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After forty years, government union propagandists still wrong about Prop. 13

Forty years ago this month, California voters began the modern tax revolt movement that spread across America like wildfire. The idea that citizens could take back control from an overreaching government helped to propel Ronald Reagan to the presidency. Reagan, who had a close friendship with Howard Jarvis, took his message of limited government to Washington and his message of freedom to the world.

Proposition 13 cut property taxes, put limits on their rise, and toughened the requirements for passing other tax increases. It passed overwhelmingly in June 1978, and ever since, liberals have failed to acknowledge how wrong they were about it — both in terms of politics and policy.

Two months before the vote, California’s then Gov. Jerry Brown (version 1.0), was quoted in the New York Times as saying “I don’t think there is one credible observer who thinks Proposition 13 will endure over the long period.” Forty years later, it’s Brown who is heading into the political sunset while Proposition 13 continues to protect grateful California taxpayers.

So-called “experts” were also wrong in their dire predictions about the harm that would be inflicted on California if Prop. 13 were to pass. One of the TV commercials run by the well-funded opposition campaign featured a doom-saying UCLA economist who predicted that California would be plunged into a deep recession if voters approved the measure. But in the years immediately following passage, California had an extraordinarily booming economy.

Progressives like to perpetuate another falsehood about Prop. 13 in their ceaseless efforts to divide and conquer the taxpayer coalition that supports the law. They seek to target the owners of business properties who, like homeowners, benefit from predictable taxes under Prop. 13. A false argument is advanced that during the 1978 campaign, voters weren’t told that Proposition 13 protections would be extended to business properties as well as homes.

This simply isn’t true. The opponents of Prop. 13 themselves repeated that fact throughout the campaign and, specifically, in the official ballot pamphlet.

Perhaps the granddaddy of all lies about Proposition 13 is how it “destroyed education” in California. This falsehood is repeated so often and with such vigor that it is accepted as established fact by liberal elites and mainstream media. For example, just a couple of weeks ago, Sacramento mayor and former Senate leader Darrell Steinberg blamed Prop. 13 for “years of cutbacks to arts funding in public schools.” This despite record revenues being pumped into education.

To be specific, it is true that just prior to Prop. 13’s passage in the late 1970’s, schools in California were top notch with good facilities, high test scores and competent teachers and administrators. It is also true that, around the same time, education in California began a steep decline. But the cause has not been a lack of revenue. Today California is spending 30 percent more on a per-student, inflation-adjusted basis than it did in the mid-70’s. The cause of the decline is the subject of another column, if not a book, but there were two other big changes to the law in the late 1970s: court decisions that redistributed education funding, and legislation granting California teachers the right to unionize and go on strike.

Today’s higher spending on education is mirrored throughout the California government. Property tax revenues have far outstripped population and inflation increases, so it’s not Prop. 13 that has caused the ills that plague California. Waste, fraud and abuse of taxpayer dollars on top of heavy-handed tax burdens and overregulation are what’s draining the gold from the Golden State.

Despite a persistent and powerful coalition of tax-raising, big-spending special interests arrayed against us, California taxpayers are prepared to defend Prop. 13 for another 40 years. We have the truth and the facts on our side, and as John Adams observed, “facts are stubborn things.”

Jon Coupal is president of the Howard Jarvis Taxpayers Association.

Striking at the wrong target

Teachers should stop listening to union leaders and look at the data before striking. When one looks at the actual dollars-and-cents reality, the emotional photo of the kindly old 1st grade teacher picketing for more money “for the classroom” falls flat. Very, very flat. There are several relevant facts that teachers and all Americans – especially the taxpaying variety – need to know.

Local Voters Uphold Utility Tax in Sierra Madre

Voters in tiny, affluent Sierra Madre, three square miles of leafy neighborhoods nestled at the foot of the majestic San Gabriel mountains, had an opportunity earlier this week to repeal their utility tax. As reported in the San Gabriel Valley Tribune, by a margin of more than four-to-one, they decided to keep their tax.

Opponents of the utility tax repeal pointed out that Sierra Madre has very low per capita sales tax revenue (claiming 460th out of 481 California cities), and therefore depends on their utility tax. And in any case, the numbers are vanishingly small. Had Sierra Madre’s citizens voted to repeal their utility tax, it would have eliminated $2.6 million, or 24%, from the city’s annual revenue.

The real question facing Sierra Madre, and all of California’s cities, isn’t whether or not to repeal various local taxes, but how many new taxes to approve in the next few years. As documented by CalTax, every election cycle, hundreds of new local taxes are proposed, and they usually pass. For example, in November 2016, 224 new local tax increases were proposed, and 71% of them were approved by voters.

How these measures get approved by voters is nicely exemplified by the Sierra Madre ballot. Measure D, at the top of the ballot, presented the question to voters: “Shall the City of Sierra Madre adopt a measure repealing the City’s Utility Users Tax in its entirety?

But below Measure D on this ballot was Advisory Measure A, which read “If Measure “D” passes, repealing the Utility Users’ Tax and eliminating approximately 24% or $2.6 million of the City’s General Fund Revenues, should the City Council eliminate paramedic services, reduce and outsource police services and library services, reduce code enforcement, and fire suppression services, in addition to other reductions which will be required to balance the budget?

SIERRA MADRE SPECIAL ELECTION BALLOT – 4/10/2018

If that isn’t an anti Measure D campaign message masquerading as an “advisory measure,” then there’s a bridge for sale in San Francisco, and the moon is made of green cheese.

It’s worth wondering why the pro-repeal campaign didn’t just try to reverse Sierra Madre’s recent utility tax increase, instead of calling for its total repeal. After all, that tax has been in place since 1993. But in 2016, Sierra Madre’s voters approved an increase in the utility tax rate from 8% to 10%. Rolling back that increase, which equates to about a half-million per year in additional tax collections, would not have broken the city’s finances. It could have been marketed for what it would have been – a way to pressure Sierra Madre’s elected officials to finally confront their escalating pension payments.

ALL NEW TAXES ARE TO PAY MORE FOR GOVERNMENT PENSIONS

Beyond any serious debate by now is the fact that payments to CalPERS by California’s cities are set to nearly double in the next six years, from a projected total of $3.1 billion in 2017-18 to over $5.8 billion in 2024-25. This is based on recent “Public Agency Actuarial Valuation Reports” issued by CalPERS actuaries for each of their participating agencies, summarized here by the California Policy Center.

In the case of Sierra Madre, this year they will pay $1.5 million to CalPERS, which is 13.8% of their total general fund revenues. By 2024, they will be paying CalPERS $2.2 million, or over 20% of their total general fund revenues.

One in five dollars of Sierra Madre’s tax revenue will be paying for pensions. And that does NOT include (1) any payments for other post-employment benefits, (2) any increases to those payments based on investments deciding not to perform as well in the next ten years as they have in the past ten years (imagine that), or (3) any additional payments if Sierra Madre happens to have issued “pension obligation bonds” in prior years. We didn’t look into this, but plenty of cities have succumbed to the temptation to borrow money to make their pension payments.

One possible source of relief for this comes in the form of the CalFire vs CalPERS case that is working its way through the California Supreme Court. There is a possibility that a ruling could undermine the “California Rule,” which to-date has been aggressively – and successfully – interpreted by government union attorneys to mean that pension benefits cannot be diminished, even for work not yet performed.

If the outcome of that case tilts in favor of reform, you might see this “advisory measure” on a local ballot, right beneath the next proposed tax increase.

HYPOTHETICAL SIERRA MADRE SPECIAL ELECTION BALLOT
(including “advisory measure” that proposes reducing pension benefits)

That would be the day. When immediately below a proposed tax increase, an “advisory measure” proposes to reduce pension benefits if the tax increase does not pass.

And that certainly would not be an anti-tax campaign message, would it?

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Discrimination to Ensure Diversity – A Goldmine for Government Unions

It is impossible to achieve diversity without discriminating. The only way that would be possible would be if every imaginable human subgroup were equally qualified to perform every imaginable task. In reality, while individual talents vary dramatically in a manner completely irrespective of group identity, on average, groups exhibit huge and verifiable differences in aptitude.

The objective of diversity, however, is indifferent to this fact. To achieve their objective, discrimination against the more qualified is inevitable. To enforce this across all walks of life, a growing army of unionized government bureaucrats have been hired.

When it comes to discrimination in the name of diversity, California is the trendsetter. It is the most diverse state in America, it has the worst performing K-12 system of public education of any large state, and it has the most left-leaning electorate in America. And to enforce discrimination to ensure diversity, California has its all-powerful public sector unions, that will support any new bureaucracy that increases its numbers.

The University of California provides a perfect example of how discrimination to ensure diversity is working. Starting at the top, each campus has a “Chief Diversity Officer.” Take a look at the pay and benefits packages for these individuals, bearing in mind how many high-paid administrators must work for each of them:

(1) Berkeley, Oscar Dubón, Jr., Vice Chancellor for Equity and Inclusion, (2) Davis, Adela de la Torre, Vice Chancellor for Student Affairs and Campus Diversity, (3) Irvine, Doug Haynes, Vice Provost for Academic Equity, Diversity and Inclusion, (4) Los Angeles, Jerry Kang, Vice Chancellor for Equity, Diversity and Inclusion, (5) Merced, Luanna Putney, Associate Chancellor & Senior Advisor to the Chancellor, Ethics and Compliance, (6) Riverside, Mariam Lam, Associate Vice Chancellor for Diversity, Excellence and Equity, (7) San Diego, Becky Petitt, Vice Chancellor for Equity, Diversity and Inclusion, (8) San Francisco, Renee Navarro, Vice Chancellor for Diversity and Outreach, (9) Santa Barbara, Maria Herrera-Sobek, Associate Vice Chancellor for Diversity, Equity and Academic Policy, (10) Santa Cruz, Ashish Sahni, Associate Chancellor, Office of Diversity, Equity and Inclusion.

The average pay and benefits for each of these ten University of California Chief Diversity Officers was $311,474 in 2016. To get just a partial idea of what members of their staff, or members of the California’s overall diversity bureaucracy make, go to Transparent California and search job titles under the key words “diversity” or “inclusion.”

The toxic impact of California’s unionized diversity bureaucracy is hard to overstate. California’s K-12 public schools have been destroyed by unionization, which, among other bad things, caused the worst teachers to end up in the poorest, most disadvantaged neighborhoods because they could not be fired. But why fix the K-12 public schools, when you have a diversity army that forces college admissions to reflect proportional representation regardless of academic performance?

The University of California’s “Freshman Admissions Count” for 2017 showed the following results by ethnicity: 34.2% Asian, 33.2% Latino, 23.8% White, 5.0% Black, and 3.9% “Other.”

Here’s where the tactics of the diversity army become truly suspect, because they aren’t just discriminating in order to achieve proportional representation. If they were, based on the numbers of college-aged Californians by ethnicity, 2017 admissions would have been 13% Asian, 50% Latino, 31% White, and 6% Black.

To put this in perspective, a recent California Policy Center analysis that took into account the number of college age students along with SAT performance, came up with what should have been UC’s 2017 freshmen class if admissions were based on merit: 21% Asian, 35% Latino, 41% White, and 3% Black. The CPC analysis, moreover, yielded understated results because the SAT criteria used was “met college ready benchmark,” whereas in reality the UC system purports to admit students who greatly outperform the “college ready” SAT benchmark. This is an important distinction – it means that in reality, a far greater percentage of Asians and significantly greater percentage of Whites would be admitted in a hypothetical merit based analysis, if more complete SAT data were accessible.

One can only assume the UC diversity bureaucracy, controlled by the UC Regents, who are themselves controlled by the State Legislature, did not reduce Asian admissions to their proportional representation because Asians still vote – by a margin of two-to-one, in favor of Democrats. So Asians were admitted to the UC system more-or-less based on their merit. Blacks were admitted based on proportional representation. Latinos, comprising 50% of college age students, but at most 35% of merit-based successful applicants, broke nearly even on that basis with 33% of the admissions. But where did that leave the Whites? Instead of being at least 41% of the successful applicants based on merit, only 24% of the UC system’s 2017 freshman class are White. Apart from keeping Asians firmly in the Democratic voting bloc, does any of the University of California’s systemic racial discrimination to enforce “diversity” actually help anyone?

It certainly doesn’t help White and Asian students who are left behind. It also doesn’t help Latino or Black students who are admitted to an elite university without having the academic skills to succeed. Rather than fix the ruined K-12 system that, thanks to union work rules, demonstrably provides inferior public education to the Black and Latino communities, the rules are changed and manipulated to get them into a UC program anyway. And then in an attempt to accommodate them, the campus syllabus becomes rife with academically weak majors in various types of ethnic studies.

Could it be that much of the campus polarization we are witnessing is because unqualified, struggling students are being indoctrinated to believe their academic failures are caused by racism instead of taking personal responsibility?

Discrimination to enforce diversity is not confined to academia. It is institutionalized across most of corporate America. It is enshrined in countless laws and incentives which are designed to “level the playing field,” but in reality discriminate against more qualified actors. It breeds bitterness and corruption. It creates tribalism where none had previously existed.

Ultimately, as America becomes more “diverse” at the same time as huge gaps in aptitude and achievement remain between groups, discrimination to enforce diversity in all areas of life will become increasingly tyrannical. And as it occurs, the role of government unions will remain pervasive and negative. They will continue to ruin inner city schools, then hire lavishly compensated bureaucrats to enforce equal outcomes.

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Edward Ring co-founded the California Policy Center in 2010 and served as its president through 2016. He is a prolific writer on the topics of political reform and sustainable economic development.

FOOTNOTES

(1) The University of California’s “InfoCenter” has interesting data on graduation rates by ethnicity. The data is through 2016, meaning that graduation rates within six years of entry are available for freshmen entering the UC system in 2010. Here is a summary of results by ethnicity:

White – 64.5% graduated within four years, 86.1% graduated within six years.
Asian – 63.9% graduated within four years, 88.1% graduated within six years.
Latino – 47.1% graduated within four years, 77.6% graduated within six years.
Black – 46.8% graduated within four years, 75.4% graduated within six years.

(2) The University of California’s “Diversity Accountability Report 2017” collects an amazing amount of data on how students and faculty “feel” about their group identity, but not much in terms of useful data on academic performance by ethnicity. For example, no data is provided, by ethnicity, on how many non-international undergraduates chose STEM majors. Some information in this regard can be gathered for UC graduate students – ref. table 7.2.1. The percentage of non-foreign graduate students who pursue post-graduate degrees in either the physical sciences, engineering, or computer science, by ethnicity, are: 67% White, 26% Asian, 6% Latino, and 1% Black.

(3) Some examples of pertinent information – at least to any diversity advocate (or critic) – that do not appear to be available on the UC “diversity” website pages are the following: What number and percentage of non-foreign undergraduates pursue STEM majors, by ethnicity, and what are their graduation rates? And, what number and percentage of non-foreign undergraduates pursue non-STEM majors, by ethnicity, and what are their graduation rates? What were the SAT scores – numbers and percentages by ethnicity – of applicants who were accepted to the 2017 freshman class in the UC system? What were the SAT scores – numbers and percentages by ethnicity – of applicants who did not gain acceptance to the 2017 freshman class in the UC system? With respect to SAT scores – is there any report that has compiled a bell-curve distribution showing the range of SAT scores from highest to lowest, proportioned by quantity of test takers, per ethnic group, on one overlay?

(4) The high school class of 2017 – admitted to the UC system as incoming freshmen in the Fall of 2017 – earned SAT scores by ethnicity as shown on the following chart (below) from the SAT College Board. As can be seen, across the U.S., the percentage of test takers who met the college-ready benchmark varied significantly by ethnicity – 70% of Asians met the benchmark, 59% of Whites, 31% of Latinos, and 20% of Blacks. Moreover, as documented by Ed Source, the disparity between the SAT performance of California’s students and all U.S. students is not significant. In fact, the average Math/Reading combined score for California’s White students was 1,153 vs. 1,118 nationally; for Latinos, 992 CA vs. 990 US; Asians 1,145 vs 1,181 US; Blacks 961 vs 941 US.

(5) In May 2016 the Public Policy Institute of California produced a study that includes data that tracks the correlation between SAT scores and graduation rates. As can be seen on Figure 4 in the study (shown below), the correlation is quite high. The upper chart depicts six year graduation rates, the lower chart depicts four year graduation rates. The orange dots represent results for Cal State campuses, which were the focus of the study. The more numerous grey dots represent similar universities nationwide. As can be seen, it is roughly accurate to state that for every 50 point improvement in a student’s Math SAT score, there is a 10% greater probability that they will graduate from college.

Correlation between SAT Math score and graduation

(6)  As California’s population becomes more “diverse,” the proportion of “mixed race” individuals will proliferate. This is a welcome development to anyone who believes in assimilation, but may be of great concern to the diversity bureaucrats. For the UC System, for example, to handle this complexity, one recommendation is they require all applicants to submit to blood tests to determine their ancestry. Some of the new services, such as “Advanced Ancestry” can offer tremendous detail, showing the DNA based areas of origin for any human. The bureaucrats only need overlay that data with the geographic areas around the world that are known to be the places of origin for “marginalized peoples,” and they will have exactly what they need to continue to discriminate against individuals in order to enforce equality of group outcomes.

(7) Then again, since DNA affects individuals differently, it may not be possible to properly identify “people of color” for discriminatory favoritism based solely on geographically based DNA analysis. To compensate for this, the UC diversity bureaucrats can learn a great deal from the American Progressives of the early 20th century, and, for that matter, the German Nazis of the WWII era. Both of these groups created a robust set of best practices aimed at classifying humans based on their racial appearance. Going into the details of these best practices would go beyond the scope of this report, but clearly the UC diversity bureaucrats, and all diversity bureaucrats, can learn a lot of useful skills from their racist predecessors of the previous century.

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The Underrecognized, Undervalued, Underpaid, Unfunded Pension Liabilities

“It’s the economy, stupid.”
–  Campaign slogan, Clinton campaign, 1992

To paraphrase America’s 42nd president, when it comes to public sector pensions – their financial health and the policies that govern them – it’s the unfunded liability, stupid.

The misunderstood, obfuscated, unaccountable, underrecognized, undervalued, underpaid, unfunded pension liabilities.

According to CalPERS own data, California’s cities that are part of the CalPERS system will make “normal” contributions this year totaling $1.3 billion. Their “unfunded” contributions will be 41% greater, $1.8 billion. As for counties that participate in CalPERS, this year their “normal” contributions will total $586 million, and their “unfunded” contributions will be 36% greater at $607 million.

That’s nothing, however. Again using CalPERS own estimates, in just six years the unfunded contribution for cities will more than double, from $1.8 billion today, to $3.9 billion in 2024. The unfunded contribution for counties will nearly triple, from $607 million today to $1.5 billion in 2024 (download spreadsheet summary for all CalPERS cities and counties).

Put another way, by 2024, “normal contribution” payments by cities and counties to CalPERS are estimated to total $2.8 billion, and the “unfunded contribution” payments are estimated to total almost exactly twice as much, $5.5 billion.

So what?

For starters, every pension reform that has ever made it through the state legislature, including the Public Employee Pension Reform Act of 2013 (PEPRA), does NOT require public employees to share in the cost to pay the unfunded liability. The implications are profound. As public agency press releases crow over the phasing in of a “50% employee share” of the costs of pensions, not mentioned is the fact that this 50% only applies to 1/3 of what’s being paid. Public employees are only required to share, via payroll withholding, in the “normal cost” of the pension.

Now if the “normal cost” were ever estimated at anywhere near the actual cost to fund a pension, this wouldn’t matter. But CalPERS, according to their own most recent financial report, is only 68% funded. That is, they have investments totaling $326 billion, and liabilities totaling $477 billion. This gap, $151 billion, is how much more CalPERS needs to have invested in order for their pension system to be fully funded.

A pension system’s “liability” refers to the present value of every future pension payment that every current participant – active or retired – has earned so far. In a 100% funded system, if every active employee retired tomorrow and no more payments ever went into the system, if the invested assets were equal to that liability, those assets plus the estimated future earnings on those invested assets would be enough to pay 100% of the estimated pension payments in the future, until every individual beneficiary died.

A pension system’s “normal payment” refers to the amount of money that has to be paid into a fully funded system each year to fund the present value of additional pension benefits earned by active employees in that year. When the normal payment isn’t enough, the unfunded liability grows.

And wow, has it grown.

CalPERS is $151 billion in the hole. All of California’s state and local pension systems combined, CalPERS, CalSTRS, and the many city and county independent systems, are estimated to be $326 billion in the hole. And that’s extrapolated from estimates recognized by the pension funds themselves. Scenarios that employ more conservative earnings assumptions calculate total unfunded liabilities that are easily double that amount.

With respect to CalPERS, how did this unfunded liability get so big?

An earlier CPC analysis released earlier this year attempts to answer this. Theories include the following: (1) Letting the agencies decide which type of asset smoothing they’d like to employ, (2) permitting the agencies to make minimal payments on the unfunded liability so the liability would actually increase despite the payments, (3) making overly optimistic actuarial assumptions, (4) not taking action sooner so the unfunded payment wouldn’t end up being more than twice as much as the normal payment.

One final alarming point.

CalPERS recently announced that for any future increases to the unfunded liability, the unfunded payment will have to be calculated based on a 20 year, straight-line amortization. This is a positive development, since the more aggressively participants pay down the unfunded liability, the less likely it is that these pension systems will experience a financial collapse if there is a sustained downturn in investment performance. But it begs the question – why, if only increases to the unfunded liability have to be paid down more aggressively, is the unfunded payment nonetheless predicted to double within the next six years?

CalPERS information officer Tara Gallegos, when presented with this question, offered the following answers:

(1) The discount rate (equal to the projected rate-of-return on invested assets) is being lowered from 7.5% to 7.0% per year. But this lowering is being phased in over five years, so it will not impact the 2018 unfunded contribution. Whenever the return-on-investment assumption is lowered, the amount of the unfunded liability goes up. By 2024, the full impact of the lowered discount rate will have been applied, significantly increasing the required unfunded contribution.

(2) Investment returns were lower than the projected rate of return for the years ending 6/30/2015 (2.4%) and 6/30/2016 (0.6%). Lower than projected actual returns also increases the unfunded liability, and hence the amount of the unfunded payment, but this too is being phased-in over five years. Therefore it will not impact the unfunded payment in 2018, but will be fully impacting the unfunded payment by 2024.

(3) The unfunded payment automatically increases by 3% per year to reflect the payroll growth assumption of 3% per year. This alone accounts, over six years, for 20% of the increase to the unfunded payment. The reason for this is because most current unfunded payments are calculated by cities and counties using the so-called “percent of payroll” method, where payments are structured to increase each year. CalPERS is going to require new unfunded payments to not only be on a 20 year payback schedule, but to use a “level payment” structure which prevents negative amortization in the early years of the term. Unfortunately, up to now, cities and counties were permitted to backload their payments on the unfunded liability, and hence each year have built in increases to their unfunded payments.

The real reason the unfunded liability has gotten so big is because nobody wanted to make conservative estimates. Everybody wanted the normal payments to be as small as possible. The public sector unions wanted to minimize how much their members would have to contribute via withholding. CalPERS and the politicians – both heavily influenced by the public sector unions – wanted to sell generous new pension enhancements to voters, and to do that they needed to make the costs appear minimal.

As a result, taxpayers are now paying 100% of an “unfunded contribution” that is already a bigger payment than the normal contribution, and within a few years is destined, best case, to be twice as much as the normal contribution.

Camouflaged by its conceptual intricacy, the cleverly obfuscated, deliberately underrecognized, creatively undervalued, chronically underpaid, belatedly rising unfunded pension liabilities payments are poised to gobble up every extra dime of California’s tax revenue. And that’s not all…

Sitting on the blistering thin skin of a debt bubble, a housing bubble, and a stock market bubble, amid rising global economic uncertainty, just one bursting jiggle will cause pension fund assets to plummet as unfunded liabilities soar.

And when that happens, cities and counties have to pay these new unfunded balances down on honest, 20 year straight-line terms. They’ll be selling the parks and libraries, starving the seniors, releasing the criminals, firing cops and firefighters, and enacting emergency, confiscatory new taxes.

Whatever it takes to feed additional billions into the maw of the pension systems.

Budget surplus? Dream on.

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Edward Ring co-founded the California Policy Center in 2010 and served as its president through 2016. He is a prolific writer on the topics of political reform and sustainable economic development.

RELATED ARTICLES

How to Restore Financial Sustainability to Public Pensions, February 14, 2018

How to Assess Impact of a Market Correction on Pension Payments, February 7, 2018

California Government Pension Contributions Required to Double by 2024 – Best Case, January 31, 2018

Did CalPERS Use Accounting “Gimmicks” to Enable Financially Unsustainable Pensions?, January 24, 2018

How Much More Will Cities and Counties Pay CalPERS?, January 10, 2018

If You Think the Bull Market Rescued Pensions, Think Again, December 7, 2017

Did CalPERS Fail to Disclose Costs of Historic Bump in Pension Benefits?, October 26, 2017

Coping With the Pension Albatross, October 13, 2017

How Fraudulently Low “Normal Contributions” Wreak Havoc on Civic Finances, September 29, 2017

Pension Reform – The San Jose Model, September 6, 2017

Pension Reform – The San Diego Model, August 23, 2017

Union, Inc.

Did CalPERS Use Accounting “Gimmicks” to Enable Financially Unsustainable Pensions?

Gimmick – a concealed, usually devious aspect or feature of something, as a plan or deal.
– Dictionary.com

In the past week, from Millbrae’s city hall to the inner sanctum of the CalPERS leviathan in Sacramento, defenders of pensions have been active. In particular, they have criticized the recent analysis, published by the California Policy Center, “How Much More Will Cities and Counties Pay CalPERS?” It would advance the ongoing debate over pensions to summarize the points of the CPC analysis, how CalPERS and their allies attacked those points, and how those attacks might be challenged.

On January 19th, in a report published online by Chief Investment Officer magazine entitled “CalPERS: Ring’s Flippant Claim of ‘Tricky Accounting Gimmicks’ Is False,” author Christine Giordano interviewed CalPERS spokesperson Amy Morgan. Tellingly, they did not discuss the substance of the CPC analysis, which specified, using CalPERS’ own data, how much more cities and counties are going to have to pay CalPERS. They focused instead on specific criticisms of CalPERS that followed those payment calculations.

As noted by the title of the report, CalPERS spokesperson Amy Morgan seemed to suggest the characterization of their accounting practices as employing “gimmicks” is not backed up by evidence. Morgan is invited to review the following evidence, after which she may join our readers in deciding whether or not “gimmicks” were employed.

GIMMICK #1  –  THE CORRUPTION OF “ASSET SMOOTHING”

Asset smoothing is a practice whereby pension funds do not overestimate their assets after years of good returns, nor underestimate their assets after years of poor returns. It is a good way to avoid overreacting to market volatility. But in 2001, when the Dow Jones stock index had already been correcting for over a year and the Nasdaq was collapsing, CalPERS abdicated their responsibility to set the rules on smoothing.

When participating agencies in the CalPERS system were contemplating whether or not to follow the lead of the California Highway Patrol (SB 400, 1999) and retroactively increase pension benefits, CalPERS sent projections to these agencies in which a CalPERS actuary presented to elected officials three distinct values for the assets they had invested with CalPERS. Remarkably, that document gave these agency officials the liberty to choose which one they’d like to use – the higher the value they chose for their existing assets, the lower the cost from CalPERS to pay for the benefit enhancements they were contemplating. The usual disclaimers were present, but the mere fact that city officials were given three scenarios is suspect. Obviously these officials would be under pressure to pick the scenario that provided the biggest benefit enhancement for the lowest cost. Read “Did CalPERS Fail to Disclose Costs of Historic Bump in Pension Benefits?” for more details including several source documents.

One of the most revealing documents is exemplified by the “Contract Amendment Cost Analysis,” sent to Pacific Grove by CalPERS in July, 2001. Here is an excerpt from that document, showing the choices CalPERS offered Pacific Grove:

The available rate choices are offered under three different Alternatives:
Alternative 1 – No increase in Actuarial Value of Assets
Alternative 2 – Actuarial Value of Assets increased by twice the increase in the Present Value of Benefits due to the amendment, limited to 100% of Market Value of Assets
Alternative 3 – Actuarial Value of Assets increased by twice the increase in the Present Value of Benefits due to the amendment, limited to 110% of Market Value of Assets

To reiterate: CalPERS provided abundant disclaimers. They suggested that given recent “market volatility,” city officials “are strongly encouraged to have in-depth discussions with your CalPERS actuary about the financial consequences of any amendment.”

Now let’s get real: Further on in this same letter, CalPERS provides a breakdown of how much pension benefit enhancements will cost in terms of annual contributions as a percent of payroll under each of these three scenarios:

Alternative 1 – The actuarial value of the assets is not tampered with, the normal cost goes from 4.6% to 25.0%.
Alternative 2 – The actuarial value of the assets is lifted up to market value, the normal cost goes from 4.6% to 19.9%.
Alternative 3 – The actuarial value of assets goes up to 110% of the market value, the normal cost – to implement a massive, retroactive enhancement to pension benefits – goes from 4.6% to 6.2%.

What option would you choose, if you were a city manager whose own pension would be enhanced, or a city council member who has to answer to powerful unions whose members want more generous pension formulas?

The reason CalPERS was able to cram this through, in July 2001 as the market was cratering, was based on their decision to present various asset “smoothing” options to members. Why? Because the smoothing options they’d been using were understating the value of their assets because stock values had exploded in the final years of the 1990s. One can only speculate as to why they did this as late as July 2001 when it was obvious the internet stock bubble had popped. It’s possible CalPERS officials knew several agencies had already lobbied for pension benefit enhancements and the officials were under pressure to leave no agency behind. But to offer local bureaucrats and elected officials a choice of various asset smoothing methods was passing the buck.

Overnight, the CalPERS practice of asset smoothing went from being a prudent accounting guideline to a clever rationalization for disastrous policy decisions. If that’s not a gimmick, I don’t know what is.

GIMMICK #2 – CREATIVE AMORTIZATION OF UNFUNDED LIABILITY

When you talk about “tricky accounting gimmicks,” it’s hard to find one worse than the methods the participating agencies chose to amortize their unfunded liability. To be fair, final responsibility for these decisions usually rests with the cities and counties. But CalPERS should have tried to crack down on these practices a long time ago, and indeed, has recently become more aggressive in doing just that. The basic choice facing agencies with huge unfunded liabilities is whether they want to pay them off aggressively, or come up with creative accounting techniques that push the tough repayments into the future. For example, instead of using a “level payment” repayment calculation, many of them use a “percent of payroll” scheme which allows for graduated payments.

In practice, this means calculating a stream of payments that will pay off the liability in 30 years, but varying the payments so that as projected payroll increases, the payment increases. This allows agencies to make low payments in the early years of the amortization term, which frequently means the unfunded liability isn’t even being reduced in the early years of the amortization term. Then when the payments become burdensome, they refinance the new, larger unfunded liability, to get that unfunded payment down again, in a new tranche, again using the same “level percent of payroll method.”

Anyone who lost their home because a “negative amortization” loan conned them into buying something they couldn’t afford would likely call that type of loan a “gimmick.” Similarly, negative amortization payment schedules on unfunded pension liabilities are also gimmicks. To their credit, CalPERS is now recommending 20-year straight line amortization. Which begs the question, why didn’t they do this all along?

GIMMICK #3 – OVERESTIMATING LONG-TERM RATE-OF-RETURN ASSUMPTIONS

CalPERS spokesperson Morgan correctly claims that CalPERS returns have averaged an 8.4% return over the past 30 years. But Morgan conveniently selects the 30 year timeframe to capture all of the pre-1999 run-up in stocks that began in the Reagan years as interest rates were reduced from inflation-fighting highs of 16% (30 year T-bill in the early 1980s) and American consumers began piling on debt. The 20-year return for CalPERS investments through June 30, 2017 is 6.58%. And these last 20 years of returns are far more relevant, because not quite 20 years ago is when CalPERS began to offer pension benefit enhancements that were sold as affordable when they clearly are not.

But if CalPERS is exceeding its projected rates of return over the past 30 years, why is it only 68% funded (ref. CalPERS 2016-17 CAFR, page 4, “Funding”)? At the end of a prolonged bull market, pension systems should be overfunded. Being 68% funded would not be terribly alarming if we were at the end of a prolonged bear market, but we’re in the opposite place. How can CalPERS possibly claim their actuaries are doing a competent job, if the system is this underfunded at this point in the market cycle? For more on this, read “If You Think the Bull Market Rescued Pensions, Think Again.”

It is important to emphasize that even if CalPERS can get a 7.0% return on investment – and there is some chance that they can – why did the agency wait until it was 68% funded to announce the drop in its projected returns from 7.5% to 7.0%? The United States economy is in the terminal phases of a more than 60 year long-term credit cycle, and one might argue there is a stronger case to be made that even 7.0% is highly optimistic. But we like optimism, so never mind that for now. Why wait until 2018 to phase in that half-point drop? The actuaries at CalPERS are well aware how sensitive their payment schedules are to even half-point drops in long-term rate-of-return assumptions. Overstating returns understates true cost. Is this an accounting gimmick? Only if you can prove intent. But read on.

GIMMICK #4 – QUIETLY ALLOWING THE UNFUNDED PAYMENT TO DWARF THE “NORMAL” PAYMENT

Every year, each active worker who gets CalPERS benefits vests another year of service. This means that in the future, during their retirement years, they will have an incrementally greater pension benefit in recognition of one more year of work. To pay for that incrementally greater pension benefit in the future, additional money must be invested today. That amount of money is called the “normal” contribution. But when the “normal” contribution isn’t enough, and it hasn’t been for years, the so-called unfunded liability grows. This unfunded liability represents the amount by which invested pension assets need to increase in order to earn enough to eventually pay for all the future pensions that have been promised.

This “unfunded liability” may seem theoretical when a pension system has hundreds of billions in assets. But it has to get paid down, because when there aren’t enough assets in the pension system earning interest, higher contributions are inevitably required from the participating agencies. If the unfunded liability isn’t reduced via catch-up payments, it will grow even if the normal contributions are adequate to cover newly earned benefits.

This reality is corroborated using CalPERS’ own data, which announces that payments required, as a percent of payroll, are set to increase by 50% (in some cases much more) over the next six years in nearly every agency it serves. And where are these projected increases most pronounced? In the unfunded contribution – that payment to reduce the unfunded liability.

And why does the unfunded liability grow in the first place? Because the normal contribution is too low. Why is the normal contribution too low? Could it be because public employees are only required to assist (via payroll withholding) to pay the normal contribution? Could that be the reason that lifespans were underestimated and returns were overestimated? The actuaries obviously got something wrong, because CalPERS is only around 68% funded. You can download the spreadsheet that shows the impact of this on California’s cities and counties here –  CalPERS-Actuarial-Report-Data-Cities-and-Counties.xlsx.

In the original CPC report, along with the term “gimmick,” the term “outrageous” was used. If you don’t think sparing the beneficiaries of these pensions any responsibility to share in the costs to pay down the unfunded liability isn’t outrageous, you aren’t paying attention. For example, by 2024, using CalPERS own data, the City of Millbrae will be paying CalPERS a normal contribution of $1.0 million, and an unfunded, or “catch-up” contribution of $5.8 million – nearly six times as much! Is Millbrae just an isolated example? Not really.

Again, using CalPERS’ own data, in 2017-18, their 426 participating cities will contribute $3.1 billion to CalPERS, an amount equal to 32% of their cumulative payroll. In 2024-25, just six years from now, they are estimated to contribute 5.8 billion, 48% of payroll. And the normal vs unfunded contributions? This year in the cities in the CalPERS system, 13% of payroll constitutes the normal contribution and 19% of payroll constitutes the unfunded contribution – for which current employees and retirees have no responsibility to help pay down. In 2024-25? The normal contribution is estimated to increase to 16% of payroll, and the unfunded contribution, rising to $4.0 billion, is estimated to increase to 33% of payroll.

Put another way, today the unfunded “catch-up” pension contribution for California’s cities, cumulatively, is 140% of the normal contribution. By 2024-25, that “catch-up” contribution is going to be 210% of the normal contribution, more than twice as much! And participating individual employees and retirees have zero obligation to help pay it down, even though that payment is now twice as much as the normal payment.

But it’s not the fault of the individual beneficiaries. The responsibility lies with CalPERS and the politicians they reassured for all these years, using gimmicks.

Let’s review these practices: (1) Letting the agencies decide which type of asset smoothing they’d like to employ, (2) permitting the agencies to make minimal payments on the unfunded liability so the liability would actually increase despite the payments, (3) making overly optimistic actuarial assumptions, (4) not taking action sooner so the unfunded payment wouldn’t end up being more than twice as much as the normal payment.

“Gimmicks”? You decide.

THE CASE OF MILLBRAE

On January 22, the San Mateo Daily Journal published an article entitled “Millbrae officials question, criticize pension cost report.”

The paper’s Austin Walsh reports that Millbrae officials told him that using staffing projections to calculate Millbrae’s future pension burden won’t work because Millbrae has fewer employees than most municipalities. Here’s how Millbrae’s Finance Director DeAnna Hilbrants put it: To limit pension costs, Millbrae contracts for positions in police, fire and public works departments. Quote: “Most notably, Hillbrants pointed to Millbrae joining the Central County Fire Department with Burlingame and Hillsborough and contracting with the San Mateo County Sheriff’s Office for law enforcement.”

What Millbrae officials are saying is that because they contract out much if not most of their personnel costs, their pension contribution is a small percent of their total budget. What they neglect to acknowledge is the fact that the Central County Fire Department and the San Mateo Sheriff’s Office themselves have pension costs, which are passed on to Millbrae to the extent Millbrae uses their services. Millbrae may have made a financially beneficial decision to outsource its public safety requirements. But they did not escape the pension albatross.

CALPERS IS NOT UNIQUE

What has been described here does not just apply to CalPERS. It is the rule, not the exception, for every one of California’s pension systems to engage in the same gimmickry. The consequences for California’s cities, counties, agencies, and system of public education are just beginning to be felt.

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