

Tables may even contain erroneous data. After some confusion, researchers realized that an Official Statement for the Napa Valley Unified School District contained major errors. It indicated total debt service as $77 million instead of the actual $665 million and also indicated a November 5, 2002 bond measure as authorizing $219 million instead of the actual $95 million. This was an unfortunate district to have an erroneous Official Statement: a California Watch article published in the San Francisco Chronicle just three months before the Official Statement was posted identified the Napa Valley Unified School District as a district where taxpayers will eventually “pay dearly for bonds.” In 2009 it borrowed $22 million through Capital Appreciation Bond sales that will cost $154 million by the time the last bonds in the series mature forty years later, in 2049.

Researchers also had to be cautious about accurately identifying school districts with similar names. For example, Central, Oak Grove, and Columbia are words shared by more than one school district. And “College School District” in Santa Barbara County is not a community college district. Some of the inconsistencies found in cross-referencing various sources for bond measure data seem to be a result of misidentifying districts with similar-sounding names.

Even after these challenges were overcome, researchers recognized that the list of debt service for school and college districts needs to be considered with some caveats. (Table 6 is “Cautionary Considerations When Evaluating Current Debt Service Data for School and College Districts.”) Researchers are also aware of arguments that debt service — even when considered with other financial data — is not always a useful way to assess whether or not school or college districts have been irresponsible in their choices for debt finance of facilities construction. A few of those arguments are listed in Table 7: Why Some Analysts Downplay Debt Service Data.

Despite these potential limitations, aggregate debt service amounts available through Official Statements posted on EMMA provide new insight into the long term debt obligations owed by California local educational districts for facilities construction. This data set represents a major advance in informing Californians about the tremendous debt accumulated by educational districts that borrow money for school construction by selling bonds.

Table 6: Cautionary Considerations When Evaluating Current Debt Service Data for School and College Districts
1For some school or college districts, debt service may be relatively low compared to the total amount authorized to borrow because those districts haven't issued all of the bonds (or any of the bonds) yet. When those districts sell all of the bonds in the amount authorized by voters, debt service will be higher.
2An educational district in a wealthy area can have high debt service but also have high and stable total assessed property value. That high debt service may be inappropriate, but it is not as risky as the same debt service in a less affluent district with unstable property values and an uncertain economic future.
3Some California educational districts do not have debt service listed in the appendices because they recently sold bonds through “private placement.” These transactions do not require Official Statements to be posted on EMMA. Without an Official Statement, long term debt obligation from bonds is more difficult to obtain. And when obtained through annual financial reports, that number may be outdated compared to information available in an Official Statement.
4The appendices indicate all aggregate debt service for 642 districts in which voters approved bond sales since Proposition 39 was enacted in 2000. This means there may be some distortions when comparing data, for the following reasons:

Aggregate debt service listed for districts may originate from bond measures approved by two-thirds of voters as far back as 1987 and up through November 7, 2000. This means that debt service for some districts may appear disproportionately high relative to the amount authorized by voters to borrow from 2001 through 2014.

There are a handful of districts that have current debt service resulting from bond measures approved in 2000 or earlier but have not asked voters to authorize additional borrowing since the November 7, 2000 election. That debt service is not included in the grand total reported here.

Likewise, California voters approved several ballot propositions before Proposition 39 was enacted in 2000, including a $9.2 billion bond measure passed in 1998 that included $6.7 billion for K-12 school districts and $2.5 billion collectively for community college districts and the California State University and the University of California campuses.
5Several K-12 school districts have merged in the past 15 years. Some Official Statements segregate debt service for the districts before they merged, and some combine the debt service.
6Several community college district and K-12 school districts have created “School Facilities Improvement Districts” carved out from the complete jurisdiction of the districts. Some Official Statements segregate debt service for these sub-districts, and some combine the debt service for the sub-districts with the debt service for the complete district.
7Debt service tables in Official Statements do not account for Bond Anticipation Notes, Certificates of Participation, lease revenue bonds, and other ways that educational districts borrow money.
8Community Facilities Districts funded by Mello-Roos bonds are not included in Official Statements.

Sources

Electronic Municipal Market Access (EMMA) website administered by the Municipal Securities Rulemaking Board (MSRB) http://emma.msrb.org

“Napa Valley Unified School District,” Electronic Municipal Market Access (EMMA), May 9, 2013, accessed June 28, 2015, http://emma.msrb.org/EA524107-EA408291-EA805228.pdf

“School Districts Pay Dearly for Bonds,” San Francisco Chronicle, January 31, 2013, accessed June 28, 2015, www.sfgate.com/education/article/School-districts-pay-dearly-for-bonds-4237868.php

###

How California School and College Districts Acquire and Manage Debt (Section 4 of 9)

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
More Borrowing for California Educational Construction in 2016 (2 of 9)
Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
You are here: How California School and College Districts Acquire and Manage Debt (4 of 9)
Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
The System Is Skewed to Pass Bond Measures (7 of 9)
More Trouble with Bond Finance for Educational Construction (8 of 9)
Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
Guide to all Tables and Appendices – Comprehensive Reference for Researchers


How Educational Districts Acquire and Manage Debt 

It’s likely that most California voters have limited familiarity with the organization and governance of their local school and community college districts. When voters authorize their local educational districts to borrow money for construction by selling bonds, presumably they trust that the local school or college district will exercise prudence in managing the process.

Sometimes their trust is betrayed.

To discourage abuse of the school construction finance system, voters need to be aware of how their local government is organized and managed. They also need to realize that state law does not explicitly give Independent Citizens’ Bond Oversight Committees broad authority to review construction programs funded by bond measures.

How can voters become informed about bonds and the process of borrowing money for educational construction through bond sales? Is there a way to explain in clear plain language what actually happens after voters approve a bond measure and authorize a school or college district to borrow money via bond sales?

Bonds Help Local Governments Borrow Money to Better Serve the People

When people talk about municipal securities or municipal bonds, they’re talking about state governments or local governments borrowing money from investors with the promise to pay it back to them later, with interest. Municipal (derived from the Latin word municipium, meaning a free city) simply means a local government, such as a county, city, water district, sanitation district, irrigation district, utility district, transportation district, cemetery district, mosquito vector district, and many other kinds of special districts formed by the people to serve the people. And it includes school districts and community college districts.

Despite a lack of public attention to bonds, this method of debt finance is important, especially for governments such as California’s school districts and community college districts that want to initiate or continue major construction programs. U.S. Securities and Exchange Commissioner Luis A. Aguilar recently described the importance of municipal bonds:

It is difficult to overstate the importance of the municipal securities market. There is perhaps no other market that so profoundly influences the quality of our daily lives. Municipal securities provide financing to build and maintain schools, hospitals, and utilities, as well as the roads and other basic infrastructure that enable our economy to flourish. Municipal bonds’ tax-free status also makes them an important investment vehicle for individual investors, particularly retirees. Ensuring the existence of a vibrant and efficient municipal bond market is essential, particularly at a time when state and local government budgets remain stretched.

Such comments are appreciated by state and local governments as murmuring continues in Washington, D.C. that income from municipal bonds should lose tax-exempt status.

Basic Information About California K-12 School Districts

In the case of a local elementary school district (kindergarten though eighth grade), high school district (ninth through twelfth grade), or unified school district (kindergarten through twelfth grades), voters elect a board of trustees (often called a “school board” or a “board of education”) to oversee operations of the school district and make major decisions as representatives of the people. The board appoints a District Superintendent and other professional administrators to handle day-to-day management of the district.

In addition, each county has an elected County Board of Education and an elected County Superintendent of Schools with specific responsibilities. There is also a State Board of Education appointed by state elected officials to oversee education policies that are common for all school districts in the state. There is also a State Superintendent of Schools elected by the people of California.

Table A-1 (“California K-12 School Districts 2013-2014 – Ranked by Enrollment”) lists 945 elementary school districts, high school districts, and unified school districts with enrollment tracked by the California Department of Education as of June 15, 2015.

Basic Information About California Community College Districts

In the case of a local community college district, voters elect a Board of Trustees (often called a “college board” or a “governing board”) to make decisions for the college district as representatives of the people. There is also a Board of Governors of the California Community Colleges appointed by state elected officials to oversee education policies that are common for all college districts in the state. The Board of Governors appoints a Chancellor of the California Community Colleges and other professional administrators to handle day-to-day management of the state college system.

Boards for the University of California and California State University systems are appointed by state elected officials and not directly chosen by the people.

As of June 15, 2015 there are 72 community college districts in California with 112 colleges. (Some districts contain multiple colleges.) Table A-2 (“California Community College District Enrollment Fall 2014 – Ranked by Number of Students”) lists these districts.

What Are the Independent Citizens’ Bond Oversight Committees? 

To strengthen the arguments for Proposition 39 in 2000, the California legislature passed Assembly Bill 1908, the “Strict Accountability in Local School Construction Bonds Act of 2000,” with these stated intentions:

  1. Vigorous efforts will be undertaken to ensure that school and college districts spend the proceeds of bond measures, including those passed under criteria of Proposition 39, in strict conformity to law.
  2. Taxpayers will directly participate in the oversight of bond expenditures.
  3. Members of the oversight committees appointed for these purposes will promptly alert the public to any waste or improper spending of money borrowed through bond sales.
  4. Unauthorized expenditures of school construction bond revenues will be vigorously investigated, prosecuted, and restrained by the courts.

A school or college district board must appoint an independent citizens’ bond oversight committee with 60 days after the board enters the election results in its minutes. The committee must include at least seven members to serve for a term of two years and for no more than two consecutive terms. District employees, officials, vendors, contractors, or consultants are prohibited from serving on the committee, and it must include at least one “active” representative of the following groups:

  1. a business organization, located within the district, representing the business community
  2. a senior citizens’ organization
  3. a bona fide taxpayers’ organization
  4. for a school district: parents or guardians of children enrolled in the district
  5. for a school district: parents or guardians of children enrolled in the district who are also active in a parent-teacher organization, such as the Parent Teacher Association or school site council
  6. for a community college district: students who are currently enrolled in the district and also active in a community college group, such as student government
  7. for a community college district: organizational support groups of the district, such as advisory councils or foundations

These committees have several responsibilities listed in state law meant to ensure the district spends bond proceeds only on projects listed in the ballot statement and avoids spending bond proceeds on ineligible projects, programs, or “teacher or administrative salaries or other school operating expenses.” State law also assigns these committees to review “efforts by the school district or community college district to maximize bond revenues by implementing cost-saving measures.”

The committee does NOT have a explicit oversight role for how the district pays for these construction projects, and a narrow interpretation of the law could claim that oversight committees do not have legal authority to review bond sales. However, the California League of Bond Oversight Committees (CalBOC) believes these committees have the authority to review and comment on the structure of bond issues under the provisions for reviewing “cost-savings” measures. Districts often defer to legal counsel for interpretations of the responsibilities and limitations of oversight committees.

A Private Organization Has Taken Responsibility for Independent Citizens’ Bond Oversight Committees

Currently a private organization is providing services and advice to oversight committees. The California League of Bond Oversight Committees (CalBOC), founded in 2006, is a non-profit public service organization that filled a need for training, education, and legislative advocacy for the state’s bond oversight committees.

This arrangement has shortcomings. A private organization is dependent on voluntary financial contributions and a committed volunteer leadership, and it lacks power to take action against educational districts that fail to comply with state laws. Membership and involvement is dependent on the motivations and self-initiative of individual bond oversight committee members. CalBOC does not have any professional staff to monitor districts, collect data, and provide it to the public.

In addition, school districts can discourage oversight committee members from participating in the California League of Bond Oversight Committees, and some school district administrators openly disparage it. Some district administrators and legal counsel don’t want oversight committees interpreting their purpose broadly and consuming district staff time and district funds on investigations outside of a narrowly-defined purview.

The author of this report has been and continues to be a member of the Advisory Committee for the California League of Bond Oversight Committees (CalBOC).

Translating School Finance Decisions For Ordinary People to Understand

For many Americans, the phrase “stocks and bonds” evokes the image of an established and wealthy investor. Someone who buys a stock becomes an owner of a corporation, and someone who buys a bond becomes a creditor who is owed money by a corporation or a government. It’s likely that more Americans could explain stocks than could explain bonds.

The lack of public awareness or knowledge about bonds may be attributable to the complex provisions of certain bonds and the fact that bonds typically do not offer the very large potential returns offered by equity in growing firms.

Bonds rarely get news media attention outside of a few financial wire services such as Bloomberg, Reuters (which had a “MuniLand” blogger), and specialty publications such as The Bond Buyer. And in popular culture, depictions of bond brokers have been mainly limited to two books by Tom Wolfe: The Bonfire of the Vanities (subsequently made into a movie) and I am Charlotte Simmons.

What Is a Bond?

Some technical definitions of a bond are listed in Table 10. But rather than focusing on the definition of a bond, Californians need to focus on what a bond does in practice.

For a school or community college district, issuing (“selling”) bonds means the district borrows money for a specific length of time from investors with the obligation to return all of that money to them when that time period ends. The amount borrowed is called the principal.

During that length of time the district pays a fee to the investors, either on a regular basis (for Current Interest Bonds) or accumulated with compounded interest at the end of the time period (for Capital Appreciation Bonds). The amount paid is called interest.

The term of maturity between borrowing the money and paying back the money with interest can be one to three years (short-term bonds) or decades (long-term bonds). Under California law, a school district or community college district cannot issue a current interest bond with a maturity over 40 years. As a result of Assembly Bill 182 enacted in 2013, California local governments are now prohibited from issuing Capital Appreciation Bonds with a maturity over 30 years.

AB 182 allows a school district or community college district to issue Current Interest Bonds bonds with a term of maturity between 30 and 40 years. The district must use that borrowed money for projects with a “useful life” that equals or exceeds the term of maturity.

What Are “General Obligation Bonds” Referenced in Ballot Language for Bond Measures?

Corporations and state and local governments issue bonds to raise money. Bonds sold by local governments are called municipal bonds. An appealing aspect of many municipal bonds for investors is their tax-exempt status.

Municipal bonds such as those sold by California school districts and community college districts for construction are called general obligation bonds, meaning they are backed by the “full faith and credit” of the districts. These districts theoretically have legislative power to collect enough money through property taxes, other borrowing, selling assets, or other sources of revenue to fulfill their obligation to make payments on the bonds when due. Those taxes are collected from property owners in the district. (Revenue bonds are another kind of municipal bond, paid off through tolls, lease payments, user fees, or other service payments.)

Comparing Current Interest Bonds to Capital Appreciation Bonds

When voters are asked at an election to approve a bond measure to pay for construction at a school district or community college district, they generally have been told that a “Yes” vote will authorize the sale of general obligation bonds to fund that construction.

California educational districts are issuing two kinds of general obligation bonds: Current Interest Bonds and Capital Appreciation Bonds. Usually the district does not tell voters what kind of general obligation bonds it will sell, unless it specifically passes a resolution before the election stating it will not sell Capital Appreciation Bonds and includes that condition in the ballot statement.

1. Current Interest Bonds (also called Fixed Rate Bonds)

These are the “traditional” kind of municipal bonds. A buyer of Current Interest Bonds gets a periodic interest payment (usually semi-annually). When the bond matures, the buyer gets the principal back.

2. Capital Appreciation Bonds (also called Zero Coupon Bonds)

A buyer of Capital Appreciation Bonds does not receive semiannual or other periodic interest payments. Instead, the buyer receives all of the interest – compounded over the length of maturity for the bond – together with the principal when the bond matures. There is no regular payment of interest, but the accumulated (“accreted”) interest is compounded over many years, making the wait a worthwhile investment. Capital Appreciation Bonds are purchased at a deeply discounted amount from their face value.

Capital Appreciation Bonds are discussed in more detail in Section 5.

Two Costs to Educational Districts of Borrowing Money Via Bonds

From the perspective of the school district, the additional financial cost of borrowing money by selling bonds as opposed to spending money from the district general fund results from (1) interest and (2) transaction fees.

Interest

If someone borrows $1000 for five years from a lender at an annual interest rate of 5 percent, the borrower and the lender agree that the borrower will pay back the $1000 over five years and also pay 5% of that $1000 ($50) multiplied by five years for a total of $1250. The borrower gets the $1000 immediately to use, and the lender earns annual interest income of $50 over five years for a total of $250. Both parties consider themselves to get a benefit from the transaction.

Likewise, if a school district issues a traditional $1000 Current Interest Bond at an annual interest rate of 5 percent with a five-year term of maturity and an investor buys the bond at its face value of $1000, the school district gets the $1000 immediately to use for construction, and the investor earns annual interest income of $50 over five years for a total of $250. When the five years are over, the investor gets the $1000 back. Both parties get a benefit from the transaction. In addition, the investor does not have to pay taxes on the interest.

School districts usually sell series of bonds as a package with different maturities and interest rates.

Transaction Fees (Issuance Fees)

Bond buyers are not the only party to make money from bonds issued by California school districts and community college districts. Similar to taking out a mortgage, a variety of parties in the financial services industry are involved in the preparation and sale of bonds, and each party gets a fee for participating in the transaction. These fees are classified as “costs of issuance.”

To prevent these fees from cutting into the amount of money authorized by voters for construction, educational districts routinely inflate the interest rates on bonds they sell so that the price is higher than the face value of the bond. After the bonds are sold, that extra money, or “premium,” is used to pay the costs of issuance.

Table 8: Types of Issuance Fees
underwriter’s discount
bond counsel fees
disclosure counsel fees
paying agent fees
escrow agent fees
rating agency fees
bond insurance fees
verification agent fees
financial advisor fees
printing fees
other miscellaneous expenses

How are Municipal Bonds Bought and Sold? Who Buys Them?

Municipal bonds are not traded on an exchange like stocks. Instead, investors buy and sell bonds “over the counter” through dealers and brokers registered with the Municipal Securities Rulemaking Board (MSRB), a self-regulatory organization overseen by the U.S. Securities and Exchange Commission. These dealers and brokers act as underwriters or intermediaries between issuers and investors. They charge fees, or “mark-ups” for the transactions.

Once a school district sells a bond, the bond can be traded in the municipal bond market. The price will fluctuate and investors will be concerned about yield — the amount of income earned as prices rise and fall.

According to Federal Reserve statistics, individual investors hold a little more than two-thirds of municipal bonds, about 42 percent directly and about 28 percent through mutual funds and other investment vehicles. Major institutional investors include asset management firms, insurance companies, and commercial banks.

One of the arguments to cap or eliminate the federal tax exemption for income from municipal bonds is that the exemption mainly benefits wealthy individuals who buy bonds as a tax-exempt investment. Buyers of municipal bonds do not generally “keep the money in the community” because they aren’t in the community. And they generally do not buy bonds issued by educational districts to “help the children” or “provide vocational training to veterans.” They buy them to make money.

Ironically, the same Progressive activists who call for higher taxes on the rich also tend to support educational bond measures that help the rich to earn investment income that is tax-free. Forcing the rich to pay taxes on income earned through municipal bonds could collapse the demand for these bonds and make borrowing money for construction a much more expensive proposition for school and college districts.

Table 9: Some Advantages for Investors in Municipal Bonds
Interest earned on municipal bonds is usually exempt from federal and state income tax.
In the case of general obligation bonds, principal and interest are secured by the full faith and credit of the issuer and usually supported by either the issuer’s taxing power. Despite negative nationwide publicity about a relatively small number of bankrupt local governments (such as the California cities of Vallejo, Stockton, and San Bernardino), a government defaulting on municipal bonds is “extremely infrequent,” according to Moody’s. They are thus a relatively safe investment.
In the case of Current Interest Bonds, investors get a regular interest payment, usually semi-annually. There is a regular, dependable income stream.
In the case of Capital Appreciation Bonds, investors can earn a substantial amount of interest over a long period of time through compounding while still enjoying the relatively safe investment of general obligation bonds.

How Does an Educational District Pay Back the Borrowed Principal Plus Interest on Bond Sales?

People pay back the principal and interest on car loans, school loans, and mortgages using their income. Educational districts pay back the principal and interest on bonds using their “income,” that is, taxes collected from property owners in the district.

After a school district or community college district borrows money by selling bonds for construction, it informs the county auditor and county treasurer/tax collector. Based on the assessments of property value determined by the county assessor, the county treasurer calculates the appropriate tax rate and generates individual tax bills for owners of property such as houses, farms, apartment buildings, commercial buildings, manufacturing facilities, business infrastructure, and undeveloped land. A specific rate and tax for each bond measure is listed on the tax bill.

These taxes are called ad valorem taxes. Ad valorem is Latin for “according to worth” and indicates that taxes are levied (imposed) on property owners in proportion to the assessed value of their property.

Does Renting or Leasing Mean That You Don’t Pay for Educational Construction or the Cost of Borrowing Money for It?

Households that rent property or businesses that lease property do not pay property taxes directly. However, it is not true to claim or think that renters or lessees don’t have to pay for educational construction and the costs of borrowing money to pay for that educational construction. Property owners can and do incorporate the cost of their property taxes into their rents or leases. Bond sales by a school or college district may result in higher rent.

Technical Definitions of Bonds

Notice that the common term in all of these definitions is debt. When a school or college district sells bonds, it borrows money from investors and must pay them the money back over time, with interest.

Table 10: Technical Definitions of Bonds
SourceDefinition
California Education Code Section 15140.5 (added to law by Assembly Bill 182 in 2013)Evidence of indebtedness payable, both principal and interest, from the proceeds of ad valorem property taxes that may be levied without limitation as to rate or amount upon property subject to taxation by the governing board of the school district or community college district.
Glossary on the Municipal Securities Rulemaking Board (MSRB) websiteThe written evidence of debt, which upon presentation entitles the bondholder or owner to a fixed sum of money plus interest. The debt bears a stated rate(s) of interest or states a formula for determining that rate and matures on a date certain.
U.S. Securities and Exchange Commission website definition of municipal bondsDebt securities issued by states, cities, counties and other governmental entities to finance capital projects, such as building schools, highways or sewer systems, and to fund day-to-day obligations. Investors who buy municipal bonds are in effect lending money to the bond issuer in exchange for a promise of regular interest payments, usually semi-annually, and the return of the original investment, or “principal.” The date when the issuer repays the principal, the bond’s maturity date, may be years in the future. Short-term bonds mature in one to three years, while long-term bonds generally will not mature for more than a decade. 
Internal Revenue Service Tax-Exempt Governmental Bonds Compliance Guide description of municipal bondsTax-exempt bonds are valid debt obligations of state and local governments, commonly referred to as “issuers” - the interest on which is tax-exempt. This means that the interest paid to bondholders is not includable in their gross income for federal income tax purposes. This tax-exempt status remains throughout the life of the bonds provided that all applicable federal tax laws are satisfied…Governmental bonds are tax-exempt bonds issued by a state or local government, the proceeds of which are generally used to finance activities or facilities owned, operated, or used by that or another government for its own purposes. This can include financing the building, maintenance, or repair of various types of public infrastructure such as highways, schools, fire stations, libraries, or other types of municipal facilities.

Sources

“Statement on Making the Municipal Securities Market More Transparent, Liquid, and Fair,,” U.S. Securities and Exchange Commission, February 13, 2015, accessed June 28, 2015, www.sec.gov/news/statement/making-municipal-securities-market-more-transparent-liquid-fair.html

“Letters to Congress/Administration,” National Association of Bond Lawyers, accessed June 28, 2015, http://registration.nabl.org/about/Governmental-Affairs/Tax-Reform-Resources/Letters-to-Congress-Administration.html

California League of Bond Oversight Committees (CalBOC) www.calboc.org

Reuters “MuniLand” blogger Cate Long blogs.reuters.com/muniland/

The Bond Buyer www.bondbuyer.com

Municipal Securities Rulemaking Board (MSRB) www.msrb.org

Board of Governors of the Federal Reserve System – Data Releases, June 11, 2015, accessed June 28, 2015, www.federalreserve.gov/releases/z1/current/z1r-4.pdf