In New Year, court could usher in dramatic reform on California’s pension front

Sacramento

When it comes to California’s underfunded pension system and to its root cause – the excess power of public-employee unions – we’ve gotten used to the same old story every year. The pension funds go deeper into debt, public services are cut and taxes are raised to make up for past shortfalls. Reformers stand on their soap boxes and warn about the troubling fiscal fundamentals, but the pension funds and union-allied politicians treat these folks like Cassandras.

This has been going on for 19 years, since the time the California Public Employees’ Retirement System helped push through a 50-percent retroactive pension increase for the California Highway Patrol. That deal spread across the state faster than a rumor of a newfound pension-spiking gimmick spreads around a union break room. CalPERS said it wouldn’t cost taxpayers a dime, but never figured that the stock market might drop like a rock. Oops.

Yet no matter how prescient have been the reformers’ predictions, nothing changes thanks to the astounding ability of the state to kick spending problems down the road. But there’s reason to believe that 2018 will not be like every other year. This year, a major state Supreme Court battle (Cal Fire Local 2881 v. CalPERS) could, without hyperbole, determine whether California will ever be able to rein in its pension problems – or whether California taxpayers are destined to keep paying more for an ever-declining level of public services.

The case involves something known as the “California Rule.” Nearly every effort to reform the state’s overburdened pension system runs into this rule, which is the main roadblock to reform. This isn’t actually a rule or a law, but a series of judicial interpretations that go back to the 1950s. Basically, the rule forbids government agencies from reducing pension benefits for current employees unless they are offered another benefit of equal or greater value. We’re not talking about reducing pension benefits that these workers already have accrued, but reducing benefit accruals going forward – i.e., starting tomorrow.

In the private sector, such reductions happen all the time. This writer had a small defined-benefit pension at a company where he worked. The company could no longer afford it, so it eliminated the benefit in the future. Nothing was taken from me, as the company made good on all past and current promises. I still liked the job, so I continued to work there even though the new retirement benefit was no longer as generous as it had been. Such is life.

This reduction isn’t allowed for public employees thanks to the longstanding California Rule interpretations. Once the Legislature or a City Council approves a benefit increase (such as that 50-percent retroactive giveaway) it must legally be paid until the retiree and her spouse pass away. There is no paring it back under any circumstances. Ever.

You can see where this poses a problem, especially as funding levels fall below 70 percent, unfunded liabilities hit hundreds of billions of dollars, and cities slash services and raise taxes to pay for an endless torrent of fee increases imposed by CalPERS to make up for the shortfall. For example, efforts such as San Jose’s 2012 Measure B pension reform would have put its employees in a less-generous pension plan, so it was tossed by the courts – despite its nearly 70 percent approval by voters.

The only remaining option for policy makers is to trim back benefits for new hires only. That’s useful, but new hires won’t retire for many years – thus limiting the ability of such modest reforms to change the trajectory of the pension systems. That’s the current dilemma. Cities are cutting positions and even raising taxes to deal with soaring costs. There’s really nothing else they can do unless the California Rule is amended and they can reduce future benefits.

In a series of lawsuits, some local groups challenged Gov. Jerry Brown’s Public Employees’ Pension Reform Act of 2013 (PEPRA), which trimmed back benefits for new employees but also eliminated some pension-spiking gimmicks used by current workers. One of those is called “airtime.” Under this scheme, employees can buy fictional future years of service to retire even earlier than they get to retire now. It was supposed to pay for itself, but it was underpriced by as much as 40 percent and it became yet another giveaway.

The unions should have just taken this tiny hit to a widely scorned benefit and moved on, but – fortunately – Cal Fire Local 2881 argued in court that eliminating airtime violated the California Rule. This provides a great chance for the state’s high court to toss that noxious rule in its entirety. Indeed, lower court rulings have concluded that the rule only guarantees a reasonable pension – not a pension that can never be amended to deal with fiscal realities.

The Brown administration’s legal brief to the state high court dismantled the union’s weak argument about airtime by noting that airtime was never meant as an irrevocable, vested benefit. It was granted by statute and could be taken away by statute. Plus, it was always meant to pay for itself. It’s hard to imagine the courts not agreeing with the governor on this particular point. But the big news is the Brown administration’s brief goes further and argues that “not every change in a retirement law constitutes an impairment of the obligation of contracts.” The brief uses language that appears to back changes to the California Rule in general.

At the federal level, the U.S. Supreme Court in the Janus case is likely to toss mandatory unionization in states such as California that require it. That won’t affect pensions directly, but it will undermine the financial power of the state’s public-sector unions, thus reducing their ability to halt reform to the state’s pension system. It’s been many years, but the stars might finally align for pension reformers in 2018.

But Cal Fire Local 2881 v. CalPERS is the state case to watch in 2018. It’s one of three similar cases that is making its way to the state high court, which is waiting for lower court resolution of one of them. The court is expected to consider the matters in several months.

The often-eluded Day of Reckoning – i.e., when California officials have no choice but to fix the pension system to avoid a crisis – probably won’t arrive this year. But there’s a good chance that the foundation will be built for a solution when that day comes. If the court defends PEPRA but doesn’t toss the California Rule, then it will be a missed opportunity. If the court amends the California Rule, then all bets are off – and the mechanism will be in place to fix the problem once California’s leaders finally muster the courage to do so.

Steven Greenhut is contributing editor to the California Policy Center. He is Western region director for the R Street Institute. Write to him at sgreenhut@rstreet.org.