America’s Homeless Industrial Complex – Causes & Solutions

The Financial Context of the Imminent California Supreme Court Decision on the “California Rule”

Any day now, the California Supreme Court will rule on what may be one of the most significant cases affecting pension reform in California history. The case, CalFire Local 2881 vs. CalPERS, challenges one of the provisions of PEPRA (Public Employee Pension Reform Act) Governor Brown’s 2013 pension reform legislation. The plaintiffs argue that PEPRA’s abolition of purchases of “air-time,” where employees who are about to retire can make a payment in exchange for more years of service applied to their pensions, is illegal. They cite the “California Rule,” an interpretation of California contract law that requires any reduction in pension benefits to be offset by providing some new benefit of equal value.

The stakes couldn’t be higher. Even though pension benefit formulas have been changed for new employees, and are now somewhat more financially sustainable, the California Rule prevents any significant pension reform for existing employees, even for work not yet performed. Changing pension benefit formulas for new employees, while helpful, are not enough. If the California Supreme Court overturns the California Rule, it will not affect the pension benefits that existing employees have earned to-date, but will allow changes going forward. For example, if a public employee has worked 15 years, and earns 3 percent per year towards their pension, if they retired tomorrow their pension would be 15 (years) times 3 percent = 45 percent times their final salary. This would not change. But if they worked another 15 years, and their pension benefit was reduced going forward, they might only earn 2 percent per year for the second half of their career.

The impact of such a change would be dramatic, since less than 20 percent of California’s public sector workforce was hired after the PEPRA reforms took effect for new employees. Reforming the rate of pension benefit accrual for future work for 80 percent of California’s workforce would have a decisive impact on the financial sustainability of the pension systems.

There are many possible ways to further reform California’s public employee pensions, and they cannot come too soon. California’s public sector employers will contribute an estimated $31 billion to the pension systems this year. Extrapolating from officially announced pension rate hikes from CalPERS, California’s largest pension system, by 2024 those payments are projected to increase to $59 billion. According to the State Controller’s office, the unfunded liability for California’s state and local public employee pension systems totaled over $250 billion in 2016. That number could be grossly understated, because one of the biggest variables affecting the amount by which a pension system is unfunded is how much a pension fund’s invested assets will earn. If pension fund earnings don’t meet projections, annual contributions have to rise to make up the difference.

Pension systems have made well publicized reductions to the amount they claim they will earn, touting these reductions as proof of their commitment to cautious, prudent management of their funds. But as reported recently by Andrew Biggs, writing for Forbes, these pension funds have quietly lowered their inflation assumption at the same time, meaning they are still claiming their investments will achieve nearly the same real rate of return. As anyone saving for retirement – or funding a pension – knows without any doubt, the real rate of return is all that matters.

California’s pension systems currently rely on a real rates of return, i.e., the nominal return less the rate of inflation, of approximately 4.5 percent. They have not substantially altered that target, despite the hoopla surrounding the reduction they made in their nominal rate of return projections. The aggressive increases the pension systems are requiring to the contribution rate are a reflection more of their crackdown on the terms of the “catch up” payments employers must make to reduce the unfunded liability than on a genuine reduction to their expected real rate of return. But can pension systems continue to earn real rates of return in excess of 4 percent per year?

For over ten years, pension systems have been the beneficiaries of the longest sustained bull market in U.S. stocks in history. From its nadir in 7,063 in February 2009, to its high of 26,743 in September 2018, the Dow Jones Industrial Average more than tripled. The compounded annual increase was 15.9 percent, while at the same time the rate of inflation averaged 1.8 percent. But trough to peak is a misleading trend. The last peak for the Dow was September 2007, when it had risen to 13,895. This more appropriate peak to peak evaluation has the Dow increasing by 90 percent over 11 years, for an annual average rate of return of 6.1 percent; adjusted for inflation, the return was 4.3 percent. Since September 2018, of course, the Dow has given up 11 percent, and who knows where it’s headed.

Because the Dow Jones Industrial Average generates returns that are nearly always in synch with the other major indexes, these results matter. In the coming years, will inflation adjusted returns on equity investments remain around 4 percent? More important, why is it that after the longest bull run in stock market history, California’s pension systems are underfunded by several hundred billion dollars? Healthy, well managed pension systems should be overfunded at a time like this.

This is the context in which California’s Supreme Court Justices will make a huge decision. The boom in investment returns could well be over, with the pension funds now facing several years of doldrums. The PEPRA reforms weren’t enough to restore financial sustainability in an economic downturn. The required pension contribution rates are already set to double, and California’s cities and counties are unlikely to all be able to handle the stress of pouring additional billions into pension systems. During the last era of pension fund surpluses, pension benefits were increased retroactively. It seems hardly unfair that contract law might also permit them to be reduced, but only from now on.

 *   *   *

 

The Varieties and the Potential Impact of Post-Janus Litigation

The landmark ruling by the US Supreme Court in the Janus vs AFSCME case has given government workers the right to not only refuse union membership, but to refuse to pay any dues or fees to that union. In the wake of this ruling, new lawsuits have been filed on behalf of plaintiffs who allege the unions are attempting to circumvent the Janus ruling.

Enforcing Provisions of the Janus Ruling

A notable example of such a case is Few vs UTLA, In this case, the plaintiff, Thomas Few, is a special education teacher in Los Angeles. Few was told that he could end his membership in the United Teachers of Los Angeles union. But even as a nonmember, the union told him that he would still have to pay an annual “service fee” equivalent to his union membership dues. Few’s position, which is likely to be upheld, is that he cannot be compelled to pay anything to a union he does not choose to join, regardless of what the payment is called.

This lawsuit and others are likely to ensure that the Janus ruling is enforced. The practical result will be that government unions lose some of their members, and some of their revenue. But how many? After all, there is a valid economic incentive for public employees to belong to their unions. In California, unionized state and local workers earn pay and benefits that average twice what private sector workers earn.

For this reason, most people refusing union membership will be doing so for ideological reasons. They will find their objections to the political agenda of these unions to be more compelling than the economic reasons to support them. But there are additional ways the unions compel public employees to remain members.

For example, in some cases, within the same bargaining unit, unions will negotiate pay and benefit packages for their members that are more favorable than the pay and benefit packages they negotiate for the non-members. In some cases in academia, only union members are permitted to sit on faculty committees that determine curricula and hiring decisions.

Challenging Exclusive Representation

This right to exclusive representation is the next major target of public sector union reformers. They argue that it is unconstitutional for public sector unions – whose activity the Janus ruling verified is inherently political – to advocate on behalf of non-members, or to represent non-members, or to exclude non-members from participating in votes or discussions on policy, or to deny non-members the same negotiated rates of pay and benefits as members, or, possibly, all of the above.

Just filed this week in the US Supreme Court is the case Uradnik vs IFO, which worked its way through the lower courts in under a year. It is possible it will be heard in the 2019 session. This case calls for an immediate end to laws that force public-sector employees to accept a union’s exclusive representation.

Kathleen Uradnik, a professor of political science at St. Cloud State University in Minnesota, alleges that her union (“IFO” or Inter Faculty Organization) “created a system that discriminates against non-union faculty members by barring them from serving on any faculty search, service, or governance committee, and even bars them from joining the Faculty Senate. This second-class treatment of non-union faculty members impairs the ability of non-members to obtain tenure, to advance in their careers, and to participate in the academic life and governance of their institutions.”

There is a strong possibility that within a few years, if not much sooner, this case will be heard and ruled on by the US Supreme Court in favor of the plaintiff. If so, the future of public sector unions will be altered in ways even more significant than Janus. Unions will be prohibited from discriminating in any way against non-members who are part of their bargaining unit. They also will be powerless to stop public employees from withdrawing completely from their bargaining unit to – gasp – represent themselves in salary and benefit negotiations, something that professionals in the private sector have always done.

The Impact of Non-Exclusive Representation

An impact of a favorable Uradnik vs IFO ruling that would have even greater consequences would be if it enabled the emergence of competing unions. What if two or more unions represented a bargaining group? What if a super-union emerged whose membership welcomed government workers from an entire state, or entire profession, or the entire nation. What if these super-unions embraced a political agenda that ran counter to the left-wing agenda that has dominated public sector unions for decades?

The possibilities are tantalizing.

What if faculty members in America’s colleges and universities had the option to join a conservative union with a national membership that advocated a return to pro-Western college instruction, an end to reverse discrimination, a restoration of academic merit as the sole criteria for admission and graduation, and the abolition of divisive courses of study that offer no useful skills? What if conservative faculty members who have been silent all these years had the power of a national union to protect them from the Left?

What if K-12 teachers across America had a national union to protect them when they objected to curricula designed to turn immigrant children against the people and traditions of their host culture? What if police and firefighters across America had a national union that advocated unequivocally for a merit-based system of immigration? What if civil engineers across America had a national union that was implacably opposed to the environmentalist extremism that has doubled the cost of infrastructure projects and quadrupled the time it takes to complete them?

Enforcing Janus will begin to undermine public sector union power, which is deployed almost exclusively in the service of the Left. Enforcing Uradnik may actually create a balance of power between public sector unions that lean Left vs Right, and that, in turn, would represent a seismic shift in the political landscape of America. At the least, it would neutralize the tremendous boost that public sector unions have given the political Left in America. At most, it might create a hitherto unthinkable consensus in America that public sector unions are indeed inherently political, and have far too much political influence, and must be subject to draconian restrictions including losing the right to collectively bargain, if not complete abolition.

 *   *   *

Towards a Grand Bargain on California Water Policy

When it comes to water policy in California, perhaps the people are more savvy than the special interests. Because the people, or more precisely, the voters, by huge majorities, have approved nine water bonds in the past 25 years, totaling $27.1 billion. It is likely they’re going to approve another one this November for another $8.9 billion.

The message from the people is clear. We want a reliable supply of water, and we’re willing to pay for it. But the special interests – or whatever you want to call the collection of politicians, unelected bureaucrats with immense power, and other stakeholders who actually decide how all this money is going to be spent – cannot agree on policy. A recent article in the Sacramento Bee entitled “Why San Francisco is joining Valley farmers in a fight over precious California water,” says it all. “Precious California water.” But what if water were so abundant in California, it would no longer be necessary to fight over it?

As it is, despite what by this time next year is likely to be $36 billion in water bonds approved by voters for water investments since 1996, the state is nowhere close to solving the challenge of water scarcity. As explained in the Sacramento Bee, at the same time as California’s legislature has just passed long overdue restrictions on unsustainable groundwater withdrawals, the political appointees on the State Water Resources Control Board are about to enact sweeping new restrictions on how much water agricultural and municipal consumers can withdraw from the Sacramento and San Joaquin rivers.

This is a perfect storm, and every conservation, recycling and storage project currently funded or proposed will not make up the shortfall. In 2002, well before these new restrictions were being contemplated, the California Dept. of Water Resources issued an authoritative study, “Averting a California Water Crisis,” that estimated the difference between demand and supply at between two and six million acre feet per year by 2020. An impressive response from the public during the most recent drought, combined with some investment in water infrastructure has narrowed that gap. But the squeeze is ongoing, with tougher challenges and tradeoffs ahead.

Abundance vs Scarcity

When thinking about solutions to California’s water challenges, there is a philosophical question that has to be addressed. Is it necessary to persistently emphasize conservation over more supplies of water? Is it necessary to always perceive investments in more supplies of water as environmentally unacceptable, or is it possible to decouple, or mostly decouple, environmental harm from investment in more water supplies? Is it possible that the most urgent environmental priorities can be addressed by increasing the supply of water, even if investing in more water supplies also creates new, but lessor, environmental problems?

This philosophical question takes on urgent relevance when considering not only the new restrictions on water withdrawals that face Californians, but also in the context of another great philosophical choice that California’s policy makers have made, which is to welcome millions of new immigrants from across the world. What sort of state are we inviting these new residents to live in? How will we ensure that California’s residents, eventually to number not 40 million, but 50 million, will have enough water?

It is this reality – a growing population, a burgeoning agricultural economy, and compelling demands to release more water to threatened ecosystems – that makes a grand political water bargain necessary for California. A bargain that offers a great deal for everyone – more water for ecosystems, more water for farmers, more water for urban consumers – because new infrastructure will be constructed that provides not incremental increases, but millions and millions of acre feet of new water supplies.

The good news? Voters are willing to pay for it.

How to Have it All – A Water Infrastructure Wish List

When considering what it would take to actually have water abundance again in California, the first step is to try to determine the investment costs, imagining a best case scenario where every good idea got funded. Here’s a stab at that list, not differentiating between local, state and federal projects. These are very approximate numbers, rounded upwards to the nearest billion:

Projects to Increase Supplies of Water

(1) Build the Sites Reservoir (annual yield 0.5 MAF) – $5.0 billion.

(2) Build the Temperance Flat Reservoir (annual yield 0.25 MAF) – $3.0 billion.

(3) Raise the height of the Shasta Dam (increased annual yield 0.5 MAF) – $2.0 billion.

(4) So Cal water recycling plants to potable standards with 1.0 MAF capacity – $7.5 billion.

(5) So Cal desalination plants with 1.0 MAF capacity – $15.0 billion.

(6) Desalination plants on Central and North coasts with 0.5 MAF capacity – 7.5 billion

(7) Central and Northern California water recycling plants to potable standards with 1.0 MAF capacity – $7.5 billion.

(8) Facilities to capture runoff for aquifer recharge (annual yield 0.75 MAF) – $5.0 billion.

Total – $52.5 billion. Increased supply – 5.5 MAF.

Projects to Increase Resiliency of Water Distribution Infrastructure

(9) Retrofit every dam in California to modern standards, including Oroville and San Luis – $5.0 billion.

(10) Aquifer mitigation to eliminate toxins with focus on Los Angeles Basin – $7.5 billion.

(11) Retrofit of existing aqueducts – $5 billion.

(12) Seismic retrofits to levees statewide, with a focus on the Delta – $7 billion.

Total – $24.5 billion.

The total of all these projects, $77 billion, is not accidental. That happens to be the latest best case, low-ball estimate for California’s completed high speed rail project. Without belaboring the case against high speed rail, two comparisons are noteworthy.

First, an ambitious program to create water abundance in California and water infrastructure resiliency in California based on this hypothetical budget is achievable. These numbers are deliberately rounded up, and the final costs might actually be lower, whereas it is extremely unlikely that California’s high speed rail project can be completed for $77 billion.

Second, because people will actually consume these new quantities of water that are being supplied and delivered, private financing will be attracted to significantly reduce the taxpayer’s share.

The Impact of a $77 billion Investment on Water Supply, Resiliency, and Ecosystems

As itemized above, at a capital cost of $52.5 billion, the total amount of water that might be added to the California’s statewide annual water budget is 5.5 million acre feet.

This amount of water would have a staggering impact on the demand vs. supply equilibrium for water. It is nearly equal to the total water consumed per year by all of California’s urban centers. Implementing this plan would mean that nearly all of the water that is currently diverted to urban areas could be instead used to ensure a cool, swift flow in California’s rivers, while preserving current allocations for agriculture. The options for environmentalists would be almost unbelievable. Restore wetlands. Revive the Delta. Refill the shrinking Salton Sea.

The environmentalist arguments against the three dams are weak. Shasta Dam is already built. The impact of expanding the Shasta Dam is purportedly the worst on McCloud creek, where it will affect “nearly a mile” of what was “once a prolific Chinook salmon stream,” (italics added). That negative impact, which seems fairly trivial, has to be balanced against the profound benefit of having another 500,000 acre feet of water available every summer to generate pulses of swift, cool water in the Sacramento River. The proposed Temperance Flat Reservoir is proposed on a stretch of the San Joaquin River that already has a smaller dam. The Sites Reservoir is an offstream reservoir that will not interfere with the Sacramento River.

The environmental benefits of these dams are not limited to their ability to ensure supplies of fresh water for California’s aquatic ecosystems. They can also be used to store renewable electricity, by pumping water from a forebay at the foot of the dam into the reservoir during the day, when solar energy already brings the spot price of electricity down to just a few cents per kilowatt-hour, then generating hydro-electric power later in the evening when peak electrical demand hits the grid. This well established technology has already been implemented on dams throughout California, and remains one of the most cost-effective ways to store clean, but intermittent, renewable energy. It will also be a profit center for these dams.

The environmentalist arguments against desalination are also weak. The energy required to desalinate seawater is comparable to the energy necessary to pump it from Northern California to the Los Angeles Basin. The outfall can be discharged under pressure a few miles from shore, where it is instantly disbursed in the California current. The impact from the intakes is grossly overstated by environmentalists, when considering that even if all of these contemplated desalination plants were built, the water they would intake is only a fraction of the amount of water taken in for decades by California’s power plants that are sited on the coast and use seawater for cooling.

As for the Delta, the primary environmental threat to that ecosystem is the chance that an earthquake destroys the hundreds of miles of levees, causing the agricultural areas behind those levees to be flooded. Not only would agricultural contaminants enter the water of the Delta, but the rush of water flooding into the areas behind the levees would cause salt water from the San Francisco Bay to rush in right behind, creating conditions of salinity that would take years to remove, if ever.

This is why investing in levee upgrades and a Delta Smelt hatchery is a preferable solution to the Delta tunnels. The tunnels would ensure a resilient supply of water from north to south, but the Delta would still be vulnerable to levee collapse. Levee upgrades and a Delta Smelt hatchery would accomplish both goals – resiliency of the water supply and of the Delta ecosystem. Moreover, the presence of massive water recycling and desalination facilities in Southern California would take a great deal of pressure off how much water would need to be transported through the Delta from north to south.

How to Finance $77 Billion for Water Infrastructure

Funding capital projects depends on three possible sources: operating budgets, general obligation bonds, or revenue bonds. Operating budgets, which used to help pay for capital projects, and which ought to help pay for capital projects, will never be balanced until real pension reform occurs. So for the most part, operating budgets are not a source of funds.

A useful way to differentiate between general obligation bonds and revenue bonds are that the general obligation bonds impose a progressive tax on Californians, since wealthy individuals pay about 60% of all tax revenues in California. Revenue bonds, on the other hand, because they are serviced through sales of, for example, water produced by a desalination plant, are regressive. This is because all consumers see these costs included in their utility rates, and utility bills constitute a far greater proportion of the budget for a low income household.

The Grand Bargain – Creating Water Abundance in California
(MAF = million acre feet)

By financing water infrastructure through a combination of revenue bonds and general obligation bonds, instead of solely through revenue bonds, water can remain affordable for ordinary Californians. The $24.5 billion portion of the $77.0 billion wish list, the funds for dam, aqueduct, and levee retrofits, along with aquifer mitigation, are not easily serviced through revenue bonds. A 30 year general obligation bond for $24.5 billion with an interest rate of 5% would cost California’s taxpayers $1.6 billion per year. Some of these projects, to the extent they are improving water delivery to specific urban and agricultural consumers, might be funded by bond issuances that would be serviced by the agencies most directly benefiting.

To claim that 100% of the revenue producing water projects can be financed through revenue bonds is more than theoretical. The Carlsbad Desalination Plant financing costs, principle and interest payments a nearly $1.0 billion for the plant’s construction, are paid by the contractor that built and operates the plant, with those payments in-turn funded through the rates charged to the consumers of the water. The contractor also retains an equity stake in the project, meaning that additional capital costs incurred privately are also funded via a portion of the rates charged to consumers.

Some of the revenue producing assets on the grand bargain wish list may also have a portion of them paid for by general obligation bonds. Determining that mix depends on the consumer. For example, a revenue bond for the reservoir projects may be applied to agricultural consumers who are willing to pay well above historical rates to have a guaranteed source of water for their orchards, which have to survive through dry years.

For urban consumers in particular, making the more expensive projects financially palatable may require general obligation bonds to cover part of the costs, so the remaining costs are affordable for ratepayers. For example, desalination is a relatively expensive way to produce water, making it harder to finance 100% with revenue bonds. But without desalination, wastewater recycling and runoff capture are not sufficient local sources of water in places like Los Angeles. The overall benefit to Californians of adding another 1.5 million acre feet per year to the state’s water supply, using desalination which is impervious to droughts, may be worth having some of its cost financed with general obligation bonds.

To fund roughly 50% of the revenue producing water supply infrastructure ($26.2 billion) and 100% of the water resiliency and distribution infrastructure ($24.5 billion) on this list would cost taxpayers about $3.0 billion per year. While this might strike some as an unthinkable amount to even consider, these projects meet all the criteria for so-called “good debt.” Constructing them all would solve California’s challenge of water scarcity, possibly forever. All of the projects are assets yielding ongoing and long-term benefits that will outlast the term of the financing. At the same time, water would become so abundant in California that prioritizing water allocations to revive ecosystems would no longer provoke bitter opposition. And California’s residents would live again in a state where taking a long shower, planting a lawn, and doing other water-intensive activities that are considered normal in a developed nation, would once again become affordable and normal.

Other Ways to Help Pay for Water Abundance in California

Enable and Expand Water Markets

Even if a grand bargain is struck between environmentalists, farmers, and water districts, and massive investments are made to increase the supply of water, enabling and expanding water markets will help optimize the distribution of available water resources. Similarly, reforming California’s labyrinthine system of water rights might also help, by making it easier for owners of water rights to sell their allocations. Fostering water markets while protecting water rights have interrelated impacts, and ideally can result in more equitable, appropriate water pricing across the state. It might also help make it unnecessary to impose punitive tiered rates or rationing on household consumers.

Reform Environmentalist Barriers to Development

CEQA, or the California Environmental Quality Act, is a “statute that requires state and local agencies to identify the significant environmental impacts of their actions and to avoid or mitigate those impacts, if feasible.” While the intent behind CEQA is entirely justifiable, in practice it has added time and expense to infrastructure projects in California, often with little if any actual environmental benefit. An excellent summary of how to reform CEQA appeared in the Los Angeles Times in Sept. 2017, written by Byron De Arakal, vice chairman of the Costa Mesa Planning Commission. It mirrors other summaries offered by other informed advocates for reform and can be summarized as follows:

  • End duplicative lawsuits: Put an end to the interminable, costly legal process by disallowing serial, duplicative lawsuits challenging projects that have completed the CEQA process, have been previously litigated and have fulfilled any mitigation orders.
  • Full disclosure of identity of litigants: Require all entities that file CEQA lawsuits to fully disclose their identities and their environmental or, increasingly, non-environmental interest.
  • Outlaw legal delaying tactics: California law already sets goals of wrapping up CEQA lawsuits — including appeals — in nine months, but other court rules still leave room for procedural gamesmanship that push CEQA proceedings past a year and beyond. Without harming the ability of all sides to prepare their cases, those delaying tactics could be outlawed.
  • Prohibit rulings that stop entire project on single issue: Judges can currently toss out an entire project based on a few deficiencies in environmental impact report. Restraints can be added to the law to make “fix-it ticket” remedies the norm, not the exception.
  • Loser pays legal fees: Currently, the losing party in most California civil actions pays the tab for court costs and attorney’s fees, but that’s not always the case with CEQA lawsuits. Those who bring CEQA actions shouldn’t be allowed to skip out of court if they lose without having to pick up the tab of the prevailing party.

Find Other Ways to Reduce Construction Costs

The Sorek desalination plant, commissioned in Israel in 2015, cost $500 million to build and desalinates 185,000 acre feet of water per year. Compared to Carlsbad, which also began operations in 2015, Sorek came online for an astonishing one-sixth the capital cost per unit of capacity. Imagine if the prices Israelis pay to construct desalination plants could be achieved in California. Instead of spending $15 billion to build 1.0 million acre feet of desalination capacity, we would spend less than $3.0 billion. How did they do this?

The bidding process itself adds unnecessary costs to public infrastructure projects. Moving to a design-build process could significantly reduce duplicative work during the plant’s engineering phase. Project labor agreements are another practice that at the very least deserve serious reconsideration. Would it be possible objectively evaluate the impact of project labor agreements, and determine to what extent those mandates increase costs?

What about economies of scale? If ten desalination plants were commissioned all at once, wouldn’t there be an opportunity for tremendous unit savings? What about creativity? Elon Musk, who has disrupted the aerospace industry by building rockets at a fraction of historical prices, said “the construction industry is one of the only sectors in our economy that has not improved its productivity in the last 50 years.” Is he even partly correct? Is that worth looking into?

Shift Government Spending Priorities

Cancel High Speed Rail: The most obvious case of how to redirect funds away from something of marginal value into water infrastructure, which is something with huge public benefit, is to cancel the bullet train. The project is doomed anyway, because it will never attract private capital. But what if Californians were offered the opportunity to preserve the planned bond issuances for high speed rail, tens of billions of capital, but with a new twist? If voters were asked to redirect these funds away from high speed rail and instead towards creating water abundance through massive investment in water infrastructure, there’s a good chance they’d vote yes.

Cancel the Delta Tunnels: By investing in levee hardening, the Delta’s ecosystems can be fortified against a severe earthquake. Reducing the possibility of levee failure protects the Delta ecosystems from their worst environmental threat at the same time as it protects the ability to transfer water from north to south. Investing in hatcheries to increase the population of the threatened Smelt is a far more cost-effective way of safeguarding the survival of that species. And investing in infrastructure on the Southern California coast to make that region water independent greatly reduces the downside of a disruption to water deliveries through the Delta. Canceling the Delta Tunnels would save $20 billion, money that would go a long way towards paying for other vital water infrastructure.

Reform Pensions: The biggest out of control budget item, by far among California’s state and local agencies, is the cost of public sector pensions. A California Policy Center analysis released earlier this year, based on public announcements from CalPERS, estimated that the total employer payments for pensions for California’s state and local government employees is set to nearly double, from $31 billion in 2018 to $59 billion by 2024. And that is a best case baseline. If there is a severe market correction, those required contributions will go up further. No discussion of how to find money for other government operations can take place without understanding the role of pension costs in creating budget constraints.

Reduce State Spending: Other ways to shift spending priorities in California, while worth a discussion, are mostly controversial. Returning the administrator to faculty ratio in California’s UC and CalState systems to its historical level of 1:2 instead of the current 1:1 would also save $2.0 billion per year. Outsourcing CalTrans work and eliminating redundant positions could save $2.5 billion per year. Reducing just state agency headcount and pay/benefits by 20% would save $6.5 billion per year. Just enacting part of that, incremental pension reform for state workers, could stop the runaway cost increases that are otherwise inevitable.

California’s state budget this year has broken $200 billion for the first time. Of that, general fund spending is at $139 billion, also a record. Revenues, however, have set records as well. The rainy day fund is full, and an extra deposit of $2.6 billion has it overflowing. Why not spend that $2.6 billion on water infrastructure? For that matter, why not spend all of the $1.4 billion of cap and trade revenue on water infrastructure?

Financing more water infrastructure will more likely come via public and private debt financing. But redirecting intended future borrowings, in particular for high speed rail and for the Delta Tunnels, could cover most if not all of the infrastructure investments necessary to deliver water abundance to Californians. And at the least, redirecting funds from government operating budgets can defray some of the operating costs, if not some of the capital costs.

Work to Build a Consensus

How many more times will California’s voters approve multi-billion dollar water bonds? The two passed in the last four years, plus the current one set for the November ballot, raise $20 billion, but only $2.5 billion of that goes to reservoir storage. Only another $3.3 billion more goes to any type of supply enhancements – mostly to develop aquifer storage or fund water recycling. Meanwhile, consumers are being required to submit to permanent water rationing, and dubious projects are being funded to save water. Artificial turf is a good example. There isn’t a coach in California who wants their athletes to compete on these dangerous surfaces. On a hot day in Sacramento, the temperature on these “fields” can reach 150 degrees. They are actually keeping sprinkler systems operating on these horrendous boondoggles, just to reduce the deadly heat buildup.

Credibility with voters remains intact to-date, but cannot be taken for granted. If a grand bargain on California’s water future is struck, it will need to promise, then deliver, water abundance to California’s residents.

Change the Conventional Wisdom

California’s current policies have stifled innovation and created artificial scarcity of literally every primary necessity – not just water, but housing, energy and transportation. Each year, to comply with legislative mandates, California’s taxpayers are turning over billions of dollars to attorneys, consultants and bureaucrats, instead of paying engineers and heavy equipment operators to actually build things. The innovation that persists despite California’s unwelcoming policy environment is inspiring.

California’s policymakers have adhered increasingly to a philosophy of limits. Less water consumption. Less energy use. Urban containment. Densification. Fewer cars and more mass transit. But it isn’t working. It isn’t working because California has the highest cost of living in the nation. Using less water and energy never rewards consumers, because the water and energy never were the primary cost within their utility bills – the cost of the infrastructure and overhead was the primary cost.

Changing the conventional wisdom applies to much more than water. It is a vision of abundance instead of scarcity that encompasses every vital area of resource consumption. A completely different approach that could cost less than what it might cost to fully implement scarcity mandates. An approach that would improve the quality of life for all Californians. Without abandoning but merely scaling back the ambition of new conservation and efficiency mandates, embrace supply oriented solutions as well. Build wastewater recycling and desalination plants on the Pacific coast, enough of them to supply California’s massive coastal cities with fresh water. Instead of mandating water rationing for households, put the money that would have been necessary to retrofit all those homes into new ways to reuse water and capture storm runoff.

Paying for all of this wouldn’t have to rely exclusively on public funds. Private sector investment could fund a large percentage of the costs for new water infrastructure. Water supplies could be even more easily balanced by permitting water markets where farmers could sell their water allotments without losing their grandfathered water rights. If the bidding process and litigation burdens were reduced, massive water supply infrastructure could be constructed at far more affordable prices.

The Grand Bargain

Water abundance in California is achievable. The people of California would welcome and support a determined effort to make it a reality. But compromise on a grand scale is necessary to negotiate a grand bargain. Environmentalists would have to accept a few more reservoirs and desalination plants in exchange for plentiful water allocations to threatened ecosystems. Farmers would have to pay more for water in exchange for undiminished quantities. While private financing and revenue bonds could cover much of the expense, taxpayers would bear the burden of some new debt – but in exchange for permanent access to affordable, secure, and most abundant water.

 *  *  *

This is the third and final part of an investigation into California’s water future. Part one is “How Much California Water Bond Money is for Storage?,” and part two is “How to Make California’s Southland Water Independent for $30 Billion.” Edward Ring is a co-founder of the California Policy Center and served as its first president.

 

California’s Transportation Future, Part Four – The Common Road

With light rail, high speed rail, and possibly passenger drones and hyperloop pods just around the corner, it’s easy to forget that the most versatile mode of transportation remains the common road. Able to accommodate anything with wheels, from bicycles and wheelchairs to articulated buses and 80 ton trucks, and ranging from dirt tracks to super highways, roads still deliver the vast majority of passenger miles.

As vehicles continue to evolve, roads will need to evolve apace. Roads of the future will need to be able to accommodate high speed autonomous vehicles. They will also need to be smart, interacting with individual vehicles to safely enable higher traffic densities at higher speeds. But can California build roads competitively? How expensive are road construction and maintenance costs in California compared with other states in the U.S.? How can California make the most efficient use of its public transportation funds?

PHYSICAL VARIABLES AFFECTING CONSTRUCTION COSTS

The Federal Highway Administration maintains a cost/benefit model called “HERS” (Highway Economic Requirements System) which they use to evaluate highway construction and highway improvement projects. One of the products of HERS is the FHWA’s most recent summary of road construction costs, updated in 2015. Its findings reveal both the complexity facing any cost analysis as well as the wide range of results for similar projects.

For example, on the FHWA website’s HERS summary page, Exhibit A-1 “Typical Costs per Lane Mile Assumed in HERS by Type of Improvement” data is presented in nine columns, each representing a typical project category for which the FHWA analyzes costs. They are: “Reconstruct and Widen Lane,” “Reconstruct Existing Lane,” “Resurface and Widen Lane,” “Resurface Existing Lane,” “Improve Shoulder,” “Add Lane, Normal Cost,” “Add Lane, Equivalent High Cost,” New Alignment, Normal,” “New Alignment, High.”

The FHWA then break their results in each of the nine project categories into two broad groups; rural and urban. Within each of those two groups, they offer the subgroups; “Interstate,” “Other Principal Arterial” (these two are combined in the “Rural” group), “Minor Arterial,” and “Major Collector.” This creates seven cost groups, each of which are then further split. For “Rural” categories, they split into “Flat,” “Rolling,” and “Mountainous.” For “Urban” categories, they split into “Small Urban,” “Small Urbanized,” “Large Urbanized,” and “Major Urbanized.”

To make a long story short, and to state the obvious, “cost per lane mile” is never one number. The FHWA’s HERS table, which itself is a reductive, arguably arbitrary summary, there are 252 distinct cost per lane mile estimates, 24 per project category. And within these nine categories, the range of costs is dramatic.

According to the HERS analysis, adding a new lane to an interstate on flat terrain in a rural area costs $2.7 million per lane mile. To do the same thing in a major urbanized area costs $62.4 million per lane mile, more than twenty times as much. Even minor projects display wide ranges in cost. Resurfacing an existing lane of a principal arterial in a flat, rural area costs $279,000 per lane mile. To do the same in a major urbanized area costs $825,000 per lane mile, three times as much.

The fact that topography, existing usage and population density affect road construction costs isn’t news. But the wide variation in costs that result from these physical variables compounds the other major factor affecting road construction costs, which is the political and economic environment of the states where projects occur. As will be seen, the FHWA compiles state by state data on road construction. This data, however, is apparently not sufficient to allow the FHWA to produce a HERS summary showing costs per lane mile by state.

EXAMINING FEDERAL DATA ON ROAD EXPENDITURES BY STATE

The FHWA Office of Highway Policy Administration does issue a highway statistics report, updated annually, that provides valuable per state data on highway mileage and transportation budgets. Their 2016 report is available but incomplete (still missing key tables such as “Disbursements by States for Highways”) so the 2015 report is still the most current. These tables are uniformly formatted and downloadable.

California’s Spending per Mile vs. Condition of Roads

An excellent analysis of FHWA data is produced every year by the Reason Foundation. Earlier this year they released “23rd Annual Highway Report,”ranking each state’s highway system in 11 categories, including highway spending, pavement and bridge conditions, traffic congestion, and fatality rates.” Highlights from this study can offer insights into how efficiently California is spending its highway dollars compared to other states through using the following logic: How does California rank in terms of how much it spends per mile, compared to how California ranks in terms of the condition of its roads.

Overall California is ranked 43 among the 50 states “Total Disbursements per mile.” California is ranked 41 in “Capital & Bridge Disbursements per mile,” 47 in “Maintenance Disbursements per mile, and 46 in “Administrative Disbursements per mile.” In terms of road condition, California is ranked 33 in “Rural Interstate Pavement Condition,” 45 in “Urban Interstate Pavement Condition,” and 46 in “Rural Arterial Pavement Condition.”

There’s not too much you can conclude from that in terms of efficient use of funds. Among the 50 states, California appears to be at or near the bottom 10% in spending per mile of road, and also in pavement condition.

In terms of cost-efficiency, among all states, this data suggests California is in the middle of the pack.

How Centralized Are California’s Road and Highway Agencies?

Within the FHWA data an interesting finding is the great variation between states in road mileage under state administration vs. road mileage under other administration – mostly cities and counties, but also federal. Only a few states, mostly the larger western states, have any significant mileage administered directly by the federal government – Alaska 14%, Arizona 22%, Idaho 16%, Montana 16%, New Mexico 16%, Oregon 28% and Washington 11%, and Wyoming 13%. Most all other states have low single digit percentages of roads administered by the federal government. The national average is 3%. California, only 6%.

State administration of road construction is higher, but still relatively low. The national average is 19% of road mileage administered by state agencies. California’s is significantly lower than average, at only 8%. Altogether, nationally, 78% of road mileage is administered by local agencies, mostly cities and counties. In California, 87% of road mileage is administered locally.

Before inferring too much from this fact, that road construction and administration is overwhelmingly ran by local agencies, FHWA funding data is useful. The data shows that total funding for roads in California in 2015 was $19.0 billion. Of that, 44% ($8.3 billion) was for “Capital Outlay,” which refers to new roads, new lanes on existing roads, new bridges, and bridge upgrades. The national average is 47% of all road spending on capital.

More to the point, the CalTrans budget in 2015 was $10.5 billion. According to the California Office of Legislative Analyst, that “includes $3.9 billion for capital outlay, $2 billion for local assistance, 1.8 billion for highway maintenance and operations, and $1.7 billion to provide the support necessary to deliver capital highway projects. How much of that was reported to the FHWA as part of the total $8.3 billion spent on capital? Certainly the $3.9 billion “for capital outlay.” Probably the “$1.7 billion to provide the support necessary to deliver capital highway projects”? What about the $2.0 billion of local assistance? For capital projects, it appears that between $5.6 billion and $7.6 billion of the total spending of $8.3 billion came from CalTrans.

The State of California’s role in total spending on road transportation is also reflected in the budget allocations in that year for the California Highway Patrol, $2.4 billion, which is included in the FHWA’s total for California, under “Law Enforcement” ($3.4 billion). It is possible, if not likely, that the state’s $1.1 billion for the Dept. of Motor Vehicles is included either in the Law Enforcement or Administration categories in the FHWA data, or allocated between them. Finally, the finance charges – interest payments and debt retirement totaling $1.5 billion – are not coming out of the budgets for the state’s transportation agencies, but some percentage of that total is paid by the state. Altogether it is likely that the State of California directly funded about $12 billion, roughly 63% of the $19 billion spent on road construction and administration in 2015.

Based on funding data, state agencies clearly play a central role in constructing and maintaining California’s roads.

California’s Spending per Lane Mile vs. Percentage of Lane Miles in Urban Areas

An interesting alternative way to get at how efficiently California uses its public transportation funds is to evaluate based on the expanded variables of total lane-miles instead of state administered road mileage, and total spending on roads by all public transportation agencies instead of just Caltrans. The rationale for using lane-miles relies on the assumption that it is more costly to build a mile of six lane highway (three lanes in each direction) than a mile of two lane road, meaning that lane miles provides a more meaningful denominator, if the numerator is total public spending on roads. The rationale for examining spending by all public transportation agencies relies on the assumption that many, if not most of the political and economic factors that govern road construction costs in California are common throughout the state, having the same effect on construction costs regardless of the funding source.

Using FHWA data on lane miles and total spending by state to calculate spending per lane-mile, California was found to average $43,999 in total spending per lane-mile. This ranks California 42 among all states. The national average is $25,474 in transportation spending per lane-mile. Put another way, for every dollar that, on average, is spent to build and maintain a lane-mile in the nation as a whole, California spends $1.73. This suggests that California is not spending its transportation funds nearly as efficiently as the most other states, but without considering other variables this is a misleading statistic.

One of the largest factors determining cost per lane-mile is urbanization. This is clearly evident in the previously mentioned FHWA website’s HERS summary page, Exhibit A-1 “Typical Costs per Lane Mile Assumed in HERS by Type of Improvement,” where costs per lane-mile are uniformly higher in urban areas, and in some cases far higher. As noted earlier, “According to the HERS analysis, adding a new lane to an interstate on flat terrain in a rural area costs $2.7 million per lane mile. To do the same thing in a major urbanized area costs $62.4 million per lane mile, more than twenty times as much.”

The idea that road construction costs more in urban areas can be attributed to several interrelated factors: Land values are typically greater in densely populated areas. Construction challenges are greater in urban areas where it is more likely that existing structures may have to be acquired and demolished to permit road construction or widening. Labor costs are typically higher in urban areas. Urbanized regions also are likely to have more local restrictions on development, leading to more costly permitting processes and higher fees. There are other key factors influencing road construction costs – for example, climate and topography – but urbanization is easily quantifiable and likely the most significant of them.

For this reason, the following chart includes not only spending per lane-mile by state, but also includes the percentage of lane-miles, by state, that are in urban areas. Here, California distinguishes itself as one of the most urbanized states, having 59% of its lane-miles within urban areas. The national average, by contrast, is almost half that; only 31% of the nation’s lane miles are located in urban areas. Tracking these two rankings, spending per lane-mile and percentage of urban lane miles, permits an illuminating comparison. If one assumes there is a correlation between cost per lane mile and percentage of lane miles in urban areas, then how a state ranks in one should be similar to the how it ranks in the other.

Six states conform exactly to this assumption. Utah, for example, is the 24th most expensive state to construct roads per lane-mile, and it has the 24th most rural percentage of roads. Similarly, Illinois has a $/mile rank of 34, and it has a rural road % rank of 34. Texas, Pennsylvania, New Jersey, and the District of Colombia all have $/mile rankings exactly equal to their rural road % ranking. Five more states have a deviation between their $/mile rank and their rural road % rank of only one. California’s is only two – it is ranked 42 in its cost per lane mile, making it quite expensive relative to most states, but it is ranked 44th in its percentage of lane-miles in rural areas, meaning it is one of the most urbanized states.

The final set of columns on the chart, on the right, show a score for each state based on the rural road percent ranking less the $/mile ranking. If the score is negative, that means the state spending on lane miles ranks better (less per mile) than its rank based on its percentage of rural lane-miles. In other words if the score is negative, that means the state is spending less per lane mile than one might expect based on their level of urbanization, and if the score is positive, the state is spending more per lane mile than one might expect based on their level of urbanization.

Once again, California is in the middle of the pack.

Spending per Lane-Mile by State; Percentage of Urban Lane-Miles by State
(Source: Federal Highway Administration, 2015)

If one assigns any credence to these rankings, it presents interesting questions. Why is it that states like Georgia and Tennessee, which are relatively urbanized, are among the top performers in terms of being able to cost-effectively construct and maintain their roads? In the case of Tennessee, it isn’t as if they’ve neglected their roads, they are in the top ten in all three FHWA measurements of pavement condition. Georgia’s scores on pavement condition put them in the middle among states.

In some of the poorly ranked states, topography and climate may be factors. Alaska, the one of the least urbanized states nonetheless is one of the most expensive states to build and maintain roads, which should come as no surprise. Most of the states with low scores have harsh climates.

A final note regarding California – while it shows a high correlation between its cost per lane-mile and its level of urbanization, it does not score well in the three pavement condition indexes; 33 out of 50 for rural interstates, 45 out of 50 for urban interstates, and 46 out of 50 for rural arterial roads.

California can do better.

OBSERVATIONS AND RECOMMENDATIONS

Federal data indicates that while California scores poorly compared to other states in terms of road conditions, California also spends less than other states in terms of expenditures per lane mile. Considered in isolation, those two facts only suggest that California is using its transportation funds no more and no less efficiently than the average state. While federal data also indicates that California, overall, spends nearly twice as much per lane-mile as the national average, California is also more heavily urbanized, and normalizing for that reveals again that California is being roughly as cost effective in its use of transportation dollars as the average state.

When factoring in the condition of California’s roads, however, which are near the bottom in pavement condition indexes, California is not using its transportation dollars as well as it could.

Anecdotally, literally everyone surveyed – and we talked with representatives from dozens of agencies, research firms, and transportation agencies – agreed that per mile road construction costs are higher in California than most other states. But the federal data we had access to does not offer documentary proof of that, and Caltrans, despite numerous attempts, could not produce data on per mile construction costs that could be compared to national averages.

The lack of transparency, the complexity, and the subjective nature of any resulting analysis makes it difficult to assert with any certainty where California falls relative to other states – it is either somewhat below average, or far below average, but making that call requires a level of evidence and clarity that is simply not available. Ultimately it does not matter where California falls in that continuum, because regardless of how efficiently California spends their public transportation funds per lane mile of new or upgraded roads, there are ways to improve. The following recommendations were heard repeatedly, from contractors, trade associations, and researchers familiar with the topic. The first two in particular:

(1) Reform CEQA

CEQA, or the California Environmental Quality Act, is a “statute that requires state and local agencies to identify the significant environmental impacts of their actions and to avoid or mitigate those impacts, if feasible.” While the intent behind CEQA is entirely justifiable, in practice it has added time and expense to infrastructure projects in California, often with little if any actual environmental benefit. An excellent summary of how to reform CEQA appeared in the Los Angeles Times in Sept. 2017, written by Byron De Arakal, vice chairman of the Costa Mesa Planning Commission. It mirrors other summaries offered by other informed advocates for reform and can be summarized as follows:

  • End duplicative lawsuits: Put an end to the interminable, costly legal process by disallowing serial, duplicative lawsuits challenging projects that have completed the CEQA process, have been previously litigated and have fulfilled any mitigation orders.
  • Full disclosure of identity of litigants: Require all entities that file CEQA lawsuits to fully disclose their identities and their environmental or, increasingly, non-environmental interest.
  • Outlaw legal delaying tactics: California law already sets goals of wrapping up CEQA lawsuits — including appeals — in nine months, but other court rules still leave room for procedural gamesmanship that push CEQA proceedings past a year and beyond. Without harming the ability of all sides to prepare their cases, those delaying tactics could be outlawed.
  • Prohibit rulings that stop entire project on single issue: Judges can currently toss out an entire project based on a few deficiencies in environmental impact report. Restraints can be added to the law to make “fix-it ticket” remedies the norm, not the exception.
  • Loser pays legal fees: Currently, the losing party in most California civil actions pays the tab for court costs and attorney’s fees, but that’s not always the case with CEQA lawsuits. Those who bring CEQA actions shouldn’t be allowed to skip out of court if they lose without having to pick up the tab of the prevailing party.

(2) Restructure Caltrans

Caltrans currently outsources only about 10% of its work. Despite repeated attempts to legislate changes that would require Caltrans to use contractors to lower costs, no action has been taken. In a report prepared in 2015 by state senator Moorlach, the failure of California’s legislature to implement reforms is described: “In previous administrations, Governor Schwarzenegger pushed for an 89/11 ratio and could not achieve it. Even Governor Brown proposed a reduced ratio that was rejected by the Legislature.”

By maintaining permanent engineering staff instead of contracting, whenever projects are concluded these engineers are often idle until another project comes along. The Legislative Analyst’s Office in 2015 reported that there were 3,500 of these positions created for programs that have expired, requiring an extra $500 million each year.

The advantage of contracting out engineering work isn’t merely based on more efficiently allocating personnel to projects to avoid down time. When Caltrans does the designing, then puts the project out for bids, the contracting companies have to conduct redundant design analysis in order to prepare their bids. This also contributes to increased costs which are passed on to the taxpayer as well as extra time. In moving to a system where Caltrans just specifies the project goals and lets the contractors prepare competitive bids based on in-house designs, the taxpayer saves time and money. Ways to restructure Caltrans might include:

  • Immediately increase the ratio of contracted work from 10% to 20%.
  • Permit the headcount of in-house engineers at Caltrans to reduce through retirements and voluntary departures, systematically increasing the ratio of contracted work as the number of Caltrans in-house engineers decreases. Set a goal of at least 50% contracted work within five years.
  • Abolish the current requirement that the state legislature has to approve any projects that are contracted by Caltrans instead of designed in-house.

(3) Decentralize and Innovate

On the FAQ page for Elon Musk’s Boring Company, the following innovations are proposed to lower the cost of tunneling by a factor of between 4 and 10: (1) Triple the power output of the tunnel boring machine’s cutting unit, (2) Continuously tunnel instead of alternating between boring and installing supporting walls, (3) Automate the tunnel boring machine, eliminating most human operators, (4) Go electric, and (5) Engage in tunneling R&D. More generally, on that FAQ page the following provocative assertion is made: “the construction industry is one of the only sectors in our economy that has not improved its productivity in the last 50 years.”

How can California use public transportation dollars to nurture innovation that will deliver more people to more places, faster, safely, for less money? One way would be to nurture competition by nearly eliminating Caltrans. Why should one state agency control nearly two-thirds of the funds for road construction and maintenance in California? Why not reduce Caltrans to a couple dozen administrators to handle federal regulations and direct federal funds and move all road work, expansion and maintenance to the counties? The counties can conform to a general state plan, but there’s no reason to have a state bureaucracy any more when the counties can be challenged to be more efficient, effective and non-duplicative in their work.

Imagine the innovation that might come out of Santa Clara County, where stretches of roadway could be immediately prioritized to add smart lanes where autonomous cars – including mini-buses and share cars – can operate safely at much higher densities and speeds. Imagine the innovation that might come out of Los Angeles County, where entire transit corridors could have congestion greatly relieved because thousands of cars are being swiftly and safely transported from point to point in underground tunnels. Imagine the innovation that might come out of San Francisco, where congestion pricing completely eliminates their chronic gridlock, or out of Orange County, where private investors team up with public agencies to use roboticized equipment to perform heavy road construction at a fraction of the cost for conventional processes?

Why not decentralize transportation management in California and turn the counties into laboratories of innovation?

(4) Expand Into the Vastness of California

It is an accident of history that California is so densely urbanized. Most metropolitan regions on the east coast, developed gradually over three centuries or more, have thousands of square miles of spacious suburbs, and tens of thousands of even more spacious expanses of moderately settled lands on the edges of remaining wilderness areas. California, in stark contrast, has nearly 18 million people residing in greater Los Angeles and over 7 million people residing in the greater San Francisco Bay Area. If you add residents of the San Diego region and Sacramento regions, you account for 32 million out of a population of 39 million. And yet all of California’s urban areas, the most densely urbanized in the nation, only constitute five percent of its 163,696 square miles! The math is compelling – you could settle ten million people in four person households on half-acre lots and it would only consume 1,953 miles. Double that for roads, parks, commercial and industrial space, and you are still only talking about urbanizing another 2.4% of California’s land. The idea that we cannot do this is preposterous.

The cost of infrastructure, roads in particular, is much higher in urban areas. So why not expand along the nearly empty Interstate 5 corridor, creating new towns and cities that are spacious and zoned to never become congested? Why not upgrade I-5 to accommodate high speed smart vehicles that provide nearly the speed of high-speed rail, while preserving the point-to-point convenience that only a car can offer? Why not expand along the entire fringe of California’s great Central Valley, where currently thousands of square miles of cattle rangeland are being taken out of production anyway? Why not build more roads on this raw land, bringing down the cost both for roads and the homes that will be built around them?

(5) Change the Conventional Wisdom

California’s policymakers have adhered increasingly to a philosophy of limits. Urban containment. Densification. Less energy use. Less water consumption. Fewer cars and more mass transit. But it isn’t working. It isn’t working because California has the highest cost of living in the nation. Using less energy and water never rewards consumers, because the water and energy never were the primary cost within their utility bills – the cost of the infrastructure and overhead was the primary cost, and those costs only go up with renewables. Cramming home construction into limited areas not only destroys the ambiance of existing neighborhoods, but simply cannot increase the supply of homes enough to lower the cost.

There is a completely different approach that would cost less and improve the quality of life for all Californians. Without abandoning but merely scaling back the ambition of new conservation and efficiency mandates, free up funds to build safe, generation III+ advanced nuclear reactors. At the same time, construct desalination plants on the Southern California coast, enough of them to supply the entire Los Angeles basin with fresh water. Instead of mandating water rationing for households, put the money that would have been necessary to retrofit all those homes into new ways to reuse water and capture storm runoff.

Paying for all of this wouldn’t have to rely exclusively on public funds. Private sector investment could fund most of the energy and water infrastructure. Water supplies could be even more easily balanced by permitting water markets where farmers could sell their water allotments without losing their grandfathered water rights. If the permit process and mandated design requirements were reduced, builders could carpet former cattle ranches with new homes, sold for a profit at affordable prices.

CONCLUSION

This is the final segment of a four part excursion into California’s transportation future. In each section the same themes emerged: It isn’t just what gets built to serve future Californians, it’s how cost effectively the money is spent. Innovation and regulatory reform – CEQA in particular, but also repealing SB 375, AB 32, and related anti-growth legislation – together have the potential to lower the cost of infrastructure, transportation in particular, by at least 50%.

California’s current policies have stifled innovation and created artificial scarcity of literally every primary necessity – housing, energy, water and transportation. Each year, to comply with legislative mandates, California’s taxpayers are turning over billions of dollars to attorneys, consultants and bureaucrats, instead of paying engineers and heavy equipment operators to actually build things.

The innovation that persists despite California’s unwelcoming policy environment is inspiring. Right here are the pioneering companies that will deliver flying cars, commercial access to outer space, breakthrough modes of transportation such as hyperloop and urban tunnels. Right here are the companies that will deliver self-driving cars, cars on demand, high-speed smart cars. These things will happen within a time frame that is, by the standards of human history, breathtakingly short. And with the right assortment of pro-growth policies in place, more of them will happen right here.

California’s transportation future cannot be predicted with any certainty. If the past few decades have taught us anything, it is that innovation routinely delivers products and solutions that nobody could have possibly imagined. But it is a reasonably safe bet that the common road is the most useful mode of transportation infrastructure for which public policy can risk public funds. A flat surface where wheeled conveyances of every conceivable design can all travel from point to point, clean, smart, versatile, sustainable, and fast.

 *   *   *

Edward Ring co-founded the California Policy Center in 2010 and served as its first president.

California’s Transportation Future, Part One – The Fatally Flawed Centerpiece

California’s Transportation Future, Part Two – The Hyperloop Option

California’s Transportation Future, Part Three – Next Generation Vehicles

REFERENCES

[1] Federal Highway Administration – Highway Economic Requirements System

[2] Office of Highway Policy Information – Highway Statistics 2015

The FHWA’s annual highway statistics report is actually a series of tables, uniformly formatted and downloadable as Excel files. For this report, the following tables were downloaded and consolidated:

[2-A] Selected measures for identifying peer states

[2-B] Disbursements by States for highways

[2-C] Length by ownership

[2-D] Estimated lane-miles

[2-E] Disbursements by States for State-administered highways

[2-F] Total disbursements for highways, all units of government

[2-G] Estimated lane-miles by functional system

[3] Reason Foundation – 23rd Annual Highway Report

[4] California Office of Legislative Analyst – The 2015-16 Budget: Transportation Proposals

[5] California Office of Legislative Analyst – The 2014-15 Budget: Capital Outlay Support Program Review

 

California’s Government Unions Collect An Estimated $800 Million Per Year

Editor’s note: This post was updated on 7/13/2018 to include the following RETRACTION: The CSEA (California Schools Employees Association) has provided clarification of actual member dues revenue. The author’s previous assumptions, now known to be erroneous, were that (1) CSEA is a decentralized union meaning that significant dues revenue is retained by local affiliates, and (2) that annual dues revenue was based on 2% of pay instead of the lower 1.5%, and (3) that the maximum allowable dues per year was higher than what is actually the case.

To rectify this, this article now states that total government union revenue in California is at least $800 million per year. That is based on the inaccurate estimate originally made for CSEA’s annual revenue, $159 million, now being reduced to the revenue disclosed by the CSEA on their 990, $67M. This lower annual figure for CSEA, $67M, has been incorporated accordingly into the revised analysis to follow. While the CSEA does have independent affiliates, their revenue is far less than what we assumed, for the reasons stated, and for this overall estimate of all union revenue we are simply leaving that amount out of our calculations.

As explained in the article, it is difficult to accurately compile estimates of total government union dues and memberships, and to do so with the information and resources available requires making reasonable assumptions. If we learn of further erroneous assumptions used to compile any of these estimates, they will be diligently corrected. We regret the error.

 *   *   *

In the wake of the Janus ruling, it is useful to estimate just how much money California’s government unions collect and spend each year. Because government unions publicly disclose less than what the law requires of public corporations or private sector unions, only estimates are possible.

The primary source of information comes from Form 990s that government unions must provide to the IRS each year. Copies of these 990s can usually be found on Guidestar.org; sometimes they are also available on the union websites. While these 990s are useful, to put together reasonably accurate estimates of total government union revenue they require careful analysis and supplemental information from elsewhere. With these limitations noted, here are summary estimates of how much money California’s taxpayers are providing to government unions, who withhold their dues directly from the payroll departments of public agencies.

PUBLIC EDUCATION UNIONS

According to the U.S. Census Bureau, in 2016 there were 422,248 “full time equivalent” teachers employed in California’s K-12 system of public education. In California’s UC and CSU systems of higher education, there were 30,005 faculty instructors. Support staff in the K-12 system numbered 239,726 employees, and in higher education they numbered 40,770 employees.

The largest union focused on K-12 teachers is the California Teachers Association (CTA), easily the largest and most powerful union in California. Their most recent financials, for the year 2015, show declared revenue of $190 million, with $178 million of that declared as dues from members. This, however, greatly understates the power of the CTA.

Not only is the CTA a branch of the nationally focused National Education Association, but the CTA in turn is comprised of local chapters. These local chapters retain a significant share of dues revenue, which they report on their own 990 forms. The CTA chapter United Teachers of Los Angeles (UTLA), for example, declared membership dues of $38.9 million in 2015.

Collecting exact financial data including dues revenue for all CTA chapters would be possible, but not easy. Including the behemoth UTLA, the CTA has 1,100 chapters, plus the California Faculty Association and 42 chapters in the Community College Association. But making a reasonable estimate is possible based on the CTA “Fact Sheet” where they declare a membership of 325,000, combined with the UTLA’s disclosure of their “new dues structure,” wherein full time members pay $1,014 per year.

Based on this information, one may estimate the total annual dues revenue of the CTA and its affiliates at around $330 million per year. While some members may not pay the full dues, which might lower this estimate, the CTA and affiliates have other sources of income including investment income. For example, at the end of 2015 the CTA declared net assets of over $190 million, and the UTLA declared net assets of $28.6 million.

While the CTA is huge, it is not the only union player in California’s system of public education. A much smaller but still very large and powerful teachers union active in California is the California Federation of Teachers (CFT), a branch of the American Federation of Teachers. On their “Who We Are” page, the CFT claims a membership of 120,000, spread over 145 local chapters.

Just as with the CTA, precisely calculating the total dues revenue of the CFT is nearly impossible. Moreover, some of the AFT’s claimed chapters, the UTLA in particular, are actually quasi-independent unions that are affiliated with the CTA and the CFT. But based on their membership claims, and taking into account these complicating factors, a reasonable estimate of the total dues revenue for the CFT and their direct local affiliates is probably around $100 million.

The power of the unions in California’s system of public education doesn’t stop with the CTA and CFT, however. There is also the California School Employees Association (CSEA), claiming membership of 240,000 mostly “classified” (non-instructional) support staff. The CSEA is divided into “Areas” and “Regions”  which is their equivalent of local chapters. Their 990 reports a 2015 revenue of $67.2 million.

In summary, subject to the limitations in the available data and what appear to be reasonable assumptions, California’s public education employee unions, the CTA, the CFT, and the CSEA, altogether are probably collecting around $497 million per year.

PUBLIC SAFETY UNIONS

The difficulties inherent in estimating revenue for public education unions are equally present when trying to estimate revenue for public safety unions. The firefighter unions and police unions are for the most part decentralized. The Los Angeles Police Protective League illustrates this point. With revenue in 2016 of $11.6 million. When their membership dues, $10.4 million, is divided by their 9,900 membership, their average dues can be estimated to be $1,152 per year.

Extrapolating this estimate of average dues to the total number of full-time police officers in California, 63,230, as defined by the U.S. Census Bureau as “Police Protection – Persons with Power of Arrest,” it is reasonable to estimate the California’s total police union dues revenue is around $72.8 million per year. This number could be larger, based on the Public Policy Institute’s recent analysis which states “In 2015 there were more than 118,000 full-time law enforcement employees in California; roughly 77,000 were sworn law enforcement officers (with full arrest powers) and 41,000 were civilian staff.”

Firefighter unions, also decentralized into locals, defy easy compilations of total revenue. A conservative estimate of their average dues would be to assume they are comparable to police union dues, $1,100 per year. According to the CPF website they “claim over 175 IAFF locals as CPF affiliates, serving more than 30,000 paid professional firefighters. ” This is consistent with the U.S. Census data, which estimates “Fire Protection – Firefighters” at 28,907 employees” and “Fire Protection – Other” at 4,182 employees.

Based on these variables, total annual revenue for all affiliates of the California Professional Firefighters union is estimated to be around $33 million per year.

The other public safety union, the California Correctional Peace Officers Association, appears to be a centralized organization, claiming 39,750 members. Their 990 for 2016 declares total revenue of $29.3 million, This implies an annual dues of $1,088 per year, which is consistent with other unions.

In summary, California’s public safety unions, the CPOA, the CPF, and the CCPOA, along with their local affiliates, altogether are probably collecting around $135 million per year.

OTHER PUBLIC SECTOR UNIONS

No survey of California’s government unions is complete without taking a look at three very large and influential unions – the American Federation of State, County and Municipal Employees (AFSCME), the California State Employee Association (CSEA, not to be confused with the California School Employees Association), and the California Nurses Association.

With these unions as well it is difficult to gather accurate compiled data, because in each case dozens if not hundreds of local affiliates are filing separate 990 forms. AFSCME California, for example, includes the following:

Council 36 – extending across Los Angeles to Orange County to San Diego representing more than 55 autonomous Local Unions whose members work in local government agencies and nonprofit organizations.

Council 57 – representing workers in schools and community colleges, transit agencies, public works and services, clinics and hospitals, and water and wastewater facilities throughout Northern California and the Central Valley, as well as the health and social service professionals in corrections facilities across California.

Employees Association of the Metropolitan Water District, Local 1902 – representing the workers of Southern California water districts including accountants, designers, electricians, engineers, environmental specialists, inspectors, IT, mechanics, meter technicians, pipelayers, and PR specialists.

Management and Professional Employees Association of the Metropolitan Water District, Local 1001 – representing the management and professional employees of the the Metropolitan Water District of Southern California.

United Nurses Associations of California/Union of Healthcare Professionals (UNAC/UHCP) – representing over 29,000 registered nurses and other health care professionals, including optometrists; pharmacists; physical, occupational and speech therapists; case managers; nurse midwives; social workers; clinical lab scientists; physician assistants and nurse practitioners.

United Domestic Workers of America, Local 3930 (UDW) – representing nearly 98,000 in-home support services (IHSS) workers in 21 California counties who take care of Californians with disabilities, the sick, and the elderly.

United EMS Workers, Local 4911 – representing approximately 4,000 private sector emergency medical services (EMS) workers in California whose mission is to raise standards in EMS and protect services for the public.

Union of American Physicians and Dentists, Local 206 (UAPD) – representing doctors working for the State of California, California counties, non-profit healthcare clinics, and in private practice.

University of California Employees, Local 3299 – the University of California’s largest employee union, representing more than 24,000 employees at UC’s 10 campuses, five medical centers, numerous clinics, research laboratories and UC Hastings College of the Law.

Public Employees Union, Local 1 – representing public employees in Contra Costa, West Contra Costa, Merced, Sutter/Yuba, and El Dorado counties.

Calculating the total dues revenue of AFSCME California’s ten major networks of union locals is difficult; precisely estimating their total number of members is impossible to acquire via publicly available information. Based on the information provided on the websites of these locals, total membership can be guessed at. Four of the AFSCME California networks disclose their membership (in italics, above), totaling 155,000. Examining the descriptions of the other six networks suggests a conservative estimate of an additional 45,000 members. Assuming annual dues revenue of $400 per year per member, AFSCME is collecting $80 million per year. That’s probably on the low side.

The California State Employee Association is an agglomeration of three principle unions, the California State University Employees Union with revenue in 2016 of $7.1 million, the Association of California State Supervisors, with 2016 revenue of $3.4 million, and the powerful Service Employees International Union (SEIU) Local 1000, with 96,000 members and 2016 revenue of $63.2 million. Altogether the unions that comprise the California State Employees Association in 2016 collected revenue of $73.7 million.

Including the California Nurses Association among a survey of public sector unions requires some explanation. It clearly would be inaccurate to claim that all their members work in the public sector. For the purposes of this compilation, we will assume that 25% of them work for public healthcare facilities, based, for example, on their penetration of the UC system healthcare networks and many of California’s county medical centers. The CNA claims membership of 80,000 and for 2016 their 990 declared revenue of $107.8 million.

In summary, California’s other major public sector unions, AFSCME, the CSEA including SEIU Local 1000, and the CNA (est. public sector portion at 25%), along with their local affiliates, altogether are probably collecting around $135 million per year.

CONCLUSION

Based primarily on publicly disclosed 2016 form 990s along with information obtained from their individual websites, in aggregate, California’s major public sector unions are estimated to be collecting $800 million per year.

Because there are undoubtedly smaller and less visible public sector unions operating in California, this number may be conservative. The number is also possibly understated because when making assumptions, conservative estimates were always applied. This was the done when estimating average membership dues in nearly all cases, and also with respect to total membership.

Editor’s Note – 7/15: Notwithstanding the above, because we have learned new information that required us to revise downwards our assumptions regarding the CSEA’s total revenue (including all local affiliates), we must (1) caution any reader that these numbers are difficult to compile precisely because in California there are many hundreds, if not thousands, of individual local public sector union affiliates all filing separate 990 forms, often including financial transfers between entities that have to be offset in any thorough analysis – a nearly impossible task, and (2) upon learning of them, we will diligently correct any further wrong assumptions remaining in this analysis. 

 

California’s Public Sector Unions (including local affiliates)
Estimated Total Membership and Revenues

 

It would go beyond the scope of this analysis to speculate as to what impact the recent Janus ruling will have on government union membership and revenues, or to ponder the degree and kind of political influence of the three major blocks of unions; teachers, public safety, and public service.

It is relevant, however, to emphasize that the reach of these unions, because many of them are highly decentralized, extends to the finest details of public administration, into the smallest local jurisdictions. When recognizing the profound statewide impact of public sector union political agenda, it is easy to forget that fact, and the implications it carries for virtually every city, county, special district, or school district in California.

Ed Ring co-founded the California Policy Center and served as its first president.

 *   *   *

 

 

 

 

 

 

How Can Local Officials Prepare for the Upcoming Janus vs AFSCME Ruling?

“A public employer shall provide all public employees an orientation and shall permit the exclusive representative, if applicable, to participate.”
– Excerpt from California State Assembly Bill AB 52, December 2016

In plain English, AB 52 requires every local government agency in California to bring union representatives into contact with every new hire, to “allow workers the opportunity to hear from their union about their contractual rights and benefits.” What’s this all about?

As explained by Adam Ashton, writing for the Sacramento Bee, “New California government workers will hear from union representatives almost as soon as they start their jobs under a state budget provision bolstering labor groups as they prepare for court decisions that may cut into their membership and revenue.”

Ashton is referring to the case set to be heard by the U.S. Supreme Court early next year, Janus v. American Federation of State, County, and Municipal Employees. A ruling is expected by mid-year. It is possible, if not likely, that the ruling will change the rules governing public sector union membership. In pro-union states like California, public sector workers are required to pay “agency fees,” which constitute the vast majority of union revenue, even if they laboriously opt-out of paying that portion of union dues that are used explicitly for political campaigning and lobbying.

Needless to say, this law is designed to allow union representatives to get to newly hired public employees as soon as they walk in the door, in order to convince them to join the union and pay those dues. But can anyone argue against union membership?

The short answer is no. To deter such shenanigans, SB 285, thoughtfully introduced by Senator Atkins (D-San Diego), adds the following section to the Government Code: “A public employer shall not deter or discourage public employees from becoming or remaining members of an employee organization.” Governor Brown signed this legislation on October 9th. So much for equal time.

So what can local elected officials do, those among them who actually want to do their part to attenuate the torrent of taxpayer funded dues pouring into the coffers of public employee unions in California? Can they provide the contact information for public employees to outside groups who may be able to provide equal time?

Once again, the answer is no. To deter access even to the agency emails of public employees, a new law bans public agencies from releasing the personal email addresses of government workers, creating a new exemption in the California Public Records Act. Those email addresses could be used by union reformers to provide the facts to public employees. How this all became law provides another example of just how powerful public sector unions are in Sacramento.

In order to quickly get the primary provision of AB 52 enacted, which allows union representatives into new public employee orientations, along with a provision to deny public access to public employee emails, both were added at the last minute to the California Legislature’s 2017-2018 budget trailer bill, AB 119. The union access to new employee orientations is Article 1. The denial of email access is Article 2.

So how are the unions preparing for the Janus ruling? By (1) making sure the union operatives get to new employees as soon as they begin working, (2) by preventing agency employers from saying anything to deter new employees from joining the unions, and (3) by preventing anyone else from getting the official agency emails for new employees in order to inform them of their rights to not join a union. That’s a lot.

So what can you do, if union reformers control a majority on your agency board or city council, and you in a position to try to oppose these unions?

First, examine the legal opinions surrounding the wording of SB 285, “A public employer shall not deter or discourage public employees from becoming or remaining members of an employee organization.” The words “deter” and “discourage” do not in any way preclude providing facts. Consider this preliminary opinion posted on the website of the union-controlled Public Employee Relations Board:

“One major concern I have is that the terms “deter” and “discourage” are not defined. What if an employee comes to an employer with questions about what it means to be a member of the union, and the employer provides truthful responses. For example, assume that the employer confirms that being a member will mean paying dues. What if that has the effect of deterring or discouraging the employee from joining the union?”

It is possible for employers to present facts regarding union membership without violating the new law. Find out what disclosures remain permissible, and make sure new employees get the information.

Another step that can be taken, although probably not by local elected officials, is to challenge the new law that exempts public agency emails from public information act requests. And apart from accessing their work emails, there are other ways that outside groups can communicate with public employees to make sure they are aware of their rights.

California’s public employee unions collect and spend over $1.0 billion per year. If the Janus vs AFSCME ruling takes away the ability of government unions to compel payment of agency fees, and imposes annual opt-in requirements for both agency fees and political dues, these unions will collect less money. How much less will depend on courage and innovative thinking on the part of reformers who want to rescue California from unionized government.

REFERENCES

Get a state job and meet your labor rep: How state budget protects California unions, Sacramento Bee, June 21, 2017
http://www.sacbee.com/news/politics-government/the-state-worker/article156146364.html

AB 52, Public employees: orientation and informational programs: exclusive representatives, California Legislature
https://leginfo.legislature.ca.gov/faces/billTextClient.xhtml?bill_id=201720180AB52

Janus v. American Federation of State, County, and Municipal Employees, Supreme Court of the United States Blog
http://www.scotusblog.com/case-files/cases/janus-v-american-federation-state-county-municipal-employees-council-31/

SB 285, Atkins. Public employers: union organizing, California Legislature
https://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201720180SB285

2017-2018 budget trailer bill, AB 119, California Legislature
https://leginfo.legislature.ca.gov/faces/billTextClient.xhtml?bill_id=201720180AB119

California Public Records Act, Office of the Attorney General
http://ag.ca.gov/publications/summary_public_records_act.pdf

Fact Sheet – AB 52 (Cooper) & SB 285 (Atkins), California Labor Federation
http://calaborfed.org/wp-content/uploads/2017/04/2-AB-52-Cooper-and-SB-285-Atkinsweb.pdf

Legislative Bulletin – California School Employees Association
http://www.csea.com/web/portals/0/csea_pdf/leg_rpt.pdf

SB 285: Public Employers Cannot Discourage Union Membership, Public Employee Relations Board
http://www.caperb.com/2017/04/04/sb-285-public-employers-cannot-discourage-union-membership/

Public employee unions wield hefty Atkins stick [SB 285], San Diego Reader
https://www.sandiegoreader.com/news/2017/aug/28/ticker-public-employee-unions-wield-atkins-stick/#

California Cities Facing Huge Pension Increases from CalPERS

In their most recent actuarial reports CalPERS for the first time provided pension cost estimates for the next 8 years, from 2015 to 2023.

How high are these costs going for California’s cities who retroactively increased their pensions at CalPERS urging over the past 15 years? To answer that question I looked at the largest city in my county, Santa Rosa and this is what I found.

Data Sources for this Report

The data used to develop the spreadsheet analysis done as part of this report are NOT numbers that I calculated. The past numbers for 2002 to 2015 are taken directly from the City of Santa Rosa’s Comprehensive Annual Financial Reports found on the City’s website (This page has the links to Santa Rosa’s CAFRs from 2001 through 2015. In each of these CAFRs, the pension information is found in the section entitled “Notes to Basic Financial Statements” under the heading “Employees Retirement Plan.”). The projected growth of certain costs – such as retiree healthcare benefits (also known as “other post employment benefits,” or OPEB), the payroll and sales and property tax revenues – use inflation rates or growth rates similar to what CalPERS uses.

The future pension costs were obtained directly from the 2013 and 2015 Actuarial Reports prepared by CalPERS and found on the CalPERS website. Since the future costs are based upon CalPERS achieving a 7.5% net rate of investment return, I believe their costs are understated, but I used them anyway. But since the pension plan has $804 million worth of assets if the pension fund returns 6.5%, in a single year it will add $8 million to the City’s pension debt and a 5% return would add $20 million.

Looking at the data going back 16 years what I found is that in 2000, Santa Rosa’s pension contribution was $1.8 million and the plan was 122% funded, meaning there were $1.22 worth of invested assets in the fund for every $1.00 worth of benefits earned.

With CalPERS wholehearted support and assistance, on August 6, 2002, the Santa Rosa City Council passed a board resolution to enact a new contract with CalPERS that changed formulas from 2% per year of service at 55 years of age for non-safety Miscellaneous employees to a 3% at 60 formula.  The new formula was provided prospectively, meaning it only applied to future years of service, not past years.

For Police and Fire employees, the new contract was adopted retroactively so it applied to past and future years of service. Their formula went from 2% per year of service at 55 years of age to 3% at 50. This represents a more than 50% increase in the benefit, since along with the “multiplier” increasing from 2% to 3%, the age of eligibility dropped from 55 to 50. But it was the retroactive granting of this benefit that caused even more significant financial liability. This is because the multiplier was increased by 50% even for years already worked and raised pensions from 60% of salary to 90% of salary for 30 years of service.

These changes ended up having a serious impact on the pension costs and the unfunded liability because CalPERS used an overly optimistic rate of investment return of 8.25% compounded per year in their cost analysis. Over the past 15 years since the increase, CalPERS has only achieved a 5% compound rate of return. Many experts believe in this current low interest rate environment returns will remain at the 5% return level for the foreseeable future.

In July of 2003 the City took on $53 million worth of new debt by selling Pension Obligation Bonds (POB) and giving the proceeds to CalPERS to pay down the unfunded liability that was created by the new formulas. With interest these bonds will divert over $100 million from government services to debt service.

CalPERS Flawed Cost Analysis and Lack of Proper Disclosure

CalPERS cost analysis provided to the City in 2002 stated the cost for the new 3% at 50 formula for Safety members would be 13.27% of salary and the cost for the 3% at 60 formula for Miscellaneous members would be 9.87% of salary. However, as previously stated, these estimates were calculated assuming that pension assets would grow at 8.25% per year into the future. Since CalPERS investments have only averaged 5% over the past 15 years the increases have created $287 million in unfunded pension liabilities for the City as of 2015.

In addition, the analysis did not provide the City with any warning or disclosure regarding what would happen if the 8.25% investment return was not achieved. CalPERS simply wrote “For many plans at CalPERS the financial soundness of the plan will not be jeopardized regardless of the new formula choice made by the employer.”

The Growth of Pension Costs Since the Increase

In 2001, the City’s pension contribution was $1.5 million and in the first 4 years following the increase it grew to $11.5 million. In addition, the funding ratio dropped from 122% in 2001 to 70% in 2005 meaning the fund, instead of $63 million in excess assets now had $128 million in unfunded liabilities.

In 2006, the annual cost grew by another $5 million hitting $16.6 million and by 2015 had grown to $21 million. However, this was a very modest growth considering CalPERS lost 29% of its assets during the Great Recession in 2008 and 2009. CalPERS lowered contributions in order to help cities and counties who saw their tax revenues during the recession drop. So CalPERS extended the amortization period on the unfunded liabilities from 9 to 20 years and smoothed their investment gains and losses from 4 to 15 years into the future. Basically, these were accounting gimmicks that resulted in severe underfunding of the pension plan and these changes exist today. The chart below shows the growth of Santa Rosa public employee retirement costs (click here to see the underlying calculations).

Santa Rosa Retirement Cost Growth

However, now CalPERS is worried that the plans are not being properly funded and pension contributions need to be doubled over the next 9 years.

Projected Future Costs

In their 2015 actuarial reports, CalPERS provided the City with their normal employer contribution as a percentage of payroll and the unfunded actuarial liability (UAL) as a total cost each year from 2015 to 2023. Using a 3% payroll growth assumption and their UAL numbers, I calculated the annual costs going forward. In addition, I added the pension obligation bond debt service each year going forward along with the cost of retiree healthcare benefits using a 5% annual cost increase assumption as CalPERS does.

My analysis indicates that during the next 8 years, the cost for retiree benefits will increase from $31.0 million or 33.7% of payroll in 2015 to $59.1 million or 48% of payroll in 2023.

The nearly doubling of pension and retiree healthcare costs means the City will need to cut salaries, benefits, services and/or increase taxes each and every year going forward by $3.2 million per year to meet their retiree benefit costs.

Pension and Healthcare Costs as a Percentage of Tax Revenues

More important than pension costs as a percentage of payroll are pension costs as a percentage of tax revenues because tax revenues are what enables the City to pay for its benefits. Once retiree benefit costs exceed the City’s ability to pay them, they will no longer be able to be fully paid and at that point either they will need to be reduced in bankruptcy or through significant pension reductions. The chart below shows the growth of pension costs relative to that of general fund property tax and sales tax revenues.

churchill-2016-10-31-chart

The results of my analysis are staggering. Over the past 15 years’ sales and property tax revenues have climbed an average of 3% per year, while employee retirement costs have increased an average of 19% per year. This has led to a growth of retiree benefit costs from 3.5% of major tax revenues in 2001 to 47% in 2015 and an estimated growth to 70% of major tax revenues by 2023 (Editor’s note:  the city receives other revenues which may also be available to finance pension costs).

Growth of the Unfunded Liability

The unfunded liability of the pension plan is calculated by taking the assets in the plan minus the present value of the benefits already earned by current employees and retirees, considered the plan’s liability. The funding ratio is determined by dividing the market value of assets in the plan by the liability.

CalPERS discounts the long term liability by assuming before the money is paid to retirees, it will earn investment income. CalPERS currently uses an assumed 7.5% rate of investment return to calculate the liability and payments to the plan. So if the assumed investment return is lowered, the unfunded liability of the plan increases along with the cost of paying off the liability. Unfunded liability costs are borne by taxpayers and are not a shared expense with the employees.

Currently, using a 7.5% assumed rate of return, the pension fund has $287 million worth of unfunded liabilities and pension bond debt and is 74% funded. However, many experts believe in this low interest rate environment a lower investment return assumption should be used. Many experts think that a 5.5% to 6.5% rate should be used. Other experts believe a 3.5% rate should be used since this is about the rate private pension plans are required to use and what CalPERS uses if a City wanted to buy their way out of the CalPERS system. I won’t guess what the future investment returns will be, but here is what happens to the unfunded liability at various rates of investment return assumptions:

  • At 6.5% the unfunded liability would increase to $426 million and $50 million per year to would be added to the City’s pension costs.
  • At 5.5% the unfunded liability would increase to $585 million and $97 million per year would be added to the City’s pension costs.
  • At 4.5% the unfunded liability would increase to $755 million and $137 million per year would be added to the City’s pension costs.
  • At 3.5% the unfunded liability would increase to $967 million and $187 million per year would be added to the City’s pension cost.

Santa Rosa Analysis of Unfunded Liability at Various Rates of Investment Return

20161028-cpc-churchill1

City Pension Plan Status Using ERISA Standards

Under the Federal ERISA rules for private pensions, a high quality bond rate of return is used to determine the assumed rate of investment return. Today that is around 3.5%. ERISA also defines the health of a pension plan as follows:

  • Less than 80% funded is considered “seriously endangered”
  • Less than 70% funded is considered “at risk”
  • Less than 65% funded is considered “critical status”

So under ERISA standards, the City of Santa Rosa’s pension plan at 45% funded when assuming a 3.5% return is 20 percentage points below what ERISA would consider “critical status”. So one could more accurately describe the pension system as being on “life support”.  Also, under ERISA rules the pension benefits each year would stop being accrued until the plan becomes 60% funded to keep the hole from going deeper.

ERISA also requires the plan sponsor pay off their unfunded liabilities over 7 years. CalPERS currently allows public agencies to pay off their liability over up to 30 years. If the City was required to pay off its unfunded liability over the next 7 years, their annual contribution to the pension fund would grow from $28 million to $146 million in 2015 alone. So under ERISA rules pension costs would increase by $120 million per year and take them to 145% of payroll.

Conclusion

The City of Santa Rosa and all cities in California who retroactively increased pensions need to restructure their pension systems. Otherwise it is increasingly unlikely they will be able to afford the benefits that have already been earned and provide taxpayers with the services they deserve for their tax dollars.

City officials can no longer pretend a crisis does not exist. They would be well advised to form a Pension Advisory Committee and bring all the stakeholders to the table to look at all the options, have an actuary determine the savings for each option and make informed decisions to save the pension plan and benefits people are counting on to fund their retirement.

 *   *   *

About the author:  Ken Churchill is the author of numerous studies on the pension crisis in California and is also the Director of New Sonoma, an organization of financial experts and citizens concerned about Sonoma County’s finances and governance.

REFERENCES AND RELATED ARTICLES

California Court Ruling Allows Pension Changes, August 26, 2016

How CalPERS has Created a Ticking Time Bomb, November 30, 2015

The Devastating Impact of Retroactive Pension Increases in California, April 27, 2015

Evaluating Total Unfunded Public Employee Retirement Liabilities in 20 California Counties, May 6, 2014

Sonoma County’s Pension Crisis – Analysis and Recommendations, January 12, 2014

The Sonoma County Retroactive Pension Increase: Gross Incompetence or Billion Dollar Scam?, April 15, 2012

How Retroactive Benefit Increases and Lower Returns Blew Up Sonoma County’s Pensions, April 5, 2012

 

California’s Misguided Water Conservation Priorities

If you’ve recently driven on most any California freeway, you’ve seen the default message on the government-owned electronic billboards, “Severe Drought Conditions – Reduce Outdoor Water Use.”

The message seems reasonable enough. Several years of lower-than-average rainfall have left the state’s reservoirs depleted, so why should households be wasting water, indoor or outdoor? And if you think that reducing residential water consumption will make a difference, the solutions seem reasonable as well:  Let your lawn die, install drip irrigation to keep your perennials alive, plant “drought tolerant” plants, buy a side-loading washer, a low flow toilet, put a flow restrictor on your shower, etc., etc., etc. But will all of this make any difference?

20160817-CPC-water-quote

To answer this question it is necessary to determine just how much water is available to Californians, and how much of that water is being consumed by residential households in California. When making this analysis, we will not only estimate how much water California’s households purchase from their utility, but how much water is embodied in the food they eat.

TOTAL ANNUAL WATER SUPPLY AND USAGE IN CALIFORNIA

Here’s a rough summary of California’s annual water use. In a dry year, around 150 million acre feet (MAF) fall onto California’s watersheds in the form of rain or snow, in a wet year, we get about twice that much. [1] Most of that water either evaporates, percolates, or eventually runs into the ocean. In terms of net water withdrawals, each year around 31 MAF are diverted for the environment, such as to guarantee fresh water inflow into the delta, 27 MAF are diverted for agriculture, and 6.6 MAF are diverted for urban use. [2] Of the 6.6 MAF that is diverted for urban use, 3.7 MAF is used by residential customers, and the rest is used by industrial, commercial and government customers. [3]

Put another way, we divert 65 million acre feet of water each year in California for environmental, agricultural and urban uses, and the recommended 25% reduction in water usage by residential customers will save exactly 0.9 million acre feet – or 1.4% of our total statewide water usage. One good storm easily dumps ten times as much water onto California’s watersheds as we’ll save via a 25% reduction in annual residential water consumption.

#1 – Total Annual Water Supply and Usage in California20160817-CPC-CA-total-water-usage1

Armed with these facts, there’s a strong argument that cutting back on residential water consumption will not make a significant difference in California’s overall water use. And there are additional facts that can put this argument into an even sharper context: How much water do California’s households consume in terms of the water that was required to grow the food they eat, and how does that amount compare to the water they purchase from their utility for indoor/outdoor use?

THE “WATER FOOTPRINT” OF FOOD PER OUNCE AND PER CALORIE

While the information to determine this is readily available, it isn’t typically compiled in this context, so here goes. The best source of comprehensive data on the “water footprint” for various types of food comes from the Water Footprint Network [4], a project initially funded by UNESCO. An excellent distillation of that information was produced in April 2015 by Kyle Kim, John Schleuss, and Priya Krishnakumar, writing for the Los Angeles Times [5]. Information on calories per ounce was found on the website “fatsecret.com” [6]. That information is summarized on the following table.

#2 – Water “Footprint” per Ounce and per Calorie of Food20160817-CPC-water-footprint-per-food-category

As can be seen on the above chart, when evaluating the water efficiency of various food sources, it is misleading to rely only on gallons per ounce, since the number of calories per ounce are highly variable. But putting these two variables together to calculate a gallons per calorie measurement is quite useful. Clearly, meat products require a huge amount of water per calorie. The most efficient sources of meat protein are found in chicken, which at 0.37 gallons per calorie is around four times as water-efficient as red meat. Some sources of protein from vegetables are surprisingly efficient, including avocados at 0.20 gallons per calorie, and the almond – much maligned as a water waster – at 0.15 gallons per calorie. But we digress. How much water does it take to feed the average household in California, and how does that compare to the amount of water they buy from the utility for indoor/outdoor use?

TOTAL ANNUAL CONSUMPTION OF WATER-IN-FOOD PER HOUSEHOLD

The next table, below, provides this estimate based on a typical diet. The estimate of 2,000 calories necessary to sustain the average human (men, women, children) comes from WebMD [7]. The breakout of food consumption by category, while somewhat arbitrary, relies on data on “the average American diet” [8] compiled by researcher Mike Barrett, writing for the Natural Society website. In turn, Barrett relied on USDA and other government sources for most of his data, which is reflected here.

#3 – Total Annual Consumption of Water-in-Food per Household
20160817-CPC-water-in-food-consumption-per-capita

In one year, the average American consumes a quantity of food that required 1.3 acre feet of water to grow. In turn, at 2.91 people per household in California [9], the average household consumes a quantity of food per year that requires 3.9 acre feet of water to grow.

AVERAGE ANNUAL WATER USE PER CALIFORNIA HOUSEHOLD

Putting all of this together yields a revealing table, below, that shows that the average household purchases a relatively trivial amount of water from their utility, when compared to how much water they purchase in the form of the food they eat. By dividing the 3.7 million acre feet of water used by residences each year in California by the 12.8 million households in California [10], the average annual water consumption per household is 0.289 acre feet. By contrast, the amount of water that is eaten, so to speak, by the average California household is 3.9 acre feet, thirteen and a half times as much. By the way, it is irresistible to point out that drinking water, that quantity each human requires for their daily hydration, based on the 0.5 gallon per day recommendation from AuthorityNutrition.com [11], comes out to a paltry 0.0016 acre feet per year per household – not even a rounding error when compared to the other uses. Think about that the next time you have to ask for your water at a California restaurant.

#4 – Average Annual Water Use per California Household
20160817-CPC-average-water-use-per-household

OBSERVATIONS AND RECOMMENDATIONS

(1)  Projects that increase water supply via sewage reuse, runoff storage via reservoirs or aquifers, and desalination, are options that benefit all users, urban and agricultural.

(2)  Increasing the supply of water from diverse sources creates system resiliency which can be of critical benefit not only in the face of persistent drought, but also against catastrophes that may, for example, disable a pumping station on a major aqueduct.

(3)  The energy costs to desalinate seawater, approximately 4.0 kilowatt-hours per cubic meter, are overstated. Desalination plants can be co-located with power plants, eliminating power loss through transmission lines, whereas far-flung pumping stations consume significant amounts of electricity. Depending on transmission loss and desalination plant efficiency, the amount of lift beyond which desalination consumes less power than pumping is about 1,500 feet.

(4)  Public investment in water saving home appliances, for example via tax rebates to consumers to purchase them, by contrast, do not increase the overall supply of water.

(5)  It is nearly impossible to engage in excessive use of indoor water in a household, because 100% of the sewage is treated and released as clean outfall to the environment. Moreover, sewage is increasingly treated and reused as potable water, and eventually 100% of indoor water waste will be cycled immediately back for reuse by households.

(6)  One preferred way to reuse household sewage is referred to as “indirect potable reuse,” where the treated water is percolated into aquifers where it is eventually pumped back for household reuse. This practice has the virtue of banking the water against supply disruptions, recharging the aquifer which is especially beneficial in coastal areas where there can be salt water intrusion, and even, as water is repeatedly cycled through the aquifer, causing an ongoing improvement to the quality of the water in the aquifer as treatment progressively reduces levels of undesirable residual toxins.

(7)  While achieving 100% reuse of sewage will render indoor water conservation pointless, the virtues of outdoor water use are understated. Healthy landscaping, consisting of abundant vegetation including lawns, reduce the incidence of dust-borne pathogens, reduce the incidence of asthma, and clean and moisturize the air. Replacing grass playing fields with artificial turf introduces toxins, causes more ACL and other sports injuries, and retains heat – often to the point of making these faux fields unplayable unless they are, ironically, watered.

(8)  Simply giving up consumption of red meat would reduce the average household’s water consumption by nearly 2.0 acre feet per year. By comparison, the average Californian household’s total water consumption from the utility averages 0.29 acre feet per year. That is, just replacing consumption of red meat with an equivalent caloric intake of chicken will save the average household seven times as much water as they buy from the utility for all uses, indoor and outdoor.

Policies designed to reduce household water use are a good idea, but must be kept in perspective. Perhaps what has already been done is more than enough, and priorities might now shift towards investment in infrastructure to increase the supply of water. Nearly all water diversions in California, about 90%, are either to preserve ecosystem health or to supply agriculture. Indoor water overuse is becoming a myth, and will become entirely irrelevant as soon as 100% sewage reuse capacities are achieved. Outdoor water use should not be thoughtless, but allowing grass and perennials to die, or converting landscaping to “desert foliage,” is a cultural shift that is not necessary or desirable.

Along with investing in infrastructure to increase the supply of water, public education to help Californians adopt healthier diets would have the significant side benefit of being sound water policy. A trivial change in patterns of food consumption yields a major reduction in water required for food. For example, a public education campaign that caused a voluntary 10% reduction in red meat consumption (from 25.0% of all calories to 22.5% of all calories) would reduce California’s water consumption by 2.5 million acre feet per year. By comparison, total outdoor residential water consumption in California is estimated at only 1.8 million acre feet per year.

Perhaps, in lieu of renouncing escalating and entirely unnecessary mandates to reduce household water use, those of us who love our lawns might at least be granted a waiver if we were to present an annual affidavit to document our below-average consumption of red meat. Our smart refrigerators might actually submit the report to the utility, sparing us the paperwork.

 *   *   *

Ed Ring is the president of the California Policy Center

 

 

FOOTNOTES

(1) Total Precipitation in California during wet, average, and dry years:
California Water Supply and Demand: Technical Report
Stockholm Environment Institute
Table 2: Baseline Annual Values by Water Year Type and Climate-Scenario (MAF)
http://sei-us.org/Publications_PDF/SEI-WesternWater-CWSD-0211.pdf

(2) California water use by sector:
California Water Today
Public Policy Institute of California
Table 2.2, Average annual water use by sector, 1998–2005
http://www.ppic.org/content/pubs/report/R_211EHChapter2R.pdf

(3) California urban water use by sector:
California Dept. of Water Resources
2010 Urban Water Management Plan Data – Tables
Download spreadsheet “DOST Tables 3, 4, 5, 6, 7a, 7b, & 7c: Water Deliveries – Actual and Projected, 2005-2035”
http://www.water.ca.gov/urbanwatermanagement/2010_Urban_Water_Management_Plan_Data.cfm

(4) Water required to grow food – comprehensive resource:
The Water Footprint Network
http://waterfootprint.org/en/resources/water-footprint-statistics/
Their study explaining the data (downloadable PDF):
http://waterfootprint.org/media/downloads/Mekonnen-Hoekstra-2011-WaterFootprintCrops.pdf
The raw data (downloadable spreadsheet):
http://waterfootprint.org/media/downloads/Report47-Appendix-II.xlsx

(5) Graphic explaining water required to grow 1.0 ounces of various common types of food:
Los Angeles Times, April 2015
http://graphics.latimes.com/food-water-footprint/

(6) Tables showing calories per ounce of food:
Meat:
Lamb – https://www.fatsecret.com/calories-nutrition/generic/lamb-cooked
Pork – https://www.fatsecret.com/calories-nutrition/generic/pork-cooked-ns-as-to-fat-eaten
Beef – https://www.fatsecret.com/calories-nutrition/generic/beef-cooked-ns-as-to-fat-eaten
Chicken – https://www.fatsecret.com/calories-nutrition/generic/chicken-rotisserie-ns-as-to-skin-eaten
Starch:
Rice – https://www.fatsecret.com/calories-nutrition/generic/rice-white-cooked-regular
Pasta – https://www.fatsecret.com/calories-nutrition/generic/spaghetti-cooked
Wheat bread – http://www.fatsecret.com/calories-nutrition/usda/whole-wheat-bread
Potatoes – https://www.fatsecret.com/calories-nutrition/generic/white-potato-roasted
Vegetables & Fruit:
Broccoli – https://www.fatsecret.com/calories-nutrition/usda/broccoli
Asparagus – https://www.fatsecret.com/calories-nutrition/usda/asparagus
Cucumber – https://www.fatsecret.com/calories-nutrition/usda/cucumber-(with-peel)
Avocado – https://www.fatsecret.com/calories-nutrition/usda/avocados
Banana – https://www.fatsecret.com/calories-nutrition/generic/banana-raw
Spinach – https://www.fatsecret.com/calories-nutrition/usda/spinach
Peaches – https://www.fatsecret.com/calories-nutrition/usda/peaches
Tomatoes – https://www.fatsecret.com/calories-nutrition/generic/tomatoes-raw
Fluids:
Milk – https://www.fatsecret.com/calories-nutrition/generic/milk-cows-fluid-whole
Wine – https://www.fatsecret.com/calories-nutrition/usda/white-table-wine
Beer – https://www.fatsecret.com/calories-nutrition/generic/beer
Orange juice – https://www.fatsecret.com/calories-nutrition/usda/orange-juice
Nuts:
Almonds – http://flowingdata.com/2015/04/07/gallons-of-water-to-produce-foods/

(7) Daily calorie requirement for the average American:
WebMD
http://www.webmd.com/diet/features/estimated-calorie-requirement

(8) Average American diet by food category:
Mike Barrett, Natural Society
http://naturalsociety.com/average-american-diet-infographic/

(9) Average number of residents per household in California:
Point2Homes.com
http://www.point2homes.com/US/Neighborhood/CA-Demographics.html

(10) Total number of households in California:
Point2Homes.com
http://www.point2homes.com/US/Neighborhood/CA-Demographics.html

(11) How much water should the average human drink per day:
AuthorityNutrition.com
https://authoritynutrition.com/how-much-water-should-you-drink-per-day/

How a Major Market Correction Will Affect Pension Systems, and How to Cope

Summary:  Based on historical trends, three key aggregated stock market ratios – price/earnings, price/sales, and price as a percent of GDP – all show that publicly traded U.S. stock are overvalued by approximately 50%. This article explains the significance of these ratios, then, using a financial model developed specifically for this purpose, evaluates the impact of a major stock market correction on the funded status of California’s pension funds.

For all of California’s pension funds consolidated, the analysis finds that if the market corrects downwards by 50%, then recovers to grow at 5% per year, without benefit reductions, the required annual contribution will rise to 80% of pension eligible payroll. This will cost California’s taxpayers an additional $50 billion per year. If the market corrects by 50% then recovers to grow at 4% per year, without benefit reductions, the required annual contribution will rise to 113% of pension eligible payroll. This scenario will cost California’s taxpayers an additional $86 billion per year. The study evaluates the impact of benefit reductions, exploring cases where only new employees are affected, as well as cases where benefits earned for future work by existing employees are also affected.

When evaluating what level of benefit reductions can preserve pension systems without increasing employer contributions – which currently average about 33% of pension-eligible payroll – the study found the following:

In the case of a stock market negative correction of 50% followed by 5% annual growth, if the annual multiplier (the amount that is multiplied by years work times final salary to calculate an initial pension) is cut by 40% for new employees, the annual retiree cost-of-living adjustment is cut by 40% for new employees, the retirement eligibility age is raised by five years for new employees, AND the annual multiplier is cut by 20% for existing employees for future work, the current level of payments – approx. 33% – would be sufficient to bring the systems to 100% funded status by 2050.

In the case of a stock market negative correction of 50% followed by 4% annual growth, if the annual multiplier is cut by 40% for new employees AND existing employees for future work, and the annual retiree cost-of-living adjustment is cut by 40% for new employees AND existing employees, and the retirement eligibility age is raised by five years for new employees AND existing employees, the current level of payments – approx 33% – would be sufficient to bring the systems to 100% funded status by 2050.

The article concludes by recommending policymakers and stakeholders negotiate contingency plans to handle a major stock market correction that strikes an appropriate balance between costly tax increases and benefit reductions. The model used for this analysis can be downloaded here. Researchers at the California Policy Center may be available to assist those interested in using this model to analyze their particular pension system. 

INTRODUCTION

Pension systems rely on investment returns to ensure their ability to pay retired participants far more in retirement benefits than they, along with their employers, ever contributed into those funds during the times they were working. Public employee pension systems are particularly dependent on strong investment returns, because they are exempt from ERISA guidelines that mandate conservative, low-risk investments. Pension systems subject to ERISA are forced by its rules to make modest return-on-investment projections, and as a result they collect relatively more from their participants and their employers during their working years, and pay out relatively less in retirement benefits.

Because public employee pension systems make higher risk investments and depend on higher returns – in order to collect less from their participants and pay out more in retirement benefits – they are unusually vulnerable to sustained downturns in the stock markets. These pension funds typically have 70% or more of their assets invested in publicly traded stocks, and these investments are typically where they expect to earn the bulk of their high returns.

California’s public employee pension systems currently project between 7.0% and 7.5% per year on their investments. Some of the major funds have announced that over the next 20 years they intend to drop that projection to 6.5%. They adhere to this rather bullish long-term projection despite a stock market that in aggregate has returned almost nothing to its investors for nearly two years. Because public sector pension funds are so big, managing in aggregate over $4.0 trillion in assets nationwide, they cannot reasonably expect to beat the market. One of the premises of this article is that the historical performance of the stock market over the past 60 years, and especially over the past 30 years, is not an indication of similar returns from now on, and may in fact be counter-indicative.

This article will discuss the probability of a major market correction in part one. It will present a financial model to analyze the impact of this correction in part two, and it will present various options to policymakers in part three. It is important to emphasize from the outset, however, that there are no easy solutions to public pensions in the face of major downward correction in the market followed by a recovery that takes several years.

Last month we released a related article entitled “The Coming Public Pension Apocalypse, and What to Do About It.” That article is recommended reading for anyone interested in this topic. The format of this article parallels the earlier work but uses a different but complementary analysis in part one, and then relies on a comprehensive pension analysis model – prepared over the past two months and publicly introduced here – as a framework for discussion in parts two and three.

PART ONE:  USING KEY RATIOS TO ESTIMATE HOW MUCH THE MARKETS ARE OVERVALUED

In the previous article, part one surveyed the reasons why pension fund rates of return will fall dramatically. The emphasis was on causes, which can be briefly summarized in two categories, demographics and debt.

Causes of unsustainable stock market appreciation: Demographics and Debt

The challenge demographics poses to pension funds is based on the rapidly changing ratio of retirees to workers. According to the Federal Administration on Aging, using Census Bureau data, in 1970, 9.9% of the US population was over the age of 65. By 2030 that percentage is projected to more than double, to 19.3% of the U.S. population. This means that twice as many people, as a percent of the total population, will be retired and living on their savings. Simply put, this means they will be sellers instead of buyers in the market, driving down prices. Pension funds, where you would not expect such a dramatic change in the ratio of workers to retirees since their demographics are based on growth of the government workforce, not birth-rates, have also recently become net sellers in the markets, because the benefit enhancements they lobbied for starting around 1999 are now translating into a retired population of who are people retiring earlier with larger pensions compared to older pensioners.

The challenge rising levels of debt poses to pension funds is based on three related trends – interest rates, total market debt as a percent of GDP, and stock market appreciation. What has happened since 1980 has been a long-term downward trend in interest rates, a long-term upward trend in the stock market, and a long term upward trend in total debt as a percent of GDP. These trends are connected: Lowering interest rates stimulates borrowing which increases consumer debt and creates an incentive (fully realized) for increasing government debt. Each time interest rates are lowered, two things happen to the stock market, (1) corporate profits rise because new rounds of borrowing stimulate consumer and government spending, which in turn makes their stock worth more, and (2) more people are buying stock since the return they can get on loans has just gone down – also driving up stock prices. The problem with this model however is that it is unsustainable. Ever since the last stock market low in February 2009, interest rates have remained at or near zero, and debt as a percent of GDP has plateaued at roughly 350%. Lowering interest rates can no longer stimulate economic activity or stock market appreciation.

Evidence of unsustainable stock market appreciation: Three Key Ratios

(1) Aggregate Price/Earnings Ratio

The first table illustrates the historical trend for the price-to-earnings ratio for the S&P 500. The historical average price earnings ratio for publicly traded stocks in the U.S., as can be seen from looking at the trend line, is about 16x. Currently it is about 25x. It should be noted that while earnings are considered too volatile to serve as the most reliable indicator of whether or not a stock is overvalued or undervalued, the table here, developed by economist Robert Shiller, presents a “cyclically adjusted price to earnings ratio.” Using this technique, a rolling ten-year average earnings is calculated, and that is what is being depicted on the chart.

As can be seen, the stock market crash of 1929 was preceded by an aggregate P/E of 30. The overvalued stock market before the correction of 2000, soaring on internet IPOs for companies that, in many cases had no earnings, achieved a P/E of nearly 45 before the fall. And the overvalued stock market before the correction of 2009 had a P/E of just over 25. These high P/Es are not sustainable. The S&P 500 closed on July 8th, 2016 at a value of 2,129. If the P/E of the S&P 500 were to revert to a sustainable historical average of 16, the S&P index would fall by 36% to 1,362. And while that’s a usable projection, in reality when corrections occur, the P/E ratio falls below the average for a time, i.e., a correction to 1,362 might be a best-case scenario for the S&P 500.

Aggregate Price/Earnings Ratio, S&P 500
Last 136 years through 2016 

20160630 Schiller price earnings ratio

(2) Aggregate Price/Sales Ratio

If the price/earnings ratio, even smoothed to a ten year rolling average, is considered unreliable because earnings are volatile, then the lesser known price/sales ratio is a good way to take a second look. A price/sales ratio is relatively easy to grasp intuitively – it measures the annual revenue of the company divided by the value of the company. An aggregate price/sales ratio for the entire S&P 500 would simply be the total annual revenues of all 500 companies, divided by the total market value (expressed in their stock price x number of shares outstanding) of all 500 companies. The sustainable historical average price/sales ratio for the S&P 500 is 0.9x.

The next chart, going back to 1965, shows that aggregate price/sales ratios for the S&P 500 are at 50 year highs. As can be seen, at the 2000 peak the price/sales ratio was around 1.6x, and back in 2008 it moved just over 1.8x. Today the aggregate price/sales ratio for the S&P 500 is about 2.1x. If the P/S of the S&P 500 were to revert to a sustainable historical average of 0.9x, the S&P index would fall by 57% to 912.

Aggregate Price/Sales Ratio, S&P 500
Last 51 years through 2016
20150228_S&P-price-sales-ratio

(3) Market value of all publicly traded U.S. stocks/GDP

Another way, using ratios, to assess whether or not the U.S. stock market is overvalued is to compare the market value of all publicly traded U.S. stocks to the gross domestic product for the U.S. economy. The chart depicting the trends for this ratio since 1955 shows that it is just off a 60 year high. Before the 2000 correction the market cap/GDP ratio was 204%. Before the correction of 2009 it got up to 183%. And at the end of 2015 it was just under 200%. After both the 2000 and the 2009 correction the market cap/GDP ratio dove to around 100%. If public stocks in the U.S. were to revert to a market cap/GDP ratio of 100%, the S&P 500 would fall 50% to 1,064.

Market Value of all Publicly Traded U.S. Stocks / GDP
Last 60 years through 2015

20160416_Stock Market percent of GDP

The conclusion of this section, using the average of the three ratios just considered, is that if stock prices were to return to sustainable levels, the indexes would fall by 47%. This is consistent with the findings of the previous article, which demonstrated that debt formation can no longer be used to stimulate the economy and the markets because interest rates have been stuck at or near zero for the last seven years. The next section will examine the impact of a 47% correction on the pension funds.

PART TWO:  THE IMPACT OF A MAJOR MARKET CORRECTION ON CALIFORNIA’S PENSION FUNDS

To evaluate the impact of a major market correction on California’s state/local pension systems, we have created a model to perform “Pension System Long-Range Financial Analysis.” As will be demonstrated, this model projects the annual cash flow for a pension system through 2075 under a variety of assumptions. It also shows the assets, liabilities (NPV) and funding status for a pension system by year through 2075. Readers are invited to download this model, evaluate its internal logic, view the assumptions underlying the baseline case, and experiment with various scenarios.

Download model for “Pension System Long-Range Financial Analysis.”

Baseline Case: No change to pension benefits, no reduction in return on investments

As a starting point for comparisons, the model projects the future cash flow and funding status for all of California’s state and local government worker pension systems combined under the following assumptions:

  • Contributions are not increased.
  • Benefits are not reduced.
  • Annual returns on invested assets, with the exception of 2015 which we optimistically estimate yielded 2.0%, continue from 2016 through 2075 at 7.5% per year without exception.

Key cash flow and benefit assumptions input in this baseline case include the following:

  • The average participant works 25 years, and there is a five year gap, on average, between when the average participant retires, and when they become eligible for pension benefits.
  • The average benefit multiplier (amount that is multiplied by years worked times final salary to calculate the initial amount of a pension) for retirees through 1999 is 1.8%.
  • The average benefit multiplier for post 1999 retirees is 2.5%, to reflect the retroactive benefit enhancements that began in that year.
  • The average pension cost-of-living increase per year is 2.5%.

The model permits variations to the inputs that are beyond the scope of this report to describe in full, but retains sufficient simplicity that anyone downloading it with a reasonable understanding of spreadsheets and pension finance can examine them in detail. Comments and criticisms on the efficacy of this model are most welcome. To summarize a few of these features, the user can:

  • Vary the life expectancy – we have assumed a life expectancy increase of 0.15% per year,
  • Vary the number of workers according to the birth year of each participant – we have used Census Bureau data on California’s state/local workforce and state/local retirees to assume a roughly accurate total of 1.8 million pension “full-time equivalent” eligible workers and 1.8 million “full career” retirees, straight-lined at 60,000 participants per year of birth.
  • Vary the amount that the beginning salary of a worker increases each year – we have assumed 2.75% per year which translates into an average starting salary of $15,000 in 1960 becomes an average starting salary of $66K in 2015.
  • Change the amount of annual salary increase (promotion, “step increases,” and COLAs) – we have assumed 3.0% per year which translates into an average salary of $71K in 2015 for a worker hired in 1990. US Census estimates place the average salary for a state/local government worker in California at $72K. Our average pension eligible salary, using the above-noted assumptions, is $69K, which assumes an average overtime payment (not pension eligible) of 5%.

By inputting these assumptions and others into the model, it calculates the following results for California’s consolidated state/local pension systems at the end of 2015:  A funded ratio of 65%, total assets of $756 billion, total liabilities (NPV) of $1.16 trillion, incoming contributions of $34 billion, and contributions as a percent of payroll of 32%. These results are almost exactly consistent with the consolidated estimates as provided by the U.S. Census Bureau for 2014 and 2015. Those references are footnoted on the “data” tab of the model.

The results calculated by the model, based on this “business as usual” are surprisingly positive. They show the unfunded liability being consistently whittled away, such that by 2020 the consolidated systems are 72% funded, by 2025 they are 81% funded, by 2030 they are 91% funded, and by 2040 they are 118% funded.

All of that assumes, however, that from 2016 on, the consolidated system assets earn 7.5%. Every year without exception.

First Set of Downturn Cases:  The markets fall 47% in 2017, and earn 5% per year thereafter.

This set of cases is to show the impact of a severe market correction, followed by modest returns from then on. This set of cases assumes a 7.5% return in 2016, followed by the crash in 2017, followed by modest 5% returns from then on. The five cases depicted here reflect escalating reductions to benefits. In all cases, what is solved for is the contribution – as a percent of payroll – required for the systems to achieve 100% funding by 2030. The baseline, by the way, under this earnings scenario – that is, if no changes are made to benefits or contributions in the face of this market correction – has the pension systems completely out of funds by 2041.

In the chart depicted below, five cases are presented. The first one makes no changes to benefits, solving for what contribution as a percent of payroll is necessary to restore 100% funding to the pension systems by 2050. As can be seen, the required contribution “$ Contr” is 80% of payroll. Recall that the consolidated average for California’s state/local pension systems is currently 32%, which equates to $34 billion per year. Put another way, it would cost California’s taxpayers another $51 billion per year if the market corrects by 47%, recovers at an earnings rate of 5% per year, and no changes are made to pension benefits.

The next three cases in the chart below consider changes to new hire benefits starting in 2020. Case #2 lowers the pension multiplier for new hires from 2.5% to 2.0%; a significant change that goes further than any pension reforms being seriously considered. As can be seen, it results in a lowering of the required contribution for these systems to restore 100% funding by 2050 to 66% of payroll, still more than twice what it is today.

Case #3 shows the impact of lowering the annual multiplier for new hires from 2.5% to 2.0%, combined with raising the eligible retirement age by five years. This results in a lowering of the required contribution for these systems to restore 100% funding by 2050 to 52% of payroll. Case 3 is highlighted because it probably represents the extreme limit of what current discussions indicate might eventually be negotiable.

In an attempt however to establish parameters for what additional reforms might yield, Case #4 shows the impact of lowering the pension multiplier for new hires still further, to 1.5%. The result is significant, bringing the required contribution for these systems to restore 100% funding by 2050 to 43% of payroll. Case #5 delves into territory that some would consider reasonable; it lowers the pension multiplier for existing employees to 2.0% per year – but only from now on, not retroactively. This yields significant savings, lowering the required contribution to 35% of payroll in order to achieve 100% funding by 2050. This scenario represents a viable way to preserve defined benefits without costing taxpayers tens of billions per year.

Contributions Required as Percent of Payroll to Achieve 100% Funding by 2050
Assume -47% Market Correction in 2017, Followed by 5.0% Annual Returns1 - 5 percent results

Second Set of Downturn Cases: The markets fall 47% in 2017, and earn 4% per year thereafter.

It is possible however that 5% returns per year after a severe market correction may be too much. After the last major stock market crash, in 1929, it took several decades before the cumulative average returns post-1929 reached 5% per year. The next set of cases examines the results of a 47% market downturn in 2017, followed by four percent returns from then on. The results are dramatically different from the 5% return scenario in the first set of cases, and illustrates the extraordinary sensitivity of pension fund solvency to the long-term rates of return.

In Case #6, just as in Case #1, no change has been made to the benefits either for new or existing employees. As can be seen, going from a 5% post crash annual average return to a 4% post crash annual average return causes the required contribution as a percent of payroll to jump from 80% (Case #1) to 113% (Case #6). This translates into an increase to taxpayers of $85 billion per year.

The next four cases in this 4% earnings scenario depict the same set of benefit reductions as in the previous 5% earnings scenario. But in this case, by the time you get to Case #10 (4% post crash earnings), which has the same set of reductions as Case #5 (5% post crash earnings), instead of whittling the required annual contribution (to achieve 100% funding by 2050) down to 35%, it is still at 48%. For this reason, additional cases are considered.

Cases #11 and #12 impose additional reductions to benefits on existing employees. By lowering the pension multiplier to 1.5% for existing employees – again, only from now on – the required contribution drops to 41%. By raising the age of eligibility for benefits by five years for existing employees, the required contribution drops to a manageable 37%.

Contributions Required as Percent of Payroll to Achieve 100% Funding by 2050
Assume -47% Market Correction in 2017, Followed by 4.0% Annual Returns2 - 4 percent results

PART THREE:  CONCLUSION AND RECOMMENDATIONS

Based on historical trends, three key aggregated stock market ratios – price/earnings, price/sales, and price as a percent of GDP – all show that publicly traded U.S. stock are overvalued by approximately 50%. These indicators are supported by evidence that debt accumulation can no longer be useful as a tool to stimulate the economy or the stock markets, and that demographic trends – where an aging population is introducing more sellers into the markets – creates additional downward pressure on the stock markets.

It is easy enough to step back and claim that the rules have changed, that these unusually high stock market multiples can be sustained for additional decades, and that productivity improvements will enable the U.S. economy to support both massive debt and an aging population. Those who argue this position are betting that the U.S. economy, because of its diversity, sheer size, relatively lower levels of total market debt as a percent of GDP, relatively higher interest rates (i.e. still positive), stability and security, will become a refuge for wealth fleeing far more tumultuous economies elsewhere in the world. Staking the future of pension fund systems on this argument is a dangerous gamble. For more on why conservative rates-of-return may be inevitable, and imminent, read Michael Lebowitz’s two-part series, recently published by the California Policy Center, “The Death of the Virtuous Cycle,” and “The Fifteenth of August.”

For all of California’s pension funds consolidated, the analysis finds that if the market corrects downwards by 50%, then recovers to grow at 5% per year, without benefit reductions, the required annual contribution will rise to 80% of pension eligible payroll. This will cost California’s taxpayers an additional $50 billion per year. If the market corrects by 50% then recovers to grow at 4% per year, without benefit reductions, the required annual contribution will rise to 113% of pension eligible payroll. This scenario will cost California’s taxpayers an additional $86 billion per year. This analysis has also evaluated the impact of benefit reductions, exploring cases where only new employees are affected, as well as cases where benefits earned for future work by existing employees are also affected.

When evaluating what level of benefit reductions can preserve pension systems without increasing employer contributions, the study found the following:

In the case of a stock market negative correction of 50% followed by 5% annual growth, if the annual multiplier (the amount that is multiplied by years work times final salary to calculate an initial pension) is cut by 40% for new employees, and the annual retiree cost-of-living adjustment is cut by 40% for new employees, the retirement eligibility age is raised by five years for new employees, AND the annual multiplier is cut by 20% for existing employees for future work, the current level of payments would be sufficient to bring the systems to 100% funded status by 2050.

In the case of a stock market negative correction of 50% followed by 4% annual growth, if the annual multiplier (the amount that is multiplied by years work times final salary to calculate an initial pension) is cut by 40% for new employees AND existing employees for future work, and the annual retiree cost-of-living adjustment is cut by 40% for new employees AND existing employees, the retirement eligibility age is raised by five years for new employees AND existing employees, the current level of payments would be sufficient to bring the systems to 100% funded status by 2050.

Preserving defined benefit pensions in the face of a prolonged period of low investment returns will require the stakeholders in public employee pension funds to make hard choices. For example, lowering benefit accruals – just for future work by existing employees –  can have a significant impact on reducing the required contribution. Reducing benefits for new employees is helpful, but the savings to be realized are decades in the future and are therefore heavily discounted when calculating a current pension system liability. For this reason, only restricting benefit reductions to new employees means they must be severe indeed. Balancing benefit reductions between existing employees (for future work) and new employees yields far less severe overall reductions – although as demonstrated, if the average market returns dip below 5% in the long-term – there is no incremental way to preserve system solvency without also dramatically increasing the required contributions.

Policymakers and stakeholders should plan now. They should negotiate, at the least, contingency plans to handle a major stock market correction that strikes an appropriate balance between costly tax increases and benefit reductions. Should there be a significant stock market downturn, taxpayers themselves will have depleted savings. They should not have to endure higher taxes to maintain public sector retirement accounts, when their own retirement accounts have been equally affected.

 *   *   *

Ed Ring is the president of the California Policy Center.

 

UC Berkeley’s ‘income inequality’ critics earn in top 2%

Scholars from the University of California at Berkeley have played a pivotal role in making income inequality a major political issue. But while they decry the inequities of the American capitalist system, Berkeley professors are near the top of a very lopsided income distribution prevailing at the nation’s leading public university.

Among the most prominent of these scholars is Robert Reich, Chancellor’s Professor of Public Policy at the University of California at Berkeley. Reich’s 2013 film, Inequality for All, is an indictment of a rigged U.S. economy that makes a select few richer while consigning the middle class to stagnation. A review of the film and Reich’s other work suggests that the economist and former Clinton-era Labor Secretary provided numerous talking points for Bernie Sanders’ high-profile – though ultimately unsuccessful – presidential campaign.

While Reich helped popularize the income inequality theme, much of the intellectual heavy lifting has been done by UC Berkeley economist Edward Saez and his colleagues at the university’s Center for Equitable Growth (CEG). Saez has been researching income inequality since 2003, when he co-authored a paper on the topic with Thomas Piketty, the French economist whose book Capital in the Twenty-First Century also played a key role in popularizing the income inequality issue. The pair continue to collaborate.

Since these Berkeley academics preaches, we wondered whether the university community also practices greater equality. To answer this question, we examined distributional equity at the university, relying on publicly available data.

Statistical Comparisons of Inequality

Social science researchers often measure income inequality with the Gini Coefficient – a calculated value that can range between zero and one. The higher the Gini Coefficient, the more unequal the country, municipality or community. If everyone in a population has exactly the same income, that group’s Gini Coefficient is zero.  By contrast, if one individual receives all of a community’s income (and everyone else receives nothing), the Gini Coefficient is 1.

According to World Bank statistics, the average country had a Gini Coefficient of around 0.36 in 2012, when data for 68 countries were available. In 2013, the coefficient for the U.S. was 0.4106 – roughly the same as it was under Bill Clinton in 1997. The country with the lowest reported Gini was Ukraine (at 0.2474) and the highest was Haiti (at 0.6079). Scandinavian countries are among the most equal (between 0.26 and 0.29), while Latin American nations dominate the high Gini countries (with several over 0.50).

Within the United States, the Census Bureau reports Gini coefficients for over 500 cities.  The latest data available are for 2014. The city of Berkeley’s Gini score of 0.5356 places it in the top 5% of U.S. cities for income inequality. In California, it ranks third of 133 – behind Davis (another city dominated by a UC campus) and Los Angeles. Internationally, city of Berkeley’s score is virtually identical to that of Colombia.

Public employee compensation data allows us to measure income inequality on campus. The State Controller’s Public Pay database contains salaries for all UC employees, indicating which campus each employee is on. The Gini coefficient for the 35,000 UC Berkeley employees in the data set is 0.6600 – higher than that of Haiti.

Getting Rich from Researching and Critiquing Inequality

Income inequality at Cal extends to the university’s inequality research arm, the Center for Equitable Growth mentioned earlier. According to 2014 data from Transparent California, Center Director Emmanuel Saez received total wages of $349,350. Its three advisory board members are also highly compensated Cal professors: David Card (making $336,367 in 2014), Gerard Roland ($304,608) and Alan Auerbach ($291,782). Aside from their high wages, all four professors are eligible for a defined-benefit pension equal to 2.5% times final average salary times number of years employed. It is also worth noting that all four are in the top 2% of UC Berkeley’s salary distribution, and that Saez is in the top 1%. It could be that an effective researcher has to know his or her subject: thus to the study the top 1%, we suppose one has to be in the top 1%.

Pricey Textbook

BOOK CLUB: Cal economics students are pounded by high-priced textbooks.

Robert Reich receives somewhat lower compensation than the four CEG economists, collecting $263,592 in pay during 2014. But Reich’s salary was likely not his only source of income in 2014. Reich makes himself available to give paid speeches through a number of speaking bureaus, charging a fee estimated at $40,000 per talk. He is also likely to receive some income from his books, movies and pensions from previous employers.

Reich is not the only senior academic who can avail himself of significant income aside from that provided by his university employer. Because teaching and publication demands on tenured professors are relatively modest, there’s time to earn extra income from consulting and writing textbooks. The latter can be surprisingly lucrative, since many college textbooks sell for over $200 per copy. Last September, the Cal bookstore offered an introductory economics textbook for $294. Lucrative opportunities to supplement one’s income with consulting fees and royalties are typically unavailable to a college’s administrative staff.

Highly Paid Coaches and Administrators

Aside from tenured professors, UC Berkeley also provides generous compensation for athletic coaches and administrators. The highest paid UC Berkeley employee in 2014 was Daniel Dykes who received $1,805,400 for coaching the California Golden Bears football team, which went 5-7 that year and did not make a bowl appearance. Dykes was followed closely by Jeff Tedford (at $1,800,000), the Bears’ former coach who was still on the payroll in 2014 despite having been relieved of his coaching responsibilities. The next five highest paid UC Berkeley employees were also coaches.

UC Berkeley Chancellor Nicholas Dirks was paid $532,226 in 2014, but a unique perk substantially boosted his effective compensation.

Dirks House

HE BUILT A WALL AND YOU PAID FOR IT: Chancellor Dirks’ residence with new $700k fence.

Like all UC Chancellors, Dirks is provided with a free residence. According to the San Francisco Chronicle, University House – now occupied by Dirks – contains 15,850 square feet of living and meeting space. Living on campus has not been an unalloyed benefit for Chancellor Dirks, however. The home has been attacked on numerous occasions by student activists. In response, the university recently completed a metal fence around the home at a cost of $699,000 – two and a half times over budget.

Dirks’ cash compensation was slightly lower than that of former UC President Mark Yudof, who co-instructed one class at Cal’s Law School in 2014, receiving $546,057 for his time. According to the Sacramento Bee, “Yudof benefited from a UC policy that allows high-ranking administrators to receive a year of pay if they are preparing to teach again.” After stepping down as president, Yudof took a one-year sabbatical, co-taught one class in Fall 2014 and another in Spring 2015, and then retired.

Tenured faculty and administrators at Cal have also been shielded from harsh discipline, even when they engage in sexual harassment. According to a recent report in the San Jose Mercury News:

Astronomer Geoff Marcy received a warning last year despite the university’s finding that he had serially harassed students over nearly a decade. Former law school dean Sujit Choudhry received a 10 percent pay cut but was initially allowed to keep his position after he was found to have sexually harassed his executive assistant. And former Vice Chancellor Graham Fleming — who stepped down last April amid allegations he had sexually harassed a staff member — quickly landed an administrative job as ambassador for UC Berkeley’s new Global Campus, a satellite campus in Richmond.

The three Cal employees cited received generous compensation in 2014. Marcy collected $217,861; Choudhry made $472,917 and Fleming received $404,625. More recently, Berkeley has taken stronger disciplinary measures in response to media attention and pressure from UC’s system President Janet Napolitano. Fleming was fired and Choudhry resigned in March.

Life for the Other 99%

High compensation for tenured faculty does not necessarily come with a heavy teaching workload. Instead, most of the teaching burden appears to fall on junior faculty and teaching assistants.

Introductory classes at UC Berkeley often have several hundred students. Although a faculty member gives the lectures and designs the syllabus, students functioning as teaching assistants, readers and graders handle most live interaction with course participants, review their homework and score their exams. Students fulfilling these roles may be in a graduate program, but are often juniors or seniors.

In Fall 2013, Cal’s Intro to Computer Science – CS 61A – had 1,098 registered students, exceeding the capacity of the lecture hall. The assistant professor conducting the course, John DeNero, recorded lecture videos for those who could not fit into the room. He told the student newspaper: “Almost all of the learning in computer science courses happens in the lab and when they’re working on projects. So if you don’t fit in the room, you can definitely still participate in all the important parts of the course.” Students taking the class had access to 19 teaching assistants and 15 readers. DeNero was paid $46,643 in 2014 – likely exceeding the amounts paid to the enormous assistant and reading staff who now receive around $14 per hour. Thus, one of the university’s most important services – orienting new students to the fast-growing field of computer science – was delivered by poorly paid staff, without any input from its highly compensated senior faculty.

Although the City of Berkeley has a higher minimum wage than the rest of the state, Cal is exempt from this municipal minimum. In late 2014, The East Bay Express reported that the university was paying hundreds of student workers less than the $10 per hour city minimum.  More recently, the university implemented a UC-wide Fair Wage/Fair Work Plan under which the minimum wage rose to $13 per hour in October 2015 with subsequent increases to $14 per hour in October 2016 and $15 per hour in October 2017. It should be noted that, unlike other minimum wage requirements, UC’s minimums apply only to employees working more than 20 hours per week, so it is possible that some student workers will remain below the City of Berkeley minimum, currently set at $12.53.

It is difficult to assess how little of the teaching burden falls on the shoulders of tenured faculty.  The University of California’s Annual Accountability Report (covering all 10 UC campuses) indicates that most instruction is provided by “full-time permanent faculty.” This designation includes assistant and associate professors who have yet to obtain tenure. Further, the university employs a misleading metric for reporting relative instructional burdens between full-time permanent faculty, lecturers, visitors, adjuncts and others. Teaching loads are shown in “student credit hours (SCH),” which is the number of students enrolled in a given course times the number of credits earned from that course. If a permanent faculty member gives the lectures for a 4-credit course attended by 1000 students, 4000 SCH are added to the full-time permanent faculty total even though most instructional activities in the course are performed by juniors, seniors and graduate students.

Relatively low-paid and heavily worked staff also keep many of Cal’s core functions running. Administrative staff faced a round of layoffs in 2011 and are now undergoing a further workforce reduction despite increasing enrollment numbers. Meanwhile, unrepresented staff (those not unionized) have seen minimal salary growth in recent years. Although administrative tasks – such as managing financial aid applications, administering grants applications and maintaining university software platforms – may seem less glamorous than research, individuals performing these functions often work much harder than tenured faculty while earning far less.

Conclusion

The University of California at Berkeley has a great reputation, and the school continues to earn its high standing with a mixture of world-class scholars, outstanding students and (at least some) great facilities.

To attract excellent academics and administrators, the university must offer competitive compensation packages. In some cases, these packages will draw truly outstanding people who go on to do excellent work for the university. In other instances, these packages amount to sinecures enabling high-status individuals to receive compensation disproportionate to their contributions.

In this respect, Cal is no different from a large, publicly held corporation. Companies offer big salaries to CEOs and other high-level professionals, sometimes getting their money’s worth and other times not. Just as it isn’t reasonable to expect a tenured professor or senior administrator to be paid in line with entry-level employees, we shouldn’t expect senior university administrators and tenured professors to be paid the same as work-study students.

While it is true that the compensation ratios between the highest- and lowest-paid employees are greater at many large corporations than at universities, there is an offsetting consideration. A very large portion of compensation at UC Berkeley and other public universities is paid by federal and state taxpayers through grants and financial aid. This is not the case for private companies – at least those that don’t sell to the government.

The hefty salaries and generous pensions awarded to Berkeley administrators, professors and coaches are funded by taxpayers – most of whom earn far less than these academic luminaries. So if UC Berkeley economists are really opposed to income inequality and are concerned about low-paid workers, they might consider sharing some of their compensation with the teaching assistants, graders, readers and administrative staff at the bottom of Cal’s income distribution.

We’re not saying income inequality is a bad thing; we’re not saying that Reich, Saez and other Berkeley professors should make less than they do, or that student teachers ought to make much, much more. In fact, there are reasonable arguments that income inequality is not only inevitable and even ethical, but that it’s also a generally positive feature of advanced economies.

We are saying there’s something unusual in the Berkeley phenomenon – the high-profile role of high-income earners in criticizing income inequality.

ABOUT THE AUTHOR
Study author Marc Joffe is the founder of Public Sector Credit Solutions and a policy analyst with the California Policy Center. Joffe founded Public Sector Credit Solutions in 2011 to educate policymakers, investors and citizens about government credit risk. PSCS research has been published by the California State Treasurer’s Office, the Mercatus Center and the Macdonald-Laurier Institute among others. Before starting PSCS, Marc was a senior director at Moody’s Analytics. He earned his MBA from New York University and his MPA from San Francisco State University.

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