The California Budget Crisis – Causes and Recommendations

December 31, 2012

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By William D. Fletcher

INTRODUCTION

California needs the equivalent of a readable annual report that lets everyone who is interested see how well the state is doing and where it’s headed. Hopefully, this report is a step in that direction. The closest overview available is the State Controller’s Office annual report and reports published by the LAO (Legislative Analyst’s Office).

This report is not trying to make a political statement or promote a specific agenda. The objective is to present the facts and any logical conclusions supported by the facts. The author is a social moderate and a fiscal conservative who is in favor of a social safety net, progressive taxation, and good pay and benefits for public employees. However, we should only promise what we can deliver longer-term. And, we should pay our way now and not burden future generations with excessive debts and unfunded obligations.

California is the “golden state” and should be the leading state in the nation. The state has the largest population and GDP by far. If California were an independent country, it would be the ninth largest economy in the world, slightly smaller that Italy but significantly larger than countries such as Spain, Russia, and India. California is the gateway to the Pacific, the fastest growing region in the world. The state has rich agriculture and other natural resources and is a leader in attracting high-tech investments. The state has an excellent university system, a terrific climate, is the entertainment capital of the world, and is a major tourist destination.

However, our finances are not in order. When analyzing California’s finances, there is a lot of data, but not much information. What is missing – or at least not easily accessible includes:

• Trend analysis, where are we headed?
• A long-term forecast
• Productivity, performance, or competitiveness measurements
• Comparisons to other states
• Total debt, underfunded liabilities, and other obligations

While there are several think tanks analyzing California’s finances, they are largely focused on the micro view, single topics or issues, or complex, in-depth analysis.

Slide01
WHERE ARE WE HEADED?

Where you might think the state is heading depends upon whether you are an optimist or somewhat pessimistic. This diagram is a simple model of the dynamics driving California’s economy. Will higher taxes and a poor business climate retard the state’s growth, keep unemployment high, and increase entitlement spending? Will our debts and underfunded liabilities lead to a financial crisis?

The economist Herb Stein stated “if something can’t go on forever, it will stop.” We just don’t know when or how. Hopefully, this report will give some insights as to how it could end and what needs to be done.

Slide02

This is an attempt to get an overview of the state’s public finances. The state budget only captures about 40 percent of the public spending in the state. In addition to the state government, there are:

• 984 school districts
• 4,772 special districts such as for power generation, flood control, and water conservation
• 57 counties
• 481 incorporated cities

Each of these entities has the ability to raise and spend money from taxes, fees, and other sources and incur debts that must be paid by taxpayers. The state’s finances are complicated and hard to understand. These other government entities are even less visible. Because the numbers on this chart come from several sources, it’s not possible to balance revenues and expenses. However, the numbers do give an idea of the relative size of these organizations. Federal payments are only payments that go to state and local government organizations. The largest single federal grant is for Medicaid. Federal spending that goes directly to citizens and organizations such as Medicare and Social Security payments, student loans, pay and benefits for military personnel and federal government employees in the state are not included.

Slide03

This is another overview of the state’s finances. Most discussion is over the General Fund. The General Fund is that portion of the budget over which the Governor and the legislature have the most control. However, the General Fund is only about 64 percent of the state’s spending and about 27 percent of the total. Proposition 98 directs that about 40 percent of General Fund spending has to go to K through 12 education. Recently, in a process referred to as “realignment” about $6 billion of annual spending has been shifted from the General Fund to Special Funds. This is cost shifting and not a reduction in spending.

Slide04

How are we doing? The state has run deficits since the 2000-01 fiscal year. When times were good and tax revenues were increasing, we spent it all and more. When times were tough and tax revenues were down, we ran bigger deficits.

During good times, pay and benefits were increased and budgets grew making it harder to control or reduce spending during slowdowns and recessions. The state should have a rainy day fund to set aside some money during boom times to cover deficits during lean times. There is legislation to this effect but it has not been effective in setting aside any funds.

Note that in 1999, Governor Gray Davis signed SB400 giving state workers significantly enhanced pensions and granting some retroactive pension increases to retirees. The assumption was that the high investment returns earned by the state’s pension funds would pay for this generosity, $600 million/year at the time, and no additional pension contributions would be required. Unfortunately, this was about a year before the Tech Bubble burst and investment returns fell to earth.

These generous retiree pension and healthcare benefits are taking a larger share of the state’s budget and causing big problems for many cities and counties.

Slide05

In about 1990, the state’s revenues depended on personal income taxes, corporate income taxes, and sales taxes for more or less equal shares of revenue. Since then, the state has increasingly become dependent upon the very volatile income tax for most state revenue. High-income taxpayers (top 10 percent) pay about 80 percent of these income taxes. A significant portion of their income is dependent upon capital gains and other investment income that is very dependent upon changes in the economy. The wealthiest citizens should pay a high share of income taxes. However, this volatility needs to be taken into account when preparing the state’s budgets. Don’t spend it all during good times because it won’t be there in bad times.

Slide06

This volatility has had a big impact on the state’s spending on education and Health & Human Services since the Real Estate Bubble burst in the 2007-08 fiscal year. Spending has been flat to down since the Housing Bubble collapsed.  However, this was after substantial spending increases over the previous ten years.

Slide07

Since the Housing Bubble burst in 2008, General Fund spending was reduced but more than made up for by federal stimulus funds so that total spending has been essentially flat. There hasn’t been any significant reduction in state employment during this period. Locally, about 30,000 teachers lost their jobs, or about ten percent of the state’s teachers. There have also been cuts in public safety and other employees at the county and city level.

Slide08

Due to the passage of Propositions 30 and 39, the state will have additional revenue starting this fiscal year. In addition, the Governor and the legislature have agreed on a number of budget cuts. The state’s economy is improving slowly, but steadily. All are good signs. According to the state’s Legislative Analyst’s Office, there is a good chance that the state will balance its budget this fiscal year, 2012-13, and over the next five years. This will depend upon the Governor and the legislature where the Democrats have a super majority in both houses, having the discipline to control spending. Five months into the current fiscal year, the state has a $2.7 billion deficit according to the Controller’s Office. It will be necessary to wait a few months to see if Propositions 30 and 39 and the improving economy close this gap.

We should probably dismiss the possible effects of going over the “fiscal cliff.” Even if congress and the President let the country go over the edge, they will eventually take actions to soften or eliminate its effects. A potentially bigger concern is implementation of the Affordable Care Act, a.k.a. Obamacare. California has committed to fully implement this program. The ACA is scheduled to be fully implemented in 2014, about a year from now. The ACA’s cost is hard to estimate. For example:

• How many new enrollees will sign up?
• What will be the cost per enrollee?
• Will more employers drop company-provided health insurance in favor of the public option?
• How much of the cost will be covered by the federal government?
• Will cost control measures yield intended results?

Medicaid is already one of the largest expense items in California’s state budget, second only to K-12 education.

Today, California has about 11.0 million enrolled in Medi-Cal, the state’s Medicaid program. There are an estimated 7.1 million uninsured in the state, and it is estimated that about 5.0 million of these uninsured will become eligible for benefits under the ACA.

Slide09

Where’s the balance sheet? What are the state’s total liabilities, including underfunded benefits and entitlements? There isn’t an accurate overview of the state’s total liabilities. Most debt is at the local level and does not show up in the state’s financial statements. The Controller’s Office does attempt to summarize the finances of the counties, cities, school districts, and special districts in annual reports. These reports list revenue, spending and debts but do not comment on any potential problems or required actions.

There are problems at the county and city level with the bankruptcies of Vallejo, San Bernadino, Mammoth Lakes and Stockton. Are these exceptional situations or an indication of a much wider developing problem?

Slide10

The next two charts summarize 2012-13 revenue and spending from the General and Special Funds as reported in the Governor’s Budget Summary for the enacted budget.

General Fund and Special Funds forecast revenues are $11.9 billion more than was raised in 2011-12, a 9.8 percent increase over last year. This includes the additional revenue anticipated by the approval of Propositions 30 and 39.

Slide11

General Fund and Special Funds spending for this fiscal year, 2012-13, is forecast to be about $7.1 billion greater than last year. Bond Fund spending is forecast to be about $1.0 billion less than last year. We can see that K-12 education and Health and Human Services make up the two largest spending categories by far.

Bond fund spending is from bonds issued by the state, not from current income. The interest and principle payments on these bonds is an expense under the General and Special Funds.

Slide12

Demographic trends are not favorable. Retirees, people over 65 years old, are the fastest growing segment of the state’s population by far. As people enter retirement, their earnings and taxes paid go down, and their demands on the state’s services go up, especially for healthcare. For a very long time, California had about five wage earners for every person of retirement age. This ratio is expected to decline to 3.6 wage earners per retiree in 2020, about eight years from now, and to less than 3.0 wage earners per retiree in 2030.

This demographic trend will put a lot of pressure on the state’s finances as retirees pay fewer taxes but require more state services.

California is also losing population through net migration to other states as reported in a recent study by the Manhattan Institute. Since 1990, California has lost about 3.4 million residents to other states. California’s population growth is due to internal growth (births minus deaths) and foreign immigration. Domestically, California has more residents leaving for other states, than those who are choosing to move to California.

The states that are receiving the most former California residents are Texas, Arizona, Nevada, Oregon, and Washington, in that order.

Who cares? Isn’t it a good idea to have lower growth? There will be less demand on the environment, infrastructure, school systems, etc. Unfortunately, there will be fewer taxpayers to pay for the state’s aging population, infrastructure improvements, public employee retirement benefits, and other essential state expenditures. It’s much easier to balance the budget and fund the future if the state has a growing population and economy.

In 1960, New York was the largest state with a population of 16.8 million. California was a close second. Since 1960, over 50 years, New York’s population has only increased about 17 percent to 19.6 million while California’s population has grown 240 percent and Texas’ population has grown 270 percent. Will California’s growth rate stagnate like New York’s going forward? If so, it will be harder to balance the budget and pay for essential services.

Slide13

Another ominous trend is the growing share of the state’s budget being consumed by retiree pensions and healthcare for state employees. There will be increasing crowding out of other essential spending. Controlling pension and retiree healthcare obligations is essential for the future of California’s finances.

STATE-BY-STATE COMPARISONS

How does California compare to other states?

Intitally, the plan was to compare California to Texas, the next largest state. New York and Florida were added to give comparisons of the four largest states and states that have some similarities and important differences in how they are managed. Findings are grouped under several headings: governance, the economy, taxation, finances, K-12 education, higher education, social policies, and the prison system.

Tables for each of these headings summarize the comparisons of these four states. This report will highlight what’s most significant in each table.

What is Texas doing right?

One statistic that is overwhelming is Texas’ job growth. For over 20 years, Texas has led the nation in the creation of new jobs.

Slide14

Two of the other largest states, California and New York, are laggards. Florida was doing well until the Housing Bubble collapsed. Some people dismiss Texas’ job growth as jobs for “hamburger flippers.” This isn’t true. Texas has growing high-tech, energy, and service industries and there is no reason to believe that jobs created in Texas are lower quality than those created in other states. Fast growing Austin, Houston, Dallas, and San Antonio all have abundant high-tech, and high paying service and professional jobs.

Slide15

A recent study of job growth by major city showed Texas having four cities in the top 10. Austin and Houston are the top two cities in the nation for job growth. California had one city, San Jose, barely make the top ten and three cities in the bottom ten: Oakland, Sacramento, and Riverside.

Slide16

California is by far the largest state by population and GDP with almost 38 million residents. California is almost fifty percent larger than Texas, and is twice the size of New York and Florida. Two states are heavily Democratic, California and New York, and two are largely Republican, Texas and Florida. California and New York have high sales and personal and corporate income taxes while Texas and Florida don’t have any personal income tax. California and Texas are both border states with identical percentages of their populations made up of Hispanics.

Slide17

In comparing the governments in each state, it’s interesting to note that Texas and Florida have part-time legislatures. The Texas legislature meets every other year for 90 days and the Florida legislature meets every year for 60 days. The governors of these states can call special sessions of the legislature if needed to deal with a specific issue.

In Texas’ part-time legislature about seventy five percent of the legislators are employed in businesses, farming, or medicine and nineteen percent work as attorneys in private practice. They have day jobs. In California, the legislature is essentially in continuous session and only about eighteen percent of the legislators worked in business or medicine before being elected to the legislature. Most were in government, worked as attorneys, or were community organizers.

Does the Texas legislature’s composition and part-time nature have any relationship to the state’s lower taxes, balanced budgets, or job growth?

Slide18

California has the largest economy by far as measured by GDP. As stated earlier, California’s economy would be slightly smaller than Italy’s if California were a separate country, and larger than the economies of Spain, Russia, or India.

In looking at job growth for approximately the last ten years, California had a net loss of almost 500,000 jobs at a time when Texas added about 1.3 million jobs. If we adjust for California’s larger population, Texas jobs growth equals about 1.9 million equivalent jobs in California. Think about how much better off the people of California would be today if California had approached Texas’ rate of job creation. There would have been more tax revenue, lower unemployment, and lower spending on entitlements.

A big part of the problem is California’s business climate that includes high taxes as well as burdensome regulations and other deterrents to business formation and job growth. Recent surveys show that California ranks very low as a place to do business, dead last in a recent CNBC survey. On the other hand, Texas ranked first in two leading surveys.

It’s not the policy of the governor or legislature to be anti-business. However, it is perhaps the unintended consequence of other actions that raise the cost and complexity of doing business in California. Improving the state’s business climate and promoting job growth has to be the cornerstone of the state’s economic policies.

Slide19

California’s tax burden is significantly higher than Texas or Florida, but lower than New York’s. These statistics are from earlier in the year and do not reflect the higher taxes associated with Propositions 30 and 39.

California’s maximum personal income tax rate is 13.3 percent following voter approval of Proposition 30. California now has the highest income tax rate of all the states. It remains to be seen if this tax increase raises as much revenue as anticipated. It also remains to be seen if this rate increase leads to more high income taxpayers changing their residences and making other changes to reduce their California income tax bill. California’s corporate income tax rate is also the highest of the other three states in the comparison, and is among the highest in the U.S.

It’s interesting to note that California collects more property tax revenue per resident and per home when compared to Texas or Florida even though these states don’t have state personal income taxes as a source of income. The higher cost of housing in California offsets the lower property tax rate dictated by Proposition 13. New York’s property taxes are the highest of these states.

Slide20

This chart shows how each state’s revenues are allocated. Florida and Texas don’t have personal income taxes and rely more heavily on property taxes and sales taxes. Texas doesn’t have a corporate income tax but does have a gross receipts tax that’s applied to businesses in the state.

Slide21

As stated earlier, California has run deficits for over ten years. Texas has been able to take actions to close its deficits and has about $7.0 billion in a rainy day fund. California is expected to balance its budget this fiscal year, 2012-13, but has a year-to-date deficit of $2.7 billion as of the end of November. All four states have high debt burdens and large unfunded obligations for public employee pensions and retiree healthcare. This is a national problem at the state level.

Another concern is that California has the lowest or next to lowest bond rating in the U.S. and has to pay an interest rate premium estimated to be 0.66 percent on its debt. If the state’s budget is balanced this year, and spending is controlled, this low bond rating should improve.

Slide22

California’s per pupil spending for K though 12th grade education has been declining due to budget pressures. On a per pupil basis, California still spends more than Texas and Florida but only about half of what New York spends. California does have the highest paid teachers in the U.S.  Results as measured by 8th grade math and reading tests, a common national metric, show that California is one of the poorest performing states. New York doesn’t do much better even though they spend twice as much per pupil as California, Texas, or Florida. Studies have shown that per pupil spending does not correlate closely with improved educational outcomes. California needs school reform as well as increased spending on K-12 education.

Slide23

It’s widely known that state funding for higher education in California has been reduced, costs are up, and tuition and fees have increased to close the gap. One striking fact is that there are now as many administrative personnel as there are faculty in both the University of California and California State University systems. For example, the California State University system has 12,019 faculty positions, whereas there are 12,183 administrative positions, and the University of California system has 8,669 faculty positions, and 8,822 administrative positions. Is this a sign of a growing bureaucracy and unnecessary cost increases? Could we deliver quality education for less if we really tried?

Slide24

An often-quoted statistic is that California has about twelve percent of the U.S. population but about thirty three percent of those on public assistance. This is due to California’s more relaxed eligibility requirements for TANF, Temporary Assistance for Needy Families. California didn’t adopt the national guidelines established under President Clinton’s welfare reform legislation. If California followed national guidelines, the state would have about 870,000 fewer people receiving benefits.

California also has the highest percentage of its population on Medicaid of any state, about 30 percent. This is partly due to the fact that more children are enrolled. However, California’s Medicaid reimbursement rate is the lowest in the U.S. California’s reimbursement rate is about half the Medicare rate, compared to a national average of about seventy percent. If you are a California resident dependent upon Medicaid, can you find a doctor who will accept you as a patient?

Slide25

California’s prison system is very expensive both relative to other states and relative to other state expenditures. California spends almost as much on its prison system, $8.9 billion, as on its university system, $10 billion. California’s cost per inmate is twice that of Texas and Florida.

Slide26

HOW DOES IT END?

Has California passed a tipping point? Is it still possible to make reasonable changes to stimulate growth of the economy, control spending, reform entitlements, and improve California’s debt ratings? Or, have we reached a point where external forces will dictate solutions to the states’s problems such as a bankruptcy court, reluctant lenders, or voters through the initiative process?

Slide27

There isn’t enough information to make a specific forecast. Instead, two future scenarios have been defined, one rosy or optimistic, and one that’s not so rosy. These scenarios are to illustrate the possible outcomes facing the state. The reader can choose one of these scenarios or something in between.

We should be cautiously optimistic but recognize that there is the potential for a bad outcome. It would probably show up as continuing deficits at the state level, and more bankruptcies at the county and city level.  Growth of the economy, job creation, and business formation could also stagnate, along with the number of high income taxpayers.  There is also the potential for a pension and retiree health care crisis if underfunded pension funds continue to earn less than the assumed 7.50 percent per year and retiree benefits absorb an increasing share of tax revenues. If we increased K-12 funding, how much would actually make it to the classroom?

RECOMMENDATIONS

What needs to be done? Specific actions are for the Governor and legislature to work out. This report will focus on the three big issues that need to be addressed:

1. Improve the state’s business climate and get the economy growing faster.
2. Control spending and balance the budget.
3. Reform state employee retirement programs to reduce costs and avoid a crisis.

Grow the economy:

As James Carville famously said “it’s the economy, stupid.” California must improve its business climate to grow the economy faster because:

Growing the economy is the best way by far to increase the state’s tax revenues.

Growing the economy is the only way to reduce unemployment and create the new jobs needed for the state’s high school and college graduates.

Growing the economy also reduces entitlement spending and the number of people who depend upon government programs.

Balance the budget:

California must also balance its budget and start paying down debt to improve its bond rating. Propositions 30 and 39 plus steady but slow growth of California’s economy will increase tax revenues, at least short-term. However, spending increases can easily overwhelm any increase in revenue. Today, the Democratic Party controls the state’s government. All state-wide political offices are held by Democrats. In addition to a Democratic governor, Democrats have a super majority in both houses of the state legislature. They have complete control of the state’s finances. It will be a big test of the Governor and the legislature to show the self-discipline needed to keep the budget in balance, and deal with other financial problems such as the state’s bond rating and needed entitlement reforms.

The voter-approved tax increases in Propositions 30 and 39 should increase revenue. However, it remains to be seen if this revenue equals what is anticipated from these tax increases. It also remains to be seen if California’s even higher taxes will, over time, further discourage new business formation and cause high income taxpayers to move their residences to other states and take other actions to decrease their taxable income.

Reform retirement programs:

The state needs to reform state employee pension and retiree healthcare benefits. Pension and healthcare benefits are already crowding out other state spending and forcing some cities into bankruptcy. These benefits shouldn’t be blamed totally for these bankruptcies but they are a major contributor. Pension plans at the state and local level still assume that their investment returns will be the 7.50 percent/year needed to adequately fund future benefits. Actual results for the past 10 years are much lower and pension plans are underfunded. If there isn’t a dramatic and permanent increase in investment returns, then the state is digging a big hole in the form of underfunded pension plans. Retiree healthcare benefits are less expensive than pensions but are significant. Also, most healthcare benefits are not funded and are paid out of current income.

If the state has to eventually admit that pension funds’ investment returns are less than current assumptions, then there will be a very big hole to fill. There is also the issue of fairness. Who should pay for any shortfall? Should current taxpayers be responsible for underfunding that occurred over the past ten or twenty years? Would these generous pension and health care benefits have been awarded in the first place if there was an honest accounting of the cost?  Also, how long will voters be willing to support public employee pay and benefits that are more generous than those available in the private sector?

One final thought is that we the voters are responsible for the government we have and are ultimately responsible for California’s success or failure.

*   *   *

About the author:
William (Bill) Fletcher retired as Senior Vice President at Rockwell International. During most of his time there he was responsible for 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 oganizations dealing with national security and international relations. The author retains all rights to the text and charts in this report.  He can be reached at cafinances@cox.net.

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Sources:
The following is a list of the main sources used in preparing this report.

Governor’s Enacted Budget 2012-2013
California State Controller’s Office
California Legislative Analyst’s Office
U.S. Census Bureau
Bureau of Labor Statistics
Bureau of Economic Analysis
State Budget Crisis Task Force
Manhattan Institute
U.S. Energy Information Administration
State Budget Solutions
PEW Center on the States
Tax Foundation
California Tax Reform Association
California Budget Project
Reason Foundation
Stanford Institute for Economic Policy
California Policy Center
California Progress Report
California Common Sense
League of California Cities
National Right to Work Foundation
CalWatchDog
CNBC’s America’s Top States for Business 2012
New York Times
Forbes
Wall Street Journal
Orange County Register
Los Angeles Times
USA Today
The Business Journals
The Taxpayers Network
Wikipedia.com
Google.com
About.com

Costa Mesa, California – City Employee Compensation Analysis

October 3, 2012

If San Jose and San Diego are ground zero for the grassroots battle to reform public sector pensions – in California at least – then Costa Mesa may be ground zero for an even broader public sector reform agenda. Because the city council in Costa Mesa has a majority of members who have been involved in a protracted and bitter fight with the public sector unions representing their employees, trying to restore financial sustainability not only to their pension benefits, but the entire package of employment compensation and work rules.

After already reporting on the total compensation packages enjoyed by the employees of San Jose (ref. “San Jose 2011 Compensation Analysis,” August 10, 2012), and Anaheim (ref. “Anaheim 2011 Compensation Analysis,” August 29, 2011), it is fitting to perform a similar analysis for the city of Costa Mesa.

The methods employed in this study mirror those used in the two prior studies. The format in which we analyze and report the data also closely follows that of the earlier studies. The source data was a spreadsheet showing compensation by category for every employee in Costa Mesa. The original spreadsheet, along with tabs that have been added to perform the necessary analysis, can be downloaded and reviewed by clicking on this link: Costa_Mesa_Total_Employee_Cost_2011.xlsx. The original spreadsheet is on the tab designated “original.” The only alteration that we have made to the original spreadsheet provided by the city of Costa Mesa’s payroll department was to delete the names of the employees in order to respect their privacy. Their job titles and departments have been retained, along with all available details regarding their compensation.

The goal of this study is to report average and median annual income for Costa Mesa’s full time city employees by department. Here is a summary of the key assumptions:

    • In order to develop representative averages, employees who retired or were terminated during the calendar year were not considered in the calculation.
    • Similarly, employees who were classified as part-time were not included in the calculation. This included city council members and their assistants, recreation staff, and other interns and part-time employees. The first three columns added on the “analysis” and “median” tabs of the spreadsheet clearly indicate which employees were excluded from the calculations based on these criteria.

Table #1 provides a summary by department of both the number of employees in each department and their average pay. As can be readily ascertained, the average base pay is highest, at $100,469 per year, for the 133 full time police officers, closely followed, at $98,372 per year, by the 76 full time firefighters. But base pay doesn’t tell the whole story, because Costa Mesa pays an unusually high percentage of its compensation before benefits in the form of “other pay,” which not only includes overtime, but also “certification” pay and “specialty” pay, along with other less significant sources of income. For example, the average payout of $56,395 in annual “Other Pay” on Table #1 for Costa Mesa’s firefighters included, on average, $44,810 of overtime pay in 2011.

It is clear from reviewing Table #1 that “Base Pay” would be a highly misleading number to report as representative, even for current year earnings. Because as can be seen, the current pay earned in 2011, when base pay and “other pay” are combined, averaged $128,650 for Costa Mesa’s police officers, $154,767 for their firefighters, and $80,327 for the 216 full time employees comprising the rest of their workforce. But no analysis of an employee’s true earnings is complete without taking into account the employer paid costs for their current health benefits, as well as the employer paid current year costs to fund their retirement benefits.

When the cost of benefits are included, as can be seen, the average total compensation in 2011 for Costa Mesa’s police officers was $181,709, for their firefighters it was $208,401, and for the rest of the workforce it was $103,755. When the payroll records for employees of all departments are consolidated, the average total compensation for an employee of the city of Costa Mesa in 2011 was $146,863.

Table #2 compares average to median total compensation for employees of the city of Costa Mesa. This comparison is important because an average, which merely divides the payroll for an entire department by the number of employees working in that department, can potentially be skewed upwards due to the presence of a small and unrepresentative handful of highly compensated managers. To determine whether or not this is the case in Costa Mesa, we calculated the median total compensation for the police department employees, the fire department employees, and all other employees. Because a properly calculated median compensation amount must have an equal number of individuals making more than the median as those making less than the median, when the median is significantly less than the average, you may infer that the average is unrepresentative of the typical employee.

As it turns out, however, in Costa Mesa the average total compensation for police only exceeds the median by 3%, for firefighters by 2%, and for the rest of the workforce, by 9%. Interestingly, because about 50% of the employees are police or firefighting personnel, who are compensated at a significantly higher rate of pay than the rest of the workforce, the total workforce comparison between average and median total compensation comes to within a half of one percent – virtually identical. Clearly the average total compensation figures developed in this analysis are not being skewed by the presence of highly compensated members of city management.

Table #3 examines Costa Mesa’s base pay averages compared to U.S. Census figures reporting average base pay for employees of local governments in California in 2010 (the most recent year of data available, ref. CA Local Government Payroll 2010). As can be seen, Costa Mesa’s employees enjoy rates of base pay that significantly exceed the reported averages for local government employees in California.

There are several possible reasons for this, but primary among them is the probability that “other pay” and other categories of direct compensation are not reported to the U.S. Census Bureau as base pay. Costa Mesa’s firefighters, for example, on average received “other pay” of $56,395 each in 2011; the police on average received “other pay” of $28,181 each in 2011. Another reason for the significant difference for the disparity in average individual pay for the entire workforce is because U.S. Census data shows a much lower percentage of police and firefighters working for local governments in California in general compared to Costa Mesa in particular. Since, in general, police and firefighters receive far greater average compensation than all other employees, this pulls Costa Mesa’s averages way up.

What appears unlikely as an explanation for this disparity, however, is that Costa Mesa actually has unusually high rates of pay for their city employees compared to other cities in California, as indicated by our recently published analyses of San Jose and Anaheim’s payroll and our examination of payroll for several other California cities and counties.


Table #4 shows how total compensation breaks down between base pay and direct overhead, which must be included in any calculation of how much an employee actually makes. Direct overhead refers to all benefits enjoyed by the employee that are paid for by the employer, including insurance premiums, payments to fund future retirement pensions and retirement health benefits, and any other employer paid benefits, such as accrued vacation reimbursement, accrued sick leave reimbursement, tuition reimbursement, housing allowance, uniform allowance, car allowance, etc.

The idea that total compensation, including benefits, must be what one uses when comparing public sector rates of pay to private sector rates of pay should be beyond serious debate. As any self-employed individual understands all too well, the difference in their case between total compensation and base pay is zero. Any benefits they enjoy, they pay for themselves.

To better understand the relationship between base pay and total compensation, Table #4 calculates payroll overhead as a percent of base pay, by treating the total employer paid benefits as the numerator, and base pay as the denominator. As can be seen, the overhead, i.e., the employer paid benefits as a percent of base pay, for employees of the city of Costa Mesa, varies between 29% and 41%. As the next table will demonstrate, this significantly exceeds the rate of payroll overhead paid under even the most generous plans available in the private sector.


Table #5 calculates what the total compensation would be for the average private sector worker in Costa Mesa, using two exceedingly generous assumptions: (1) Base pay is assumed to be the average household income for Costa Mesa (ref. City-Data.com, Costa Mesa), and, (2) payroll overhead is assumed to comprise the best set of employer provided benefits available anywhere. Since more than one wage earner occupies the typical household, and since only about 20% of all employers (if that), offer benefits this rich, we are clearly overstating how much the private sector worker in Costa Mesa actually makes. And yet, even using these absurdly generous assumptions, the total compensation for the average employee working for the city of Costa Mesa exceeds that of a private sector resident of Costa Mesa by 82%, nearly twice as much.

No discussion of public sector employee total compensation is complete without a mention of pension benefits, which must be pre-funded during the years an employee works. Currently the city of Costa Mesa pays 20.3% of their total compensation budget into pension funds. Put another way, as a percent of base pay, Costa Mesa contributes 34.4% into pension funds. Costa Mesa’s employees contribute via payroll withholding an additional 3.8 percent of their total compensation (6.4% of their base pay) to their pensions. But as we prove in our study “A Pension Analysis Tool for Everyone,” which includes a downloadable Pension Analysis Model, for every 1.0% that a pension fund’s long-term rate of return goes down, the annual contribution to the pension fund must go up by 10% of base pay. Because the pensions are currently underfunded, and because pension benefits are being accrued or paid out to employees who are about to retire or have already retired, this rough estimate of how much more payments will rise per each 1.0% drop in returns is definitely on the low side.

To refrain a passage from our recent studies of San Jose and Anaheim’s city payroll, to properly assess how much Costa Mesa’s city employees really make in total compensation, one needs to rebuke the preposterous notion that pension funds will reliably earn 7.5% per year for the next several decades, and instead assume they will only earn somewhere between 3.0% and 5.0% per year. CalPERS themselves discount pension liabilities at a rate of 3.8% for any participant who wants to opt out of their program, a telling indication of what they consider the “risk free” rate of return. At a 3.8% rate of return, you would have to increase the average total compensation for the typical employee of the city of Costa Mesa from the current $146,863 per year to around $175,000 per year. The typical firefighter’s pay would have to increase from the current $208,401 average per year to around $250,000 per year.

It is important to emphasize that the employment packages Costa Mesa has awarded their unionized city workforce are not unique. In much larger cities, San Jose and Anaheim, analysis of original and comprehensive payroll data has yielded very similar results:

San Jose: Average total compensation, all workers = $149,907
Anaheim: Average total compensation, all workers = $146,551
Costa Mesa: Average total compensation, all workers = $146,863

Workers employed by local governments in California are earning total compensation that averages about $150,000 per year. And this is without taking into account the looming impact of lower earnings forecasts from the pension funds. It is in this context that the ongoing debate between Costa Mesa’s union representatives and Costa Mesa’s elected officials must be viewed. By any objective analysis, Costa Mesa’s city employees earn more than twice as much as the local residents they serve.

Journalists who dutifully report “base pay” rates for city workers that sound somewhat high, but not ridiculously unreasonable, are ignoring glaring facts about compensation: (1) “Other pay” now adds more than 50% to the current earnings of many city workers, and (2) The only honest measure of how much someone earns is their total compensation, i.e., everything the employer pays each year in direct pay and benefits for an employee. That is what they earn. That is what they cost taxpayers. That is the number that should be compared to what taxpayers themselves earn. In Costa Mesa, the average employee’s total compensation of $146,863 adds 69% on top of their base pay. This is real money, and journalists who continue to ignore total compensation statistics in favor reporting only base pay are doing their public a disservice.

Conversely, the elected officials in Costa Mesa who are making these statistics transparent, and are attempting to bring their city’s employee compensation packages into parity with private sector norms, are blazing a trail that other elected officials must follow if California’s cities and counties are to avoid bankruptcy.

Anaheim, California – City Employee Compensation Analysis

August 29, 2012

Earlier this year the California Policy Center obtained from the city of Anaheim a comprehensive record of all payroll-related disbursements for 2011. This information was provided in the form of a spreadsheet that provided compensation details for every full and part-time employee of the city of Anaheim during 2011.

We performed subsequent analysis in order to develop total compensation averages per department. The spreadsheet provided by Anaheim’s payroll department, unaltered, can be found on the “original” tab of the larger downloadable spreadsheet, available for review, at this link: Anaheim_Total_Employee_Cost_2011.xlsx. The only data that has been deleted are the names of the individuals working for the city, in the interests of protecting their privacy. Their job titles, departments, and all other details of their compensation have been preserved.

The methodology we employed to properly develop average and median total compensation figures per department is relatively simple, and is modeled after an earlier CPPC study, published on August 10, 2012, that analyzes 2011 compensation by department for employees of the city of San Jose. In that study, entitled “San Jose, California – City Employee Total Compensation Analysis,” the reader will find a very thorough explanation of all assumptions made, assumptions that were precisely replicated in this analysis. Here is a summary of the key assumptions:

    • In order to develop representative averages, records for employees who were designated as “part-time” in their job descriptions were not included in the calculation.
    • Similarly, employees whose annual base pay was lower than the minimum annual base pay for their job description, as documented in the “City of Anaheim Pay Rates” available on the city website, were assumed to have not worked a full year, either because they were hired after January 1st, 2011, or because they retired or otherwise left service with the city before December 31st, 2011. These employee records were also not included in the calculation of average rates of compensation.

Table #1 provides a summary by department of both the number of employees in each department and their average pay. As can be readily ascertained, the average base pay is highest, at $118,373 per year, for the 24 full time employees of the City Attorney department. They are followed, at $102,029 per year, by the 17 employees of the City Administration. When the cost of benefits are included however, the 257 employees of Anaheim’s fire department have the highest average total compensation, at $193,516 per year. In terms of total compensation, the fire department is followed the 24 employees of the City Attorney’s office at $180,042, then the 523 employees of the police department at $170,866. As a whole, Anaheim’s full time workforce’s average annual base pay is $84,158, and their average total compensation is $146,551.

Table #2 compares average to median total compensation for employees of the city of Anaheim. This comparison is important because an average, which merely divides the payroll for an entire department by the number of employees working in that department, can potentially be skewed upwards due to the presence of a small and unrepresentative handful of highly compensated managers. To determine whether or not this is the case in Anaheim, we calculated the median total compensation for the police department employees, the fire department employees, and all other employees. Because a properly calculated median compensation amount must have an equal number of individuals making more than the media as those making less than the median, when the median is significantly less than the average, you may infer that the average is unrepresentative of the typical employee.

As can be seen, however, the median income for police employees is actually higher than the average, meaning that if anything, the average total compensation is unrepresentative of the typical officer because it is too low. In the case of Anaheim’s firefighters, the median and the average are almost exactly the same, strongly suggesting that the average total compensation is entirely representative of a typical firefighter’s pay. And even for the rest of the workforce, the average only exceeds the median by 11%. Clearly the average total compensation figures developed in this analysis are not being skewed by the presence of highly compensated members of city management.

Table #3 examines Anaheim’s base pay averages compared to U.S. Census figures reporting average base pay for employees of local governments in California in 2010 (the most recent year of data available, ref. CA Local Government Payroll 2010). As can be seen, Anaheim’s employees enjoy rates of base pay that significantly exceed the reported averages for local government employees in California. There are several possible reasons for this, but primary among them is the likelyhood that “other pay” and other categories of direct compensation are not reported to the U.S. Census Bureau as base pay. Anaheim’s firefighters, for example, on average received “other pay” of $29,776 each in 2011; the police on average received “other pay” of $17,827 each in 2011. Another reason for the significant difference is because U.S. Census data shows a much lower percentage of police and firefighters working for local governments in California than Anaheim. Since, in general, police and firefighters receive far greater average compensation than all other employees, this pulls Anaheim’s averages way up. What appears unlikely as an explanation for this disparity, however, is that Anaheim actually has unusually high rates of pay for their city employees compared to other cities in California, as indicated by published analysis of San Jose’s payroll and our examination of payroll for several other California cities and counties.

Table #4 shows how total compensation breaks down between base pay and direct overhead, which must be included in any calculation of how much an employee actually makes. Direct overhead refers to all benefits enjoyed by the employee that are paid for by the employer, including insurance premiums, payments to fund future retirement pensions and retirement health benefits, and any other employer paid benefits, such as accrued vacation reimbursement, accrued sick leave reimbursement, tuition reimbursement, housing allowance, uniform allowance, car allowance, etc.

The idea that total compensation, including benefits, must be what one uses when comparing public sector rates of pay to private sector rates of pay should be beyond serious debate. As any self-employed individual understands all too well, the difference in their case between total compensation and base pay is zero. Any benefits they enjoy, they pay for themselves. To better understand the relationship between base pay and total compensation, Table #4 calculates payroll overhead as a percent of base pay, by treating the total employer paid benefits as the numerator, and base pay as the denominator. As can be seen, the overhead, i.e., the employer paid benefits as a percent of base pay, for employees of the city of Anaheim, varies between 48% and 56%. As the next table will demonstrate, this is more than twice the rate of payroll overhead paid under even the most generous plans available in the private sector.

Table #5 calculates what the total compensation would be for the average private sector worker in Anaheim, using two exceedingly generous assumptions: (1) Base pay is assumed to be the average household income for Anaheim (ref. City-Data.com, Anaheim), and payroll overhead is assumed to comprise the best set of employer provided benefits available anywhere. Since more than one wage earner occupies the typical household, and since only about 20% of all employers (if that), offer benefits this rich, we are clearly overstating how much the private sector worker in Anaheim actually makes. And yet, even using these absurdly generous assumptions, the total compensation for the average employee working for the city of Anaheim is more than twice that of a private sector resident of Anaheim.

No discussion of public sector employee total compensation is complete without a mention of pension benefits, which must be pre-funded during the years an employee works. Currently the city of Anaheim pays 17.3% of their total compensation budget into pension funds. Presumably some additional percentage is paid by the employees via payroll withholding. But as we prove in our study “A Pension Analysis Tool for Everyone,” which includes a downloadable Pension Analysis Model, for every 1.0% that a pension fund’s long-term rate of return goes down, the annual contribution to the pension fund must go up by 10% of base pay. Because the pensions are currently underfunded, and because pension benefits are being accrued or paid out to employees who are about to retire or have already retired, this rough estimate of how much more payments will rise per each 1.0% drop in returns is definitely on the low side.

To properly assess how much Anaheim’s city employees really make in total compensation, therefore, one needs to rebuke the preposterous notion that pension funds will reliably earn 7.5% per year for the next several decades, and instead assume they will only earn somewhere between 3.0% and 5.0% per year. CalPERS themselves discount pension liabilities at a rate of 3.8% for any participant who wants to opt out of their program, a telling indication of what they consider the “risk free” rate of return. At a 3.8% rate of return, you would have to increase the average total compensation for the typical employee of the city of Anaheim from the current $146,551 per year to at least around $190,000 per year. The typical firefighter’s pay would have to increase from the current $193,516 average per year to at least around $235,000 per year.

It is the obligation of journalists reporting on government budget deficits, as well as policymakers who face these challenges, to produce analyses of this nature for the cities and counties where they report or where they serve. Municipal payroll data is publicly available and the techniques necessary to perform this analysis are not beyond the abilities of anyone with an intermediate command of Excel. It is unconscionable to report on negotiations over furlough days, foregone cost-of-living adjustments, deferred benefit enhancements, or any other details relating to the eternal bargaining between public sector unions and politicians attempting to manage municipal budgets, without providing the overall context. How much do public employees really make in total compensation? How much will they make if their retirement benefits are prefunded at realistic rates of investment return? Anaheim and San Jose are but two examples, and they are likely typical of nearly every other city and county in California.

San Jose, California – City Employee Total Compensation Analysis

August 10, 2012

On June 5, 2012 the City of San Jose thrust itself into the forefront of the national debate over public sector pensions with its passage of Measure B, a landmark measure that dramatically restructured the pension and retirement benefits of the city’s current employees. Though the internal pressure that led to this measure had been building for some time, the passage of this measure was still quite noteworthy in itself. For one, this measure forced city employees to either now contribute much more towards their pension plan or be placed in a pension scheme that offered far fewer benefits than is typically enjoyed by public sector employees in California.

More remarkable, though, was the fact that this measure was passed in one of California’s largest cities and in its most liberal region. For the state’s public sector unions, this was home turf. Yet, Measure B was supported by an overwhelming 69.6% of San Jose voters, by San Jose’s Democrat Mayor, Chuck Reed, who lobbied hard on its behalf, and by a significant portion of the city council. So strong was the public support for this measure that the city’s public sector unions didn’t even seriously attempt to challenge it during the election, and instead looked to the courts as where they would have it overturned.

As to be expected, San Jose’s Measure B has generated a significant amount of discussion and commentary within the nation’s political and legal circles, all of who have taken a keen interest in the outcome of San Jose’s efforts to avoid financial ruin. In an attempt to add to this discussion, we have prepared a detailed analysis of the total compensation packages for all of San Jose’s city employees from payroll data provided directly to us from the City of San Jose. Though it is true that a multitude of causes has contributed to San Jose’s financial predicament, including the real estate downturn and recession of 2008, we will show that the most primary cause of San Jose’s problems is the pension and healthcare benefits they have committed themselves to with their employees. In the paragraphs to follow, we will make this point more evident by detailing the figures we derived from San Jose’s actual payroll report for the 12 month period through 12-31-2011 and the publicly available pension data the city provides on its website.

Method:

Since the primary focus of this analysis is how the city’s employment costs have affected its financial stability, we first requested and obtained a copy of the city’s payroll report that listed all of actual expenditures for each employee for the entire year 2011, separated by department. During this period, the City of San Jose employed 7,752 workers. In order to get as precise of a reading as possible for our analysis, we made sure to have the city separate and identify all of the expenditures for each employee (e.g., salary, overtime, cash benefits, sick pay). This allowed us to get a better idea of what types of benefits the employees were able to obtain and what the average employee was getting for each of these types of benefits. The payroll report we obtained also showed each type of deduction taken from each employee’s paycheck, such as health insurance, pension contributions, etc. Of course, all of these figures varied from department to department, so we were careful to separately analyze all of the workers by department.

In the interests of both making our research as transparent as possible, and also to provide a detailed example for anyone wishing to perform this analysis for their community, we have uploaded the Excel file used for this analysis. Anyone who would like to look at the data is encouraged to download this file onto a computer equipped with Excel 2010. The reader will note that the spreadsheet has two primary tabs, the “original” which is what we received from the City of San Jose’s payroll department, and the “analysis,” which retains everything in the original, but has a few additional columns added that allowed us to screen out part-time and partial year workers. The only data we have omitted are the actual names of the individuals themselves, out of respect for their privacy. If you download this spreadsheet, San_Jose_Total_Employee_Cost_2011.xlsx, please be aware that it is over 3.0 megabytes.

To avoid skewing our averages, we had the city identify all the employees who retired during 2011. We also worked with the city to identify all employees who worked on either a part-time basis or for less than a year so we could exclude them from our primary computations. The assumption we made to screen out part-time employees was simply to sort the payroll records by job title and flag any record where the job title included the words “temporary,” “intern,” or “part-time (ref. column B of analysis).” The assumption we made to screen out partial-year employees was to sort the payroll record by job title, then by base salary, and flag all records where salaries that fell below the minimum base salary for that job title (ref. column C of analysis).

This process, while time consuming, is an accurate way of making certain that employees who only worked a partial year didn’t have their necessarily lower salaries included in the average. Since the city also provided data on who retired during 2011 (ref. column P of analysis), we were able to correlate our analysis based on base salary comparisons with that data and found it was a nearly perfect match. Those employees who did not retire, yet had lower base salaries than the minimum for their job title were assumed to be employees newly hired or newly promoted to that job classification. Because we used the minimum salary for our criteria, this exercise still understates the impact of partial year employees on the average. Our reference for this information, “City of San Jose Pay Plan,” is posted on the city’s website.

The importance of this step became apparent when we compared the averages for all categories of compensation before and after excluding part-time and partial year employees. The only average that didn’t rise considerably once part-time and partial year employees were excluded was the sick and vacation payoffs, which will be discussed in the findings section of this analysis.

Lastly, we carefully verified all of our assumptions about this data by reviewing the labor agreements (MOUs) and other payroll documents that San Jose provides through their website. We also had several discussions with members of San Jose’s Human Resources and Payroll Departments. In all of our requests and questions, we found these employees to be very gracious and accommodating, and their assistance proved to be wholly invaluable to our efforts.

Findings:

The first thing to note was the degree to which base pay is not an accurate indicator of total compensation. When comparing rates of compensation it is necessary to include all payments made by an employer that directly benefit the employee, including salary and overtime, but also any “other compensation,” “deferred compensation,” the cost for medical benefits, and the cost to contribute annually to the employee’s future retirement benefits, both health insurance and pensions. Table #1 shows the average total compensation for San Jose’s full time employees in 2011, sorted by department:

In Table #1, above, one can readily see that virtually all full time employees working for San Jose enjoy a total compensation of over $100,000 per year. Only the 65 employees who report to City Council members, barely one percent of the workforce, make less than that; their average in 2011 was $94,662 per year. Whenever comparing public sector employee compensation, it is necessary to review the averages for public safety employees separately from the rest of the workforce, because their average compensation is dramatically higher than the rest of the employees. As can be seen, the average policeman in San Jose in 2011 earned total compensation of $178,821, the average firefighter earned $203,098, and the average for all other employees was $120,092.

A frequent criticism of “averages” when discussing California’s state and local employee compensation is that the average includes highly compensated public administrators and therefore skews the data. For this reason, we also have included an analysis of median data, wherein half of all employees make more than the median employee, and half of them make less. For the median calculation, we used the total earnings including city paid benefits, i.e., the total reported compensation of San Jose’s city employees. We excluded, of course, employees who worked part-time or retired during 2011, since that information will also prevent an accurate assessment of what a truly representative median, or average, might be.

As shown on Table #2, for all San Jose city employees, the median total compensation in 2011 was $139,634. For police officers, including the leadership, but also including the data technicians, i.e., all police personnel, the median total compensation in 2011 was $189,411 in 2011. For firefighters, again, including all members of the department, the median total compensation was $205,557 in 2011. And for all full-time employees in San Jose not including police or firefighters, the median total compensation in 2011 was $114,923.

The significance of this fact, that the median total compensation for San Jose’s city workers is nearly identical to their average total compensation, is easily understated. One certainly might say it  proves a commendable level of pay equity exists between the highest and lowest paid positions. And it entirely puts to rest the contention that studies that cite average pay are presenting distorted data because a handful of grossly overpaid executive positions pull the average up to an unrepresentative level. As a matter of fact, for San Jose’s public safety personnel, the median total compensation actually exceeds the average, implying – using this same logic – that the lower echelon positions are actually overpaying.

The impact of “other pay” adds a great deal to total direct compensation on top of base pay. In our subtotals, “Other Pay” includes overtime, sick and vacation payouts, and “other cash compensation,” which is defined by the San Jose’s payroll dept. as “Premium Pays,” “Certification Pays,” “Higher Class Pays,” “Retroactive Pays,” ” Taxable Reimbursements,” “Benefits ‘in-Lieu’ payments,” and “Supplemental Pays.” The fact that this other pay is awarded sporadically, and therefore may not be reported by census respondents as part of their income, could help account for the fact that San Jose’s average payroll is considerably higher than what is reported per department by the U.S. Census Bureau for California’s local government workers.
Table #3 illustrates the degree of this disparity – as can be seen, the full time workplace averages for San Jose’s city workers are fully 39% higher than the averages reported by the U.S. Census Bureau for 2010 for local government workers in California. This point requires emphasis, because when critics who are concerned about potential cases of overcompensation point to U.S. Census data as their proof, they are often accused of exaggerating their figures. In reality, certainly in the case of San Jose, the U.S. Census data significantly understates the average direct compensation.
Not reported by the U.S. Census, but evident in precise amounts from the City of San Jose’s payroll records, are the other elements of total compensation – the employer paid benefits including Medicare, health insurance, retirement pension contributions, and other miscellaneous benefits such as life insurance and disability insurance. A valid way to compare total compensation between San Jose’s city workers and the taxpayers who support them begins by calculating the employer paid benefits, and dividing that amount by the total direct pay. This yields a payroll overhead rate that can be compared to overhead rates that typically apply in the private sector.
In Table #4, all other pay is included in the denominator, making total direct pay the sum of base pay, overtime, and “other pay.” In the case of San Jose’s firefighters, this “other pay” classification (defined earlier) comprises a major portion of total compensation, averaging nearly $15,000 per year.
As can be seen, the major element of employer paid benefits is the retirement pension contribution, averaging over $50,000 per year per police officer and over $60,000 per year per firefighter. Even for the rest of the workforce, over $26,000 per year is being contributed towards their pension every year by the city. And the amount being contributed per year towards health insurance by the city – nearly $12,000 per year for the firefighters, and over $10,000 per year for the police and the rest of the workforce – significantly exceeds private sector norms.
In all, the average total compensation for a worker in the city of San Jose is just under $150,000 per year. Firefighters average over $200,000 per year in total compensation. And their payroll overhead averages 55% per year, 60% for police, 62% for firefighters, and 48% for the rest of the workforce. This payroll overhead represents hard dollar expenditures by the employer, and must be included in any comparison of how much San Jose’s city workers make, on average, compared to how much the taxpayers who pay this are themselves earning.
Table #5 provides an absolute best case average for the compensation earned by the private sector residents of San Jose. For total direct pay, the figure of $76,495 is taken from the San Jose Profile on the website City-Data.com. This figure is the estimated household income for San Jose residents – household income – and is undoubtedly higher than the per worker average since a significant percentage of households have more than one income earner.

Using this obviously best-case amount as the denominator, the table then goes on to apply best-case averages for employer paid benefits, including Medicare at 1.45% per year, Social Security at 6.2% per year, health insurance at $6,000 per year – a very good package for most companies which almost universally require significant employee co-pays via payroll withholding – and a top-of-class 401K retirement plan contribution of 6.0%. As can be seen, even under the best assumptions possible, the payroll overhead for a premium private sector position is only 21% of total direct pay. This is a staggering disparity.

If one simply assumes that only 50% of the households in San Jose have two income earners, the average direct pay reduces from $92,937 per year to $61,958 per year. And even if you apply a 21% payroll overhead rate, which represents a premium, clearly unrepresentative and overstated estimate, you arrive at an average total compensation for San Jose’s private sector taxpayers of $74,969 per year, only half as much as the average for city workers. This private sector average is still probably on the high side. Taxpayers and policymakers must ask themselves, does the premium deserved by city workers for the risks they take and for their greater average educational attainment justify paying them twice as much as the taxpayers they serve?

No discussion of how much city workers make is complete without further discussion of retirement benefits. Immediately upon retirement, for example, San Jose’s city employees typically “cash-out” their sick and vacation time, which is permitted to accrue without limit. This practice is virtually unheard of in the private sector. But in San Jose in 2011, there were 410 employees who retired, and their average sick and vacation time payouts (these figures did NOT figure into the averages reported anywhere else in the preceding analysis) were as follows:

  • 100 police retirees with an average sick/vacation payout of $56,273
  • 72 firefighter retirees with an average sick/vacation payout of $63,306
  • 238 other retirees with an average sick/vacation payout of $28,547

Returning to the issue that impelled the pension reform vote in San Jose is necessary to fully appreciate just how much San Jose’s city workers make. Because the average total compensation of $149,829 earned by these employees is based on their pension fund contributions earning an annual rate of return of 7.5% from now on. This remains the official rate used for projections by San Jose’s pension fund. This is the same rate of return still used for projections by CalPERS and CalSTRS. The pension contribution hikes of recent years have been necessary to make up for sub-7.5% returns in past years, but these increases have not added enough money to the funds to allow sub-7.5% returns from now on. The implications of lower than 7.5% returns are sobering, and should be obvious to anyone who truly appreciates the concept of compound interest.

The California Policy Center has prepared a spreadsheet that anyone wishing to analyze the sensitivity of pension fund contributions to projected rates of return. This information can be found by referring to the study “A Pension Analysis Tool for Everyone.” A quick summary of that study would be this: For every 1.0% the pension fund’s projected rate of return drops, the required pension contribution must go up by 10% of payroll. Put another way, if the direct pay of the average worker in San Jose – not including overtime – is $90,000 per year, and it is, then if San Jose’s pension fund can only return 6.5% per year from now on, the annual pension fund contribution per employee must go up by $9,000. If that fund can only return 5.5% per year, the annual pension fund contribution per employee must go up by $18,000, and so on. In reality, because pension funds are supporting people who are already retired, and employees whose benefits were retroactively increased over the past 10 years – leaving them already underfunded – each 1.0% drop in the projected rate of return has an even greater impact than 10% of payroll. And the irrefutable conclusion that follows is that unless the pension benefits are lowered and the required employee contributions to their pensions are increased, then if long-term rates of return for San Jose’s pension funds drop by at least 2.0%, the total compensation of employees in San Jose is not roughly $150,000 per year, but at least $170,000 per year.

The other pressing obligation that has constrained the city’s long-term financial health is its obligations to cover its retiree’s healthcare benefits. To the extent the City of San Jose is contractually bound to pay a portion of their retired employee’s health insurance premiums, the pre-funding of those costs during the years these employees work is something that, like pension contributions, must be considered part of payroll overhead and must be considered an integral part of their total annual compensation. In our analysis of the payroll data and the MOUs that govern the employee benefits, we were able to confirm that the city and employees each contribute equally towards (1:1) the health care benefit fund for retiree healthcare, and at a rate of 3:1 for retiree dental benefits. Further, any portion of these funds that do not achieve total funding is borne equally by the city and employee alike. This is little comfort for the City’s managers, however, since as of 2011 these funds were only 10% funded.  Although the city has also implemented a plan to achieve full funding for these plans over the course of 30 years through a series of increased contributions which began, at a minute scale, during the 2nd half of 2011, this huge outlay is still a serious impediment affecting the financial stability of San Jose for many years to come. If this obligation were fully funded, proper ongoing pre-funding would add at least a few thousand dollars per year to the average total compensation of every employee working for the City of San Jose. Because, however, San Jose is only beginning to contribute to an adequate reserve for funding retirement health insurance commitments to its retirees, a credible estimate of what it would truly take to move their retirement health insurance fund into a position of 100% solvency is probably many times that amount.

As we have shown in our analysis, the average total compensation for a full time employee with the City of San Jose averages nearly $150,000 per year. If one assumes only a modest drop in pension fund future returns, from 7.5% per year to 5.5% per year, this average total compensation jumps to at least $170,000 per year. If pension fund returns drop more than 2.0% off the current projection, average total compensation will have to go up even more. And retirement health care obligations, while amounting to less in absolute dollars than pension obligations, are significantly underfunded. Bringing them up to solvency will require additional significant increases to the average total compensation. With only modest reductions in pension fund returns, it is clear that the payroll overhead for San Jose’s city workers easily reaches 100%, whereas in the private sector, such overhead rarely exceeds 20%. And our analysis has shown, even absent these reductions in rates of return for the pension funds, and absent any increases to retirement health care pre-funding, the average worker for the City of San Jose makes more than twice as much as the average private sector worker – in an area that boasts some of the highest average rates of private sector compensation in the United States.

It is left to the reader to determine whether or not this is an appropriate level of compensation for the government workers who serve the taxpayers, or whether or not any voter approved contract modification that might reduce such a disparity between private sector and public sector compensation should pass intact through court proceedings.

Understanding the Financial Disclosure Requirements of Public Sector Unions

June 12, 2012

As political scholars and pundits across the nation continue with their post-mortem analysis of the disastrous recall effort against Wisconsin Governor Scott Walker, one charge that has gained a significant amount of traction has been that the recall campaign against the governor was overwhelmed by the amount of “secret and corporate money” that propelled the Walker campaign to victory. [1]

At its core, this claim echoes many of the criticisms that have been directed against the Supreme Court’s decision in Citizens United v. Federal Election Commission in which the Court held that corporations and unions enjoy the same rights of free speech  as those of natural human beings. [2] Whether or not this decision and its laissez-faire attitude towards political speech and campaign finance regulation compromised certain desirable qualities of the electoral process is certainly worthy of a serious and candid discussion. Nevertheless, there is also a great deal of irony in invoking this line of criticism within the context of the Wisconsin recall insofar as the very entities that led the attack against Governor Walker – i.e. the public sector unions of Wisconsin and the larger Midwest- themselves enjoy a level of privacy with regards to their financial affairs that is disproportionately greater than most other private and corporate entities in the United States.

In an attempt to make this point more clear (and the consequences that stem from it more palpable), this article will briefly describe the basic financial reporting requirements that govern public sector unions. Following from this discussion, this article will then detail a few sources of information on the public sector unions and the benefits that are conferred upon their members. To illustrate these methods, the financial positions of several major public sector unions in California will be also be given. In conclusion, this article will consider the nature of this problem in relation to the size and power of these unions and the need for an update to the laws that govern their financial reporting requirements.

Financial Reporting Requirements of Public Sector Unions

In general, public sector unions have very few reporting requirements when it comes to disclosing their financial positions to their members and to the public. This dearth of oversight is a significant contrast from the financial reporting laws that govern private sector unions, most of which impose a much greater level of openness and transparency than is found with public sector unions.

Under federal law, most of the labor unions that represent private sector employees are bound by reporting requirements of the Labor Management Reporting and Disclosure Act (LMRDA), which among other things, requires that they file an annual financial report with the Department of Labor. [3] This law was specifically designed to make the internal workings of the labor unions fully transparent to both their members as well as the public in the hopes that such openness would hinder corruption on the part of union management. [4] This law also applies to unions where an individual chapter or affiliate represents both public and private sector employees. [5] Certain chapters of the IBEW, for instance, fall under the reporting requirements of this law insofar as they have members who are employed by both municipal and private entities. [6]

In most circumstances, a union that is bound by the reporting requirements of this law will have an outside accounting firm conduct an audit of their financial records, and they will then prepare and file either an LM-2, LM-3, or LM-4 form that details their findings. The LM-2 forms are filed by unions who have over $250,000 in annual receipts; the LM-3 form is for unions that have less than $250,000 but more than $10,000 in annual receipts; and the LM-4 forms are for those unions with less than $10,000 in annual receipts. [7] These reports reflect the standard financial metrics typical of any financial statement, such as the union’s assets and liabilities, expenditures, the salaries of the union’s board members and employees, any monetary disbursements made by the union, etc. [8] Although these reports are fairly comprehensive in the data they report on, they only represent a snapshot view of a union’s financial position at the end of the fiscal year, so their application is generally limited in the absence of more extensive information.

The LMRDA also requires that these reports must be made available to all members of the union every year. [9] And in the event that a grievance suit is initiated by a union member concerning the union’s finances or its use of membership dues, the raw data from which the figures in the report are derived (e.g., accounting statements, receipts, etc.,) must also be provided to the complaining party for review upon a showing of just cause. [10]

For unions that are comprised solely of public sector employees, however, federal law does not impose any reporting requirements under the LMRDA or any law similar to it. Instead, they are only required to file a 990 tax form with the IRS, which is the same tax form that is used by most non-profit entities that fall within 501(c) of the tax code and do not claim any income. [11] This form is fairly similar in content to the LM-2/3/4 forms, and all private and public-sector unions alike must file one. But as with the LM-2/3/4 forms, the 990 provides little more than a cursory glance of a union’s financial position at the end of the fiscal year, so their usefulness is fairly narrow.

Under state law, the financial reporting requirements of the public sector unions are more scant than under federal law. In fact, they are almost non-existent. An overwhelming majority of states impose no financial reporting requirements at all upon the public sector unions that operate within their state, and only a very small few actively collect any financial data at all. [12] California, for example, only requires that a yearly financial statement be “made available” to the board of each union and to the individual union members themselves. [13] These reports that are provided to the members of the union are sometimes referred to as Hudson Reports, and like the other various filings that have been discussed, these forms only provide a very basic overview of the union’s financial position at the end of the fiscal year.

In our own discussions with the California Public Employment Relations Board, we were able to confirm that this agency does not actively monitor the financial expenditures of California’s public sector unions. [14] We were even informed that this agency will only collect a union’s financial report upon the filing of grievance complaint. Additionally, it also appears that no other state agency reviews this information either. So for all intents and purposes then, it appears that public sector unions such as the CTA or SEIU 1000, both of whom command tens of millions of dollars in revenue, are free from any significant threat of an audit or internal review of their operations.

Collecting the Data

As we have shown, there are very few available sources of information on the financial data of the public sector unions. However, there are still a number of sources from which fairly solid data on these organizations can be obtained.

From our own experiences, we believe that the most consistent and direct way to gather data on these organizations is to first obtain their 990 forms that they must file each year with the Internal Revenue Service. This can be accomplished by using the databases provided on websites such as guidestar.org or foundationcenter.org. [15] (It does not appear that the Internal Revenue Service provides any sort of database for searching the 990 forms of 501(c) entities). These two sites gather a wide variety of data on non-profit organizations, including their 990s, and they allow their users to search by region, city, net worth, etc. Although these sites generally do not charge anything to run a basic search, they may require an email registration to use their services.

For unions that fall under the reporting requirements of the LMRDA, you can obtain their financial statements (LM-2, et seq.) and other required disclosures through the portal maintained by the Department of Labor at http://kcerds.dol-esa.gov/query/getOrgQry.do. This site is a very useful option as well, and the information it provides often compliments the other sites quiet nicely. The only real limitation with this site, however, is that  financial documents it provides do not offer a very penetrating account of the financial position of the unions it reports on. It is also worth pointing out though that this site also has certain other documents available through this site such as private and public sector collective bargaining agreements. But these documents are not always current, so they are sometimes of little help. [16]

Incidentally, it is also worth noting that it is sometimes possible to obtain financial information and other relevant data on a public sector union from their own website. The website for the Southern California division of the SEIU 721, for instance, provides links to its bylaws, constitution, and current and past financial statements. [17] Although this is atypical of most other unions, it would not be a waste of time to explore this option in the chance that such information is being made available. These sites are can also be extremely useful when reviewing the search results from other sites such as guidestar.org or even Google because they can help delineate each chapter and affiliate. One city may contain several chapters or affiliate unions with similar name, so these sites can provide an invaluable reference point for keeping each entity clearly identified.

Another important and closely related source of information on the public sector unions is the collective bargaining agreements and memorandums of understanding that they enter into with the cities and counties they contract with. In California, all state and local government websites will provide links through their human resources websites to the MOUs and salary/benefit schedules that they have stipulated to under the collective bargaining agreement. These are very helpful to review because they detail the nature and duration of the collective bargaining agreement currently in force between the unions and the municipalities that their members are employed by. These documents are indispensable when conducting a more extended analysis of a city’s finances because they provide a necessary foundation for analyzing how their budget is shaped. The only downside to these documents is that they usually do not provide any specific numbers or actual expenditures. Without more facts to work with, these items can only provide a general idea of the financial obligations that a municipality or other state entity has committed themselves to.

Summary of 990 Data on Major California Public Sector Unions

To better illustrate some of the methods that have been discussed here about gathering public sector union data, we have created a table below that details the financial holdings of several major California public sector unions. These findings are based on the 990 and LM-2 data that we obtained from the websites we listed, and we have also included links to the pdf copies of all of these documents as well for further verification.

Links to all of the Federal 990 forms used for the information presented on the above table are listed as reference links immediately below this article. It is important to emphasize that the 16 entities represented here represent only a small fraction of the public sector labor organizations active in California. For example, there are 20 (public sector) SEIU local affiliates, 42 AFSME local affiliates, 45 AFT local affiliates, over 1,300 CTA local affiliates, several hundred CSEA (School Employees) local affiliates, and hundreds of CPF (Firefighter) local affiliates. With the possible exception of the CCPOA, most of the statewide unions noted here, such as the CTA, the CSEA, the CFT, and the CPF, collect revenue from members through their local affiliates, which themselves retain most of the money for local collective bargaining and political expenditures. As can be seen, many of these local affiliates are quite powerful financially – just the local police unions in the City of Los Angeles plus Los Angeles County spent nearly $20 million in 2010 (the data presented for local union chapters referenced in this article and on the above table is net of the funds transferred to state headquarters to avoid double counting). Then there are federations of various unions, such as the California State Employees Association and the Peace Officers Research Association of California, which also collect revenue from members through local affiliates.

To amalgamate the financial information provided by literally thousands of local public sector union affiliates across every department and agency throughout California’s 478 incorporated cities and 57 counties would be a herculean task, but it is reasonable to assume that the total annual dues revenue and expenditures of California’s public sector unions is at least twice what the total derived from totaling these 16 major organization’s 990 data. Put another way, at the end of 2010, following a lively election season, California’s public sector unions, collectively, were probably still sitting on well over $200 million in cash, and had just spent nearly $1.0 billion dollars on collective bargaining and political activity. It is left to the reader to ascertain why any spending to pursue the agenda of organized government workers is not intrinsically political, but dissecting actual political spending from the sparse data provided in 990 forms is an exercise in futility. And it is sobering to think that after 2011 (typically the unions file for an extension, meaning we won’t see their 2011 financials until sometime in September at the earliest), during which little election activity occurred, California’s public sector unions will probably have amassed additional hundreds of millions in cash.

As we have shown, there are only a few effective ways in which to gather data on the public sector unions and their finances. Insofar as these same entities exert an enormous amount of influence with state and national politics, it should be clear that their financial reporting requirements need to be brought up to the same standards as those for all other corporations and private sector unions. As noted above, the headquarters for the California Teacher’s Association reported a net worth of $186 million dollars for the 2009 fiscal year, an amount that does not include the net worth of the individual chapters of the California Teacher’s Association. As anyone who has ever spent anytime studying California politics well knows, this organization wields a massive amount of political power in state and local government. Yet, most citizens would probably find it shocking to know that the CTA is burdened with such little oversight. Given the well recognized legal problems associated with campaign finance on both sides of the political spectrum and the almost universal desire to keep the political process free from “secret money”, it should hardly be an extreme position to argue that these laws need to be updated.

REFERENCES

[1] Brendan O’Brian, “Democratic Leader Consoles Party After the Recall,” Reuters, June 9, 2012, http://in.reuters.com/article/2012/06/09/us-usa-wisconsin-recall-idINBRE8580BQ20120609.  See also E.J. Dionne, Jr., “Secret Money Fuels the 2012 Elections,” Washington Post, June 13, 2012.  http://www.washingtonpost.com/secret-money-fuels-the-2012-elections/2012/06/13/gJQAsZ4FaV_story.html?tid=pm_opinions_pop.

[2] Citizens United v. Federal Election Commission, 558 U.S. 50 (2010)

[3] Labor Management Reporting and Disclosure Act, 29 U.S.C.A. §§ 401, 431(b) (1959). For more information see also: http://www.dol.gov/olms/regs/compliance/rrlo/lmrda.htm.

[4] See McNamara v. Johnston, 360 F. Supp. 517, 522  (D.C. Ill. 1973).

[5] 29. U.S.C.A. §402(j)

[6] IBEW Local 47  is one example of such a union. This union represents workers for a number of private and municipal employers throughout Southern California. See http://www.ibew47.org/ for further details.

[7]  http://webapps.dol.gov/libraryforms/FormsByNum.asp

[8]  29. U.S.C.A § 431(b)

[9] Id. § 431 (c)

[10] Id.

[11] http://www.guidestar.org/rxa/news/articles/2001-older/understanding-the-irs-form-990.aspx

[12] Benjamin DeGrow, Public-Sector Union Transparency, (2009) http://www.bestthinking.com/articles/politics_government/legislation/public-sector-union-transparency

[13] Cal. Gov. Code §§ 3546.5, 3587; Cal. Pub. Util. Code § 99566.3 (West, 2010).

[14] http://www.perb.ca.gov/

[15] http://www.guidestar.org/http://www.foundationcenter.org/.

[16] http://www.dol.gov/olms/regs/compliance/cba/index.htm.

[17] http://www.seiu721.org/about/financial-statements.php

LINKS TO FEDERAL 990 FORMS FOR MAJOR CALIFORNIA PUBLIC SECTOR UNIONS

California Teachers Association (2009 data)

United Teachers Los Angeles (CTA Chapter)

California School Employees Association

California Federation of Teachers

California Professional Firefighters

California Correctional Peace Officers Association

Association for Los Angeles County Deputy Sheriffs

Los Angeles Police Protective League

California Peace Officers Association

AFSCME Sacramento

AFSCME Oakland

AFSCME San Diego

SEIU Local 1000

California State Employees Association

Why Lower Rates of Return Will Destroy Pension Funds

May 18, 2012

As reported today in Capitol Weekly, in a post entitled “CalPERS ignores Brown, delays pension payment” by Ed Mendel, the amount taxpayers will have to fork over to CalPERS next year will rise by $213 million, to a total of $3.7 billion. Governor Brown, quite rightly, believes the full amount of the necessary increase should have been assessed, another $149 million, instead of being “smoothed” over the next twenty years.

But CalPERS – the largest of over 30 major government worker pension funds in California, only manages about a third of the the state and local public sector pensions. And CalPERS is basing their increase on a lowering of their projected rate of return for their invested funds by one quarter of one percent, from 7.75% down to 7.5%.

People may debate endlessly over whether or not government worker pension funds in America, now managing over $4.0 trillion in assets, can actually earn 7.5% per year, every year, for decades on end. We have argued repeatedly that this rate of return is impossible to achieve any longer, because (1) high returns in the past depended on debt accumulation, which poured cash into the economy, which stimulated consumer spending, investing, and asset appreciation – enabling more borrowing – all of which caused investment returns to grow at levels that cannot continue now that borrowing has reached its practical limit, (2) our aging population means more people will be selling their investments to finance their retirements – including the pension funds whose participants themselves are aging and are retiring with higher benefits than previous retirees – and this puts more sellers in the market, lowering asset values and returns on invested assets, and (3) pension funds are much larger as a percent of GDP than they were in previous decades, and they are now too big to consistently beat the market.

This debate will not go away. But it is at least worth examining just how much it will cost Californians if the rates of return on state and local government worker pension funds drops by 1.0%, 2.0%, or 3.0%. The fact is, they might drop by even more than that. Go to a commercial bank and try to buy a U.S. Treasury bill or certificate of deposit that pays 4.75%. Or examine the returns on the major stock exchanges over the past 10+ years. Yields are well under 4.75%, yet CalPERS has lowered their rate of return by only one-quarter of one percent to 7.5?

What are they scared of? Why not pick a risk-free, much lower rate of return?

The table below shows how much the annual pension contribution as a percent of payroll increases when the rate of return drops. Column one shows the contributions required under the original 7.75% long-term rate of return projection, which has just been lowered to 7.5%. Columns two, three and four show the contributions required under lower rates of return, 6.75%, 5.75%, and 4.75%. The rows show just how much these contributions need to be under various pension formulas. These formulas govern most government worker pensions – the percentage noted, “1.25% per year,” for example, means that if a government worker retires after 30 years, their pension will be calculated as follows: 1.25% x 30 x final salary, or in this case, 37.5% of final salary. The amounts selected for these rows are representative of the following pension formulas:

    • 1.25% per year  –  for typical non-safety employees up until around 2000.
    • 1.6% per year  –  the average of non-safety and safety employees up until around 2000.
    • 2.0% per year  –  for typical safety employees up until around 2000; for typical non-safety employees since then.
    • 2.5% per year  –  the average of non-safety and safety employees since around 2000.
    • 3.0% per year  –  for typical safety employees since around 2000.

On the table below, row four of the pension formulas, outlined, shows how lowered rates of return will impact the contributions necessary to fund a 2.5% per year formula. Since 2.5% per year is the blended average that would represent all current state and local government employees in California, the results in this row should be of great interest to taxpayers and public employees alike. As can be seen in this case, the annual pension contribution as a percent of payroll must increase from 16.3% at the rosy rate of return of 7.75% to 21.4% (at 6.75% return), to 28% (at 5.75% return), to 36.6% (at a still impressive 4.75% rate of return).

The table above concludes by taking these pension contributions and applying them to the total payroll of California’s state and local governments, which is (using conservative estimates) 1,500,000 employees times an average annual salary of $70,000 per year (ref. U.S. Census, 2010 CA State Gov. Payroll, and 2010 CA Local Gov. Payroll). As can be seen, if the rate of return for California’s state and local government employee pension funds drops from 7.75% to 6.75%, this will cost taxpayers another $5.4 billion per year. If the return projection drops to 5.75%, it will cost taxpayers another $12.3 billion per year. And if the return projection drops to 4.75% per year, it will cost taxpayers an additional $21.3 billion per year. But wait, because the above analysis still understates the problem.

There’s one more big gotcha.

The first table is entitled “Impact of Lowered Return Projections if we could Retroactively Increase Contributions.” But we can’t do that. Contributions that are in the funds currently were made under the assumption that the 7.75% rate of return would last forever. If we lower that assumption, we still have to fund our pension obligations by investing the money we’ve already got, plus whatever additional monies we can collect from now on. This severely compounds the problem.

The next table, below, calculates how much lowered return projections will cause pension contributions to increase, if half of the contributions are already made. This assumes that in aggregate, the participants in California’s government worker pensions are at mid-career. This is an extremely conservative assumption, because there are millions of government workers who are already retired, whose pension payments are equally dependent on investment returns from the pension funds. This next table therefore understates the impact of lower investment returns on the required contributions to the fund from existing workers.

As can be seen in this more realistic, but still very much a best case scenario, if the rate of return for California’s state and local government employee pension funds drops from 7.75% to 6.75%, this will cost taxpayers another $11.3 billion per year. If the return projection drops to 5.75%, it will cost taxpayers another $24.9 billion per year. And if the return projection drops to a still quite aggressive 4.75% per year, it will cost taxpayers an additional $40.8 billion per year.


This is what the pension funds are up against. These are the scenarios the pension bankers exchange in closed meetings, where the press and even their own PR people don’t attend. Imagine if CalPERS admitted, as they should, that their funds cannot reliably expect to earn more than 4.75% per year. It would mean that – assuming all 10 million of California’s households pay taxes, which obviously is not the case – that every household in the state would have to fork over another $4,000 per year in increased taxes.

These calculations were done using a tool prepared by the California Policy Center that can be downloaded by clicking on “pension_analysis_model.” An explanation of how to use this model can be found in our April 2nd post “A Pension Analysis Tool for Everyone.” It is now in use by pension analysts and activists in several California cities and counties.

Critics of pensions and critics of pension reform alike are invited to verify for themselves the calculations made here, either using the model we provide, or their own tools for financial analysis. To imply, as CalPERS has, that about another $1.0 billion per year, spread among the 30 California government worker pension funds and “smoothed” over the next 20 years, is all it will take to shore up their solvency, is irresponsible. The additional amount necessary to save California’s government worker pensions is probably closer to $40 billion per year, from now until these pension formulas are reduced, across the board, and retroactively, of course.

A Pension Analysis Tool for Everyone

April 2, 2012

A concern often voiced by pension reform activists and politicians interested in better understanding pension finance is that they have to depend solely on the information delivered by actuaries. This information, in turn, is typically delivered in a report so voluminous and so technical that the activists and politicians have to hire their own experts to explain it all to them. The mass of data and assumptions are usually so intimidating that ultimately many people who need to understand pension finance give up. Additionally, it is difficult to eradicate bias from expert analyses of pension solvency. The result is that many people, including paid professional spokespersons and other opinion makers, offer assertions that do not necessarily reflect the reality of pension finance, while voters and policymakers alike remain uncertain regarding the the nature and severity of the problem.

This post is to provide anyone who wishes to understand some of the fundamentals of pension finance a tool that allows them to do their own “what-ifs” on pensions. Because this model has distilled the mechanics of a pension fund to a single page of data and calculations, it offers a glimpse of how pensions operate that is relatively understandable and extremely transparent. This model is not intended in any way to replace the far more complex models used by actuaries, but it can be quite useful to illustrate, for example, how very sensitive the required annual contribution to a pension is to any change in other assumptions – especially the rate of return.

To download this Excel model, simply click on “pension_analysis_model” and you will have a spreadsheet to save and experiment with. Start with the first tab “constant inputs,” the 2nd tab will be explained later. The graphic images below show the upper section of this spreadsheet; all of the cells that accept inputs are at the top of the spreadsheet and are highlighted in yellow. While this model is only designed to show the pension fund performance by year for one person, it is important to understand that pension funds that aggregate pension contributions and allocate pension benefits for thousands of people follow the same rules.

To use this model, simply enter the assumptions you would like to use into the yellow cells. Don’t enter anything in a cell that is not highlighted in yellow or you will overwrite a formula. The result that matters is displayed in the one cell highlighted in green. If this number is positive, it indicates a pension would be adequately funded under the assumptions input by the user. If this number is negative, it shows by how much a pension would be underfunded. The goal is to enter a combination of assumptions in the yellow cells that yields the smallest amount in the green cell possible without being a negative number. That is a financially sustainable pension.

The three examples provided here are chosen because they clearly illustrate some of the key financial issues that challenge the solvency of pensions today. In all three examples, the pensioner is assumed to work 30 years and enjoy 25 years of retirement. They are assumed to earn a 1.0% increase in their salary each of those 30 years for merit (promotions and raises), and a 3.0% increase in their salary each year for cost of living adjustments (COLAs). Once retired, they are assumed to get a 2.0% COLA increase in their pension each year. These assumptions can all be changed, since they are all driven by inputs in the yellow highlighted cells, but to show the impact of two key variables – the pension benefit formula, and the rate of return – they are held constant on all three examples to follow.

The first example, on the table immediately below this paragraph, shows what public safety pensions were historically – up until somewhere between 5 and 15 years ago, when virtually every city and county in California adopted more generous pension formulas. In the “pension formula/yr” cell, 2.0% is entered, which means that for every year worked, the pensioner will receive 2.0% of their final salary in retirement. This means a person who works 30 years, as in this example, will receive 60% of their final salary per year as a retirement pension. In the “fund return %” cell, the typical long-term rate of return for the pension funds is entered, 7.75% per year. Once you enter all these numbers, go to the “% of salary to pension” cell and enter various amounts until you arrive at one that provides the smallest positive number possible in the green cell. Doing this indicates that under these assumptions, an employee would require an amount equivalent to 13.1% of their salary to be set aside each year to fund a pension benefit equal to 60% of their final salary.

In the next example, shown below, one can view the impact of a change in the benefit formula from 2.0% to 3.0%. That is, the only change that has been made to the assumptions is the change in the “pension formula/yr” cell from 2.0% to 3.0%. This is to model the current typical pension formula for safety employees, 3.0% times years worked, times final salary. As shown, in order to still have a positive fund ending balance in the green cell, the amount to be contributed each year into the pension fund, “% of salary to pension,” now has to increase from 13.1% to 19.6%.

It is important to digress here to point out that because the change in the pension benefit formula from 2.0% to 3.0% (or from 1.25% to 2.0% for non-safety employees) was done retroactively, pension funds would have been required to increase their rate of contributions far beyond 19.6% going forward. This is because, for example, a mid-career employee, suddenly receiving this retroactive benefit enhancement, would have only been putting 13.1% into their pension fund for the entire first half of their career, a critical period since money invested that early has more time for earnings to compound. The impact of making the benefit enhancement retroactive will be explored at the end of this post.

The third and final example, below, shows the impact of a lowering of the fund’s rate of return. In this case, not only is the benefit formula enhanced from 2.0% per year to 3.0% per year, but the rate of return for the fund is lowered from 7.75% per year to 6.00% per year. At this rate of return, pension solvency would not require an annual contribution equivalent to 13.1% of payroll, or 19.6% of payroll, but 31.4% of payroll. This is a huge adjustment. In the concluding section of this post, a more in-depth analysis is presented explaining why even this may not be enough.

The model presented thus far is not designed to allow the user to input differing values in each year under analysis, but in the same Excel file “pension_analysis_model,” there is a 2nd tab, “flexible inputs,” that does provide this ability to the user. To delve into the details of how to use this model would go beyond the scope of this post. In short, any cell highlighted in yellow is an input cell, including entire columns where each row corresponds to a different year. The user will still iterate to achieve a near-zero result in the lone green cell which represents the final ending balance of the fund. The model on the 2nd tab uses exactly the same formulas and logic as the model illustrated above, except the user can assume and input differing values per year on this version. Here is a summary of the default case that is already entered on the downloadable spreadsheet, tab two, entitled “variable inputs:”

This analysis assumes that the change to the benefit formula from 2.0% per year to 3.0% per year was done in late 2000, in mid-career for the employee (year 15 of a 30 year career). This means that through the year 2000, holding all other assumptions constant, the annual pension contribution was only 13.1% of salary (because at through that point, that was all it needed to be – see example #1 above). What also happened starting around the year 2001 was the rate of return earned by pension funds fell – they have actually fallen to around 4.0% during the past decade, but in this analysis, the rate is lowered to 6.0% per year and held there through the rest of the timeline. Prior to 2001, from 1985 through 2000, the rate of return is assumed to be 7.75% per year.

Based on these assumptions, which reflect a fairly realistic assessment of history to-date, starting in 2001 it is necessary for an employee with these rate-of-return and benefit changes to make an annual contribution to their pension fund equaling 54.5% of their salary. And for every year they have not done this, that percentage must rise. Nowhere in this analysis, moreover, is the all-too-frequent practice of “spiking” accounted for, which raises necessary annual contributions still further.

By using in this final example a person for whom the pension fund adjustment was made in mid-career, it is reasonably accurate to say that whatever unfunded liability may exist in reality in this individual case, could be used as a basis for calculating the total unfunded liability of the fund in aggregate. To get a global estimate, of course, one must input a blended benefit rate that takes into account the lower formulas that apply to non-safety employees, or run them as separate studies.

Again, this model is not meant to replace actuarial models that take into account specific fund demographics and deliver results precisely aggregated for all participants in the fund. But actuarial models, for all their precision and complexity, must nonetheless rely on the same set of assumptions this model does, and how those assumptions are made delivers vastly differing outcomes. For anyone who uses it, this model may serve as a useful tool to better understand and communicate the dynamics of pensions, and to sanity check whatever does come out of the black boxes reserved for qualified actuaries.

Public Sector Unions Spend $4.0 Billion per Year in U.S.

March 23, 2012

In an earlier post, “Public Sector Unions & Political Spending,” we tried to estimate political spending by public sector unions in California. The top-down analysis used was straight-forward and conservative: assume 1.0 million unionized public sector workers, times average dues of $750 per year, times one-third (the proportion of dues used for political activity), and voila, public sector unions spend $250 million per year in California to influence elections at the federal, state, and local level. No wonder the politicians in California do whatever they’re told to do by the very government workers they are supposedly elected to manage. And no wonder California is broke.

One might challenge the estimate that one-third of public sector union dues in California go to support political activity. But for public sector unions, the distinction between political and non-political spending is largely irrelevant. Because virtually every expenditure by a public sector union, whether it is collective bargaining, lobbying, contributions to candidates, independent expenditures, or educational outreach, has one primary goal: The expansion of their membership and the expansion of the pay and benefits for their members.

From this perspective, California’s public sector unions are not deploying $250 million per year to influence the political process in support of their agenda, they are deploying at least $750 million per year. How much is being spent across the United States by public sector unions to pursue this same agenda?

According to the U.S. Census Bureau, there are 12.2 million local government employees across the United States. There are 4.4 million state government employees, and there are 2.6 million non-military federal government employees. In all, 19.2 million American’s, excluding military, work for the government.

According to a report released in January 2012 by the U.S. Dept. of Labor’s Bureau of Labor Statistics that surveyed union membership in the United States in 2011, there are 7.6 million government workers belonging to labor unions, about 39%. If you include those government workers who are required to belong to a bargaining unit as a condition of their employment, but managed to opt-out of full union membership, there are 8.3 million government workers who belong to unions in the United States.

Determining the total revenue available to public sector unions in the United States each year is a simple matter of multiplying the total number of government union members in the U.S. by the average dues they are required to pay each year. An excellent recent study authored by Daniel DiSalvo, a senior fellow at the Manhattan Institute and professor of political science at The City College of New York, entitled “Dues and Deep Pockets: Public-Sector Unions’ Money Machine,” provides several sources of data on this question. Based on analysis of several representative samples from across the U.S. and across job descriptions, DiSalvo estimates the average annual dues for a government union member at $500, an amount he acknowledges is probably conservative. This means, at the least, public sector unions in the United States are collecting and spending $4.0 billion per year to pursue their agenda.

Because these unions represent public sector workers, their agenda is explicitly political. Whether they are bargaining over work rules, pay and benefits, or actually engaging in political lobbying and campaigning, they are deploying $4.0 billion per year to influence how our government is operated.

The consequences of this level of influence are manifold. Government workers, despite having greater job security, greater access to health care, and far more generous paid vacation benefits than private sector taxpayers, now make as much or more than private sector workers; in fact, the average base pay for a government worker – not including benefits – now exceeds private sector averages by over 50%. For California, we have documented this in previous California Policy Center studies such as “Calculating Public Employee Total Compensation,” and similar disparities exist across the U.S. And probably the most obvious, and biggest, disparity between public sector and private sector compensation is with respect to pensions, where the average government worker retires 10-15 years earlier than the average private sector worker, and receives a pension that averages 2-3x more per year than what a private sector worker can expect from social security.

There is nothing wrong with paying government workers well. But disparities of this magnitude carry a crippling economic cost, and can’t possibly be extended to all workers. For example, in California there are approximately 10 million people over the age of 55. If all of them received the average pension currently issued to state and local workers in California after 30 years of work, which is over $65,000 per year, that would cost $650 billion per year, nearly 40% of California’s entire gross domestic product.

Public sector unions have quietly become the most powerful force in politics in the United States, not only because they spend more than any other significant actor, but because until recently, their efforts have been completely unopposed. Corporate political expenditures are almost always limited to the narrow economic interests of each corporation or industry, and almost always balanced by expenditures by a competing corporation or competing industry. Historically, no special interest group has ever arisen to effectively oppose public sector unions.

Over the past century the character of unions in the United States has changed completely. They have converted from being the courageous underdog, representing the downtrodden and underpaid working class, to the biggest, meanest dog in the pit, representing the overpaid political ruling class. The core agenda of government worker unions, backed by at least $4.0 billion per year in cold hard cash that, ultimately, originates from taxpayers, is intrinsically oriented towards bigger government – more programs, more regulations, more pay and benefits, more workers – regardless of the cost or benefit to society.

Self-Employed Workers vs. Government Workers – A Financial Comparison

February 24, 2012

When discussing what level of compensation is appropriate and affordable for government workers, it is helpful to make apples-to-apples comparisons between public and private sector workers. In this analysis, the ultimate private sector taxpayer, the self-employed worker, is compared to the typical state or local government employee in California. In both cases, the annual compensation used for comparison is $70,000, which is the average base salary paid to state and local government employees in California (ref. U.S. Census data for California: State, and Local). But the impact of benefits paid by the government employer, combined with the impact of mandatory employee contributions (taxes, retirement set-asides, and healthcare costs), yield dramatically different end results in terms of total net compensation. Both the self-employed worker and the government worker make $70,000 per year. But to say they make the same amount of money is grossly misleading.

The table below, “Total Compensation – Gov’t vs. Self-Employed Worker,” begins to illustrate this disparity. The difference between total compensation and gross earnings in the case of the self-employed worker is zero. There is nobody paying for benefits beyond what the self-employed person earns. Whatever amenities they need to purchase, they have to pay for out of their gross earnings.

In the case of the government worker, there are a host of employer funded benefits; only the basic ones are covered here, using conservative assumptions. If it is assumed the average household health insurance coverage is $500 per month, and the employer pays 50% of that, this adds $3,000 per year to the total compensation of a government worker. In reality, factoring in employer coverages of medical, dental and vision plans, it is very unlikely the average government worker doesn’t get well in excess of $3,000 per year in employer health care benefits.

Current expenses for health care, however, are not the only health expenses that governments pay for their workers. Typically there are provisions for retirement health care coverage that are taken on as obligations by the government for their workers. For example, there are “medigap” plans, with all or part of the premiums paid for by the government. In some cases, such as with most safety employees and management employees, the government pays 100% of the premiums for lifetime premium health insurance plans. These future obligations must be funded during current employment. To estimate another $2,000 per year for this cost, or, more generally, to estimate $5,000 per year per employee for the average government contribution to current and retirement health care, is definitely conservative.

In addition to healthcare costs, state and local government employers cover pension benefits for which much of the costs – and in many cases 100% of the costs – are paid by the government, not the employee. If one assumes a contribution by the government employer of only 12% of gross salary per year – clearly lower than reality – this adds another $8,400 to the total compensation of a government worker.

A simmering question regarding pensions for government workers – how much can these pension funds really earn each year in interest – generates the next estimate. In our analysis “How Much Could California’s Government Pensions Cost Taxpayers,” along with “What Payroll Contribution Will Keep Pensions Solvent,” we have explored the underlying calculations in depth. The reader is invited to review those calculations and assumptions. But the bottom line is this: If pension funds have to lower their long-term expected rate of return by 2.0%, and they will, this will add at least $11,200 per year to the cost of funding the average pension. These obligations may be scaled back, but until they are, this amount must be included when adding up the total compensation of the average government employee in California.

Taking all of this into account, a self-employed person making $70,000 per year makes $70,000 per year. A government worker making $70,000 per year in base pay is actually making $94,600 per year in total compensation, 35% more. But it doesn’t end there.

The next table, below, examines the impact of what might best be described as “mandatory employee contributions,” taking the form of the employee share of health insurance coverage, retirement pensions and social security, along with state and local taxes. Once these mandatory contributions are deducted from the income (before tax in the case of health care and retirement contributions) of both the self-employed and the government worker, and the employer provided benefits – which are tax-free – are added back to the income of the government worker, the disparity between their actual net total compensation becomes even more dramatic.

If one assumes that the self-employed person is going to purchase health insurance for their household, they will pay 100% of the premium. Using the same assumptions, this means they will spend $6,000 per year for these benefits, whereas the government worker, paying 50% of the premium, will only spend $3,000 per year.

By participating in social security and medicare as a self-employed person, they are obligated to pay both the employee and the employer share of those assessments, which at a gross annual income of $70,000 will cost them $10,500 per year. By contrast, even if the government worker pays 10% of their salary into their pension – a level that is still fairly unusual to see among government workers – this will only cost them $7,000 per year.

In the above table, “Net Total Compensation – Gov’t vs. Self-Employed Worker,” these before tax deductions are subtracted from their base annual salary to arrive at their taxable annual salary. This taxable amount then has deducted from it what a California household in 2011 would have to pay in state and federal taxes. Finally, the non-taxable employer contributions are added back to the actual take-home pay to yield the net total compensation after mandatory contributions.

This is the apples-to-apples result: A self-employed person making $70,000 per year, once they’ve paid their taxes. social security and insurance premiums, will enjoy compensation of $45,021 per year. A government worker making $70,000 per year, once they’ve paid their taxes, pension contribution and insurance premiums, with the value of their current and deferred benefits added back, will enjoy compensation of $74,781 per year, 66% more.

It doesn’t end there. As shown on the next table, “Retirement Security – Gov’t vs. Self-Employed Worker,” the self-employed worker, who must pay $10,500 per year for social security and medicare, can expect to retire at the age of 66 with a social security benefit of $20,144 per year. The government worker, who must pay $7,000 per year for their pension, can expect to retire at the age of 60 with a pension of $46,666 per year. The total value of these respective retirement benefits, based on a life-span of 80, is $282,016 for the self-employed worker, and $933,324 for the government worker.

It is important to emphasize how conservative these numbers are. While the average pay of a government worker in California is only about $70,000 per year, the average pension for state and local government workers in California is not $46K per year, but nearly $70K per year. For state and local government workers who retire at age 66 and spend their careers in government service, the average pension is nearly $100K per year (ref. CalPERS Annual Report FYE 6-30-11, page 153, and CalSTRS Annual Report FYE 6-30-11, page 149). This means the assumptions used to calculate pension contributions at various rates of return, which assumed pensions equivalent to 66% of average salary, are obviously inadequate. This is because pensions aren’t calculated on average salary, they’re calculated on final salary. The assumptions underlying our pension contribution estimates also don’t take into account the current state of underfunding for pensions.

For a self-employed person to enjoy a net total compensation equivalent to the average government employee who makes “only” $70,000 per year, they would have to earn well in excess of $100,000 per year, particularly since as they climb in gross income, they encounter higher and higher tax brackets. A self employed person who makes less than $108,000 per year and more than $74,000 per year, because their income is still under the social security withholding ceiling, actually pays taxes at the margin of over 50%. But that is a topic for another post.

How Much Could California's Government Pensions Cost Taxpayers?

January 27, 2012

This week both of California’s largest government employee pension funds, CalPERS and CalSTRS, released their portfolio earnings numbers for the most recent twelve months. In a statement released on January 24th, “CalSTRS Calendar Year-End Investment Returns Show Slight Gains,” CalSTRS disclosed “Investment returns for the California State Teachers’ Retirement System (CalSTRS) ended the 2011 calendar year posting a 2.3 percent gain.” CalPER’s statement released on January 23rd, was titled “[CalPERS} Pension Fund earns 1.1 percent return for 2011 calendar year.”

These funds, and the rest of California’s many local government employee pension funds, are still clinging to long-term rate of return assumptions of between 7.5% and 7.75% per year. So how much would taxpayers be on the hook for if rates of return stay this low?

The first step towards determining this would be to estimate the average pension paid out to a state or local worker in California, based on recent retirees who have worked a full 30 year career. Despite the claim that “The average CalPERS pension is $2,220 per month” (made yet again in the final paragraph of their above-referenced press release), for a more accurate figure, one must look at the average pension awarded recent retirees, based on a full 30+ year career. The problem with the low figure used by CalPERS and others is that it includes people who retired decades ago when salaries and pension benefit formulas were much lower, and it includes people who may have only worked a few years for the government. Since we will be multiplying this average pension by the number of full time state and local government workers in California, we have to assume a full career when calculating the average pension, since for every worker who only worked 10 years, for example, two additional retirees will also be in the system who have themselves also only worked 10 years. To calculate the cost of a full-career pension, you have to add all three of these part-career retirees together. Here is what these pensions really average, based on CalPERS Annual Report FYE 6-30-11 (page 153), and CalSTRS Annual Report FYE 6-30-11, (page 149):

CalPERS average final salary for 30 years work, retiring 2010: $82,884
CalPERS average pension for 30 years work, retiring 2010: $60,894  –
Pension equals 73% of final salary (average of 25-30 year and 30+ year stats)

CalSTRS average final salary for 30 years work, retiring 2010: $88,164
CalSTRS average pension for 30 years work, retiring 2010: $59,580  –
Pension equals 68% of final salary (average of 25-30 year and 30-35 year stats)

If one extrapolates the CalPERS and CalSTRS data to the many independent pension funds serving local agencies – many of these are quite large, such as the one for Los Angeles County employees – it is probably conservative to peg the average pension going forward for full-career government workers in California at at least $60,000 per year, and at least 70% of final salary.

The next step in figuring out how much state and local government worker pensions could cost California’s taxpayers in the future is to establish the sensitivity of pension contribution rates to changes in the rate of return of pension funds. The California Policy Center has explored this question repeatedly, with a good summary in the July 2011 study entitled “What Payroll Contribution Will Keep Pensions Solvent?” Using the same financial assumptions as were used in that analysis, here is how the required pension contribution rates – expressed as a percent of payroll – change in response to lower earning rates for the pension funds. This is based on pensions averaging 70% of final salary, and assumes 30 years working, 25 years retired, and salary (in real dollars) eventually doubling between hire date and retirement date:

If the pension fund’s return is 7.75%, the contribution rate is 22% of payroll.
If the pension fund’s return is 6.75%, the contribution rate is 28% of payroll.
If the pension fund’s return is 5.75%, the contribution rate is 37% of payroll.
If the pension fund’s return is 4.75%, the contribution rate is 48% of payroll.
If the pension fund’s return is 3.75%, the contribution rate is 63% of payroll.

What the above figures quickly indicate is not only that the required payroll contributions go up sharply when projected rates of investment return come down, but that the lower the rate of return goes, the more sharply the required contribution rises.

To complete this analysis, one only needs to multiply the number of full time state and local government employees in California by the average payroll for these employees, and multiply that result by the various required contribution rates. Using 2010 U.S. Census data for California’s State Employees and for California’s Local Government Employees, one can quickly determine that there are 339,430 state workers earning on average $68,880 in base annual salary, and there are 1,185,935 local government workers earning on average $69,399 in base annual salary.

To sum this up, there are currently 1,525,365 full time (not “full-time equivalent,” which would be an even higher number, but those part-time employees may or may not have pension benefits) state and local government employees in California. They earn, on average, $69,284 per year in base pay. Here is how much pensions will cost for these workers each year based on various rates of return:

If the pension fund’s return is 7.75%, the state pays $23 billion to pension funds each year.
If the pension fund’s return is 6.75%, the state pays $29 billion to pension funds each year.
If the pension fund’s return is 5.75%, the state pays $39 billion to pension funds each year.
If the pension fund’s return is 4.75%, the state pays $51 billion to pension funds each year.
If the pension fund’s return is 3.75%, the state pays $66 billion to pension funds each year.

It is interesting to note that both CalPERS and CalSTRS failed to even achieve a 3.75% return in calendar year 2011, the lowest amount used in these examples and the lowest amount that can even keep pace with inflation.

When one takes into account the fact that only about five million households in California pay net taxes, the impact of the pension con job Wall Street brokerages have enlisted the support of public sector unions to foist onto taxpayers is even more dramatic. Because if, during the great deleveraging that likely will consume this economy for at least another decade, California’s pension funds only deliver 3.75% per year, instead of 7.75% per year, that will translate into $8,600 per year in new taxes for each and every taxpaying California household.