Comparing Federal and California State Retirement Exposures

Californians may be accustomed to living with the specter of a public pension crisis. But the federal government’s problem with its retirement system – including Social Security – is far worse, and yet none of the three remaining major-party candidates for president has a plan to do anything about it.

The California Policy Center generally focuses on state and local issues. But with just days left before California’s June 7, we offer this comparison of California and federal exposure to pension liability.

State Retirement Expenditures

According to the governor’s May Budget Revision, the state will make a total of $8.1 billion in pension contributions during the 2016-2017 fiscal year. This amount represents a sharp increase from the current fiscal year level of $7.1 billion and fiscal 2014-2015 contributions of $6.3 billion. (These numbers exclude Other Post Employment Benefit payments.)

The rapid increase is attributable to lackluster stock market performance, more conservative actuarial assumptions implemented by CalPERS and a teacher’s pension reform that increased the state’s responsibility for CalSTRS. However, even the newly increased contribution levels are unlikely to resolve chronic underfunding in both CalPERS and CalSTRS because these two systems assume a 7.5% annual rate of return, which seems unrealistic in today’s slow growth, low interest rate economy.

Figures 1 and 2 provide a longer term perspective on the growth of state pension costs. These graphs go back to the 1999-2000 budget year when the governor signed SB 400, a bill that provided a large, retroactive increase in pension benefits. In that year, pension contributions were only $1.2 billion.

StateVFed-Chart1

Figure 1

StateVFed-Chart2

Figure 2

Because of inflation and the growth of the state economy, it may be more helpful to look at state pension contributions in relation to some broader economic indicator. In previous CPC studies, we have shown pension costs as a percentage of overall government revenue – identifying a number of California cities and counties that devote over 10% of their income to retirement plan contributions.

The state’s position is much better than that of the most burdened counties and cities. In 2014-2015 (the last year for which audited financial statements are available), $6.3 billion of pension contributions represented 2.29% of total state revenues – including general fund revenue, other governmental fund revenue and business type activity revenue – which totaled $276 billion. We project that this ratio will rise to about 2.76% in 2016-2017.

For those interested in general fund statistics only, pension contributions accounted for 5.57% of general fund revenue (on a budgetary basis) in 2014-2015 and are projected to rise to 6.49% in 2016-2017. These ratios overstate California’s pension burden, because many employees are compensated with resources outside the general fund.

On the other hand, some California state spending effectively subsidizes pension costs incurred by city, county, school districts and special districts. For example, most of the state’s $87.6 billion education budget for 2016-2017 will be distributed to local educational authorities, which will use some of these funds to make employer contributions to public employee pension systems.

As Ed Ring reported in a recent CPC study, total California government employer pension contributions in 2013-2014 were $21.2 billion. While only one quarter of this total was directly paid by the state government, some portion of the local government share would not have been made in the absence of state aid payments.

Ring’s report also offers some insight into how much state pension contributions would have to rise if more realistic return assumptions were used.  For example, if pension funds used a 5.5% return assumption, pension fund contributions would have to triple from current levels.

Social Security

The vast majority of federal retirement expenditures take the form of Social Security benefits. Because most American workers are eligibility for Social Security, the program is quite large. In the current federal fiscal year, Social Security expenditures are projected to be $911 billion or just over 27% of federal revenues. About 83% of these costs take the form of retiree and survivor benefits, 16% goes to disabled workers and under 1% covers administrative expenses.

Each year, the Social Security Board of Trustees publishes an actuarial report. The report includes short- and long-term projections, with an emphasis on the status of the Social Security trust fund. The latest report shows that the trust fund contained about $2.8 trillion in assets at the end of calendar year 2014. The report also projects that the trust fund will be exhausted in 2034 based on a set of intermediate cost assumptions. The report also includes projections based on two alternative scenarios: one reflecting higher-cost assumptions (such as greater longevity) and lower cost assumptions. Under the high-cost scenario, the trust fund would be exhausted by 2030, while under the low-cost scenario the trust fund maintains a positive balance throughout the report’s 75-year projection horizon.

Although discussion of Social Security often revolves around the trust fund, this emphasis is misplaced. Unlike CalPERS or CalSTRS, the Social Security trust fund does not contain real assets. Instead, it holds special-issue U.S. Treasury bonds. Since the trust fund is part of the federal government, its assets are merely IOUs issued by its owner. The situation is analogous to an individual removing money from his piggy bank and replacing it with a note showing the amount he plans eventually to put back.  This may be a good commitment device, but any financially knowledgeable third party would not consider the note a meaningful asset.

One might argue that the Treasury bonds in the trust fund represent a claim on federal assets, but as shown in its latest audited financial statements, the federal government has a negative net position. Total federal assets of $3.2 trillion are easily exceeded by $13.2 trillion of federal debt securities held by the public and $8.2 trillion of other liabilities. So the IOUs held by the Social Security trust fund compete with claims held by many external parties for a relatively small pool of federal assets.

While the trust fund assets are not economically meaningful, they do have a legal significance – but even that is less than meets the eye. Under current law, if the trust fund is exhausted, benefit payments must be immediately reduced so that they are equivalent to Social Security revenues, which mostly derive from Federal Insurance Contribution Act (FICA) taxes paid by employees and employers. Under the trustee’s intermediate scenario, benefits would fall to 79% of the then-current level when the trust fund is exhausted in 2034.

However, this sudden, sharp reduction is extremely unlikely. Given the large number of Social Security recipients, the high voting propensity of older voters and the power of AARP, the benefit cut would almost inevitably be reversed, with additional costs borne by the general fund. There is a recent precedent for general fund transfers of this type: when Congress temporarily reduced FICA taxes in 2011 and 2012, the loss of trust fund income was offset by general fund transfers.

Rather than view Social Security through the trust fund prism, its fiscal impact is better understood in terms of its net impact on the consolidated federal budget. In other words, we should look at the difference between Social Security revenues and expenditures. The trustee report includes interest on the Treasury bonds held by the Social Security trust fund, but this notional income should be disregarded: the interest is paid and received by the same entity, the federal government.

Figure 3 shows Social Security’s net cash flow in constant dollars back to 1957. Projected revenues are depicted by three lines, with shaded areas in between. The middle line reflects the trustee’s intermediate assumptions, with the low cost and high cost scenarios shown by the lowest and highest lines respectively. As the chart shows, program revenues and expenditures were roughly equal for the first three decades. Between the late 1980s and the last decade, revenues exceeded expenditures, often by large margins. In the late 1990s, this surplus helped balance the federal budget; later, it offset budget deficits that developed under the George W. Bush Administration.

StateVFed-Chart3

Figure 3

Increased disability insurance claims associated with the Great Recession and the beginning of baby boomer retirements ushered in a series of negative net balances beginning in 2010. These deficits are expected to continue under all three trustee scenarios, and to become quite large under the intermediate and high cost assumptions. By 2040, the shortfall reaches $371 billion under the intermediate scenario and $610 billion under the high cost scenario – in 2015 constant dollars.

Unprecedented deficits of this magnitude have very serious implications for the federal budget, especially when combined with escalating Medicare and Medicaid costs. Last year, the Congressional Budget Office projected that the ratio of publicly held debt to GDP will increase from 74% currently to 107% by 2040.

Federal Employee Retirement Programs

The federal government also has a large number of employees and retirees eligible for defined pension benefits. According to its latest annual report, the Civil Service Retirement and Disability Fund, paid $81 billion of retirement benefits in fiscal year 2015, or 2.49% of federal revenues. The system reported an Unfunded Actuarial Liability of $804.3 billion and Assets of $858.6 billion, implying a funded ratio of only 51.6%. Further, the fund’s assets are almost entirely invested in U.S. Treasury securities. Similar to the Social Security Trust Fund, the economic meaning of these investments is questionable.

The Defense Department also provides retirement benefits. The latest available actuarial report shows $54.8 billion of benefits paid in fiscal year 2013 and a 35% funded ratio. Last year, President Obama signed a Defense Authorization Bill containing a military pension reform. Instead of a straight defined-benefit plan, new recruits joining the armed forces after January 1, 2018 will be placed in a hybrid plan containing a 401(k)-style component with an employer match. The defined benefit component will remain, but will be reduced by 20%. This reform should improve the program’s funded ratio, but won’t reduce military pension costs by very much – if at all. Under the current system, service members must remain in the military for 20 years to become eligible for pension benefits. Vesting in federal matching payments under the new defined contribution plan will begin after two years.

Comparing the Federal and State Governments

Overall, the federal government has much greater exposure to pension costs that does the state of California. Civilian and military pension benefits consume a proportionately larger amount of the federal revenue than the share of total state revenue absorbed by CalPERS and CalSTRS contributions. Further, the federal government is responsible for providing most American workers pension benefits through Social Security, which absorbs more than a quarter of federal revenue and has an inadequate level of pre-funding, even if one considers Treasury securities to be an acceptable investment vehicle for a federal retirement system.

That said, it is worth considering some advantages the federal government has relative to the state in dealing with pension costs. First, the U.S. constitution does not provide a right to accrued benefits. In an emergency, Congress and the president could cut or terminate benefits to Social Security recipients, federal civilian retirees or veterans. This is not the case for the state of California.

As Alexander Volokh points out: “In California, when a public employee begins work, he not only acquires a right to the pension accumulated so far — presumably zero on the first day, and increasing as he works longer — but also the right to continue to earn a pension on terms that are at least as generous as the ones then in effect, for as long as he works. And if pension rules become more generous in the future, then those more generous terms are the ones that are protected.”

As I discussed earlier, I do not expect Social Security benefits to be reduced when the trust fund runs out, so the fact the Social Security recipients do not have access to the courts may be a distinction without a difference.  But it is still true that the federal government has a tool for reducing benefit costs – especially during a fiscal emergency – that is not available to the state.

Further, there is a widespread belief that the federal government is less vulnerable to a fiscal emergency than California because it has access to the printing press. In other words, if the federal government cannot obtain enough tax revenue to pay retirement benefits, it could do so with newly created money.

While this is a fair distinction, it comes with a couple of caveats. First, at the national level, money creation has become the role of the Federal Reserve, which has some degree of political independence.  Strictly speaking, the president cannot order the Fed Chair to create money. Second, U.S. state and local governments have been able to create circulating IOUs in the past. During the Depression, numerous cities issued scrip, while, in 2009 the state issued IOUs to vendors amidst a budget crisis. These IOUs were eventually traded on a secondary market.

These caveats notwithstanding, it is true that a central government controlling an international reserve currency does have more fiscal flexibility than a state which is legally obligated to balance its budget each year. So the federal government’s ability to absorb pension obligations is greater than California’s. This is fortunate, because the federal governments exposure is so much greater.

Solutions

We have seen that both California and the federal government face high and rising pension costs, and that each has not fully accounted for these obligations. The drivers of these problems are similar, and are duplicated throughout much of the developed world:  retirement of the large baby-boom generation, increased longevity and a failure of political institutions to deal effectively with long-term problems.

While the specific policies to improve pension sustainability differ across jurisdictions, the basic ideas are similar. These include:

  • Paring back benefit levels, especially for the most highly paid, most affluent beneficiaries.
  • Increasing retirement ages and then indexing them to longevity.
  • Increasing employee contributions.
  • Replacing deceptive accounting techniques and rosy actuarial assumptions, with conservative, fact-based financial reporting.

Finally, libertarians and fiscal conservatives working on these issues should re-evaluate their tactics. In 2005, George W. Bush’s strategy of using the impending Social Security crisis to justify a partial switch to personal accounts was roundly rejected by Democrats and Republicans alike. While many of us in the public-sector pension reform community like the idea of 401ks, we need to understand that employees – especially those who are risk-averse or financially unsophisticated – prefer defined benefits. Rather than attacking defined-benefit plans, we should try to fix these plans so that they don’t bankrupt the governments that offer them.

Comparing Fresno City and County Pension Systems

As the Fresno Bee recently reported, the city of Fresno’s pension systems are in much better financial shape than the Fresno County Employees’ Retirement Association (FCERA). As of June 30, 2015, the city’s two systems reported a combined $349 million of assets (at market value) in excess of actuarially accrued liabilities. By contrast, FCERA’s assets were $1.043 billion below its liabilities. Actuarial surpluses are rare in California, and the discrepancy between the city and county is so great that we thought it would be worth diving into the finances of Fresno’s retirement system to explain the contrast.

The systems provide extensive financial reports on their websites. The two most useful are Comprehensive Annual Financial Report (which includes financial statements and 10-year histories for many data points) and the Actuarial Valuation Study (which provides in-depth data about system assets, contributions and benefit payments). FCERA posts its reports at http://www.fcera.org. The two city systems – one for Fire and Police, and one for non-public safety employees – publish their reports at http://www.cfrs-ca.org/.

Table 1 below compares some key metrics across the plans.

The Valuation Value of Assets (VVA) is used by system actuaries to determine future contributions. But for our purposes, VVA is less useful than the Market Value of Assets (MVA). While MVA is simply the total market value of all the bonds, stocks and other investments the system holds, VVA includes various smoothing adjustments – reporting practices, some of them legitimate, that can mask liabilities.

Benefits

Contributing to the difference in the financial health of Fresno’s city and county systems is the difference in benefit levels. For example, the City of Fresno limits public safety pensions to no more than 75% of final average salary (as per Section 3-333 of the municipal code). The county imposes no similar cap and also provides very generous benefit accrual rates, in some cases exceeding 3% per year of service. According to calculations we performed using the county system’s Benefit Calculator, a Tier 1 public safety employee retiring at age 60 with 30 years of service would get a pension equal to 97% of final salary. Tier 1 employees were hired before 2007; newer county employees receive less generous benefits.

The city does not cap miscellaneous employee benefits, but its employees earn substantially less credit for each year of service. According to the city’s Benefit Calculator, a miscellaneous employee retiring at age 65 with 30 years of service would receive 72% of final compensation, compared to 97% for a county employee retiring at the same age and the same number of service years.

 

Asset Returns

Another potential distinction between the city and county systems is investment performance. A pension plan can improve its actuarial balance by achieving higher asset returns. Over the five years ended June 30, 2015, the city’s investments outperformed the county’s. FCERA generated annualized investment returns net of fees of 9.8%. The two Fresno city systems, whose assets are jointly managed, achieved net returns of 10.9% over the same period. This 1.1% difference compounded over five years is fairly significant. One billion dollars growing at the county’s rate of 9.8% becomes $1.596 billion after five years, while the same amount growing at the city’s 10.9% annual rate becomes $1.677 billion – $81 million more.

However, when we look at the 10-year period that includes the Great Recession, the performance numbers reverse. Over the 10 years ended June 30, 2015, county assets grew at an annual rate of 6.8% versus 6.4% for the city. Both of these return rates are below the annual asset return rates assumed by each system (more on this below).

Further, it’s worth noting that funding levels for all systems declined over the 10-year period. Between June 30, 2005 and June 30, 2015, FCSERA’s funded ratio based on VVA declined from 91.5% to 80.7%. The Fresno Fire & Police plan saw a decline from 126.4% to 119.6%, while the city’s Employee Retirement System witnessed a funded ratio decline from 139.8% to 109.2%.

 

Discount Rates

In general, the market value of a plan’s assets is fairly easy to determine and is not subject to substantial estimation error. Most plan assets are invested in stocks and bonds that trade frequently and whose values are easy to establish independently.

By contrast, plan liabilities are based on numerous assumptions. How much a plan will have to pay in the future depends upon when employees retire and when they pass away. Expressing these future benefit payments in current dollars requires the choice of a discount rate – a choice subject to controversy.

Fresno city plans use a higher discount rate than FCERA. The city’s ERS and Fire & Police plans both assume annual returns of 7.50% and then use that rate to discount future benefit payments. FCERA uses a slightly more conservative rate of 7.25%. Both of these assumptions exceed the actual 10-year returns experienced by the city and county pension systems, and thus should arguably be reduced.

But to compare the systems, we don’t need to determine the ideal discount rate; we simply need to apply the same rate to each system. If we reduce the city’s discount rate from 7.5% to 7.25%, pension liabilities across the two city systems would increase about $61 billion and their funded ratio would fall by about 3.5%. (These estimates are discussed in an appendix at the end of this study). While significant, this fact only explains a small portion of the 38.3% gap in funded ratios between the city and county systems.

 

Mortality Assumptions

While the pension literature includes much discussion of discount rates, less has been written about mortality assumptions. But good death rate estimates are important: if beneficiaries live a lot longer than expected, pension payments will be much greater than forecast. This recently became clear in Detroit, where city officials faced a sudden spike in projected retirement payments after its pensions actuary switched to a new mortality table.

Mortality tables are produced by the Society of Actuaries. Most public pension plans use a table from the Society’s RP-2000 Mortality Tables Report produced in the year 2000. The large increase in Detroit’s projected pension costs occurred after actuarial firm Gabriel Roeder switched to the Society’s new RP-2014 Mortality Tables.

The RP-2000 report included a supplemental schedule that can be used to scale mortality rates to future years. The scaling procedure assumes a steady improvement in longevity, and thus a steady decrease in mortality rates over time. By applying the adjustment factor from the scaling schedule multiple times, an actuary can approximate what a future mortality table might look like. For example, by applying the scaling factors to the 2000 mortality rates 15 times an actuary can approximate 2015 mortality rates. In Detroit, Gabriel Roeder did not apply the scaling factor, thereby causing the big change when it transitioned to the newer mortality table.

Both the Fresno city plans and FCERA use the RP-2000 Combined Healthy Mortality Table and then scale the death rates from this table with factors in Mortality Projection Scale AA. However, there is an important difference. The city performs the scaling six extra times: it uses mortality rates scaled to 2021, while FCERA uses death rates scaled to 2015. This means that the city plans are projecting fewer deaths at any given retiree age – and therefore greater liability – than does FCERA.

The county’s mortality projections are thus more “optimistic” than those of the city plans, in the sense that its approach anticipates shorter-lived recipients – and that translates into lower expected benefit payments. The sooner an employee is assumed to pass away the less he or she is projected to receive from the system. If FCERA performed the same scaling as the city plans, its reported funding level would be worse. Without more data, we cannot say how much worse.

Finally, it ‘s worth noting that retirement rate assumptions differ between the city and county systems. The difference may be justified, and the impact is unclear. Since the plans have different benefit structures, they present different incentives to workers timing their retirements. When an employee retires early, he or she will receive benefits for more years but generally at a lower rate. So a change in retirement-age assumptions, may raise or lower projected system costs.

 

Conclusion

Overall, our conclusion is mixed. Fresno’s Employee Retirement System and Fire & Police Retirement System offer less generous benefits that the Fresno County Employees’ Retirement Association. This difference in benefit levels makes a substantial contribution to funding disparities between the systems.

FCERA uses a more conservative discount rate, while the city plans use more (financially) conservative mortality assumptions. These modeling differences affect the disparity between reported city and county funding levels, but they do not represent real differences and simply muddy our understanding of relative system performance. Ideally, all California pension systems would use the same actuarial assumptions (unless there are real demographic differences between workforces) so that we would be able to perform accurate comparisons.

 

Appendix: Recalculating AAL Using a Different Discount Rate

A pension system’s AAL is the discounted amount of future benefit payments. Unless one has a table of projected future benefit payments, it is impossible to precisely calculate AAL using another discount rate.

In 2013, Moody’s adjusted pension liabilities by using more conservative discount rate assumptions. The rating agency’s method of restating liabilities involves projecting forward the system’s reported liability for 13 years and then discounting the result back for 13 years using the more conservative rate. Moody’s refers to the 13-year re-discounting period as a “common duration” and recognizes that applying the same duration to all plans could be a source of estimation error.

Moody’s also noted at the time that more precise estimates would be possible once pension plans implemented enhanced reporting required under Government Accounting Standards Board Statements 67 and 68.

Under these new rules, pension systems must report the “Sensitivity of Net Pension Liability to Changes in the Discount Rate.” This new schedule shows the Net Pension Liability calculated using the current discount rate, a rate 1% higher and another rate 1% lower. For the Fresno city systems, we have Net Pension Liabilities based on rates of 6.5%, 7.5% and 8.5%.

We can estimate the impact on Net Pension Liability by linearly interpolating between the 6.5% and 7.5% values. For the two Fresno systems combined, the estimated impact of a change in discount rate from 7.5% to 7.25% is $69 billion.

Net Pension Liability as reported under GASB Statement 67 is higher than each system’s Actuarially Accrued Liability. In the case of the Fresno city systems, the difference is about 11.5%. If we reduce the Net Pension Liability difference of $68 billion by 11.5%, we arrive at the $61 billion estimate presented in the main text.

The author wishes to thank Lisa Schilling at the Society of Actuaries and Bill Bergman of Truth in Accounting for their assistance with some technical points in this study. Any errors are my responsibility.

The Coming Public Pension Apocalypse, and What to Do About It

When the next market downturn hits, every public employee pension fund in the United States will face severe challenges. Because public employee pension funds are not subject to the same rules that private pension funds have to adhere to – namely, the restrictions on risky investments as specified in the federal Employee Retirement Income Security Act of 1974 – they will be hit much harder in a downturn than private pension funds. Some states will face more significant challenges than others. California is destined to be one of the hardest hit.

This discussion of California’s coming public pension apocalypse has three sections. Part one will make the case, yet again, that public employee pension funds cannot possibly hope to earn the rates of return over the next 20 years that they earned over the past 20 years. Part two will show the precise impact that lower rates of return will have on the unfunded liability, the normal contribution, and the unfunded contribution – using projections that show all of California’s state and local public employee pension funds in a consolidated report. Those who are already convinced that pension funds are headed for trouble are encouraged to skip immediately to part two, to see exactly how many hundreds of billions we’re talking about.

Finally, this discussion will offer recommendations to mitigate the impact of the coming public employee pension apocalypse, and pave the way for more sustainable programs in the future. These recommendations are in three parts – how to restore the pension funds, how to restore economic vitality to Californians, and policies to advocate at the federal level.

PART ONE: WHY PENSION FUND RATES OF RETURN WILL FALL DRAMATICALLY

“For the first time in the pension fund’s history, we paid out more in retirement benefits than we took in contributions.”
–  Anne Stausboll, Chief Executive Officer, CalPERS, 2014-2015 Comprehensive Annual Financial Report

There are few examples of a seemingly innocuous statement with more significance than Anne Stausboll’s admission, buried in her “CEO’s Letter of Transmittal,” summarizing the performance of CalPERS, the largest public employee retirement system in the United States. Because what’s happening at CalPERS – they now pay more in benefits than they collect in contributions – is happening everywhere in America.

For the first time in history, America’s public employee pension funds, managing well over $4.0 trillion in assets, are becoming net sellers, not buyers. And as any attentive student of economics will tell you, when there are more sellers than buyers, prices drop. Behind this mega economic trend is a mega demographic trend: across the developed world, certainly including the United States, an increasing percentage of the population is retired. The result? An increasing proportion of people who are retired and slowly liquidating their lifetime savings – also driving down asset values and investment returns.

Current events create volatility in the market and returns have been flat for the past 18 months. Turmoil in the Middle East. A long overdue slowdown to China’s overheated economy. Depressed energy prices. But there are two long-term trends that will keep investment returns down. Demographics is one of them: The more retirees, the more sellers in the market. The other mega-trend, equally troubling to investors, is that debt accumulation, which stimulates spending, has reached its limit. We are at the end of a long-term, decades-long credit cycle. The next three charts will illustrate the relationship between interest rates, debt formation, and the stock market during two critical periods – the first one following the stock market peak in December 1999, and the second following the stock market peak in September 2007.

The first chart, showing the federal funds rate over the past 30 years, shows that when the stock market peaked in December 1999, the federal funds rate was 6.5%. Within three years, in order to stimulate borrowing that would put more cash into the economy, that rate was dropped to 1.0%. Once the stock market recovered, the rate went back up to 4.25% until the stock market peaked again in the summer of 2007. Then as the market declined precipitously for the next 18 months through February 2009, the federal funds rate was lowered to 0.15% and has stayed near that low ever since.

The point? As the stock market has recovered since February 2009 to the present, unlike during the earlier recoveries, the federal funds rate was never raised. This time, there’s no elbow room left.

Table 1-A
Effective Federal Funds Rate – 1985 to 2015

20160111-UW-ER-fedrate

To put these low interest rates in context requires the next chart which shows total U.S. credit market debt as a percent of GDP over the past 30 years. Consumer debt, commercial debt, financial debt, state and federal debt (not including unfunded liabilities, by the way), is now estimated at 340% of U.S. GDP. The last time it was this high was 1929, and we know how that ended. As it is, even though interest rates have stayed at nearly zero for just over seven years, total debt accumulation topped out at 366.5% of GDP in February 2009 and has slightly declined since then. The point here? Even low interest rates, this time at or near zero, no longer stimulate a net increase in total borrowing, which in turn puts cash into the economy.

Table 1-B
Total U.S. Credit Market Debt – 1985 to 2015

20160111-UW-ER-debtGDP

Which brings us to the Dow Jones Industrial Average, a stock index that tracks nearly in lockstep with the S&P 500 and the Nasdaq, and is therefore an accurate representation of the historical performance of U.S. equities over the past 30 years. As you can see from this graph and the preceding graphs, the market downturn between December 1999 and September 2002 was countered by lowering the federal funds rate from 6.5% to 1.0%. Later in the aughts, the market downturn between September 2007 to February 2009 was countered by lowering the federal funds rate from 5.25% to 0.15%. But during the sustained market rise for the seven years since then, the federal funds lending rate has remained at near zero, and total market debt as a percent of GDP has actually declined slightly.

Table 1-C
Dow Jones Industrial Average – 1985 to 2015

20160111-UW-ER-DJIA

It doesn’t take a trained economist to understand that the investment landscape has fundamentally changed. The trend is clear. Over the past 30 years, debt as a percent of GDP has doubled (from 150% to over 350%), then remained flat for the past seven years. At the same time, over the past 30 years the federal lending rate has dropped from high single digits in the 1980s to pretty much zero by early 2009, and has remained there ever since. The conclusion? Interest rates can no longer be used as a tool to stimulate the economy or the stock market, and the capacity of the American economy to grow through debt accumulation has reached its limit.

For these reasons, achieving annual investment returns of 7.5%, or even 6.5%, for the next several years or more, is much harder, if not impossible. Conditions that produced stock market growth over the past 30 years no longer exist. Public employee pension funds, starting with CalPERS, need to face this new reality. Debt and demographics create headwinds that have changed the big picture.

PART TWO: THE IMPACT OF LOWER RETURNS ON CALIFORNIA’S PENSION FUNDS

“Pension-change advocates failed to find funding for a measure during the depths of the 2008 recession and the havoc it wreaked on government budgets, so they won’t pass (a measure) when the economy is doing well.”
–  Steve Maviglio, political consultant and union coalition spokesperson, Sacramento Bee, January 18, 2016

It’s hard to argue with Mr. Maviglio’s logic. If the economy is healthy and the stock market is roaring, fixing the long-term financial challenges facing California’s state/local government employee pensions systems will not be a top political priority. But that doesn’t mean those challenges have gone away.

One of the biggest problems pension reformers face is communicating just how serious the problem is getting, and one of the biggest reasons for that is the lack of good financial information about California’s government worker pension systems.

The California State Controller used to release a “Public Retirement Systems Annual Report,” that consolidated all of California’s 80 independent state and local public employee pension systems into one set of financials, but they discontinued the practice in 2013. The most recent one issued, released in May, 2013, was itself almost two years behind with financial data – using FYE 6-30-2011 financial statements, and it was almost three years behind with actuarial data – used to report funding ratios – using FYE 6-30-2010 actuarial analysis. Now the state controller has created a “By the Numbers” website, but it’s hard to use and does not provide summaries.

No wonder it’s so easy to assert that nothing is wrong with California’s pension systems!

The best source of easily understood compiled data on California’s pensions comes from the U.S. Census Bureau. Since that data is better than nothing, here are some critical areas where roughly accurate numbers can be reported.

The Cash Flow, Money In vs. Money Out

What is the net cash flow of these pensions funds? How much are they collecting in contributions and how much are they distributing in pension benefits? This information, especially if it can be compiled over a period of years, determines whether or not pension funds are net buyers or sellers in the markets. The reason this matters is because if America’s pension funds, with over $4.0 trillion in assets, are net sellers, they put downward pressure on stock prices. They’re that big.

Table 2-A
California State/Local Pension Funds Consolidated

2014 – Cash Flow

20160201-UW-Ring-1

This cash flow (above) shows that during 2014, California’s state/local pension funds, combined, collected 30.1 billion from state and local agencies, and paid out $46.1 billion to pensioners. They are paying out 50% more than they’re taking in, and this is a relatively recent phenomenon. Historically, pension funds have been net buyers in the market. Now, pension funds across the U.S., along with retiring baby boomers, are sellers in the market. This is one reason it is difficult to be optimistic about securing a 7.5% average annual return in the future, despite historical results. And as for that healthy 15.4% return on investments in 2014? That was offset in 2015 and 2016 so far, when the markets were flat. It is also noteworthy that employee contributions of $8.9 billion are greatly exceeded by the $21.2 billion in employer (taxpayer) contributions. How many 401K recipients get a 2.5 to 1.0 matching from their employer?

The Asset Distribution and Portfolio Risk

What is the asset distribution of these pension funds? How much have they invested in relatively risk free, fixed income bonds, vs. their investments in stocks and other variable return assets?

Table 2-B
California State/Local Pension Funds Consolidated

2014 – Asset Distribution

20160201-UW-Ring-2

This asset distribution table (above) indicates that the ratio of riskier, variable return investments to fixed return investments is nearly four-to-one. What if stocks fail to appreciate for a few years? What if real estate values don’t continue to soar? What if there simply aren’t enough high-yield investments out there to allow these assets, valued at a staggering $751 billion in 2014, to throw off a 7.5% annual return? This is a precarious situation. If these projected 7.5% returns were truly “risk free,” the ratios on this table would be reversed, with most of the money in fixed return investments.

The Effect of Lower ROI on the Unfunded Liability and Required Contributions

What is the amount of the unfunded liability for these pension funds? And of the total amount collected and invested each year in these funds, how much is the “unfunded contribution” – the amount allocated to pay down the unfunded liability and eventually restore the systems to 100% funding – and how much is the “normal contribution” – the amount required to fund future pension benefits just earned in that particular year by active workers?

This question, for which neither the State Controller, nor the U.S. Census Bureau, can provide timely and accurate answers, is the most complex and also the most important. While consolidated data is not readily obtainable for these variables, by assuming these pension systems, in aggregate, are officially recognized as 75% funded, we can compile useful data:

Table 2-C
California State/Local Pension Funds Consolidated

2014 – Est. Funding Status and Required Contributions at Various ROI

20160516-CPC-Ring-pension-liabilities

The above table, column one, estimates that at a 75% funded ratio, at the end of 2014 the total pension fund liabilities for all of California’s state and local government pension funds was just over $1.0 trillion, with unfunded liabilities at $250 billion. The second column in the table shows, using conventional formulas adopted by Moody’s investor services for analyzing public pensions, that if the annual rate-of-return projection is lowered to a slightly more realistic 6.5% (already being phased in by CalPERS), the unfunded liability jumps to $380.1 billion, and the funded ratio drops to 66%. For a detailed discussion of these formulas, refer to the California Policy Center study “A Method to Estimate the Pension Contribution and Pension Liability for Your City or County.”

The lower portion of the table spells out the consequences of lower rates-of-return in terms of required annual payments. The first row shows the required normal contribution as a percent of payroll, based on an average retirement age of 57 and an average annual pension multiplier of 2.5%. To evaluate the methods used to arrive at these percentages, refer to the California Policy Center study “A Pension Analysis Tool for Everyone.” The second row shows the taxpayer’s share of the normal contribution, in billions, under the assumption the employees are paying one-third of the normal contribution via payroll withholding.

The final row in the lower portion of the table shows the required unfunded contribution under various ROI assumptions. Using standard amortization formulas, and a 20 year payback term, at a 6.5% rate-of-return assumption, it would take a payment of $34.5 billion per year to return California’s pension funds to 100% funded status by 2036. Since the total taxpayer payments into California’s pension funds – refer back to table 1 – were only 21.2 billion in 2014, it is pertinent to wonder just how much the official numbers would report for the normal contribution, in aggregate, in 2014, vs. the unfunded contribution.

The significance of these numbers can’t be overstated. Even if pension funds earn 7.5% per year, taxpayers should be putting $38.1 billion into them each year, instead of only $21.2 billion. That’s a shortfall of $16.9 billion per year. If pension funds earn 6.5%, it will cost taxpayers $52.3 billion per year. That is an increase of 150% over what is currently being paid. And if they earn 5.5% per year – a return for which most ordinary savers would invest every spare penny they have – it will require a taxpayer contribution of $67.6 billion per year, over three times what is currently being paid.

The implications of this are staggering. A city that pays 10% of their total revenues into the pension funds, and there are plenty of them, at an ROI of 7.5% and an honest repayment plan for the unfunded liability, should be paying 17% of their revenues into the pension systems. At a ROI of 6.5%, these cities would pay 24% of their revenue to pensions. At 5.5%, 32%. And so on. It is impossible for these levels of payments to be sustained, but that’s exactly what will be necessary if the markets drop, and reforms are not implemented.

PART THREE: HOW TO MITIGATE THE IMPACT OF THE PUBLIC PENSION APOCALYPSE

Recommended Pension System Reforms to Maintain Solvency

(1) Make it possible to increase employee contributions. Social Security withholding can be increased or decreased at the option of the federal government. If collections into public employee pension funds are inadequate, increase the withholding from employee paychecks – not only for the normal contribution, but also to help pay the unfunded contribution.

(2) Make it possible to decrease benefits. Nothing in Social Security is guaranteed. Benefits can be cut at any time to preserve solvency. Decreasing benefits may be the only way to preserve defined benefit pensions. Equitable ways to do this must be spread over as many participant classes as possible. For example, the reform passed by voters in San Jose (severely reduced in scope after union litigation) called for suspending cost-of-living increases for retirees, and prospectively lowering the annual rates of benefit accruals for existing workers.

(3) Increase the retirement age. This has already been done several times with Social Security. Pension reforms to-date have also increased the age of eligibility for benefits.

(4) Calculate benefits based on lifetime earnings. Social Security calculates a participant’s benefit based on the 35 years during which they made the most. Public sector pensions, inexplicably, apply benefit formulas to the final year of earnings, or the final few years. These pension benefits should be calculated based on lifetime earnings.

(5) Make the benefit progressive. The more you make and contribute into Social Security, the less you get back. At the least, applying a ceiling to pension benefits should be considered. But it would serve both the goals of solvency and social justice to implement a comprehensive system of tiers whereby highly compensated public servants, who make enough to save themselves for retirement, get progressively less back in the form of a pension depending on how much they make.

Recommended Policy Initiatives to Increase Economic Vitality

(1) Massive Public/Private Investment in Infrastructure

(a) Rebuild California’s aqueducts and develop additional aquifer and surface storage for runoff harvesting. Build desalination plants on the southern California coast. Upgrade existing dams and pumping stations. Permit farmers to contract with California’s urban water districts to sell their water allocations. Build the Sites and Temperance Flat reservoirs. Create water abundance and make water cheap.

(b) Build new power stations. Whether these are 5th generation nuclear power stations, or new natural gas fired power plants, the immediate establishment of an additional 20%+ of generating capacity in California would result in significant lowering of utility rates and make California a net exporter of electricity.

(c) Permit development of offshore oil and gas using slant drilling from land. It is no longer necessary to develop offshore drilling rigs to extract energy reserves. There are cost-effective ways to bring this energy onshore without the risk of an oil spill from an offshore platform.

(d) Permit development of natural gas and shale oil reserves in California.

(e) Permit development of new mines and quarries in California.

(f) Build additional pipeline capacity into California to import and export natural gas to and from elsewhere in North America.

(g) Permit development of a liquid natural gas terminal off the California coast. Get California onto the global LNG grid to import and export natural gas and further diversify sources of energy and income. Create energy abundance and make energy cheap.

(h) Upgrade existing roads, bridges, and freeways. Begin working on “smart lanes” that will facilitate cars and mass transit vehicles driving on autopilot.

(i) Upgrade California’s existing freight and passenger rail infrastructure. When practical, integrate passenger and freight service on common rail corridors in large cities where high population densities make passenger rail economically viable. Increase the speed of intercity passenger rail to 100+ MPH, which can be done on upgraded but already existing track. Improve the interstate rail links emanating from California’s major seaports, to help them remain competitive.

(2) Balance State and Local Government Budgets

(a) Lower the wages of all state and local government workers by 20% of whatever amount they make in excess of $50,000 per year. Lower the wages of all state and local government workers by 50% of whatever amount they make in excess of $100,000 per year. Include in “wages” ALL forms of compensation.

(b) In addition to the steps recommended in the previous section, solve the financial crisis facing pensions by imposing special tax assessments on state and local government pensions in the amount of 50% of all pension payments in excess of $60,000 per year and 75% of all pension payments in excess of $100,000 per year (in 2016 dollars). Adopt the same reformed financial rules governing pension liability estimates that already apply to private sector pension plans.

(c) Require 75% of all K-12 and Community College employees to be teachers in a classroom.

(d) Faithfully implement the federal welfare reforms already adopted by most other states in 1996 during the Clinton administration.

(3) Change the Rules in Sacramento

(a) Implement fundamental curbs on the rights of public sector unions, including: Grant all public sector workers the right to opt-out of union membership and payment of any union dues including agency fees. Prohibit government payroll departments from collecting union dues. Allow all public sector employees to negotiate their own wages and benefits and not be bound by collective bargaining terms if they wish. Prohibit public sector unions from negotiating over long term benefits, and require all current wage and benefit agreements to expire at the end of the term for the elected officials who approved the agreements. Prohibit public sector unions from engaging in political activity of any kind.

(b) Discontinue California’s “CO2 auctions,” which have devolved into a redistribution scheme, taking money from middle class ratepayers and giving it to bankers, politically connected green entrepreneurs, and public sector payroll departments. Repeal AB32. Crucially, lift the crippling burden of land use regulations that keep the prices of homes and commercial property artificially high in California.

(c) Revisit all business-friendly recommendations made by business associations such as the bipartisan California Chamber of Commerce. This would not include compromise positions in support of public sector unions and crony capitalist environmental regulations. This would include banning mandatory project labor agreements or requiring union only contractors on government funded projects.

Recommended Policies to Advocate at the Federal Level

(1)  Balance the Federal Budget. Until the federal government limits its spending to what it collects in tax revenue, it will continue to push for lower interest rates to help fund the deficits. This will stimulate borrowing and consumption instead of savings and production. The cycle of using debt accumulation to finance growth must be broken.

(2)  Restore Partner Liability to Banks. If consumer banks and investment banks were managed by partners who would be personally liable for losses, they would not engage in speculative activity, shielded from personal accountability. As it is, today’s financial firms are not only managed by officers who carry minimal personal liability for their actions, but they are publicly traded entities despite being nothing more than financial intermediaries.

(3)  Reintroduce the Provisions of Glass Steagall. Which the Clinton administration eviscerated in the 1990’s. In brief, this post-depression reform prevented banks from using consumer deposits for speculative investments. Consumer banks and investment banks were required to operate as separate entities.

(4)  End the War on Short Sellers and Harmonize Regulations. Short selling financial assets is one way that financial bubbles are identified and popped before they get too big. Short sales keep valuations realistic and expose financial charades. They should be properly regulated with a uniform set of international rules, but they play a vital role in a healthy market.

(5)  Increase Required Reserve Ratios. Banks are currently permitted to use customer deposits to advance loans to borrowers. Currently they are only required to hold cash equivalent to 10% of their total deposits. Increasing this ratio would increase the financial resiliency of banks.

 *   *   *

Ed Ring is the executive director of the California Policy Center.

Pension burden in 5 California counties now over 10%

Years after the Great Recession slammed their Wall Street investments, at least five California counties have broken through the 10 percent ceiling, spending at least one of out of every $10 to fund their government-employee retirement programs.

The resulting strain on local budgets, called the pension burden, is revealed in California Policy Center’s latest analysis of county reports.

Five California counties reported that their pension contributions now exceed 10 percent of total revenues: Santa Barbara County (13.1 percent), Kern County (11 percent), Fresno County (10.7 percent), San Diego County (10.4 percent) and San Mateo County (10 percent). We will consider each below.

A sixth county, Merced, is also expected to report that its required contributions topped 10 percent of 2015 revenue when it files its audit. We estimate Merced’s payments at slightly over 11 percent of revenue.

CPC’s review of audited financial statements filed by 30 California counties shows pension contributions accounting for between 3 percent and 13 percent of total county revenue.

“For years, public employee union leaders denied the pension burden was even close to 10 percent,” my colleague Ed Ring notes. “This study shows the burden is now approaching 15 percent of revenues.”

The surveyed counties, which account for more than 95 percent of California’s population, made over $5.4 billion in pension contributions during the fiscal year. These counties also made $660 million of debt service payments on pension obligation bonds, raising total pension costs to over $6 billion last year.

That figure accounts for about one-sixth of all California state and local pension contributions (not including payments on pension obligation bonds), estimated at $30.1 billion in 2014.

As investment markets remain relatively flat, it seems likely that many California counties will bow to pressure to cut government services or to raise cash through debt instruments or taxes.

METHODOLOGY

In 25 of 30 counties, we used 2015 audits. Five other counties had yet to file their 2015 reports; in these instances, we estimated revenues and pension contributions from 2014 audits, 2015 budgets and actuarial valuation reports.

Most large counties operate their own pension systems, rather than relying on CalPERS. These county systems often also serve special districts and even cities in the county. Our survey was limited to pension contributions made by the county governments themselves, and excluded separately reporting units – that is, entities that participate in county systems but produce their own financial statements.

In 2015, state and local governments implemented new accounting standards promulgated by the Government Accounting Standards Board (GASB). Aside from reporting net pension obligations as a liability on the government’s balance sheet, GASB Statement Number 67 requires filers to report “Actuarially Determined Contributions” and actual contributions made to their defined benefit plans. The Actuarially Determined Contribution (ADC), previously known as the Actuarially Required Contribution, is calculated by an independent actuary. The ADC is supposed to be the amount sufficient to finance pensions for current and future retirees while gradually closing any gaps in pension funding.

For the 25 larger counties that had released 2015 audits by late February, we recorded ADCs and total revenue, and calculated the quotient of these two values in order to get a rough idea of the relative burden that public employee contributions place on county finances. Because pension systems usually require their actuaries to assume high rates of return on their investments (typically 7.25 percent or more), it’s arguable that reported ADCs understate actual pension burdens.

That said, the reported ADCs provide a reasonable basis for comparison across counties. Further, California public agencies generally make pension contributions roughly equivalent to their ADCs, so the ADC is at least a good gauge of near-term pension burdens.

Total county revenues, ADCs and pension cost ratios appear in the following table:

California County Pension Burden
Total Annual Pension Payments As Percent of Total Annual Revenue
20160312-CPC-Joffe-County-Pensions2

  1. Santa Barbara County

Despite its strong economic performance, Santa Barbara County had the highest pension cost burden among the 25 counties we reviewed – by a considerable margin. Employer contribution rates ranged from 20.8 percent to 59.5 percent, and have risen substantially since 2007. Employer contribution rates represent the percentage of public employee salaries a public agency contributes to its pension plan; they are generally higher for public safety employees, who receive more generous retirement benefits.

In the fiscal year ended June 30, 2015, the Santa Barbara County Employees’ Retirement System (SBCERS) suffered a decline in its funded ratio, from 81.1 percent to 78.4 percent. The drop was largely due to a disappointing 0.83 percent return on plan assets, compared to an assumed 7.5 percent annual asset return.

Despite the decline, SBCERS is still on somewhat stronger footing than the state’s CalPERS – which was about 73.3 percent funded on June 30, 2015. SBCERS is also amortizing its unfunded liabilities faster than CalPERS, using a 17-year timeframe versus 30 years for CalPERS.

SBCERS ended the fiscal year with an unfunded liability of $698 million, about 93 percent of which was the responsibility of county government (the rest belongs to courts and special districts). The system was last fully funded in 2000.

According to a 2007 report commissioned by the county auditor, the system’s position deteriorated for a variety of reasons including poor investment performance and benefit improvements granted by elected officials. The report does not detail these benefit improvements, but they included a change to the final average salary calculation used to determine benefit levels. Liberalizing final average salary calculations can enable pension spiking – a practice under which employees work extra overtime or get last-minute promotions at the end of their careers to maximize pension benefits.

  1. Kern County

Although Kern County’s ADC/revenue ratio is two points lower than that of Santa Barbara County, its situation is worse in a variety of ways. According to the most recent Kern County Employees’ Retirement Association (KCERA) actuarial valuation report, the system was only 64.08 percent funded as of June 30, 2015 – down from 65.11 percent the previous year.

Also, as of June 30, 2015, the county had $284 million in outstanding pension obligation bonds. If the $51 million in scheduled debt service on these bonds is added to the $201 million in Actuarially Determined Contributions the county was required to make, its pension cost burden would exceed that of Santa Barbara County – which has not issued pension obligation bonds.

KCERA’s funded ratio reflects an assumption of 7.5 percent annual returns on its portfolio. This contrasts with an actual fiscal year 2015 return of only 2.3 percent. On the other hand, KCERA is trying to amortize its unfunded liabilities more rapidly than CalPERS – employing an 18-year amortization period versus 30 years for CalPERS. KCERA’s severe underfunding and rapid amortization help drive relatively high pension contribution rates, which range from 37.8 percent for Kern’s court employees to 63 percent for public safety employees.

Kern County shows other signs of fiscal distress. In January 2015, county supervisors declared a financial emergency, prompted by the precipitous decline in oil prices. When the emergency was declared, oil companies paid about 30 percent of the county’s property taxes. That said, it is worth noting that property taxes accounted for just 15 percent of the county’s total 2015 revenue. Counties receive a substantial portion of their revenue from state and federal grants, so declines in a major source of county tax revenue are often less damaging than they are for cities.

After the emergency declaration, Standard and Poor’s affirmed the county’s A+ rating (four notches below the agency’s top AAA rating) and changed its outlook to negative. No downgrade has followed.

Kern County’s liabilities exceed its assets, leaving it with a negative Net Position – another sign of fiscal stress. Since most of a government’s assets are already committed to specific requirements (like paying debt service) or tied up in capital assets that are difficult to sell, analysts often focus on its Unrestricted Net Position – a measure of reserves that could be freely allocated by elected officials. Kern County has a negative Unrestricted Net Position of almost $2.3 billion – suggesting a serious fiscal problem.

On the other hand, the county has a strong general fund balance – equal to more than six months of general fund expenditures. As we have reported elsewhere, low or negative general fund balances have been the best predictor of municipal bankruptcy in recent years.

More recently, the county made further budget cuts which could result in closures of fire stations, jails and other facilities. If the county was not paying over $1 in every $8 for pension contributions and pension obligation bond debt service, these reductions might not have been necessary.

  1. Fresno County

Like Kern County, Fresno County has used pension obligation bonds (POBs) to address pension underfunding. As of June 30, 2015, the county had $454 million in POBs outstanding. This balance actually exceeds the $402 million principal amount of the POBs when they were issued in 2004, because much of the 2004 offering consisted of capital appreciation bonds (CABs). Interest on CABs is added to principal over the life of the bond and then paid at maturity.

In fiscal year 2015, Fresno was scheduled to pay over $37 million in debt service on its POBs. If this is added to the $153.5 million in Actuarially Determined Contributions the county was obliged to make, its pension-cost-to-revenue ratio would (like Kern County’s) exceed that of Santa Barbara County’s, which did not issue POBs.

Fresno County has the highest employer contribution rates as a percentage of payroll of the counties discussed here. In fiscal year 2015, contribution rates range from 37.4 percent to 74.6 percent for certain public safety employees. The county’s retirement program provisions are relatively generous. According to the system’s actuarial report, most plans allow members to retire at age 50. If they remain on the payroll after 55, many classes of employees accrue additional benefits at accelerated rates.

On the plus side, the Fresno County Employees’ Retirement Association is amortizing its unfunded liabilities over a 15-year period and has a relatively strong funded ratio – 79.4 percent (down from 83 percent at the end of 2014).

Illustrating that optimistic investment forecasts plague local government financials, Fresno County assumes annual asset returns of 7.25 percent. Its actual return in fiscal 2015 was a dismal -0.10 percent.

  1. San Mateo County

Like Santa Barbara County, San Mateo County has a strong economy, so it’s surprising to see it near the top of our list. One driver of the county’s pension burden appears to be high employee salaries. Since pension benefits are based on final average salaries, high employee compensation translates into high pension benefits.

A San Jose Mercury News story revealed that San Mateo County had 78 employees paid over $200,000 in the 2013 fiscal year. More recent data available on Transparent California shows that number grew to 90 employees in 2014.

Employee contribution rates ranged from 28.3 percent to 65.5 percent. For a single employee earning $200,000, the county’s annual pension contribution could be as a high as $130,940.

A 2012 San Mateo Civil Grand Jury report noted that county pension contributions had grown from $78 million in fiscal 2006 to $150 million in fiscal 2012, but the plan continued to generate substantial unfunded liabilities. The jury made a number of recommendations including “significantly decreasing the number of county employees through outsourcing and/or reducing services, and by attrition.”

The county’s board of supervisors agreed with most of the Grand Jury’s findings but did not specifically respond to the call for headcount reductions.

In late 2013, the board of supervisors decided to make extra contributions to SamCERA (the San Mateo County Employees Retirement Association) in order to more rapidly cut its unfunded liability. The supervisors authorized a one-time payment of $50 million in fiscal 2014 followed by annual $10 million payments in each of the next nine fiscal years. These payments, totaling $140 million over 10 years, are above the county’s Actuarially Determined Contribution.

The extra contributions have improved SamCERA’s funded ratio despite lackluster stock market performance in the most recent fiscal year. The system’s funded ratio rose from 73.3 percent in 2013, to 78.8 percent in 2014 and to 82.6 percent in 2015. The system achieved portfolio returns of 3.5 percent in fiscal 2015 as opposed to a 7.5 percent projected return rate.

Since 2013, the system’s unfunded liability has fallen from $954 million to $702 million. SamCERA amortizes unfunded liabilities over a 15-year period. Given the improvement in SamCERA’s funded ratio, it seems likely that San Mateo County will fall off the list of highly burdened counties in future years.

CONCLUSION

Generous benefits, aggressive return assumptions and (in some cases) high employee pay have left a number of California counties heavily burdened with pension costs. This year’s poor stock market performance will likely mean additional stress.

Over the longer term, the state’s 2013 pension reform should provide some relief, as newly hired employees receive less generous benefits. But if the stock market continues to be weak or if county systems make poor investment choices, asset returns will remain below the 7.25 percent-7.50 percent typically anticipated in actuarial valuations. Under those circumstances, employer contributions and overall pension burdens may continue to rise. The result will likely be ballooning public debt, pressure to raise taxes and cuts in government services.

 *   *   *

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

How CalPERS has Created a Ticking Time Bomb

During the Stockton bankruptcy Judge Klein called CalPERS the “bully with a glass jaw.” Klein meant that CalPERS, as a servicing company, has no standing in the bankruptcy because the pension obligation is between the public agency and their employees and retirees.
Read more

California Ranks 50th in State Spending Transparency: What We Can Do About It

Although many California political leaders espouse their support for transparency, the state lags behind most others in opening its spending data to public scrutiny.  So while Lieutenant Governor Gavin Newsom, has called on governments to “lean into [the] notion of openness and transparency,” the state he may soon lead is leaning in quite the opposite direction.

In its March 2015 report card, the US Public Interest Research Group (US PIRG) gave California a grade of “F” for its efforts to provide spending transparency – a distinction shared only by two other states, Alaska and Idaho.  US PIRG also assigned each state a more granular numerical score on a 0-100 scale. California’s score of 34 placed it last among the fifty states – 9 points below Alaska.  US PIRG notes:

California…is weighed down by the bureaucratic fragmentation of its information. While the state has made some interesting and useful data sets available to the general public … California does not succeed in providing a “one-stop” transparency portal.

Bureaucratic fragmentation has also frustrated private efforts to elicit the state’s checkbook. In 2013, American Transparency – a not-for-profit that operates openthebooks.com – filed a Public Records Act with the State Controller’s Office (SCO) requesting detailed state spending data. SCO’s legal counsel rebuffed the request on the grounds that the controller does not hold all the spending records, and is not required under the Public Records Act to create records not already in its possession. Apparently state spending data is scattered across roughly 500 agencies, departments and commissions which pay some or all of their vendors directly.

The fragmentation issue might be resolved by Senate Bill 573 which would require the governor to hire a Chief Data Officer, who would then be tasked with creating a state-wide open data portal leveraging information from all state agencies. The bill, proposed by Dr. Richard Pan (D-Sacramento), received favorable publicity but was tabled by the Senate Appropriations Committee on August 27. Pan would have to re-introduce the bill next year if he wants it to pass before the next legislature is seated.

In the meantime, it will be up to civil society organizations to advance state spending transparency. As a part of our state’s civil society, we at the California Policy Center are eager to help.

Starting with Medi-Cal Reimbursements

Ideally, a state checkbook should contain all vendor payments. It need not include employee salaries because these are already published by both SCO and by Transparent California. While it would be extremely challenging for one or more outside organizations to compile all of this spending, a large portion of it can be assembled by examining a few of California’s largest agencies.

The entity that makes the most vendor payments is the Department of Healthcare Services which administers the state Medi-Cal program. In the last fiscal year, Medi-Ca106191228-20140630-Audl payments totaled $87 billion, including $17 billion from the General Fund, $14 billion from Special Funds and $56 billion in Federal Funds.

So just getting our hands around the payments made by this one department would go a very long way toward documenting the state’s overall spending.  Over the next few weeks, the California Policy Center will compile a DHCS checkbook to demonstrate the benefits of state spending transparency.

Our preliminary review suggests that the number one recipient of Medi-Cal funding is Los Angeles County USC Medical Center, known locally as LAC+USC. The 664-bed county hospital received over $700 million in Medi-Cal funds during the fiscal year ended June 30, 2014. LAC+USC is one of three LA County public medical centers. The two other county hospitals together received an additional $700 million in Medi-Cal funding during the same fiscal year, yielding a total of over $1.4 billion in state and federal Medi-Cal funds devoted to LA County hospitals. Medi-Cal reimbursements accounted for over 70% of all three hospitals’ patient revenues.

The prevailing view is that Medi-Cal payments are too low to adequately compensate providers. But, in the case of LAC+USC, the hospital reported $77 million of “Net Income”, i.e. revenues in excess of expenses, also known as “profit” in the private sector.  That said, it should be noted that the hospital suffered a loss on operations, and was profitable because it received $284 million in non-operating revenue.

Most of LAC+USC’s expenditures take the form of employee compensation and benefits, as well as physician fees. These three categories accounted for over $900 million of the hospital’s $1.375 billion in total operating expenses.

A review of 2013 Transparent California data shows that nine out of the ten highest paid Los Angeles County employees are physicians – apparently affiliated with one or more of the three County hospitals. All nine of these doctors received total compensation from the County in excess of $500,000 during calendar year 2013.

It appears that at least a couple of these individuals received compensation from other medical facilities. For example, Dr. John Peter Gruen, a neurosurgeon who received a total of $628,001 in County compensation is also affiliated with Huntington Memorial Hospital in Pasadena and Keck Medical Center of USC.

As this brief analysis suggests, the ability to obtain state spending details and juxtapose this information with other data sets should yield new insights into how our tax dollars are being managed. Next month, look to this space for much more information about California Medi-Cal spending.

 *   *   *

About the author:  Marc Joffe is a policy analyst for the California Policy Center. He is also the founder Public Sector Credit Solutions, established in 2011 to educate policymakers, investors and citizens about government credit risk. PSCS research has been published by the California State Treasurer’s Office, the Mercatus Center and the Macdonald-Laurier Institute among others. Prior to starting PSCS, Marc was a Senior Director at Moody’s Analytics. He has an MBA from New York University and an MPA from San Francisco State University.

Will California Voters Support Pension Reform?

A bipartisan coalition led by former San Jose Mayor Chuck Reed and former City Councilman Carl DeMaio have filed a pension reform ballot measure in California. The group seeks to qualify the measure for a possible November 2016 vote by California voters.

The California Policy Center examined polling conducted by a variety of sources and CPC also commissioned its own polling study through the polling firm Penn Schoen Berland. CPC’s poll utilized online interviews in English and Spanish from August 17-21, 2015 among n=1,002 likely voters in California.

Overwhelming Public Support for Pension Reform

CPC’s review of a number of statewide polls conducted in recent years confirms that California voters have shown overwhelming support for pension reform.

A statewide poll issued by the Public Policy Institute of California in September found that 72 percent of likely voters say public pension costs are a problem and 70 percent say voters should make decisions about retirement benefits. As in previous PPIC polls, 70 percent favor giving new government employees a 401(k)-style plan rather than a pension. The change has strong bipartisan support: Republicans 74 percent, independents 69 percent, and Democrats 65 percent.

The CPC poll used several questions to examine voters knowledge of and assessment of issues facing state and local government pension funds – as well as the level of compensation and benefit packages provided to government employees.

(1) Would you say the financial health of the pension funds for state and local government employees in California are in a better place, worse place, or about the same place as they were ten years ago?

(%) California
Likely Voters
Better place 14
Worse place 46
About the same place 25
Don’t know 15

(2)  As far as you know, are CalPERS and CalSTRS in debt or do they have a surplus?

(%) California
Likely Voters
In debt 30
Have a surplus 16
Don’t know / unsure 55

(3)  As far as you know, on average, are state and local government employees…?

(%) California
Likely Voters
Paid more than employees in the private sector 41
Paid less than employees in the private sector 34
About the same 25

(4)  As far as you know, on average, do state and local government employees…?

(%) California
Likely Voters
Get bigger pensions than employees in the private sector 60
Get smaller pensions than employees in the private sector 19
About the same 21

 *   *   *

Attorney General’s Title and Summary Impacts Support

In August, the DeMaio and Reed blasted Attorney General Kamala Harris for issuing what they called a “biased” Title and Summary of the pension reform measure the coalition filed. The Title and Summary is what voters actually see on the ballot and the Attorney General has a Constitutional obligation to provide a fair and accurate description.

Putting aside the debate over whether the Title and Summary is fair and accurate, the polling shows the Attorney General’s Title and Summary from a polling perspective does indeed have a major negative impact on the ballot proposal.

In March 2015, the coalition conducted its own poll of California voters that demonstrated solid support for the concepts contained in the ballot proposal – specifically asking this question:

Would you vote yes – in favor of, or no – against a ballot measure that would give voters the right to reform pension benefits for state and local government workers, would require voter approval before obligating taxpayers to guarantee lifetime pensions benefits for new state and local government employees, and would require new government employees to contribute at least half the cost of their retirement benefits?

California Voter Support for Pension Reform

20151116-CPC-DeMaio

CPC’s poll used the Title and Summary provided by the Attorney General – with the Title and Summary crafted by the AG resulting in less support for the measure.

PUBLIC EMPLOYEES. PENSION AND RETIREE HEALTHCARE BENEFITS. INITIATIVE CONSTITUTIONAL AMENDMENT. Eliminates constitutional protections for vested pension and retiree healthcare benefits for current public employees, including those working in K-12 schools, higher education, hospitals, and police protection, for future work performed. Adds initiative/referendum powers to Constitution, for determining public employee compensation and retirement benefits. Bars government employers from enrolling new employees in defined benefit plans, paying more than one-half cost of new employees’ retirement benefits, or enhancing retirement benefits, unless first approved by voters. Limits placement of financial conditions upon government employers closing defined benefit plans to new employees. Summary of estimate by Legislative Analyst and Director of Finance of fiscal impact on state and local government: Significant effects—savings and costs—on state and local governments relating to compensation for governmental employees. The magnitude and timing of these effects would depend heavily on future decisions made by voters, governmental employers, and the courts.

California Voter Support for Pension Reform
Using Attorney General’s Title & Summary

(%) California
Likely Voters
Vote yes to support 36
Vote no to oppose 33
Undecided 32

 *   *   *

Many Arguments in Favor of Pension Reform Poll Well

After testing the Title and Summary, CPC polled arguments that might be used by proponents of pension reform to justify major changes in state and local pension benefits.

(%) California Likely Voters

 

Much more likely Somewhat more likely Somewhat less

likely

Much less

likely

Many government employees are abusing the system to spike their pensions. In 2013, one former assistant fire chief in Los Angeles collected a government pension of $983,000. In San Diego, a former city librarian now collects $234,000 annually, and a politician in that same city started cashing full-pay pension checks at age 32. Last year alone, over 41,000 retired state and local government employees cashed pension checks of $100,000 or more! This proposal would end abuses like these. 52 27 12 9
This proposal does not take away any pension benefits lawfully earned by government employees. The proposal simply prevents any spiking of pensions going forward and also reforms benefits for any newly hired government employees going forward. It will not affect current retirees. In this way, we are fixing our pension problem while protecting the seniors and families who depend on current benefits. 47 40 8 5
Backroom deals by politicians created the California pension crisis. Politicians take campaign contributions and support from powerful government unions and in return, politicians give the unions sweetheart deals that mean bigger pension benefits. Politicians have even voted to spike their own pensions. This proposal provides a “check” on state and local politicians by requiring voter approval of any future pension deals. With this proposal, voters will be able to stop the politicians from doing backroom pension deals that taxpayers can’t afford. 47 31 13 9
If you are concerned about public safety you should support this pension reform proposal. If we don’t reform government pensions now, many cities and counties will be forced to cut police and fire services to divert our tax dollars to bail out government pension funds. For example, the Oakland Police Department no longer responds to 44 different crimes as a result of cutbacks that were necessary to fund pensions. Elsewhere in the state, fire stations have had to scale back hours of operation and in some cases close in order to pay rapidly rising pension costs. 44 40 8 8
Pension debt has grown exponentially in California, rising from $6.3 billion in 2003 to $198 billion in 2013. And when combined with unfunded liabilities for retiree healthcare programs, taxpayers owe almost $350 billion to fund future retirements for government employees. Without immediate action, the cost of government pensions will double in the next five years alone. This proposal will shrink the debt and save taxpayers billions. 44 34 14 7
Politicians and bureaucrats who run the government pension program are cooking the books and misleading the public. Last year the head of the pension program pled guilty to taking bribes and helping friends collect millions in a fraudulent investment scheme. The situation is getting worse as taxpayers lose billions from dubious investment decisions made by a board with significant conflicts of interest. This proposal would reform the government pension program, which is why the powerful elites who profit from the government pension program are opposing it. 44 30 15 11
Many government employees contribute nothing at all towards the costs of their pension benefits, leaving taxpayers to pick up the whole tab. This proposal would require new government employees to contribute at least half the cost of their retirement plans, similar to what most private sector employees have to contribute. 43 32 17 8
If you are concerned about quality education for our children you should support this pension reform proposal. If we don’t reform government pensions now, many cities and counties will be forced to cut after school programs, close libraries, and parks and recreation in order to divert our tax dollars to bail out government pension funds. For example, cities like San Jose had to restrict library hours of operation in order to pay for rapidly rising pension costs. 40 34 17 9
Mounting government pension debts have forced major cuts in important services. For example, pension contributions in Los Angeles have grown from 3% of the city’s overall budget to nearly 20% in just the last decade, crowding out other public needs. Already in cities and counties across California, higher pensions costs have meant cuts to after school programs, closures and brownouts at fire stations and cancellations of road repairs. With this pension reform proposal, we can generate savings to restore these important services. 39 34 20 7
Voters should take a close look at who opposes this pension reform proposal. One Sacramento union boss leading the charge against reform collects a pension of $183,690 annually. He says government employees trade off pay for a secure retirement. However, according to the Sacramento Bee newspaper, the average salary for employees like him is $163,000 annually plus health care and retirement at age 55. Those same union leaders are lying about this pension reform proposal because they want to keep their taxpayer-funded gravy train going. 39 29 18 15
Cities across California are being crushed under the weight of mounting pension debt. Because of pensions, major cities such as Vallejo, Stockton, and San Bernardino have already gone bankrupt, which resulted in massive cuts in important services such as police and fire protection. Unless we approve this pension reform proposal, many more cities throughout California will be forced to declare bankruptcy and make similar extreme cuts in our services. 38 36 16 9
Voters should take a close look who opposes this pension reform proposal. In 2012, the teachers unions blocked legislation that would have given local officials the power to fire teachers convicted of sexually abusing their own students even though this meant that sexually abusive teachers got to keep their jobs. Those same unions are lying about this pension reform proposal because they want to block the common-sense reform it would bring. 38 27 22 13
The pension reforms in this proposal are fair. The new benefits provided to government employees would be no better, and no worse, than the benefits provided to workers in the private and non-profit sectors. For police and fire, the measure provides a guarantee of death and disability benefits mirroring exactly what the US Military receives. 37 41 14 9
 

 *   *   *

Arguments in Opposition to Pension Reform Offer Mixed Bag of Results

(%) California Likely Voters
(among those who saw “anti” messaging first)
Much less

likely

Somewhat less

likely

Somewhat more likely Much more likely
This pension proposal is promoted and funded by Tea Party Republicans including a young billionaire Texan who is spending $50+ million dollars to take away from school bus drivers, teachers, nurses, and firefighters their hard-earned retirement benefits. He hates government so much that he wants to strip millions of middle and working class Californians of their retirement security. 53 19 17 11
This proposal to eliminate public pensions in California is led and funded by a Texas wheeler-dealer billionaire named John Arnold. Arnold is spending $50+ million dollars of his fortune to dismantle retirement plans for firefighters, nurses, and teachers. Moving California state and local government employees to 401(k) accounts would mean billions more for Arnold and his cronies to split in higher Wall Street fees. 48 21 19 13
Many public employees like teachers, police, and fire fighters do not receive Social Security or have very limited benefits. This proposal would eliminate their pensions and would undermine their ability to retire with dignity, as they will have no safety net if their 401(k) investments lose their value before or during their retirement through no fault of their own. 47 25 19 9
This pension reform proposal would likely eliminate the current death and disability benefits for new police, firefighters, and other public employees. It would be disgraceful to take these important protections away from families of police and fire fighters who make the ultimate sacrifice to protect Californians. 47 24 20 9
If enacted, this ballot measure will cost the taxpayers millions, or even billions for extra elections. Every contract at all levels of government could be on the ballot, costing school districts, cities, and counties millions of dollars to hold these elections. And it will unleash expensive lawsuits which will be litigated in the courts, with taxpayers footing the bill. 45 34 14 7
This proposal would eliminate state constitutional protections for current and future employees, breaking promises made to teachers, nurses, and firefighters by rewriting their pension benefits without negotiation. This would devastate middle class families who have contributed to these pension plans and have made long-term financial planning decisions based on the promises made to them when they were hired. 45 25 19 11
This proposal to eliminate public pensions in California is led and funded by greedy investors including America’s youngest Wall Street billionaire who made his stash out of the collapse of Enron. If a statewide pension-gutting proposal is passed in California, public sector employees will be moved to 401(k) plans, which would mean a windfall in investment fees for Wall Street. It’s as bad as when George W. Bush tried to privatize Social Security. 44 27 19 10
Pensions are important compensation for public employees, including those who work in K-12 schools, higher education, hospitals, and police protection.  Public employees earn an average of 7% less than their private sector counterparts. Adequate pensions also serve as valuable recruitment and retention tool. If we approve this proposal’s massive cuts in pension benefits, we will need to either pay government employees more or risk hiring less-qualified government employees, which will lead to lower-quality services. 38 26 20 16
This measure is part of an extreme agenda to eliminate collective bargaining for government employees in California. The proposal allows voters to increase or decrease compensation and retirement benefits of government employees without any negotiation or collective bargaining. This undermines the ability of the government and employees to negotiate and agree on contracts. These complex issues should be settled at a bargaining table, not the ballot box. 38 24 24 14
This proposal would take away vested benefits that were promised to current public employees. For example, a state employee with 8 years of service could lose retiree healthcare benefits she would have earned after 10 years under her current employment contract. This is unfair to workers and their middle-class families, especially single mothers, because many accepted lower as a tradeoff better retirement and healthcare plans. 37 32 20 11
This proposal exaggerates the pension problem. Public employees are not retiring to lavish and luxurious pensions. In 2012, California passed extensive pension changes that raised the retirement age for new workers and require all employees to pay half of their pension costs. Thanks to Governor Brown’s reforms, $100,000 plus pension payments have all but been eliminated. The average public employee pension is just $2,500 a month – hardly the gold-plated plan overhaul that the other side claims. 31 29 28 11

 *   *   *

Significant Support for Pension Reform After Title and Summary Is Explained

Among voters who were exposed to the case for pension reform immediately after the Title and Summary was provided, support shifted dramatically back in favor of the pension reform proposal.  CPC concludes that the Title and Summary as currently written confuses and scares voters, but once the proposal is clearly explained to voters, confident support returns.

(%) CA Likely Voters
Vote yes to support 63
Vote no to oppose 18
Undecided 19

 *   *   *

Pension Reform Likely to Have Major Impact on 2016 Elections

The presence of a pension reform issue in the midst of the 2016 elections in California could have a profound effect on both candidate races and the debate over a variety of tax increase measures being considered for the 2016 ballot.

(1)  In the November 2016 election, which of the following types of candidate would you be most likely to vote for?

(%) California
Likely Voters
A Democrat who opposes the proposal 24
A Democrat who supports the proposal 18
A Republican who opposes the proposal 12
A Republican who supports the proposal 20
None of the above 5
Not sure 22

(2)  If a candidate from a political party different from your own supported this proposal, would that make you…?

(%) California
Likely Voters
Much more likely to support that candidate 9
Somewhat more likely to support that candidate 23
Somewhat less likely to support that candidate 11
Much less likely to support that candidate 17
No difference 41

(3)  Some people say that we should approve tax increases on the wealthy and extend the temporary sales tax enacted in 2012, because the state still need that money to close the budget deficit. Without these funds, we will have to cut funding for schools and for other important public services.

Other people say that the politicians are only raising taxes to pump more money into these failing state and local government pension systems to continue unsustainable government pension payouts (including their own) with our tax dollars. None of this money will go to school funding. We should enact pension reform first before considering any more tax increases.

Which of the following comes closer to your view?

(%) California
Likely Voters
Approve tax increases  on the wealthy and extend 2012 tax increases 37
Enact pension reform first 32
Neither of the above 15
Unsure 17

 *   *   *

Voters Not Swayed Significantly By Groups on Pro and Con Side of Pension Reform

CPC evaluated voter views of a variety of groups that are likely to take positions both for and against pension reform proposals.

As it related to this proposal, how much would you trust the information you might receive from the following organizations or institutions?

(%) California Likely Voters A lot of trust /

very credible

Somewhat trust / somewhat credible Trust just a little / not very credible Do not trust at all / not at all credible
Police and firefighter unions 22 39 25 14
Teachers’ unions 18 35 23 23
CalPERS 13 35 33 19
Government employees’ unions 11 31 27 31
Public sector unions 11 30 34 25
California Chamber of Commerce 10 41 33 16

 *   *   *

About the Author:  Former San Diego city councilman and lifelong entrepreneur Carl DeMaio is now tackling state-wide fiscal reform policy. While on the City Council, DeMaio led the effort to cut red tape on small businesses, reform the city’s contracting processes to expedite infrastructure projects, and enact some of the toughest “Sunshine Law” open government requirements in the nation. In 2012, DeMaio crafted and led a citizens campaign to qualify and pass the “Comprehensive Pension Reform” Initiative – the first-of-its kind measure to switch San Diego from a Defined Benefit Pension Plan to a 401(k) retirement program. In 2003, DeMaio founded the American Strategic Management Institute (ASMI), which provides training and education in corporate financial and performance management. In late 2007, DeMaio sold both of his companies to Thompson Publishing Group. DeMaio holds a BA in International Politics and Business from Georgetown University.

"For the Kids" – Comprehensive Review of California School Bonds, Executive Summary (Section 1 of 9)

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
You are Here: Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
More Borrowing for California Educational Construction in 2016 (2 of 9)
Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
How California School and College Districts Acquire and Manage Debt (4 of 9)
Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
The System Is Skewed to Pass Bond Measures (7 of 9)
More Trouble with Bond Finance for Educational Construction (8 of 9)
Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
Guide to all Tables and Appendices – Comprehensive Reference for Researchers


Executive Summary 

Few Californians realize how much debt they’ve imposed on future generations with their votes for bond measures meant to fund the construction of new and modernized school facilities.

From 2001 to 2014, California voters considered 1147 ballot measures proposed by K-12 school districts and community college districts to borrow money for construction via bond sales. Voters approved 911 of these bond measures, giving 642 school and college districts authority to borrow a total of $110.4 billion.

California voters also approved three statewide ballot measures during that time to authorize the state to borrow $35.8 billion. That money has supplemented local borrowing for construction projects at school and college districts, and the state has spent all but $195 million of it.

That’s a total of $146.1 billion authorized during the last 14 years for state and local educational districts to obtain and spend on construction projects. All of it has been borrowed or will be borrowed from wealthy investors, who buy state and local government bonds as a relatively safe investment that generates tax-exempt income through interest payments.

Current and future generations of Californians are already committed to paying these investors about $200 billion in principal and interest — a number that will grow as school and college districts continue to borrow by selling bonds already authorized by voters but not yet sold.

And more borrowing is coming.

In 2016 California voters may be asked to authorize the state to borrow as much as $9 billion for school construction. More than 100 school and college districts may ask voters to approve borrowing a total of several billion more dollars. Officials at the country’s second largest school district, the Los Angeles Unified School District, claim they need more than $40 billion for additional construction and plan to ask voters to approve borrowing several billion in 2016.

It is time to be wary. The California Policy Center believes that most Californians are unaware and uninformed about this relentless borrowing and the amount of debt already accumulated to pay for school construction. Most voters cannot explain how a bond measure works and do not get enough information to make an educated decision about the wisdom of a bond measure.

California voters who want to learn more before voting will have difficulty finding relevant information. Where does an ordinary Californian find out how much money a school or college district has already been authorized to borrow from past bond measures, or the principal and interest owed from past bond sales that still needs to be repaid, or the projected changes in assessed property valuation and how they affect tax and debt limits, or the past and projected student enrollment? The state does not offer a clearinghouse of information for the public to research and compare data about bond measures and bond debt for educational districts. Much of the information available about debt finance for educational districts is oriented toward interests of bond investors rather than people who pay the debt.

Californians who recognize a need for their own local educational districts to refrain from accumulating additional debt have significant obstacles to overcome. State law gives supporters of bond measures a systematic strategic advantage when local districts develop bond measures and put them before voters for approval. Campaigns to support bond measures are funded and even managed by financial and construction industry interests that will profit after passage. And after voters approve a bond measure, educational districts are tempted to take advantage of ambiguities in state law and use bond proceeds for items and activities not typically regarded by the public as construction.

To help to fix these deficiencies, this report encourages the California legislature and the executive branch to adopt five sets of recommendations:

Five Categories of Recommendations
1Provide Adequate and Effective Oversight and Accountability for Bond Measures
2Enable Voters to Make a Reasonably Informed Decision on Bond Measures
3Eliminate or Mitigate Conflicts of Interest in Contracting Related to Bond Measures
4Reduce Inappropriate, Excessive, or Unnecessary Spending of Bond Proceeds
5Improve Understanding of Bond Measures Through Public Education Campaigns

At a time of low interest rates, California school and community college districts may benefit in some circumstances from borrowing money to fund school construction, just like households benefit from home mortgages and car loans. But California voters — and their elected representatives — need to become much more informed about the debt legacy they are leaving to their children and grandchildren.

Emotional sentiment, lobbying pressure from interest groups, and eagerness to circumvent frustrating tax and debt limits in state law can overwhelm a prudent sense of caution. Irrational decisions that burden future generations cannot necessarily be fixed after the public finds out about them.


Section Summaries

Section 2. Why This Report Matters: More Borrowing in 2016

Californians will be asked in 2016 to continue taking on debt for construction of educational facilities, but one elected official is leery. Governor Jerry Brown wants to change the funding system for school construction. He is concerned about debt that Californians have accumulated from years of allowing the state and local educational districts to relentlessly borrow.

That money borrowed through bond sales will have to be paid back — with interest — to the investors who bought them. Voters have limited understanding of bonds and how bonds provide funds for construction, and elections focus on what voters will get rather than how they will pay for it. To the detriment of future generations, few Californians realize the huge amount educational districts have been authorized to borrow and the huge amount of debt accumulated.

Section 3. Quantifying and Explaining California’s Educational Construction Debt

Whatever voters are asked to approve in 2016 will not launch a new program to fix long-neglected schools to serve a rapidly expanding state population while providing smaller class sizes. That thinking is a legacy of the 1990s that seems to endure today despite 14 years of most bond measures passing at a 55 percent threshold for voter approval. Arguments for another state bond measure in 2016 ignore or downplay how local school and college districts and the state obtained authority in the past 14 years to borrow $146.1 billion for educational construction.

If voters are not told or reminded of recent borrowing patterns, how can they make an informed decision on future borrowing? To rectify the lack of availability of statistics on total bond debt in California for educational facility construction, the California Policy Center collected, synthesized, and analyzed data regarding California educational construction finance. The California Policy Center believes it is the first and only entity to painstakingly research and present an accurate and comprehensive record of all state and local educational construction bond measures considered by voters from 2001 through 2014.

Section 4. How Educational Districts Acquire and Manage Debt

It’s likely that most California voters have limited familiarity with the organization and governance of their local school and community college districts. When voters authorize their local educational districts to borrow money for construction by selling bonds, presumably they trust that the local school or college district will exercise prudence in managing the process. Sometimes their trust is betrayed.

To discourage abuse of the school construction finance system, voters need to be aware of how their local government is organized and managed. They also need to realize that state law does not explicitly give Independent Citizens’ Bond Oversight Committees broad authority to review construction programs funded by bond measures.

How can voters become informed about bonds and the process of borrowing money for educational construction through bond sales? Is there a way to explain in clear plain language what actually happens after voters approve a bond measure and authorize a school or college district to borrow money via bond sales?

Section 5. Capital Appreciation Bonds: Disturbing Repayment Terms

In 1993, California law was changed so that school and college districts could use an innovative form of debt finance called zero-coupon bonds, also known as Capital Appreciation Bonds. These bonds allow school and college districts to borrow now for construction and pay it back — with compounded interest — many years later. The borrowing strategy has been a tempting and dangerous lure for elected school and college boards.

Some people think Capital Appreciation Bonds are a “ticking time bomb” or the “creation of a toxic waste dump.” Others regard critics as uninformed and contend that these debt finance instruments are beneficial for school and college districts. Since the people who will be paying off many of these Capital Appreciation Bonds are now children or not even born yet, there isn’t much incentive to stop the flow of borrowed money that doesn’t need to be paid back for a generation or two.

Section 6. Tricks of the Trade: Questionable Behavior with Bonds

Californians who want more spending on educational construction often express their resentment of a 2000 law limiting taxes and debt resulting from bond sales. It was passed in order to strengthen campaign arguments to voters in support of Proposition 39, which lowered the approval threshold for local bond measures from two-thirds to 55%. School districts have adopted several strategies to get around these limits in state law. One of them is very obscure but 100% successful: obtaining waivers from the State Board of Education.

Meanwhile, some districts are stretching legal definitions to use proceeds from bond sales to pay for items that resemble instructional material more than construction. One example is personal portable electronics such as iPads. Some of the state’s largest districts are purchasing this kind of technology while giving little assurance to the public that long term bonds aren’t the source of the money. This equipment may be obsolete well before the bonds mature, meaning that future generations will pay for these devices long after they are outdated and discarded.

Section 7. The System Is Skewed to Pass Bond Measures

Considering the advantages that supporters have in preparing and campaigning for a bond measure, perhaps it’s noteworthy that voters reject about 20% of local bond measures for educational construction. At every stage of the process, interests that will benefit from bond sales can take advantage of a system that favors passage of a bond measure. Some issues of concern include use of public funds to develop campaigns to pass bond measures, significant political contributions to campaigns from interests likely to benefit from construction, involvement of college foundations as intermediaries for campaign contributions, and conflicts of interest and alleged pay-to-play contracts.

Section 8. More Trouble with Bond Finance for Educational Construction

While compiling the comprehensive information provided in this study, California Policy Center researchers identified numerous other troubling aspects of bond finance. School and college districts are evading compliance with the law and making irresponsible decisions. Ordinary voters lack enough data to make an informed vote. Community activists who seek deeper understanding find themselves stymied.

Section 9. Improving Oversight, Accountability, and Fiscal Responsibility

This report encourages the California legislature and the executive branch to adopt five sets of recommendations that will help to fix these deficiencies.

Five Categories of Recommendations
1Provide Adequate and Effective Oversight and Accountability for Bond Measures
2Enable Voters to Make a Reasonably Informed Decision on Bond Measures
3Eliminate or Mitigate Conflicts of Interest in Contracting Related to Bond Measures
4Reduce Inappropriate, Excessive, or Unnecessary Spending of Bond Proceeds
5Improve Understanding of Bond Measures Through Public Education Campaigns

The California Policy Center rejects the idea that additional oversight and accountability isn’t needed or desirable. Some legislative reforms and education programs (both public and private) can overcome voter cynicism, frustration, apathy, and ignorance.

Tables and Appendices of “For the Kids: California Voters Must Become Wary…”

Tables A1 to A6

Table A-1 California K-12 School Districts 2013-2014 – Ranked by Enrollment

Table A-2 California Community College District Enrollment Fall 2014 Ranked by Number of Students

Table A-3 Details of Bond Indebtedness Waiver Requests from California School Districts to State Board of Education 2002 through March 2015

Table A-4 California School Construction & Finance History

Table A-5 Arguments for Capital Appreciation Bonds

Table A-6 Arguments Against Capital Appreciation Bonds

Appendices A to L

Appendix A – All California Educational Bond Measures Pass and Fail – 2001-2014 Ranked by Percentage of Voter Approval

Appendix B – All California Educational Bond Measures Approved by Voters – 2001-2014 Ranked by Amount Authorized to Borrow

Appendix C – All California Educational Bond Measures Rejected 2001-2014 – Ranked by Amount NOT Authorized to Borrow

Appendix D – All California Educational Bond Measures Approved With a Two-Thirds Threshold Since November 2000 Enactment of Proposition 39 – Listed By Election Year

Appendix E – All California Educational Bond Measures 55 Percent – 2001-2014

Appendix F – All California Educational Bond Measures Repurposed or Reauthorized Since November 2000 Enactment of Proposition 39 – Listed by Election Year

Appendix G – All California Educational Bond Measures Approved by Voters with 55 Percent Threshold Since November 2000 – Results if Prop 39 Had Not Been Law

Appendix H – All California Educational Bond Measures Approved by Voters Under 55 Percent Threshold Since November 2000 Enactment of Proposition 39 – Failures Under 2:3 Threshold

Appendix I – All California Educational Bond Measures Approved by Voters – 2001-2014 Ranked by Amount of Debt Service

Appendix J – All Educational Districts in Which Voters Authorized Borrowing Via Bond Sales Since Proposition 39 – Ratio of Current Debt Service to Amount Authorized

Appendix K – All Educational Districts in Which Voters Authorized Borrowing Via Bond Sales Since November 2000 Enactment of Prop 39 – Ratio of Current Debt Service to Total Yes Votes

Appendix L – All Educational Districts in Which Voters Authorized Borrowing Via Bond Sales Since November 2000 Enactment of Prop 39 – Ranked by Amount Authorized Per Yes Vote

###

More Borrowing for California Educational Construction in 2016 (Section 2 of 9)

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
You are here: More Borrowing for California Educational Construction in 2016 (2 of 9)
Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
How California School and College Districts Acquire and Manage Debt (4 of 9)
Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
The System Is Skewed to Pass Bond Measures (7 of 9)
More Trouble with Bond Finance for Educational Construction (8 of 9)
Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
Guide to all Tables and Appendices – Comprehensive Reference for Researchers


Why This Report Matters: More Borrowing in 2016

Californians will be asked in 2016 to continue taking on debt for construction of educational facilities, but one elected official is leery. Governor Jerry Brown wants to change the funding system for school construction. He is concerned about debt that Californians have accumulated from years of allowing the state and local educational districts to relentlessly borrow.

That money borrowed through bond sales will have to be paid back — with interest — to the investors who bought them. Voters have limited understanding of bonds and how bonds provide funds for construction, and elections focus on what voters will get rather than how they will pay for it. To the detriment of future generations, few Californians realize the huge amount educational districts have been authorized to borrow and the huge amount of debt accumulated.

Interest Groups Want Voters to Consider Another State Bond Measure

When the California Policy Center published this report, the California Attorney General had approved circulation of petitions through September 21, 2015 for a proposed statewide ballot initiative entitled the “Kindergarten Through Community College Public Education Facilities Bond Act of 2016.” Professional signature gatherers set up tables at grocery stores and other public locations trying to cajole citizens into signing petitions to “help the kids” by putting the measure on the ballot.

If this proposal qualifies for the ballot and voters approve it, the State of California will have the authority to borrow $9 billion through selling bonds to investors. According to the petition, this $9 billion will ensure that “K-14 facilities are constructed and maintained in safe, secure and peaceful conditions.” As reported in the Sacramento Bee, school construction interests and residential housing developers want this bond measure, or one like it, on the ballot in 2016.

Proponents point out, accurately, that most of the money that voters authorized the state to borrow in 1998, 2002, 2004, and 2006 has been distributed as matching grants to local educational districts. As of April 15, 2015, $195.4 million remains3 from $35.4 billion approved to borrow as a result of three statewide ballot propositions in the 2000s.

The petition for the Kindergarten Through Community College Public Education Facilities Bond Act of 2016 lists four “findings” explaining what the state could do if it borrowed $9 billion:

1. Career technical education facilities to provide job training for many Californians and veterans who face challenges in completing their education and re-entering the workforce.

The history of recent bond measures on the state and local level shows that voters are inclined to support more government spending when veterans are cited as beneficiaries. Poll results confirm this. A “State of California School Bond Measure Feasibility Survey” of likely voters conducted January 30 to February 9, 2014 for California’s Coalition for Adequate School Housing (C.A.S.H.) indicated that “more than six-in-ten are highly concerned about unemployment among veterans.”

2. Upgrade aging facilities to meet current health and safety standards, including retrofitting for earthquake safety and the removal of lead paint, asbestos and other hazardous materials.

Again, the “State of California School Bond Measure Feasibility Survey” concluded that “more than two-thirds agree that many California public schools need significant health and safety improvements,” specifically the statement that “many schools and community colleges throughout California are old, outdated and need upgrades to meet current health and safety standards, including retrofitting for earthquake safety and the removal of lead paint, asbestos and other hazardous materials.”

3. Studies show that 13,000 jobs are created for each $1 billion of state infrastructure investment. These jobs include building and construction trades jobs throughout the state.

Influential construction interests are part of the coalition supporting this statewide bond measure. This statement acknowledges their pivotal role in the campaign to pass it.

4. Academic goals cannot be achieved without 21st Century school facilities designed to provide improved school technology and teaching facilities.

Once again, the “State of California School Bond Measure Feasibility Survey” concludes that “in particular, voters believe that funds must be directed towards upgrading vocational/career education programs, repairing classrooms and science labs and upgrading technology.”

These are deliberately chosen arguments to justify borrowing another $9 billion for community college and K-12 school district construction projects. In fact, these were the same arguments used in newspaper opinion pieces and position papers in 2014 to support Assembly Bill 2235, which if signed into law would have asked state voters in the November 2014 election to authorize borrowing $4.3 billion for school construction through bond sales.

Regardless of whether the four arguments listed above for a statewide bond measure are factually valid, they have been tested through polling and other voter research and shown to be effective in winning voter support. Surely a 2016 campaign for a state bond measure will use them.

How do these arguments stand in the larger context of bond indebtedness for the State of California and its community college districts and K-12 school districts? This report provides some of that context and introduces information never before available to the public.

Governor Brown Worries About Debt and Seeks Change in School Construction Finance

Governor Jerry Brown has used his executive power to thwart legislative efforts to place a statewide bond measure for educational construction on the 2016 ballot. Assembly Bill 2235 never received an opposition vote as it passed the Assembly and moved through Senate committees with support from numerous interest groups. Voters didn’t get to consider it in the November 2014 election only because Governor Brown didn’t want it on the ballot. As reported by a Capitol Public Radio reporter, the bill author issued a statement explaining its abandonment: “The governor has made it clear that he does not want a school bond on the same ballot as the water bond and rainy day fund. We do not expect the legislature to send the bill on him.”

Meanwhile, the Governor is taking a leading role in calling for change in how state and local governments fund California school construction. He submitted a state budget proposal to the California legislature in January 2015 with an introduction stating that funding commitments “must be honestly confronted so that they are properly accounted for and funded.” It warned that “budget challenges over the past decade have also resulted in a greater reliance on debt financing, rather than pay-as-you-go spending…From 1974 to 1999, California voters authorized $38.4 billion of general obligation bonds. Since 2000, voters authorized more than $103.2 billion of general obligation bonds”

Table 1: All General Obligation Bonds to Be Paid Off Through
California’s General Fund
Amount Authorized to Borrow$135.2 billion
Amount Borrowed$105.7 billion
Amount Authorized But Not Borrowed$29.5 billion
Amount Owed in Principal (June 1, 2015)$72.4 billion
Amount of Debt Service Owed (June 1, 2015)$131.8 billion
Amount of Debt Service to Be Paid 2015-2016$6 billion
Sources: “Schedule of Debt Service Requirements for General Fund Non-Self Liquidating Bonds (Fixed Rate),” California State Treasurer, June 1, 2015, accessed June 28, 2015, www.treasurer.ca.gov/bonds/debt/201506/general-fixed.pdf and “Authorized and Outstanding General Obligation Bonds,” California State Treasurer, June 1, 2015, accessed June 28, 2015, www.treasurer.ca.gov/bonds/debt/201506/authorized.pdf

Concern About Debt Growing from State Matching Grants for Local Educational Districts

One funding commitment Governor Brown “confronted” in his proposed fiscal year 2015-16 budget was the State of California’s debt accumulated from funding construction of facilities for local school districts. California voters approved bond measures in 2002, 2004, and 2006 authorizing the state to borrow $35.4 billion via bond sales for school and college construction, and only $195 million remains to be borrowed. According to internal California State Treasurer documents, debt service on those three state bond measures is $56.7 billion.

According to the Governor’s 2015-16 Budget Summary, “the Administration has noted the following significant shortcomings” related to school bond finance over the past two years:

The current program does not compel districts to consider facilities funding within the context of other educational costs and priorities. For example, districts can generate and retain state facility program eligibility based on outdated or inconsistent enrollment projections. This often results in financial incentives for districts to build new schools to accommodate what is actually modest and absorbable enrollment growth. These incentives are exacerbated by the fact that general obligation bond debt is funded outside of Proposition 98. These bonds cost the General Fund approximately $2.4 billion in debt service annually.

This statement is surprising and controversial recognition that some school districts spend money on new school construction that perhaps isn’t needed. The proposed budget summary also notes that large school districts have in-house professional facilities departments that can take advantage of the first-come, first-serve application system to get funding from the State Allocation Board for local school construction.

Another surprising admission in the Governor’s budget proposal is acknowledgement that voters approve four out of five proposed local bond measures, thus providing a relatively easy flow of money for school construction: “The current program was developed before the passage of Proposition 39 (which reduced the local bond vote threshold from a two-thirds supermajority to 55 percent) in 2000, which has since allowed local school bonds to pass upwards of 80 percent of the time.”

The budget summary also reported that the California Department of Finance had met with parties interested in educational construction and developed a set of recommendations, including three related to bond finance:

1. Increase Tools for Local Control: Expand Local Funding Capacity

While school districts can pass local bonds with 55% percent approval, assessed valuation caps for specific bond measures and total caps on local bonded indebtedness have not been adjusted since 2000. In order to provide greater access to local financing, these caps should be increased at minimum by the rate of inflation since 2000.

Based on the Consumer Price Index of the U.S. Bureau of Labor Statistics, the inflation rate from November 2000 (when voters approved Proposition 39) to May 2015 was 36.6%. Therefore, under this proposal the California legislature would increase tax and debt limits at least 36.6% above existing amounts. However, the flaw in this proposal is that it does not account for increases in property value or total assessed property valuation in California since 2000. (See Section 5 of this report for background on tax and debt limits.)

2. Expand Allowable Uses of Routine Restricted Maintenance Funding

Current law requires schools to deposit a percentage of their general fund expenditures into a restricted account for use in maintaining their facilities. Rather than requiring that these funds be used solely for routine maintenance, districts should have the ability to pool these funds over multiple years for modernization and new construction projects. Expanding the use of these funds will provide school districts with yet another funding stream to maintain, modernize, and construct new facilities.

This proposal injects a bit of “pay-as-you-go” from district general funds into educational facilities construction — a departure from the bond debt financing that has driven school construction since the enactment of Senate Bill 50, the Leroy F. Greene School Facilities Act of 1998.

3. Target State Funding for Districts Most in Need

State funding for a new program should be targeted in a way that: (1) limits eligibility to districts with such low per-student assessed value they cannot issue bonds at the local level in amounts that allow them to meet student needs, (2) prioritizes funding for health and safety and severe overcrowding projects, and (3) establishes a sliding scale to determine the state share of project costs based on local capacity to finance projects.

This recommendation is based on the perception that the current first-come, first-served funding system allows certain school and college districts to win a disproportionate amount of state matching grants at the expense of other districts that may have a more legitimate need but lack the resources and wherewithal to take advantage of opportunities.

Finally, the list of recommendations concludes with a message:

…it is the intent of the Administration to advance the dialogue on the future of school facilities funding. School districts and developers should have a clear understanding of which limited circumstances will qualify for state assistance. Over the course of the coming months, the Administration is prepared to engage with the Legislature and education stakeholders to shape a future state program that is focused on districts with the greatest need, while providing substantial new flexibility for local districts to raise the necessary resources for school facilities needs.

These proposals are not new ideas. A 2003 report from the Public Policy Institute of California analyzed school bond measures and identified disparities among districts based on wealth and region. In response to these findings, the report suggested raising state debt limits for bond measures to reduce the impact of changes in assessed property valuation. It also recommended adoption of a plan that would give deserving school and college districts access to state construction funds without having to match these grants with local funding.

State Legislative Initiatives

The stage is set for change in California school construction financing. Subsequent to the release of the proposed budget from the Governor, state legislators introduced bills such as Senate Bill 114 and Assembly Bill 148. These bills would make some mild changes to the state’s school construction program, while at the same time placing a statewide bond measure on the November 2016 ballot to borrow money (for a yet unidentified amount) via bond sales for school construction.

The author of Senate Bill 114 explained the purpose of the bill:

Funding for the School Facilities Program is virtually gone and there is a backlog in applications for state assistance…while the state’s growing debt service is of concern, it is unclear whether local districts have the capacity to generate sufficient revenue at the local level to meet their specific facility needs. The “winding down” of the current program, and the Governor’s call for change, present an opportunity to rethink the administrative and programmatic structure of the State Facilities Program…

Supporting one or both of these bills are the California School Boards Association, the California Faculty Association, the California Association of School Business Officials, the American Federation of State, County, and Municipal Employees union (AFSCME); the Los Angeles Unified School District, and the Riverside County Superintendent of Schools. Further debate will reveal if these groups are willing to withhold potential objections to some of the Department of Finance proposed changes to educational construction finance in exchange for having another statewide bond measure on the 2016 Presidential general election ballot.

No formal opposition to these bills has yet emerged, but at this time the bills are just a frame, to be expanded with more detailed proposals.

Sources

“Request for Title and Summary for Proposed Initiative: Kindergarten Through Community College Public Education Facilities Bond Act of 2016,” Office of the California Attorney General, January 12, 2015, accessed June 28, 2015, https://oag.ca.gov/system/files/initiatives/pdfs/15-0005%20(Education%20Bond%20Act).pdf

“California School Builders, Others to Gather Signatures for November 2016 Bond Measure,” Sacramento Bee, January 12, 2015, accessed June 28, 2015, www.sacbee.com/news/politics-government/capitol-alert/article6143364.html

“AB 148 School Facilities: K–14 School Investment Bond Act of 2016 – California State Assembly Education Committee Analysis,” California Legislative Information, April 28, 2015, accessed June 28, 2015, https://leginfo.legislature.ca.gov/faces/billAnalysisClient.xhtml?bill_id=201520160AB148#

“State of California School Bond Measure Feasibility Survey,” California’s Coalition for Adequate School Housing, Date, accessed June 28, 2015, https://www.cashnet.org/meetings/2014_Annual_Conference/documents/38_LegislativeUpdate_Bond_Feasibility.pdf

“Text – AB 2235 Education Facilities: Kindergarten-University Public Education Facilities Bond Act of 2014,” California Legislative Information, accessed June 28, 2015, https://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201320140AB2235

“No School Bond, Lawmaker Suspension Measures On November Ballot,” Capitol Public Radio, August 19, 2014, accessed June 28, 2015, www.capradio.org/articles/2014/08/19/no-school-bond,-lawmaker-suspension-measures-on-november-ballot/

“2015-16 Governor’s Budget Summary,” Department of Finance – California Budget, January 9, 2015, accessed June 28, 2015, www.ebudget.ca.gov/2015-16/pdf/BudgetSummary/FullBudgetSummary.pdf

“2015 California’s Five-Year Infrastructure Plan,” Department of Finance – California Budget, January 9, 2015, accessed June 28, 2015, www.ebudget.ca.gov/2015-Infrastructure-Plan.pdf

“Governor’s Budget Summary 2015-16: K Thru 12 Education,” Department of Finance – California Budget, January 9, 2015, accessed June 28, 2015, www.ebudget.ca.gov/2015-16/pdf/BudgetSummary/Kthru12Education.pdf

“SB 50 – Chaptered. Leroy F. Greene School Facilities Act of 1998: Class Size Reduction – Kindergarten University Public Education Facilities Bond Act of 1998,” Official California Legislative Information, August 27, 1998, accessed June 28, 2015, www.leginfo.ca.gov/pub/97-98/bill/sen/sb_0001-0050/sb_50_bill_19980827_chaptered.html

“Fiscal Effects of Voter Approval Requirements on Local Governments,” Public Policy Institute of California, January 27, 2003, accessed June 28, 2015, www.ppic.org/content/pubs/report/R_103KRR.pdf

“Text – SB 114 Education Facilities: Kindergarten Through Grade 12 Public Education Facilities Bond Act of 2016,” California Legislative Information, June 3, 2015, accessed June 28, 2015, leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201520160SB114&search_keywords=

“Text – AB 148 School Facilities: K–14 School Investment Bond Act of 2016,” California Legislative Information, May 6, 2015, accessed June 28, 2015, leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201520160SB114&search_keywords=

“Senate Education Committee Legislative Analysis – AB 148 School Facilities: K–14 School Investment Bond Act of 2016,” California Legislative Information, March 25, 2015, accessed June 28, 2015, http://leginfo.legislature.ca.gov/faces/billAnalysisClient.xhtml?bill_id=201520160SB114#

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Quantifying and Explaining California’s Educational Construction Debt (Section 3 of 9)

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
More Borrowing for California Educational Construction in 2016 (2 of 9)
You are here: Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
How California School and College Districts Acquire and Manage Debt (4 of 9)
Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
The System Is Skewed to Pass Bond Measures (7 of 9)
More Trouble with Bond Finance for Educational Construction (8 of 9)
Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
Guide to all Tables and Appendices – Comprehensive Reference for Researchers


Quantifying and Explaining California’s Educational Construction Debt

Whatever voters are asked to approve in 2016 will not launch a new program to fix long-neglected schools to serve a rapidly expanding state population while providing smaller class sizes. That thinking is a legacy of the 1990s that still seems to endure today despite 14 years of most bond measures passing at a 55 percent threshold for voter approval. Arguments for another state bond measure in 2016 ignore or downplay how local school and college districts and the state obtained authority in the past 14 years to borrow $146.1 billion for educational construction.

If voters are not told or reminded of recent borrowing patterns, how can voters make an informed decision on future borrowing? To rectify the lack of availability of statistics on total bond debt in California for educational facility construction, the California Policy Center collected, synthesized, and analyzed data regarding California educational construction finance. The California Policy Center believes it is the first and only entity to painstakingly research and present an accurate and comprehensive record of all state and local educational construction bond measures considered by voters from 2001 through 2014.

The amount of authority approved by voters is a higher percentage than the percentage of the number of bond measures approved by voters because larger bond measures proposed by larger districts passed at a higher rate than smaller bond measures proposed by smaller districts.

Table 2: Local Educational Bond Measures Considered by California Voters After Passage of Proposition 39 in November 2000
Number on Ballot1147
Number Approved911
Number Rejected236
Percentage Approved79.42%
Percentage Rejected20.58%
Amount Proposed to Authorize$124,350,056,744
Amount Proposed to Authorize (including 16 reauthorizations)$125,080,421,744
Amount Authorized$109,620,418,737
Amount Authorized (including 16 reauthorizations)$110,350,783,737
Amount Rejected$14,729,638,007
Percentage of Authority Approved (including 16 reauthorizations)88.22%
Percentage of Authority Rejected (including 16 reauthorizations)11.78%
Amount Authorized Through Three Statewide Bond Measures$35,766,000,000
Total Amount Proposed to Authorize (State and Local Bond Measures)$160,116,056,744
Total Amount Proposed to Authorize (State and Local Bond Measures) (including 16 reauthorizations)$160,846,421,744
Total Amount Authorized (State and Local Bond Measures)
(including 16 reauthorizations)
$146,116,783,737

How Did It Become So Easy to Pass Bond Measures?

A new era of generous borrowing for educational construction in California was inaugurated by the enactment of Proposition 39. Approved by 53.4% of voters in the November 7, 2000 election, it reduced the voter approval threshold for most educational construction bond measures from two-thirds to 55 percent. (Because the measure imposes restrictions on districts using the new 55 percent threshold, a minority of districts have continued to propose measures requiring a two-thirds vote.)

This lowered obstacle apparently encouraged local educational districts to take the risk of proposing many more bond measures at much higher amounts for voters to approve. As shown in Tables 3 and 4, dropping the voter threshold from 66.67% to 55% transformed the approval of educational bond measures from a 50-50 chance to a commonplace outcome.

As shown in Table 5, between now and 2055, California’s taxpayers will pay about $200 billion in principal and interest payments to investors who have bought bonds issued by the state and by local educational districts in order to get funding for facility construction.

Table 3: Local Educational Bond Measures Considered by California Voters After Passage of Proposition 39 in November 2000
55% ApprovalTwo-Thirds
Approval
Total
Number on Ballot10371101147
Number Approved85754911
Number Rejected18056236
Percentage Approved82.64%49.09%79.42%
Percentage Rejected17.36%50.91%20.58%
Table 4: Local Educational Bond Measures: Results If Proposition 39 Wasn't Law
Under Prop 39
(55% and 2/3)
If Prop 39 Wasn’t Enacted (2/3)
Total Number of Bond Measures on Ballot11471147
Number of Bond Measures Approved911423
Percentage of Bond Measures Approved79.42%36.88%
Total Amount Authorized to Borrow
(includes reauthorizations)
$125,080,421,744$52,712,273,012
Percentage of Authorization Amount Approved88.22%42.15%
Table 5: Total Amount of Debt Service for Educational Facility Construction
Amount for 642 School and College Districts for Which Voters Approved Bond Measures Since Proposition 39 Passed in 2000$136,867,456,924
Amount for Three Bond Measures That Voters Approved for State of California Since Proposition 39 Passed in 2000$56,668,673,695
Estimate for Several Dozen School Districts Where Voters Approved Bond Measures Only Before Enactment of Proposition 39 or Lack Data$2,000,000,000
Estimated Amount for Several Bond Measures That Voters Approved for State of California Before Proposition 39 Passed in 2000$4,500,000,000
Approximate Total$200,000,000,000

How Was Debt Service Determined?

California Policy Center researchers identified, calculated, and tallied aggregate debt service for almost all of the 642 California local educational districts in which voters approved borrowing money for construction through bond sales after the election of November 7, 2000. On that date, California voters approved Proposition 39 and reduced the threshold for voter approval of most bond measures for construction from two-thirds to 55 percent.

This debt service data was obtained using tables included in about 650 “Official Statements” posted on a publicly-accessible and free-to-use Electronic Municipal Market Access (EMMA) website administered by the Municipal Securities Rulemaking Board (MSRB).

Example of Official StatementWhat are these statements? Federal law generally requires underwriters in a primary offering of municipal bonds of $1 million or more to obtain and review an Official Statement from the issuer of those bonds. (Many smaller bond offerings also have Official Statements.) In a dense report of more than 200 pages, these statements disclose financial information meant to inform a potential buyer and reduce the chance of “fraudulent, deceptive, or manipulative acts or practices.”

Official Statements include a chart that indicates how much aggregate principal and interest the issuer of the bonds would owe each year if the bonds weren’t refunded (“called in” or redeemed so that new bonds can be issued at a lower interest rate) or paid off early. California Policy Center researchers entered each district name into the EMMA system, identified the most recent bond offering or bond refunding from the list of bond issues, downloaded the associated Official Statement, located the aggregate debt service chart, and calculated the total debt service for 2015 and/or later years.

Using these Official Statements to extract data required diligence. Firms that produce the statements do not use a specific standard format, so the aggregate debt service table appears in different places. Tables differ in title, format, or details of content. Older Official Statements are not optimized for word searches. A few tables do not total up the annual debt service, thus forcing the user to convert the table into a spreadsheet and calculate the total using a formula. A handful of Official Statements outright lacked aggregate debt service tables.

Tables may even contain erroneous data. After some confusion, researchers realized that an Official Statement for the Napa Valley Unified School District contained major errors. It indicated total debt service as $77 million instead of the actual $665 million and also indicated a November 5, 2002 bond measure as authorizing $219 million instead of the actual $95 million. This was an unfortunate district to have an erroneous Official Statement: a California Watch article published in the San Francisco Chronicle just three months before the Official Statement was posted identified the Napa Valley Unified School District as a district where taxpayers will eventually “pay dearly for bonds.” In 2009 it borrowed $22 million through Capital Appreciation Bond sales that will cost $154 million by the time the last bonds in the series mature forty years later, in 2049.

Researchers also had to be cautious about accurately identifying school districts with similar names. For example, Central, Oak Grove, and Columbia are words shared by more than one school district. And “College School District” in Santa Barbara County is not a community college district. Some of the inconsistencies found in cross-referencing various sources for bond measure data seem to be a result of misidentifying districts with similar-sounding names.

Even after these challenges were overcome, researchers recognized that the list of debt service for school and college districts needs to be considered with some caveats. (Table 6 is “Cautionary Considerations When Evaluating Current Debt Service Data for School and College Districts.”) Researchers are also aware of arguments that debt service — even when considered with other financial data — is not always a useful way to assess whether or not school or college districts have been irresponsible in their choices for debt finance of facilities construction. A few of those arguments are listed in Table 7: Why Some Analysts Downplay Debt Service Data.

Despite these potential limitations, aggregate debt service amounts available through Official Statements posted on EMMA provide new insight into the long term debt obligations owed by California local educational districts for facilities construction. This data set represents a major advance in informing Californians about the tremendous debt accumulated by educational districts that borrow money for school construction by selling bonds.

Table 6: Cautionary Considerations When Evaluating Current Debt Service Data for School and College Districts
1For some school or college districts, debt service may be relatively low compared to the total amount authorized to borrow because those districts haven't issued all of the bonds (or any of the bonds) yet. When those districts sell all of the bonds in the amount authorized by voters, debt service will be higher.
2An educational district in a wealthy area can have high debt service but also have high and stable total assessed property value. That high debt service may be inappropriate, but it is not as risky as the same debt service in a less affluent district with unstable property values and an uncertain economic future.
3Some California educational districts do not have debt service listed in the appendices because they recently sold bonds through “private placement.” These transactions do not require Official Statements to be posted on EMMA. Without an Official Statement, long term debt obligation from bonds is more difficult to obtain. And when obtained through annual financial reports, that number may be outdated compared to information available in an Official Statement.
4The appendices indicate all aggregate debt service for 642 districts in which voters approved bond sales since Proposition 39 was enacted in 2000. This means there may be some distortions when comparing data, for the following reasons:

Aggregate debt service listed for districts may originate from bond measures approved by two-thirds of voters as far back as 1987 and up through November 7, 2000. This means that debt service for some districts may appear disproportionately high relative to the amount authorized by voters to borrow from 2001 through 2014.

There are a handful of districts that have current debt service resulting from bond measures approved in 2000 or earlier but have not asked voters to authorize additional borrowing since the November 7, 2000 election. That debt service is not included in the grand total reported here.

Likewise, California voters approved several ballot propositions before Proposition 39 was enacted in 2000, including a $9.2 billion bond measure passed in 1998 that included $6.7 billion for K-12 school districts and $2.5 billion collectively for community college districts and the California State University and the University of California campuses.
5Several K-12 school districts have merged in the past 15 years. Some Official Statements segregate debt service for the districts before they merged, and some combine the debt service.
6Several community college district and K-12 school districts have created “School Facilities Improvement Districts” carved out from the complete jurisdiction of the districts. Some Official Statements segregate debt service for these sub-districts, and some combine the debt service for the sub-districts with the debt service for the complete district.
7Debt service tables in Official Statements do not account for Bond Anticipation Notes, Certificates of Participation, lease revenue bonds, and other ways that educational districts borrow money.
8Community Facilities Districts funded by Mello-Roos bonds are not included in Official Statements.

Sources

Electronic Municipal Market Access (EMMA) website administered by the Municipal Securities Rulemaking Board (MSRB) http://emma.msrb.org

“Napa Valley Unified School District,” Electronic Municipal Market Access (EMMA), May 9, 2013, accessed June 28, 2015, http://emma.msrb.org/EA524107-EA408291-EA805228.pdf

“School Districts Pay Dearly for Bonds,” San Francisco Chronicle, January 31, 2013, accessed June 28, 2015, www.sfgate.com/education/article/School-districts-pay-dearly-for-bonds-4237868.php

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How California School and College Districts Acquire and Manage Debt (Section 4 of 9)

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
More Borrowing for California Educational Construction in 2016 (2 of 9)
Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
You are here: How California School and College Districts Acquire and Manage Debt (4 of 9)
Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
The System Is Skewed to Pass Bond Measures (7 of 9)
More Trouble with Bond Finance for Educational Construction (8 of 9)
Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
Guide to all Tables and Appendices – Comprehensive Reference for Researchers


How Educational Districts Acquire and Manage Debt 

It’s likely that most California voters have limited familiarity with the organization and governance of their local school and community college districts. When voters authorize their local educational districts to borrow money for construction by selling bonds, presumably they trust that the local school or college district will exercise prudence in managing the process.

Sometimes their trust is betrayed.

To discourage abuse of the school construction finance system, voters need to be aware of how their local government is organized and managed. They also need to realize that state law does not explicitly give Independent Citizens’ Bond Oversight Committees broad authority to review construction programs funded by bond measures.

How can voters become informed about bonds and the process of borrowing money for educational construction through bond sales? Is there a way to explain in clear plain language what actually happens after voters approve a bond measure and authorize a school or college district to borrow money via bond sales?

Bonds Help Local Governments Borrow Money to Better Serve the People

When people talk about municipal securities or municipal bonds, they’re talking about state governments or local governments borrowing money from investors with the promise to pay it back to them later, with interest. Municipal (derived from the Latin word municipium, meaning a free city) simply means a local government, such as a county, city, water district, sanitation district, irrigation district, utility district, transportation district, cemetery district, mosquito vector district, and many other kinds of special districts formed by the people to serve the people. And it includes school districts and community college districts.

Despite a lack of public attention to bonds, this method of debt finance is important, especially for governments such as California’s school districts and community college districts that want to initiate or continue major construction programs. U.S. Securities and Exchange Commissioner Luis A. Aguilar recently described the importance of municipal bonds:

It is difficult to overstate the importance of the municipal securities market. There is perhaps no other market that so profoundly influences the quality of our daily lives. Municipal securities provide financing to build and maintain schools, hospitals, and utilities, as well as the roads and other basic infrastructure that enable our economy to flourish. Municipal bonds’ tax-free status also makes them an important investment vehicle for individual investors, particularly retirees. Ensuring the existence of a vibrant and efficient municipal bond market is essential, particularly at a time when state and local government budgets remain stretched.

Such comments are appreciated by state and local governments as murmuring continues in Washington, D.C. that income from municipal bonds should lose tax-exempt status.

Basic Information About California K-12 School Districts

In the case of a local elementary school district (kindergarten though eighth grade), high school district (ninth through twelfth grade), or unified school district (kindergarten through twelfth grades), voters elect a board of trustees (often called a “school board” or a “board of education”) to oversee operations of the school district and make major decisions as representatives of the people. The board appoints a District Superintendent and other professional administrators to handle day-to-day management of the district.

In addition, each county has an elected County Board of Education and an elected County Superintendent of Schools with specific responsibilities. There is also a State Board of Education appointed by state elected officials to oversee education policies that are common for all school districts in the state. There is also a State Superintendent of Schools elected by the people of California.

Table A-1 (“California K-12 School Districts 2013-2014 – Ranked by Enrollment”) lists 945 elementary school districts, high school districts, and unified school districts with enrollment tracked by the California Department of Education as of June 15, 2015.

Basic Information About California Community College Districts

In the case of a local community college district, voters elect a Board of Trustees (often called a “college board” or a “governing board”) to make decisions for the college district as representatives of the people. There is also a Board of Governors of the California Community Colleges appointed by state elected officials to oversee education policies that are common for all college districts in the state. The Board of Governors appoints a Chancellor of the California Community Colleges and other professional administrators to handle day-to-day management of the state college system.

Boards for the University of California and California State University systems are appointed by state elected officials and not directly chosen by the people.

As of June 15, 2015 there are 72 community college districts in California with 112 colleges. (Some districts contain multiple colleges.) Table A-2 (“California Community College District Enrollment Fall 2014 – Ranked by Number of Students”) lists these districts.

What Are the Independent Citizens’ Bond Oversight Committees? 

To strengthen the arguments for Proposition 39 in 2000, the California legislature passed Assembly Bill 1908, the “Strict Accountability in Local School Construction Bonds Act of 2000,” with these stated intentions:

  1. Vigorous efforts will be undertaken to ensure that school and college districts spend the proceeds of bond measures, including those passed under criteria of Proposition 39, in strict conformity to law.
  2. Taxpayers will directly participate in the oversight of bond expenditures.
  3. Members of the oversight committees appointed for these purposes will promptly alert the public to any waste or improper spending of money borrowed through bond sales.
  4. Unauthorized expenditures of school construction bond revenues will be vigorously investigated, prosecuted, and restrained by the courts.

A school or college district board must appoint an independent citizens’ bond oversight committee with 60 days after the board enters the election results in its minutes. The committee must include at least seven members to serve for a term of two years and for no more than two consecutive terms. District employees, officials, vendors, contractors, or consultants are prohibited from serving on the committee, and it must include at least one “active” representative of the following groups:

  1. a business organization, located within the district, representing the business community
  2. a senior citizens’ organization
  3. a bona fide taxpayers’ organization
  4. for a school district: parents or guardians of children enrolled in the district
  5. for a school district: parents or guardians of children enrolled in the district who are also active in a parent-teacher organization, such as the Parent Teacher Association or school site council
  6. for a community college district: students who are currently enrolled in the district and also active in a community college group, such as student government
  7. for a community college district: organizational support groups of the district, such as advisory councils or foundations

These committees have several responsibilities listed in state law meant to ensure the district spends bond proceeds only on projects listed in the ballot statement and avoids spending bond proceeds on ineligible projects, programs, or “teacher or administrative salaries or other school operating expenses.” State law also assigns these committees to review “efforts by the school district or community college district to maximize bond revenues by implementing cost-saving measures.”

The committee does NOT have a explicit oversight role for how the district pays for these construction projects, and a narrow interpretation of the law could claim that oversight committees do not have legal authority to review bond sales. However, the California League of Bond Oversight Committees (CalBOC) believes these committees have the authority to review and comment on the structure of bond issues under the provisions for reviewing “cost-savings” measures. Districts often defer to legal counsel for interpretations of the responsibilities and limitations of oversight committees.

A Private Organization Has Taken Responsibility for Independent Citizens’ Bond Oversight Committees

Currently a private organization is providing services and advice to oversight committees. The California League of Bond Oversight Committees (CalBOC), founded in 2006, is a non-profit public service organization that filled a need for training, education, and legislative advocacy for the state’s bond oversight committees.

This arrangement has shortcomings. A private organization is dependent on voluntary financial contributions and a committed volunteer leadership, and it lacks power to take action against educational districts that fail to comply with state laws. Membership and involvement is dependent on the motivations and self-initiative of individual bond oversight committee members. CalBOC does not have any professional staff to monitor districts, collect data, and provide it to the public.

In addition, school districts can discourage oversight committee members from participating in the California League of Bond Oversight Committees, and some school district administrators openly disparage it. Some district administrators and legal counsel don’t want oversight committees interpreting their purpose broadly and consuming district staff time and district funds on investigations outside of a narrowly-defined purview.

The author of this report has been and continues to be a member of the Advisory Committee for the California League of Bond Oversight Committees (CalBOC).

Translating School Finance Decisions For Ordinary People to Understand

For many Americans, the phrase “stocks and bonds” evokes the image of an established and wealthy investor. Someone who buys a stock becomes an owner of a corporation, and someone who buys a bond becomes a creditor who is owed money by a corporation or a government. It’s likely that more Americans could explain stocks than could explain bonds.

The lack of public awareness or knowledge about bonds may be attributable to the complex provisions of certain bonds and the fact that bonds typically do not offer the very large potential returns offered by equity in growing firms.

Bonds rarely get news media attention outside of a few financial wire services such as Bloomberg, Reuters (which had a “MuniLand” blogger), and specialty publications such as The Bond Buyer. And in popular culture, depictions of bond brokers have been mainly limited to two books by Tom Wolfe: The Bonfire of the Vanities (subsequently made into a movie) and I am Charlotte Simmons.

What Is a Bond?

Some technical definitions of a bond are listed in Table 10. But rather than focusing on the definition of a bond, Californians need to focus on what a bond does in practice.

For a school or community college district, issuing (“selling”) bonds means the district borrows money for a specific length of time from investors with the obligation to return all of that money to them when that time period ends. The amount borrowed is called the principal.

During that length of time the district pays a fee to the investors, either on a regular basis (for Current Interest Bonds) or accumulated with compounded interest at the end of the time period (for Capital Appreciation Bonds). The amount paid is called interest.

The term of maturity between borrowing the money and paying back the money with interest can be one to three years (short-term bonds) or decades (long-term bonds). Under California law, a school district or community college district cannot issue a current interest bond with a maturity over 40 years. As a result of Assembly Bill 182 enacted in 2013, California local governments are now prohibited from issuing Capital Appreciation Bonds with a maturity over 30 years.

AB 182 allows a school district or community college district to issue Current Interest Bonds bonds with a term of maturity between 30 and 40 years. The district must use that borrowed money for projects with a “useful life” that equals or exceeds the term of maturity.

What Are “General Obligation Bonds” Referenced in Ballot Language for Bond Measures?

Corporations and state and local governments issue bonds to raise money. Bonds sold by local governments are called municipal bonds. An appealing aspect of many municipal bonds for investors is their tax-exempt status.

Municipal bonds such as those sold by California school districts and community college districts for construction are called general obligation bonds, meaning they are backed by the “full faith and credit” of the districts. These districts theoretically have legislative power to collect enough money through property taxes, other borrowing, selling assets, or other sources of revenue to fulfill their obligation to make payments on the bonds when due. Those taxes are collected from property owners in the district. (Revenue bonds are another kind of municipal bond, paid off through tolls, lease payments, user fees, or other service payments.)

Comparing Current Interest Bonds to Capital Appreciation Bonds

When voters are asked at an election to approve a bond measure to pay for construction at a school district or community college district, they generally have been told that a “Yes” vote will authorize the sale of general obligation bonds to fund that construction.

California educational districts are issuing two kinds of general obligation bonds: Current Interest Bonds and Capital Appreciation Bonds. Usually the district does not tell voters what kind of general obligation bonds it will sell, unless it specifically passes a resolution before the election stating it will not sell Capital Appreciation Bonds and includes that condition in the ballot statement.

1. Current Interest Bonds (also called Fixed Rate Bonds)

These are the “traditional” kind of municipal bonds. A buyer of Current Interest Bonds gets a periodic interest payment (usually semi-annually). When the bond matures, the buyer gets the principal back.

2. Capital Appreciation Bonds (also called Zero Coupon Bonds)

A buyer of Capital Appreciation Bonds does not receive semiannual or other periodic interest payments. Instead, the buyer receives all of the interest – compounded over the length of maturity for the bond – together with the principal when the bond matures. There is no regular payment of interest, but the accumulated (“accreted”) interest is compounded over many years, making the wait a worthwhile investment. Capital Appreciation Bonds are purchased at a deeply discounted amount from their face value.

Capital Appreciation Bonds are discussed in more detail in Section 5.

Two Costs to Educational Districts of Borrowing Money Via Bonds

From the perspective of the school district, the additional financial cost of borrowing money by selling bonds as opposed to spending money from the district general fund results from (1) interest and (2) transaction fees.

Interest

If someone borrows $1000 for five years from a lender at an annual interest rate of 5 percent, the borrower and the lender agree that the borrower will pay back the $1000 over five years and also pay 5% of that $1000 ($50) multiplied by five years for a total of $1250. The borrower gets the $1000 immediately to use, and the lender earns annual interest income of $50 over five years for a total of $250. Both parties consider themselves to get a benefit from the transaction.

Likewise, if a school district issues a traditional $1000 Current Interest Bond at an annual interest rate of 5 percent with a five-year term of maturity and an investor buys the bond at its face value of $1000, the school district gets the $1000 immediately to use for construction, and the investor earns annual interest income of $50 over five years for a total of $250. When the five years are over, the investor gets the $1000 back. Both parties get a benefit from the transaction. In addition, the investor does not have to pay taxes on the interest.

School districts usually sell series of bonds as a package with different maturities and interest rates.

Transaction Fees (Issuance Fees)

Bond buyers are not the only party to make money from bonds issued by California school districts and community college districts. Similar to taking out a mortgage, a variety of parties in the financial services industry are involved in the preparation and sale of bonds, and each party gets a fee for participating in the transaction. These fees are classified as “costs of issuance.”

To prevent these fees from cutting into the amount of money authorized by voters for construction, educational districts routinely inflate the interest rates on bonds they sell so that the price is higher than the face value of the bond. After the bonds are sold, that extra money, or “premium,” is used to pay the costs of issuance.

Table 8: Types of Issuance Fees
underwriter’s discount
bond counsel fees
disclosure counsel fees
paying agent fees
escrow agent fees
rating agency fees
bond insurance fees
verification agent fees
financial advisor fees
printing fees
other miscellaneous expenses

How are Municipal Bonds Bought and Sold? Who Buys Them?

Municipal bonds are not traded on an exchange like stocks. Instead, investors buy and sell bonds “over the counter” through dealers and brokers registered with the Municipal Securities Rulemaking Board (MSRB), a self-regulatory organization overseen by the U.S. Securities and Exchange Commission. These dealers and brokers act as underwriters or intermediaries between issuers and investors. They charge fees, or “mark-ups” for the transactions.

Once a school district sells a bond, the bond can be traded in the municipal bond market. The price will fluctuate and investors will be concerned about yield — the amount of income earned as prices rise and fall.

According to Federal Reserve statistics, individual investors hold a little more than two-thirds of municipal bonds, about 42 percent directly and about 28 percent through mutual funds and other investment vehicles. Major institutional investors include asset management firms, insurance companies, and commercial banks.

One of the arguments to cap or eliminate the federal tax exemption for income from municipal bonds is that the exemption mainly benefits wealthy individuals who buy bonds as a tax-exempt investment. Buyers of municipal bonds do not generally “keep the money in the community” because they aren’t in the community. And they generally do not buy bonds issued by educational districts to “help the children” or “provide vocational training to veterans.” They buy them to make money.

Ironically, the same Progressive activists who call for higher taxes on the rich also tend to support educational bond measures that help the rich to earn investment income that is tax-free. Forcing the rich to pay taxes on income earned through municipal bonds could collapse the demand for these bonds and make borrowing money for construction a much more expensive proposition for school and college districts.

Table 9: Some Advantages for Investors in Municipal Bonds
Interest earned on municipal bonds is usually exempt from federal and state income tax.
In the case of general obligation bonds, principal and interest are secured by the full faith and credit of the issuer and usually supported by either the issuer’s taxing power. Despite negative nationwide publicity about a relatively small number of bankrupt local governments (such as the California cities of Vallejo, Stockton, and San Bernardino), a government defaulting on municipal bonds is “extremely infrequent,” according to Moody’s. They are thus a relatively safe investment.
In the case of Current Interest Bonds, investors get a regular interest payment, usually semi-annually. There is a regular, dependable income stream.
In the case of Capital Appreciation Bonds, investors can earn a substantial amount of interest over a long period of time through compounding while still enjoying the relatively safe investment of general obligation bonds.

How Does an Educational District Pay Back the Borrowed Principal Plus Interest on Bond Sales?

People pay back the principal and interest on car loans, school loans, and mortgages using their income. Educational districts pay back the principal and interest on bonds using their “income,” that is, taxes collected from property owners in the district.

After a school district or community college district borrows money by selling bonds for construction, it informs the county auditor and county treasurer/tax collector. Based on the assessments of property value determined by the county assessor, the county treasurer calculates the appropriate tax rate and generates individual tax bills for owners of property such as houses, farms, apartment buildings, commercial buildings, manufacturing facilities, business infrastructure, and undeveloped land. A specific rate and tax for each bond measure is listed on the tax bill.

These taxes are called ad valorem taxes. Ad valorem is Latin for “according to worth” and indicates that taxes are levied (imposed) on property owners in proportion to the assessed value of their property.

Does Renting or Leasing Mean That You Don’t Pay for Educational Construction or the Cost of Borrowing Money for It?

Households that rent property or businesses that lease property do not pay property taxes directly. However, it is not true to claim or think that renters or lessees don’t have to pay for educational construction and the costs of borrowing money to pay for that educational construction. Property owners can and do incorporate the cost of their property taxes into their rents or leases. Bond sales by a school or college district may result in higher rent.

Technical Definitions of Bonds

Notice that the common term in all of these definitions is debt. When a school or college district sells bonds, it borrows money from investors and must pay them the money back over time, with interest.

Table 10: Technical Definitions of Bonds
SourceDefinition
California Education Code Section 15140.5 (added to law by Assembly Bill 182 in 2013)Evidence of indebtedness payable, both principal and interest, from the proceeds of ad valorem property taxes that may be levied without limitation as to rate or amount upon property subject to taxation by the governing board of the school district or community college district.
Glossary on the Municipal Securities Rulemaking Board (MSRB) websiteThe written evidence of debt, which upon presentation entitles the bondholder or owner to a fixed sum of money plus interest. The debt bears a stated rate(s) of interest or states a formula for determining that rate and matures on a date certain.
U.S. Securities and Exchange Commission website definition of municipal bondsDebt securities issued by states, cities, counties and other governmental entities to finance capital projects, such as building schools, highways or sewer systems, and to fund day-to-day obligations. Investors who buy municipal bonds are in effect lending money to the bond issuer in exchange for a promise of regular interest payments, usually semi-annually, and the return of the original investment, or “principal.” The date when the issuer repays the principal, the bond’s maturity date, may be years in the future. Short-term bonds mature in one to three years, while long-term bonds generally will not mature for more than a decade. 
Internal Revenue Service Tax-Exempt Governmental Bonds Compliance Guide description of municipal bondsTax-exempt bonds are valid debt obligations of state and local governments, commonly referred to as “issuers” - the interest on which is tax-exempt. This means that the interest paid to bondholders is not includable in their gross income for federal income tax purposes. This tax-exempt status remains throughout the life of the bonds provided that all applicable federal tax laws are satisfied…Governmental bonds are tax-exempt bonds issued by a state or local government, the proceeds of which are generally used to finance activities or facilities owned, operated, or used by that or another government for its own purposes. This can include financing the building, maintenance, or repair of various types of public infrastructure such as highways, schools, fire stations, libraries, or other types of municipal facilities.

Sources

“Statement on Making the Municipal Securities Market More Transparent, Liquid, and Fair,,” U.S. Securities and Exchange Commission, February 13, 2015, accessed June 28, 2015, www.sec.gov/news/statement/making-municipal-securities-market-more-transparent-liquid-fair.html

“Letters to Congress/Administration,” National Association of Bond Lawyers, accessed June 28, 2015, http://registration.nabl.org/about/Governmental-Affairs/Tax-Reform-Resources/Letters-to-Congress-Administration.html

California League of Bond Oversight Committees (CalBOC) www.calboc.org

Reuters “MuniLand” blogger Cate Long blogs.reuters.com/muniland/

The Bond Buyer www.bondbuyer.com

Municipal Securities Rulemaking Board (MSRB) www.msrb.org

Board of Governors of the Federal Reserve System – Data Releases, June 11, 2015, accessed June 28, 2015, www.federalreserve.gov/releases/z1/current/z1r-4.pdf

Capital Appreciation Bonds: Disturbing Repayment Terms (Section 5 of 9)

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
More Borrowing for California Educational Construction in 2016 (2 of 9)
Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
How California School and College Districts Acquire and Manage Debt (4 of 9)
You are here: Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
The System Is Skewed to Pass Bond Measures (7 of 9)
More Trouble with Bond Finance for Educational Construction (8 of 9)
Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
Guide to all Tables and Appendices – Comprehensive Reference for Researchers


Capital Appreciation Bonds: Disturbing Repayment Terms

In 1993, California law was changed so that school and college districts could use an innovative form of debt finance called zero-coupon bonds, also known as Capital Appreciation Bonds. These bonds allow school and college districts to borrow now for construction and pay it back — with compounded interest — many years later. The borrowing strategy has been a tempting and dangerous lure for elected school and college boards.

Some people think Capital Appreciation Bonds are a “ticking time bomb” or the “creation of a toxic waste dump.” Others regard critics as uninformed and contend that these debt finance instruments are beneficial for school and college districts. Since the people who will be paying off many of these Capital Appreciation Bonds are now children or not even born yet, there isn’t much incentive to stop the flow of borrowed money that doesn’t need to be paid back for a generation or two.

Capital Appreciation Bonds Get Attention: Some Welcomed It, Some Didn’t

There was a brief time in the last half of 2012 when California news media and even national news media alerted the public to a neglected but long-festering problem involving municipal bonds sold by many California school districts and community college districts. These educational districts chose to borrow money for construction using an unconventional debt finance instrument called a Capital Appreciation Bond.

Capital Appreciation Bonds allow school and college districts to circumvent state laws that limit taxes and debt relative to the total value of property in the districts. But they also subject future generations of Californians to potentially burdensome taxes and debt.

Explaining and Contrasting Current Interest Bonds and Capital Appreciation Bonds

The traditional Current Interest Bonds (also called Fixed Rate Bonds) are relatively easy to understand. If someone buys a Current Interest Bond and holds it until it matures (reaches the end of its time period for borrowing), that buyer receives interest on a regular basis (usually semi-annually). The buyer gets the original principal paid back when the bond reaches the end of its term of maturity.

Here’s an example of how a Current Interest Bond works:

  • An entity buys a $1000 Current Interest Bond issued by a school district at face value (also known as par value) with a 25-year term to maturity at a 2.5 percent interest rate.
  • Each year, for 25 years, the buyer gets $25 in interest from the school district, because 2.5% of $1000 is $25.
  • When the bond matures, the buyer gets the principal of $1000 back from the school district.
  • The total interest earned over 25 years is $625, because $25 times 25 is $625.
  • Although the $625 is income, the buyer will never have to pay tax on that interest if the bond is tax-exempt, as is typical with municipal bonds.

Obviously the school district must levy taxes on property owners each year throughout the 25-year term to maturity so that it has enough money to pay interest each year (and ultimately pay back the principal at the maturity date).

Capital Appreciation Bonds (also called Zero Coupon Bonds) are more difficult to understand. Someone who buys a Capital Appreciation Bond pays for it at a price deeply discounted from the face value (par value) of the bond. The buyer does not receive interest payments until the bond reaches maturity, at which point the buyer is paid the face value of the bond, which is the deeply-discounted price (the principal) plus all of the interest earned during the term to maturity.

During the term to maturity period of the Capital Appreciation Bond, interest accumulates over time. The interest is compounded, meaning interest for a time period is earned on the original amount of money and also earned on any of the interest that has already been accumulated up to that time period.

Compound interest that accumulates as a Capital Appreciation Bond grows in value is called “accreted interest.” “Accreted” (a word derived from the Latin accrescere, to increase) means accumulated over time.

Here’s an example of how a Capital Appreciation Bond works:

  • An entity buys a $5000 Capital Appreciation Bond with a 25-year term to maturity at an interest rate of 5 percent.
  • The discounted price of the bond is $1477.
  • When the bond matures, the buyer gets $5000 back from the school district.
  • The total earned over 25 years is $3,523.
  • Although the $3,523 is income, the buyer will never have to pay tax on that interest if the bond is tax-exempt, as is typical with municipal bonds.

The school district benefits because for many years it does not need to levy taxes on property owners in order to make interest payments. It can borrow much more money through bond sales without being restricted by tax and debt limits established in state law. The community can enjoy the benefits of the bond sales without having to pay for them — at least for a while.

And although the buyer does not get a regular interest payment, the accumulated (“accreted”) interest is compounded over many years, making the wait a worthwhile investment. The cliché about “the power of compound interest” for an investor is accurate.

Why Did Capital Appreciation Bonds Become Popular?

The public first became aware of Capital Appreciation Bonds in 2012 when news media reported on a 2011 debt financing arrangement at the Poway Unified School District. Most reports insinuated that limits on taxes and debt established by the legislature in 2000 in conjunction with Proposition 39 had forced schools and community colleges to borrow money by selling Capital Appreciation Bonds. Allegedly these limits were constraining school and college districts from implementing necessary construction programs at a time of plummeting property values. Educational districts saw Capital Appreciation Bonds as the only debt financing option available to alleviate school overcrowding and ensure children’s safety.

But in reality, Capital Appreciation Bonds have been a component of bond issues by California educational districts for over twenty years. Signed into law in 1993, Senate Bill 872 authorized school and college districts to sell them. Voters in the Windsor Unified School District approved a bond measure on April 12, 1994, and the district proceeded to sell $5,054,761 in Capital Appreciation Bonds in its first series of bond sales. The Old Adobe Unified School District and the Oakland Unified School District soon followed.

Capital Appreciation Bond Origins

The first sentence in a 1982 article in the New York Times declared, “Give Wall Street a headache like double-digit interest rates, and someone will invent an aspirin like the zero-coupon bond.” According to this article, in 1981 J.C. Penney became the first corporation to issue Capital Appreciation Bonds. In 1982, E.F. Hutton became the first bond broker to underwrite Capital Appreciation Bonds for municipal governments.

A survey of news coverage on Capital Appreciation Bonds during the 1980s reveals that the focus of journalistic concern for this new form of municipal debt finance was the risk to investors. Needless to say, Capital Appreciation Bonds endured past the era of high interest rates, and the aspirin for investors became a headache for taxpayers.

Who Buys Capital Appreciation Bonds?

Capital Appreciation Bonds are not necessarily a wise decision for an investor, so who sees an investment advantage in buying them? James Estes, Professor of Finance at California State University, San Bernardino tried to answer this question and reported the results of his investigation in a 2013 paper. After observing that Charles Schwab & Co, Inc. does not offer or sell Capital Appreciation Bonds, he contacted twelve companies that offer municipal bond funds. All twelve claimed they don’t market funds featuring Capital Appreciation Bonds. Company representatives told Estes that Capital Appreciation Bonds were undesirable to their investors because of their lack of current interest payments, their poor yield, and their high risk.

Estes also investigated rumors on the web that CalPERS might be holding many municipal Capital Appreciation Bonds. CalPERS spokesperson Danny Brown denied that CalPERS holds them and cited their risk. Finally, Estes mentions the claim of a finance reporter that international banks hold Capital Appreciation Bonds in a trust administered by Bank of America.

In response to a Twitter inquiry from the author of this report, a former reporter for Voice of San Diego tweeted that he never learned who held the district’s Capital Appreciation Bonds during his 2½ years reporting on Poway Unified School District’s Capital Appreciation Bond fiasco: “The word was that the debt had likely been sold and resold and resold. Also no repository for that info…I always wanted to know.”

In 2014, a municipal bond advisor named Dale Scott of Dale Scott & Company presented a plan to Poway Unified School District for the district to buy back some of its Capital Appreciation Bonds using funds from a property tax increase. One challenge for this district is identifying who owns the bonds so offers can be made to buy them back. Scott pointed out that he had managed to find owners of Capital Appreciation Bonds issued by the Stockton Unified School District and buy back about 30 percent of them. According to an August 20, 2014 article in the San Diego Union-Tribune, “Scott said there is a myth that capital appreciation bonds are impossible to acquire once they are sold, but the reality is the bond holder may have many reasons for selling bonds that may take decades to mature.”

Tax and Debt Limits for Bond Measures Qualified Under Proposition 39 (Enacted Through Assembly Bill 1908 in 2000)
Type of Educational DistrictTax LimitDebt Limit
Unified School District0.06% of taxable property value ($60 per $100,000)2.5% of taxable property value
Elementary School District0.03% of taxable property value ($30 per $100,000)1.25% of taxable property value
High School District0.03% of taxable property value ($30 per $100,000)1.25% of taxable property value
Community College District0.025% of taxable property value ($25 per $100,000)2.5% of taxable property value

Tax and Debt Limits Meant to Assure Property Owners that a 55% Approval Threshold for School Bond Measures Wouldn’t Crush Them

From a school district’s perspective, Capital Appreciation Bonds are attractive because they enable the district to borrow more within its tax and debt limits. California Education Code Sections 15268-15270 sets the current limits. The state has not changed the limits since the enactment of Assembly Bill 1908 in conjunction with Proposition 39 in 2000, although Governor Brown proposed increasing them in his 2015-16 budget. (See Section 2 for background.)

Opponents of Proposition 39 in 2000 pointed out in their ballot arguments that these tax and debt limits were not part of the constitutional amendment enacted through Proposition 39 and therefore could be amended or repealed by the state legislature at any time. This is true.

Districts can set a lower tax or debt limit in the ballot statement for a bond measure. And K-12 school districts can get waivers from State Board of Education to impose higher tax or debt limits. (See Section 6 for background on waivers.)

Tax and Debt Limits Make Funding of Construction Programs Highly Dependent on Assessed Property Valuation

Because tax and debt limits are based on annual assessed property valuation in a district, the limits change yearly as a reflection of the real estate market. If property values increase compared to the previous year, the amount of money that can be borrowed increases relative to the previous year. If property values decline compared to the previous year, the amount of money that can be borrowed that year decreases. Educational districts hope (and usually project) property value to increase at a respectable rate for many years to come.

If the substantial increase in home prices during the mid-2000s gave school and college districts several years to borrow a lot more than perhaps originally anticipated, the dramatic drop in the following years hindered school and college districts, especially those with ongoing construction programs. From 2007 to 2011, assessed property valuation in some regions of California declined by as much as 50%, especially in exurban areas of California that grew rapidly in population during the 2000s as young families sought home ownership at prices they could afford.

Not surprisingly, these same regions needed new school construction to accommodate the children in these young families. Because of tax and debt limits, educational districts could not raise tax rates or borrow more money using traditional Current Interest Bonds to compensate for the loss in revenue resulting from the decline in property values.

Capital Appreciation Bonds are a clever way to circumvent the debt limits. A school or college district can take on a long-term debt obligation of $5000 by selling a bond but declare the debt to be $1300 because the bond was sold at the deeply discounted “principal” of $1300. And by deferring payment to bond investors until the bonds mature, the district can borrow money without exceeding the tax limit.

Hoping for the Best with Capital Appreciation Bonds

Of course, school districts will eventually have to collect a lot of money through levying taxes on property owners to pay principal and accreted interest to the buyers of Capital Appreciation Bonds. Essentially, Capital Appreciation Bonds represent a district’s gamble that assessed values will climb rapidly enough to produce sufficient tax revenue to allow issuers to pay off the bonds when they become due. If the anticipated increase in assessed property valuation fails to occur during the term of maturity, the district cannot pay principal and interest owed in future years.

There is little political disincentive for elected board members to borrow money today for school construction and impose a commitment on future generations to pay it off in 25, 30, or even 40 years. Only the elected board members of the Poway Unified School District have suffered political consequences from approving this kind of debt finance. But future school and college board members (who are children today) may be unjustly subjected to voter ire when the bill on Capital Appreciation Bonds is finally due.

2013: An Incomplete Fix for the Excesses of Capital Appreciation Bonds

Assembly Bill 182 was an attempt to restrain the worst excesses of Capital Appreciation Bonds while still allowing school and college districts to use them as a debt finance tool. It developed out of a proposal from San Diego County Treasurer-Tax Collector Dan McAllister as a response to high-profile Capital Appreciation Bond sales by school districts in his county.

Supporters of this bill were prominent critics of unrestrained Capital Appreciation Bond sales: California State Treasurer Bill Lockyer, the aforementioned San Diego County Treasurer-Tax Collector Dan McAllister, the California Association of County Treasurers and Tax Collectors, the California League of Bond Oversight Committees, the Howard Jarvis Taxpayers Association, and the California Taxpayers Association. Several rural county boards of supervisors supported the bill, as well as the board of supervisors for Contra Costa County, where the West Contra Costa Unified School District, the Mt. Diablo Unified School District, and the Acalanes Union High School District received local attention for risky bond finance schemes, including Capital Appreciation Bonds.

California State Treasurer Bill Lockyer wrote the following in support of Assembly Bill 182:

…many districts face a critical need to build or modernize facilities for their children, and I recognize that falling property tax assessments, revenue losses, and statutory debt service limits have all combined to reduce districts’ debt financing options, at least at the present time. However, we cannot continue to use debt financing tools, such as CABs, that force tax payers to pay, at times, more than 10 times the principal to retire these bonds. In too many cases, these transactions have been structured with 40-year terms that delay interest and principal payments for decades, resulting in huge balloon payments. Moreover, school board members and the public have not always been fully informed about the total costs and risks associated with issuing capital appreciation bonds. As a result of such CAB deals and lack of transparency, our future generations in many California school districts will be burdened with heavy taxes for years and years to come.

But there was also significant opposition to the bill from groups heavily involved in promoting bond measures for school construction, including California’s Coalition for Adequate School Housing (C.A.S.H.), the Association of California School Administrators, the California Association of School Business Officials, and the Small School Districts’ Association. The first legislative analysis written for a committee about AB 182 described the basis for the opposition:

All of the opposition letters submitted to the Committee have an “oppose unless amended” position. Generally, the opposition supports more transparency, but is concerned that the bill will inhibit school districts’ ability to secure funding to house students and provide for renovations as promised to voters through their bond initiatives. While some of the opponents do recognize the need to establish some parameters to prevent extreme CABs, they argue that CABs, if done appropriately and in a limited way, are effective. The requested amendments vary from organization to organization. They include expanding the term of CABs to 30 years, restoring the term of 40 years for CIBs, increasing the total debt service to principal ratio to 6 to 1 and applying the ratio to bond authorization, grandfathering in bonds that are already approved but not issued, and allowing districts to seek a waiver from the SBE to increase the tax rates.

In the end, the bill passed the State Senate 36-0 and passed the State Assembly 78-0. Soon after the bill was signed into law, governing boards of school and college districts were already initiating the sale of more Capital Appreciation Bonds under the new guidelines. This method of debt finance for school and college construction is not going away.

Table 12: Provisions of Assembly Bill 182 (AB 182)
The ratio of total debt service to principal for any series of bonds sold shall not exceed four to one (debt service four times greater than principal).
If the sale of bonds includes bonds that allow for the compounding of interest, including, but not limited to, Capital Appreciation Bonds, the agenda of the governing board meeting at which the sale will be approved shall include a proposed resolution to approve the sale of Capital Appreciation Bonds. Public notice for the resolution must be on at least two consecutive meeting agendas, first as an information item and second as an action item.
The governing board must be presented with the following information:
Disclosure of the financing term and time of maturity, repayment ratio, and the estimated change in the assessed value of taxable property within the school district or community college district over the term of the bonds.
An analysis containing the total overall cost of the Capital Appreciation Bonds.
A comparison to the overall cost of Current Interest Bonds.
The reason bonds that allow for the compounding of interest are being recommended.
A copy of the disclosure made by the underwriter as required by Rule G-17 of the federal Municipal Securities Rulemaking Board.
A Capital Appreciation Bond maturing more than 10 years after being sold must be able to be redeemed before its fixed maturity date, with or without a premium, at any time, or from time to time, at the option of the issuer, beginning no later than the 10th anniversary of the date it was sold.

Case Study: Poway Unified School District’s Egregious Debt Finance

Poway Unified School District created a special School Facilities Improvement District in 2007 and asked voters in February 2008 to authorize $179 million in bonds to finance capital improvements. The bond measure passed with 63.9% support, as it qualified under Proposition 39 for a 55% voter approval threshold.

As a campaign strategy, the district promised voters that the bond measure would not require a tax increase, supposedly because assessed property values would rise enough over time to bring in more tax revenue and pay off the debt service. To keep this promise, the school board subsequently adopted some excessive debt financing schemes.

From 2008 through 2011, the district borrowed the $179 million by issuing four series of bonds, including Current Interest Bonds and non-callable Capital Appreciation Bonds, with some bonds issued to refund earlier bond issues. It even sold some 40-year bonds at the maximum legally allowed interest rate of 8 percent. It used numerous controversial debt finance practices, such as selling bonds at a 20 percent premium over face value, and ended up incurring issuance fees totaling more than $6.7 million.

Perhaps people in the Poway Unified School District did not comprehend the dangers at the time, but the school board realized the district was doing something questionable. In 2010 it filed a validation lawsuit to subvert future lawsuits against their next bond finance deal. This provoked a warning letter from the California Attorney General, but in the end no party chose to be a defendant, thus giving the district legal cover to proceed.

Property owners in the School Facilities Improvement District now have the burden of paying $1.27 billion in debt service through 2051 for the privilege of borrowing $179 million. Poway Unified School District was described in the news media as having “shot to fame” as a “poster child for an era of reckless and risky school bond borrowing” through bond sales that have “reached legendary status.” And it became a rare example of voters making school board members accountable for its decisions on bond finance.

Three of the five board members who voted for the Capital Appreciation Bond deal in 2011 have lost their reelection campaigns, and a fourth chose not to run for re-election. The only remaining board member from 2011 may still be in office because only three candidates (two incumbents and a challenger) ran to fill two seats in the 2012 election. Seeing the popular demand for change, eight candidates ran for three seats in 2014.

Michigan Banned Capital Appreciation Bonds When California Legalized Them

On April 27, 2012, a former reporter for the Detroit Free Press newspaper named Joel Thurtell published a post on his blog entitled “Muni Bomb Ticks in California.” Thurtell wrote about the popularity of Capital Appreciation Bond sales by California educational districts.

Thurtell revealed that the practice was not new; in fact it was common at Michigan school districts in the late 1980s and early 1990s:

Joel on the Road LogoThere’s a school bond scandal brewing as California schools load taxpayers with horrendous debt for the next generation of taxpayers. The blight is called CABs — short for Capital Appreciation Bonds. It hit Michigan in 1988. Within four years of the first CAB issue, Michigan public school debt had doubled to reach more than $4 billion. That was just principal. The interest on the CABs amounted to 200 percent — 300 percent — even 575 percent of principal, depending on the terms of the individual bond issue. Nineteen years ago, I delved into this fascinating but arcane world with its private argot strewn with obscure words like “zeroes” and “basis points” describing fairly simple things in language you need a special dictionary to comprehend. It’s an industry with specialized documents that seem encrypted so that people like you and I will have trouble understanding them.

Thurtell had spent many days of difficult, tedious research at the Michigan State Treasurer’s office scrutinizing paper copies of “Official Statements” produced for Michigan school districts. He produced a “Big Chart” that quantified the prevalence of Capital Appreciation Bond sales and accumulated debt service. On April 5, 1993 the Free Press published the first of a series of Thurtell’s articles about how Michigan school districts were borrowing their money for school construction. The articles changed public policy in Michigan:

Because of my Free Press stories…the state Legislature banned future issues of Capital Appreciation Bonds and ordered that future bond issues be competitively bid rather than rigged through a process the underwriters euphemistically termed “negotiation.” It was huge that CABs were banned, because as you will read in these stories, schools were piling up enormous debt to be paid by future taxpayers. Imagine the predicament schools would have found themselves in had such debt been allowed to continue accumulating into today’s depressed economy. Debt payback was predicated on rosy assumptions called “present value” that predicted large increases in real estate valuation ad infinitum.

At the May 2012 annual conference of the California League of Bond Oversight Committees, the Los Angeles County Treasurer-Tax Collector Mark Saladino and Alicia Minyen, a school bond expert and certified fraud examiner, made presentations that included discussion of Capital Appreciation Bonds. Saladino had written a May 16, 2011 white paper about risky municipal debt finance that referenced school districts issuing Capital Appreciation Bonds. Minyen was a prominent critic of a few school districts in Contra Costa County that had issued Capital Appreciation Bonds in irresponsible ways.

Minyen referenced Joel Thurtell’s articles and blog posts. The author of this report then wrote articles for his personal blog about the Capital Appreciation Bond presentations, and local taxpayer activists throughout the state began contacting him with questions and concerns about Capital Appreciation Bond sales going on in their local school and college districts. Californians who paid close attention to tax and government finance issues from a critical perspective were confused — and suspicious.

Graphic Depictions of Poway Unified School District Bond Debt Inspire Limited Reforms

Voice of San Diego Pie Chart on Poway USD Capital Appreciation BondsFinally a breakthrough in bringing public awareness to the issue occurred in August 2012, when a journalistic web publication called Voice of San Diego published a series of investigative pieces written by reporter Will Carless about the 2011 Poway Unified School District bond sales. The first article hit on August 6, 2012: “Where Borrowing $105 Million Will Cost $1 Billion: Poway Schools.”

It’s possible that Voice of San Diego was successful in bringing sudden and dramatic attention to the practice because of the simple and colorful graphics produced by Keegan Kyle and included with the articles. These graphics portrayed the deals in a way much easier to understand than the analytical writing of policy experts.

Voice of San Diego on Poway Unified School District Capital Appreciation BondsThese articles and the associated graphics were the catalyst for intense statewide public criticism. Voice of San Diego created a spreadsheet, the Los Angeles Times created a database, and other news media outlets compiled information revealing that a couple hundred community college and K-12 school districts in California had issued Capital Appreciation Bonds, with many starting long before property values began to decline in 2007.

California and national news media, state and local taxpayer organizations, and many state and local politicians spent the next year criticizing California educational districts for poor decisions about borrowing money via bond sales for school construction. About a dozen educational districts received a disproportionate amount of negative attention for their Capital Appreciation Bond sales. Criticism ebbed but did not disappear after Governor Brown signed Assembly Bill 182 in October 2013 to put limits and new oversight on Capital Appreciation Bonds.

Backers of Capital Appreciation Bonds Stubbornly Defend Them

Throughout the state and even at the Poway Unified School District, elected district officials and administrators defended their decisions to sell Capital Appreciation Bonds. Their response to criticism was common and consistent:

  1. Voters wanted school construction done as soon as possible.
  2. Capital Appreciation Bonds were the only way available to get the money.
  3. We didn’t do anything wrong.
  4. Look at the complete program instead of focusing on individual bond issues.

These claims generally echoed the arguments of parties involved in the preparation and sale of those bonds. These bond experts knew the obscure and complicated business of municipal bonds, but they also had a financial interest in seeing these bond sales continue.

Tables A-5 and A-6 are comprehensive lists of arguments for and against Capital Appreciation Bonds, with rebuttals.

Table A-5
Arguments for Capital Appreciation Bonds
ArgumentRebuttal
URGENCY
School facilities are desperately needed now: schools are overcrowded, deteriorating, outdated, and unsafe. These claims are rarely quantified. There needs to be an objective way to determine that need overwhelms the risk of massive tax and debt burdens for future generations.
Despite 14 years of Proposition 39, educational districts continue to increase the number of bond measures on the ballot and the total amount authorized to borrow. It seems that spending between $100-$200 billion on construction since 2000 has only increased the need for more.
It’s possible that educational districts are preparing for a population boom that may never occur. Average Daily Attendance for California K-12 school districts has dropped from 5,927,951 in 2003-04 to 5,631,709 in 2008-09 to 5,501,603 in 2013-14. Actual California population growth is lagging behind projections made in the 1990s.
When the bond measure was before voters for consideration, the educational district made promises to residents about what was going to be built and what the tax rate would be. Those promises must be fulfilled. Voters want the projects now.Anecdotally, it appears that voters aren’t necessarily keen on immediately proceeding with construction projects listed in bond measure ballot statements if it requires borrowing money under outlandish terms via sales of Capital Appreciation Bonds or other unconventional methods of debt finance. Taxpayers would rather give their money to their local educational district than to bond investors.
Who actually applies the most pressure on the educational district to proceed with borrowing money? Are educational districts selling Capital Appreciation Bonds or other unconventional methods of debt finance because parents and teachers are demanding it? Or is the political pressure coming from the various interests that contributed to the bond measure campaign and now want to reap the rewards of contracts for this construction program?
Interest rates are low. This is a good time to borrow money, perhaps with a mix of Current Interest Bonds and Capital Appreciation Bonds. Rates may not be so favorable when assessed valuation of property in the district goes up.Interest rates are low and provide an advantage for educational districts issuing Current Interest Bonds, but the outrageous nature of Capital Appreciation Bond negates the benefit of lower rates. The ratio of debt service to principal should not exceed 3 or 4 (at the most) for an individual bond issue.
Educational districts will jeopardize the quality of education for students if they don’t get funding for construction now.Is it true that new and modernized facilities significantly improve academic performance and life preparation for students? Is the impact of bond measures on test scores proportionate to the amount of tax revenue spent on debt service for those bond measures? Or are bond measures simply an easy method to get more money flowing into the district?
Ongoing construction programs would have to stop if funding isn’t obtained now, causing inconvenience, stopping momentum, and risking a higher cost of construction in the future.A realistic projection for assessed valuation of property would allow for better planning of construction-related contracts. Future generations should not have to pay for the risky borrowing practices of this generation’s leaders.
STINGY STATE LAWS COMPEL USE
Educational districts have to sell Capital Appreciation Bonds or other unconventional methods of debt finance because of unreasonably low tax and debt limits established in state law.The California legislature established these limits in state law in 2000 as part of a strategy to boost voter support for Proposition 39, a statewide measure on the November 2000 ballot to modify Proposition 46 enacted in 1986 - an initiative that modified the high-profile Proposition 13 enacted in 1978. Without limits and other additional taxpayer protections, Proposition 39 might have failed, as Proposition 26 failed in March 2000.
Educational districts have to sell Capital Appreciation Bonds or other unconventional methods of debt finance because assessed valuation of property in the districts unexpectedly declined, thus forcing districts to confront tax and debt limits.It’s important to obtain an independent projection of assessed property valuation that does not extend a current exceptional rate of growth for 40 years.
THESE BOND FINANCE DEALS ARE MISUNDERSTOOD
It’s wrong to consider Capital Appreciation Bonds in isolation. They are usually just a piece of a package of bond issues. When considered in conjunction with other bond issues, the debt to principal ratio is usually reasonable.This doesn’t eliminate the reality that bonds are issued that will need to be paid back decades later with compounded interest. Why include them at all?
Focusing on long-term debt service is misleading. Just because there is a high number for aggregate accreted interest in 40 years doesn’t necessary mean that amount will ever be paid. Many Capital Appreciation Bonds are “callable” and can be redeemed (and are being redeemed) with a new issue of refunding bonds that have lower rates and can be issued as traditional Current Interest Bonds. Because of the consistent increasing value of property in California over several generations, an amount that seems high to taxpayers now will not be so daunting decades from now. Routine inflation will reduce the “real” cost of paying back Capital Appreciation Bonds decades from now. This is public money. The decision to borrow money via Capital Appreciation Bonds assumes that assessed valuation of property and the rate of inflation will increase substantially over decades. And some districts (such as Poway Unified School District) have sold Capital Appreciation Bonds that are not callable.
Contrary to claims made after the fact, plenty of information is provided to educational district administrators and elected board members about bond sales. There isn’t an excuse for not understanding the proposal.Information is not presented in a standardized way that is easy to understand. Most school board members do not have a background in accounting, finance, or bonds. In addition, school board members may be hesitant to publicly acknowledge their lack of understanding, especially if everyone else in the room is nodding heads during the bond consultant presentation.
Critics have self-interested motivations to criticize. Traditional and consistent ideological detractors of government schools want to take advantage of yet another opportunity to undermine the system. Cynical politicians want to exploit bad news in order to build a reputation. News media wants to improve reader and viewer ratings through sensational and misleading coverage.Most people would acknowledge that criticism of at least a few bond issues by California educational districts has merit. In addition, there are self-interested motivations for people denying that Capital Appreciation Bonds and other unconventional bond financing are unusual or unwise. Community college and K-12 school district elected officials wanted to stay in office. District administrators wanted to keep their jobs. And of course professionals in the financial industry wanted to continue making a living from the transaction fees generated by bond sales.
Assembly Bill 182 (2013) wasn’t really needed, but it is now law and there are no valid arguments to impose more restrictions on this valuable tool for educational districts.Educational districts are still selling Capital Appreciation Bonds (and also Bond Anticipation Notes) under the assumption that assessed valuation will continue to rise for decades. The bond financing industry will continue to use these schemes to bloat borrowing and collect more transaction fees.
Table A-5
Arguments for Capital Appreciation Bonds
ArgumentRebuttal
URGENCY
School facilities are desperately needed now: schools are overcrowded, deteriorating, outdated, and unsafe. These claims are rarely quantified. There needs to be an objective way to determine that need overwhelms the risk of massive tax and debt burdens for future generations.
Despite 14 years of Proposition 39, educational districts continue to increase the number of bond measures on the ballot and the total amount authorized to borrow. It seems that spending between $100-$200 billion on construction since 2000 has only increased the need for more.
It’s possible that educational districts are preparing for a population boom that may never occur. Average Daily Attendance for California K-12 school districts has dropped from 5,927,951 in 2003-04 to 5,631,709 in 2008-09 to 5,501,603 in 2013-14. Actual California population growth is lagging behind projections made in the 1990s.
When the bond measure was before voters for consideration, the educational district made promises to residents about what was going to be built and what the tax rate would be. Those promises must be fulfilled. Voters want the projects now.Anecdotally, it appears that voters aren’t necessarily keen on immediately proceeding with construction projects listed in bond measure ballot statements if it requires borrowing money under outlandish terms via sales of Capital Appreciation Bonds or other unconventional methods of debt finance. Taxpayers would rather give their money to their local educational district than to bond investors.
Who actually applies the most pressure on the educational district to proceed with borrowing money? Are educational districts selling Capital Appreciation Bonds or other unconventional methods of debt finance because parents and teachers are demanding it? Or is the political pressure coming from the various interests that contributed to the bond measure campaign and now want to reap the rewards of contracts for this construction program?
Interest rates are low. This is a good time to borrow money, perhaps with a mix of Current Interest Bonds and Capital Appreciation Bonds. Rates may not be so favorable when assessed valuation of property in the district goes up.Interest rates are low and provide an advantage for educational districts issuing Current Interest Bonds, but the outrageous nature of Capital Appreciation Bond negates the benefit of lower rates. The ratio of debt service to principal should not exceed 3 or 4 (at the most) for an individual bond issue.
Educational districts will jeopardize the quality of education for students if they don’t get funding for construction now.Is it true that new and modernized facilities significantly improve academic performance and life preparation for students? Is the impact of bond measures on test scores proportionate to the amount of tax revenue spent on debt service for those bond measures? Or are bond measures simply an easy method to get more money flowing into the district?
Ongoing construction programs would have to stop if funding isn’t obtained now, causing inconvenience, stopping momentum, and risking a higher cost of construction in the future.A realistic projection for assessed valuation of property would allow for better planning of construction-related contracts. Future generations should not have to pay for the risky borrowing practices of this generation’s leaders.
STINGY STATE LAWS COMPEL USE
Educational districts have to sell Capital Appreciation Bonds or other unconventional methods of debt finance because of unreasonably low tax and debt limits established in state law.The California legislature established these limits in state law in 2000 as part of a strategy to boost voter support for Proposition 39, a statewide measure on the November 2000 ballot to modify Proposition 46 enacted in 1986 - an initiative that modified the high-profile Proposition 13 enacted in 1978. Without limits and other additional taxpayer protections, Proposition 39 might have failed, as Proposition 26 failed in March 2000.
Educational districts have to sell Capital Appreciation Bonds or other unconventional methods of debt finance because assessed valuation of property in the districts unexpectedly declined, thus forcing districts to confront tax and debt limits.It’s important to obtain an independent projection of assessed property valuation that does not extend a current exceptional rate of growth for 40 years.
THESE BOND FINANCE DEALS ARE MISUNDERSTOOD
It’s wrong to consider Capital Appreciation Bonds in isolation. They are usually just a piece of a package of bond issues. When considered in conjunction with other bond issues, the debt to principal ratio is usually reasonable.This doesn’t eliminate the reality that bonds are issued that will need to be paid back decades later with compounded interest. Why include them at all?
Focusing on long-term debt service is misleading. Just because there is a high number for aggregate accreted interest in 40 years doesn’t necessary mean that amount will ever be paid. Many Capital Appreciation Bonds are “callable” and can be redeemed (and are being redeemed) with a new issue of refunding bonds that have lower rates and can be issued as traditional Current Interest Bonds. Because of the consistent increasing value of property in California over several generations, an amount that seems high to taxpayers now will not be so daunting decades from now. Routine inflation will reduce the “real” cost of paying back Capital Appreciation Bonds decades from now. This is public money. The decision to borrow money via Capital Appreciation Bonds assumes that assessed valuation of property and the rate of inflation will increase substantially over decades. And some districts (such as Poway Unified School District) have sold Capital Appreciation Bonds that are not callable.
Contrary to claims made after the fact, plenty of information is provided to educational district administrators and elected board members about bond sales. There isn’t an excuse for not understanding the proposal.Information is not presented in a standardized way that is easy to understand. Most school board members do not have a background in accounting, finance, or bonds. In addition, school board members may be hesitant to publicly acknowledge their lack of understanding, especially if everyone else in the room is nodding heads during the bond consultant presentation.
Critics have self-interested motivations to criticize. Traditional and consistent ideological detractors of government schools want to take advantage of yet another opportunity to undermine the system. Cynical politicians want to exploit bad news in order to build a reputation. News media wants to improve reader and viewer ratings through sensational and misleading coverage.Most people would acknowledge that criticism of at least a few bond issues by California educational districts has merit. In addition, there are self-interested motivations for people denying that Capital Appreciation Bonds and other unconventional bond financing are unusual or unwise. Community college and K-12 school district elected officials wanted to stay in office. District administrators wanted to keep their jobs. And of course professionals in the financial industry wanted to continue making a living from the transaction fees generated by bond sales.
Assembly Bill 182 (2013) wasn’t really needed, but it is now law and there are no valid arguments to impose more restrictions on this valuable tool for educational districts.Educational districts are still selling Capital Appreciation Bonds (and also Bond Anticipation Notes) under the assumption that assessed valuation will continue to rise for decades. The bond financing industry will continue to use these schemes to bloat borrowing and collect more transaction fees.
Table A-6
Arguments Against Capital Appreciation Bonds
ArgumentRebuttal
THE BOND FINANCE INDUSTRY IS NOT TRUSTWORTHY
Promoters of bond deals are motivated by transaction fees and tend to advance funding proposals in their own interest but harmful to the public interest.Borrowing money for long-term investment is a well-accepted practice in the United States and a fundamental part of our economic system.
Most people involved with bond finance are ethical and enjoy being in a professional financial vocation that helps students and society.
The few bond finance professionals who are alleged to advise decisions not in the interest of their clients earn a bad reputation and can’t stay in the business.
Companies and individuals who work in the business of assisting with capital transfer and earn fees on those transactions are an easy target to malign, but they are essential to a prosperous economy.
Proving their lack of responsibility to the public, the California Public Securities Association in 2009 sponsored Assembly Bill 1388, a self-interested bill that repealed a law requiring that the maximum annual payment of principal and interest on a bond issue cannot exceed the minimum annual payment of principal and interest by more than 10 percent.Actually, this bill helped educational districts by allowing them greater opportunity to borrow money despite reaching state tax and debt limits or despite reaching tax and debt limits indicated in the bond measure.
Excessive competition in the market to win contracts from educational districts for bond finance services has compelled some companies to overstate benefits and understate risks of unconventional bond finance.Increased competition in municipal bond finance gives educational districts the opportunity to compare numerous potential contractors and chose the one that best suits its needs. Districts concerned about debt accumulated through Capital Appreciation Bonds can award contracts to professional service firms that adopt a conservative approach to bond finance.
Increased competition in municipal bond finance has encouraged the development and promotion of more creative and effective options to help educational districts in bond finance, such as Reauthorization Bonds and Ed-Tech Bonds.
Corruption is rampant in the municipal bond finance business, as proven by apparent “pay to play” practices between educational districts and bond underwriters.Many parties in the bond financial industry resent how their reputation is tainted by a few companies that make substantial contributions to bond measure campaigns and/or consult for those campaigns and then obtain no-bid contracts and/or higher transaction fees. They have asked the Municipal Securities Rulemaking Board (MSRB) to restrict parties in the financial services industry from contributing to bond campaigns. They have also collectively adopted a voluntary internal moratorium on the practice.
Some county treasurers, for example in Los Angeles County, have ended business with securities brokers that contribute to campaigns for bond measures. The problem is being addressed.
The Municipal Securities Rulemaking Board already has a regulation requiring brokers, dealers, and municipal securities deals to disclose their campaign contributions to allow public scrutiny of such political activity.
Political campaigns are expensive. Parents and students are unlikely to be major sources of contributions to a campaign to pass a bond measure. There is nothing wrong with companies contributing to a campaign and expressing their First Amendment constitutional right to free speech.
No one has ever proven this practice actually happens.
Claims about this practice come from firms that want to stifle competition from other firms that work harder for educational districts.
Educational districts are no different than victims of loan sharks, payday lenders, mortgage scammers, and other unsavory usurers.Comparisons of professional, certified financial service providers to criminals is unjust. Boards elected by the people consider and vote on proposals for bond issues at public meetings regulated by open meetings laws. The process is highly regulated by the US Securities and Exchange Commission and the Municipal Securities Rulemaking Board. The news media has the opportunity to follow and report on the issue to the public.
LACK OF PUBLIC KNOWLEDGE COMPROMISES ACCOUNTABILITY AND ALLOWS TAXPAYERS TO BE EXPLOITED
Few Californians have ever heard of Capital Appreciation Bonds. An even tinier percentage of Californians could adequately explain them. As a result, the public is currently incapable of evaluating this method of bond finance and petitioning their school or college board members about it.Government does many things that the general public does not know about or understand. Accountability is inherent in the regular elections for governing boards. Candidates run for and get elected to public office based on their individual expertise and experience. Voters can subsequently choose to end the public service of those individuals based on their performance.
Educational districts have professional in-house superintendents and often have other administrators overseeing bond deals, including business officers assigned to work on bond finance.
Educational districts hire outside experts to maximize the effectiveness of their bond measures and best serve the public. Contracts for these experts include terms and conditions that provide protection for the district and accountability to the consultant.
State and county elected and appointed officials and their agencies serve as checks and balances for educational district decisions. In particular, county treasurers can and do play a role in evaluating questionable bond financing.
In the few cases in which excessive or inappropriate bond deals may have occurred, (for example, the 2011 bond issue at the Poway USD), elected county treasurers and the news media did identify the failure and publicized it. Assembly Bill 182 (now in law) is the product of research and reporting by elected government officials and the news media. The system of checks and balances worked.
Voters are not informed in election ballot material that some of the money they authorize to borrow via “general obligation bonds” ends up borrowed via Capital Appreciation Bonds and other unconventional borrowing practices.Actually, some ballot statements are now indicating that “no capital appreciation bonds shall be issued.” Inclusion of language specifying the type of General Obligation bonds to be sold should be a decision of the district board and not mandated by the state.
It’s unfair for educational districts to be forced to speculate to voters on how it might borrow money. Financing decisions are made by elected board members based on economic conditions that cannot be known at the time the bond measure is considered.
State law already imposes numerous burdensome and costly requirements on educational districts to ensure voters have a reasonable degree of information for consideration of a bond measure.
Ballot statements already are so long that few people would see any authorizations for the district to Capital Appreciation Bonds and other unconventional borrowing practices if they were included.
COST, TAXES, AND DEBT ARE FOOLHARDY
It’s foolish to borrow money and then wait for decades to start paying off the principal and accreted interest.What’s foolish are the tax and debt limitations established by state voters as Proposition 13 in 1978 and state laws (Assembly Bill 1908) enacted in conjunction with putting Proposition 39 on the statewide ballot in 2000. If those limits were set at a higher threshold or eliminated altogether, Capital Appreciation Bonds and other unconventional financing schemes would become rare.
Property taxes may increase substantially many years in the future when the district begins paying off the debt.It’s unlikely the taxes will end up being particularly noteworthy or burdensome after decades of increased property value and inflation.
The amount to be paid back under Capital Appreciation Bonds is too high.Just because there is a high number for aggregate accreted interest in 40 years doesn’t necessary mean that amount will ever be paid. Many Capital Appreciation Bonds are “callable” and can be redeemed (and are being redeemed) with a new issue of refunding bonds that have lower rates and can be issued as traditional Current Interest Bonds.
Because of the consistent increasing value of property in California over several generations, an amount that seems high to taxpayers now will not be so daunting decades from now.
Routine inflation will reduce the “real” cost of paying back Capital Appreciation Bonds decades from now.
Focusing on the amount of debt service generated by Capital Appreciation Bonds ignores the intangible benefits of high-quality schools with environments conducive to teaching and learning
Capital Appreciation Bonds are used too often.For most educational districts, Capital Appreciation Bonds comprise a small percentage of the total amount of bonds issued. Capital Appreciation Bonds are a legitimate and beneficial option for educational districts that want to obtain a bit more of the money that voters authorized to borrow for needed school construction.
Capital Appreciation Bonds allow educational districts to fund contracts with local contractors and vendors, thus encouraging economic growth and job creation in the community. Capital Appreciation Bonds pay for themselves by generating increased economic activity.
There are no legal or commonly accepted definitions of “too often.” The authority to issue Capital Appreciation Bonds is granted to the educational district’s board of trustees, who are elected by the people. Each educational district has its own comfort for Capital Appreciation Bonds, and this comfort usually reflected in the decision of the board. Trust our representative democracy.
Capital Appreciation Bonds assume an ability to pay based on projections of increased value of taxable property that may extend as many as 40 years into the future.Granted, no one can perfectly predict the future. But California remains a desirable place to live because of its climate, natural beauty, economic prosperity, and culture. It’s reasonable to assume that people with ability and ambition will always come to California, a beacon for the world, and thus increase demand for housing.
The best way to ensure increased property values in the future is to build a foundation of high-quality schools with environments conducive to teaching and learning. Funding for new construction - sometimes obtained through Capital Appreciation Bonds - allow these schools to be provided and fulfills the expectation for increased property values.
Without any sort of representation, future generations of taxpayers (children and grandchildren) are bound to repaying debts accumulated by unconventional borrowing practices of current generations.Schools built using Capital Appreciation Bonds are for the benefit of our children and grandchildren. Shouldn’t they contribute to paying for the system that helped to make them successful?
This is an unfortunate distortion of the concept of “taxation without representation” that applies to people who are deprived of their right for full participation in their current governance. Many of the important and transformational social programs in the United States and in California were adopted before the people now benefiting and paying for them were even born. Generations work together cooperatively to advance progress.

Sources

“Text – SB 872 Local Agencies: General Obligation Bonds,” California Legislative Information, October 6, 1993, accessed June 28, 2015, www.leginfo.ca.gov/pub/93-94/bill/sen/sb_0851-0900/sb_872_bill_931006_chaptered

“Market Place; Zero-Coupon Municipals,” New York Times, March 21, 1982, accessed June 28, 2015, www.nytimes.com/1982/03/31/business/market-place-zero-coupon-municipals.html

“Capital Appreciation Bonds: The Creation of a Toxic Waste Dump in Our Schools,” Alpha Wealth Management, April 11, 2013, accessed June 28, 2015, www.alpha-wealth.com/resources/publications/CAB-Paper.pdf

Kevin Dayton @DaytonPubPolicy, May 9, 2015, accessed June 28, 2015 https://twitter.com/daytonpubpolicy/status/596934260381978624

Dale Scott & Company www.dalescott.com

“Questions & Answers from Capital Appreciation Bond (CAB) Public Forums,” Poway Unified School District, August 20, 2014, accessed June 28, 2015, https://www.powayusd.com/doc_library/2014-15/CommunityForumFAQs.pdf

“Plan Pitched to Lower Poway Bond Debt,” San Diego Union-Tribune, August 20, 2014, accessed June 28, 2015, www.utsandiego.com/news/2014/aug/20/poway-plan-bond-debt/

“Text – AB 182 Bonds: School Districts and Community College Districts,” California Legislative Information, October 2, 2013, accessed June 28, 2015, leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201320140AB182&search_keywords=

“Treasury: Capital Appreciation Bonds,” San Diego County Treasurer-Tax Collector, accessed June 28, 2015, www.sdtreastax.com/capital-appreciation-bonds.html

“AB 182 Bill Analysis – Concurrence in Senate Amendments,” Official California Legislative Information, September 5, 2013, accessed June 28, 2015, www.leginfo.ca.gov/pub/13-14/bill/asm/ab_0151-0200/ab_182_cfa_20130905_163723_asm_floor.html

“AB 182 Bill Analysis – Assembly Committee on Education,” Official California Legislative Information, March 20, 2013, accessed June 28, 2015, www.leginfo.ca.gov/pub/13-14/bill/asm/ab_0151-0200/ab_182_cfa_20130318_154906_asm_comm.html

“Citrus College OKs Capital Appreciation Bond Issuance,” San Gabriel Valley Tribune, May 6, 2014, accessed June 28, 2015, www.sgvtribune.com/social-affairs/20140506/citrus-college-oks-capital-appreciation-bond-issuance

“Re: Poway Unified School District v. All Persons Interested – Superior Court of California, County of San Diego, Case No. 37-2010-00106255-CU- MC-CTLAG,” California Attorney General letter to Poway Unified School District, Orange County Government, March 1, 2011, accessed June 28, 2015, http://cams.ocgov.com/Web_Publisher/Agenda11_05_2013_files/images/ATTORNEY%20GENERAL%20OPINION%20-%20POWAY%20BOND%20PREMIUM_9843497.PDF

“Muni Bomb Ticks in California,” Joel On the Road, April 27, 2012, accessed June 28, 2015, www.joelontheroad.com/muni-bomb-ticks-in-california/

“Find High-Interest School Bonds in Your District: A Five-Step Guide,” Voice of San Diego, August 8, 2012, accessed June 28, 2015, http://www.voiceofsandiego.org/investigations/find-high-interest-school-bonds-in-your-district-a-five-step-guide/

“Spreadsheet: Capital Appreciation Bonds,” Los Angeles Times, November 28, 2012, accessed June 28, 2015, spreadsheets.latimes.com/capital-appreciation-bonds/

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Tricks of the Trade: Questionable Behavior with Bonds (Section 6 of 9)

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
More Borrowing for California Educational Construction in 2016 (2 of 9)
Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
How California School and College Districts Acquire and Manage Debt (4 of 9)
Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
You are here: Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
The System Is Skewed to Pass Bond Measures (7 of 9)
More Trouble with Bond Finance for Educational Construction (8 of 9)
Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
Guide to all Tables and Appendices – Comprehensive Reference for Researchers


Tricks of the Trade: Questionable Behavior with Bonds

Californians who want more spending on educational construction often express their resentment of a 2000 law limiting taxes and debt resulting from bond sales. It was passed in order to strengthen campaign arguments to voters in support of Proposition 39, which lowered the approval threshold for local bond measures from two-thirds to 55%. (See Table 11 in Section 5 for the limits.)

School districts have adopted several strategies to get around these limits in state law. One of them is very obscure but 100% successful: obtaining waivers from the State Board of Education.

Meanwhile, some districts are stretching legal definitions to use proceeds from bond sales to pay for items that resemble instructional material more than construction. One example is personal portable electronics such as iPads. Some of the state’s largest districts are purchasing this kind of technology while giving little assurance to the public that long term bonds aren’t the source of the money. This equipment may be obsolete well before the bonds mature, meaning that future generations will pay for these devices long after they are outdated and discarded.

Debt and Tax Limits Waived When School Districts Want to Borrow More Money

Research by the California Policy Center now allows the People of California to see — for the first time — a chart listing all California K-12 school district requests to the state for waivers to sell bonds for school construction. These waivers allow school districts to circumvent state laws enacted in conjunction with Proposition 39 and meant to set limits on taxes and debt burdens imposed on property owners.

State law (California Education Code Sections 3050-33053) allows the California Board of Education to grant waivers from numerous sections of the California Education Code, including bond indebtedness limitations. This power is obscure but significant, and until now a compilation of the history of bond indebtedness waivers has not been available to the public.

Out of the 51 waiver requests from 2000 through 2014, only one received notable public attention. In 2013, the fourth waiver request since 2002 from the West Contra Costa Unified School District became controversial when some local taxpayer activists and a columnist for the Contra Costa Times criticized the district for repeatedly seeking waivers to borrow yet more money for construction through bond sales.

To develop a bond indebtedness waiver chart and provide the public with comprehensive information about the waivers, the California Policy Center obtained a document from the California Department of Education listing school district requests since 2000 to the California Board of Education for bond indebtedness waivers. Staff indicated that this listing was an “internal working file and has not been reviewed or validated for accuracy.”

California Policy Center researchers checked the data, corrected inaccuracies, and expanded on the data using meeting agendas, staff reports, and meeting minutes. Now the public has a useful resource for considering public policy related to bond indebtedness waivers.

Table A-3 provides complete history of school district requests to the California Board of Education for waivers from tax and debt limits to borrow more money for school construction by selling bonds to investors. Preliminary activity in the first three months of 2015 is also included.

Request a Waiver, Get a Waiver

From 2000 through 2014, California K-12 school districts requested 51 waivers from sections of the California Education Code that do one or both of the following:

  1. Prohibit the total amount of bonds issued (the total amount of principal) from exceeding 1.25 percent or 2.50 percent of the most recent assessed aggregate value of taxable property in the district. (Elementary and high school districts have a 1.25% limit; unified school districts a 2.5% limit.)
  2. Prohibit the total amount of bonds issued as authorized by one bond measure from requiring a property tax that exceeded $30 or $60 per year per one hundred thousand dollars ($100,000) of taxable property. (Elementary and high school districts have a $30 limit; unified school districts a $60 limit.)

Out of these 51 waiver requests, school districts ended up withdrawing three of them. The State Board of Education approved all 48 other waiver requests, without one dissenting board vote.

The 100% approval rate for waiver requests is not surprising. In 2013, the State Board of Education took action on 518 waiver requests for all sections of the California Education Code and approved 97% of them. Under state law, the California Board of Education is generally obligated to grant such waivers as long as the request is submitted correctly and the waiver doesn’t violate seven criteria specifically listed in state law:

  1. The educational needs of the pupils are not adequately addressed.
  2. The waiver affects a program that requires the existence of a schoolsite council and the schoolsite council did not approve the request.
  3. The appropriate councils or advisory committees, including bilingual advisory committees, did not have an adequate opportunity to review the request and the request did not include a written summary of any objections to the request by the councils or advisory committees.
  4. Pupil or school personnel protections are jeopardized.
  5. Guarantees of parental involvement are jeopardized.
  6. The request would substantially increase state costs.
  7. The exclusive representative of employees, if any…was not a participant in the development of the waiver.

None of those seven criteria relate to local fiscal policies, meaning there is no obvious justification in state law for the Board of Education to deny a waiver from state laws related to bond indebtedness. Nonetheless, the Board of Education has chosen to impose conditions on bond indebtedness waivers and sometimes incorporated changes from the original requests at the recommendation of California Department of Education personnel. But the Board of Education has also rejected recommendations from the Department of Education, most notably in 2013 when the board repeatedly rejected a staff recommendation that school districts applying for waivers should not be permitted to sell Capital Appreciation Bonds.

Case Study: West Contra Costa Unified School District

West Contra Costa Unified School District Bond Measure History

This school district based in Richmond is perhaps the most egregious example in California of unrestrained bond finance for a construction program. One individual was disproportionately responsible for leading the district to almost $2 billion in debt service. It remains to be seen if his legacy will be as a hero for disadvantaged students in dilapidated schools or as a politician who undermined the district’s always-tenuous fiscal stability.

During his time on the West Contra Costa Unified School District board of trustees from 1993 to 2014, Charles Ramsey claimed to work for the interests of students in this district. Ramsey played a leading role in the political deals and fundraising (through a Political Action Committee named “For the Children of West County”) needed to win voter approval of six out of eight bond measures proposed from 1998 through 2014. Those six successful bond measures authorized the district to borrow a total of $1.63 billion via bond sales.

His emailed reaction after the school district received its fourth tax and debt waiver from the State Board of Education was typical:

…I did all I could to change the attitudes that constantly plague our community and tried to make the world a better place. No longer can people sit back and point fingers about us and now I can proudly say that WE DID IT!!!! Once again and now we can add Measure E to the list of successes with the debt limit waiver now applied to this phenomenal bond program. And once again, a loud and boisterous THANK YOU. For all of us and in the end it is all about the West Contra Costa Unified School District kids!!!

The district has debt service of $1.83 billion and continues in 2015 to issue bonds that don’t mature for 40 years. It has issued Capital Appreciation Bonds. It has requested four waivers from the State Board of Education to exceed tax and debt limits, even earning attention from local news media for abuse of this obscure process. In the context of reporting on the district’s fourth waiver request, Contra Costa Times columnist Dan Borenstein asserted the following:

The West Contra Costa school district should slow its deceptive school construction program because it’s pushing too much debt onto property owners and will soon exceed tax limits it promised voters…In their quest to rebuild or replace every school, district officials are moving too fast, behaving irresponsibly and overtaxing poor and working-class residents…District officials need to start thinking about property owners who foot the bill. New schools are nice, but they must also be affordable.

Borenstein also suggested that the campaigns for the bond measures were deceptive, both in general and in specifics: “Each time they went to the ballot, district officials presented that particular bond measure to voters as if it were the only one. They never mentioned the outstanding debt taxpayers already owed from prior measures.” He also criticized a “buried” reference in a three-page long paragraph in a fourteen-page ballot statement stating that the district would have authority to seek a waiver from tax and debt limits cited elsewhere in the ballot material.

The US Securities and Exchange Commission has investigated financing of the district’s bond program, and the Federal Bureau of Investigation has also made inquiries. A grand jury questioned Charles Ramsey about his relationship to corrupt officials involved with the bond-funded construction program at the Sweetwater Union High School District in Chula Vista.

There have been continual questions about the district’s management of its construction program over its history. Frequent change orders, cost overruns, and unusually high construction costs per square foot have attracted many critics over the years. In addition, enrollment at the West Contra Costa Unified School District is expected to decline.

West Conta Costa Unified School District Enrollment Projection

Finally, one corporation – Chevron – owns 11.62% of the assessed valuation of property in the district. Chevron’s refinery operation in Richmond is perpetually targeted by environmental and social justice groups, some of which hope to close it down. Although the district is vulnerable to a future drop in assessed valuations, the closing of the Chevron refinery would be a financial disaster to the district (and the City of Richmond).

Borrowing Money for Technology Using Bonds

California community college districts and school districts continually claim funding shortfalls for operating expenses. Yet it’s easier for an educational district to get voter authorization to borrow money for construction than it is to get voter approval to impose a parcel tax to obtain supplemental revenue.

This tempts some districts to stretch credulity and declare that voters authorized bond proceeds to be spent on items tenuously related to building a school and providing it with furniture and equipment. And despite the many protections in Proposition 39, sometimes the application of bond funds to operating expenses cannot be prevented.

The Los Angeles Unified School District and the San Diego Unified School District have borrowed money through bond sales and used the proceeds to buy portable electronic tablets for students. These districts rationalize the practice by claiming that voters consented to it when they approved Proposition 39 in 2000 and then subsequently approved local district bond measures.

Recently several districts have asked voters to approve Ed-Tech Bonds®, a trademarked arrangement of bond sales marketed by Dale Scott & Company that permit a district to issue an ongoing series of new short-term bond issues to pay for technology that becomes outdated after a few years. Voters seem to support the idea of using money borrowed from short-term bonds for technology, as long as the district explains the concept openly and establishes reasonable limits.

But the Los Angeles Unified School District and the San Diego Unified School District have used construction bond proceeds to buy iPads for students to use in the classroom and even take home. Because the useful life of these devices is limited, these school boards may be making a fiscally irresponsible policy decision when financing their purchases with borrowed money from bond sales.

Why Any Educational District Can Borrow Money Via Bond Sales and Use It to Buy iPads

No group or individual has put forward a strong legal argument for the idea that school districts cannot use Proposition 39 bond proceeds to buy personal portable electronic devices. In contrast, the arguments are strong for the idea that voters gave educational districts the authority to do this, as long as the districts don’t stray too far from the purposes of Proposition 39.

Perhaps the most notorious example of questionable use of bond funds is the ill-fated Common Core Technology Project Plan at the Los Angeles Unified School District (LAUSD). The former superintendent proposed that funds from Measure R and Measure Y would be used for the first phase of a program to buy electronic tablets (specifically, iPads produced by Apple, Inc.) for students to take home. The iPads would come with software developed by another company.

On September 7, 2012,  a law firm provided the superintendent with a memorandum entitled “Use of Los Angeles Unified School District Measures R, Y and Q General Obligation Bond Proceeds for Certain Costs Related to the District’s Common Core Technology Project Plan.” It asserted that borrowed money from bond sales authorized by measures that comply with Proposition 39 could be used for (1) costs of acquiring electronic tablets, (2) costs of acquiring hardware and installing software, and even (3) costs of hiring “technology specialists who will train the District’s internal technology support teams to operate and maintain the Common Core Technology project, and technology adoption trainers who will train other school site trainers.”

The memo also exposed a oversight in the Proposition 39 language:

There is no statutory definition of many of the terms used in Proposition 39, such as what constitutes the construction, replacement or furnishing and equipping of school facilities for Proposition 39 purposes. Thus, there is no controlling legal authority expressly stating whether costs related to the Common Core Technology Project would constitute the construction, replacement or furnishing and equipping of school facilities for purposes of Proposition 39…the District should remain aware that there is no controlling legal authority expressly stating what constitutes the “equipping of school facilities” for purposes of Proposition 39. The provisions of Proposition 39 relating to the expenditure of general obligation bond proceeds for equipping of school facilities have not been interpreted by any court or other legal authority and, to our knowledge, are not pending before any court.

In practice, educational districts and their bond financial advisers were setting the standards:

Broad agreement, however exists among issuers of general obligation bonds and their advisors that costs directly connected to the construction, acquisition, equipping and furnishing of school facilities may properly be paid from proceeds from the sale of Proposition 39 Bonds, if such costs (i) are “capitalizable” under generally accepted accounting principles applied in accordance with the policies and procedures of the California School Accounting Manual, and (ii) constitute construction, reconstruction, rehabilitation, replacement, furnishing or equipping costs of a project listed on one or more bond measures passed pursuant to Proposition 39.

In effect, the parties getting the borrowed money and getting the transaction fees for the bond sales have determined how that money should be properly spent.

Los Angeles Unified School District Defies Criticism, Pushes Forward

Despite this memo, the LAUSD superintendent’s plan to use borrowed money to buy iPads with installed software generated controversy across the political spectrum. For example, both the United Teachers of Los Angeles (the teachers’ union) and the Howard Jarvis Taxpayers Association objected to it. Opponents claimed that voters never had an expectation that the bond measures would allow LAUSD to borrow money to buy personal student iPads with software. In addition, a rumor spread that LAUSD would use the proceeds of long-term bonds to buy technology only useful for a few years at most.

While LAUSD officials denied that they were going to sell long-term bonds for iPads, this argument gained attention from news media and inspired ridicule among critics. The same criticism also gained a following against the San Diego Unified School District. And the critics had a point: there was nothing in state law to prevent a school district from selling a 40-year Capital Appreciation Bond to buy an iPad with a lifespan of three years.

A major force in slowing down the rush to adopt this Common Core Technology Project at LAUSD was the district’s Citizens Bond Oversight Committee, established at LAUSD even before Proposition 39 was enacted. After significant deliberation and disagreement, this committee expressed numerous concerns but concluded that the district could legally buy portable electronic devices using funds that voters approved the district to borrow via bond sales authorized in a ballot measure that complied with Proposition 39.

This conclusion was stated in a November 18, 2013 letter from the Bond Oversight Committee Information Technology Task Force to the LAUSD School Construction Bond Citizens’ Oversight Committee:

On November 15, 2013, after months of discussions with the Office of the General Counsel (“OGC”) and many requests for a legal opinion supporting the District’s use of bond funds to pay for the majority of costs associated with the CCTP, the OGC issued a written reasoned memorandum opinion stating, among other things, that after performing its due diligence, including, but not limited to, conducting several telephone meetings with and reviewing past communications from the District’s bond counsel, in the OGC’s opinion there is legal support for the use of bond funds to purchase devices such as tablets for the purpose of equipping schools with those devices, to purchase the software packages to be used on the devices, and to allow students, teachers and staff to take the devices home. We find this opinion acceptable.

This memo is once again referenced in a letter from the head of the Bond Oversight Committee to a retired superintendent of the Los Angeles Unified School District:

Our own review of the CCTP has led us to conclude that the District’s actions to date are legal and not imprudent, and we have been assured by the District that the repayment period for the bonds used to finance this project will be reasonably related to the expected life of the assets purchased…we had requested, received, and closely reviewed a letter from the Office of the General Counsel to the District (“OGC”) setting out the reasoned basis for its opinion that bond funds may be used to purchase devices such as tablets for the purpose of equipping schools with those devices, to purchase the software packages to be used on the devices, and to allow students, teachers and staff to take the devices home.

The letter from the head of the Bond Oversight Committee to the retired LAUSD superintendent also anticipated arguments soon to be advanced by the California Legislative Counsel:

  1. Measure Q did not mention iPads as something that bond proceeds would buy because the ballot measure was passed in November 2008 and iPads were not available to the public until April 2010. It is not possible for a bond measure to anticipate specific technological devices before they are available.
  2. The Measure Q bond project list states that bond funds may be used for computer and communications projects, including, but not limited to “hardware and software for information-technology applications” undertaken at some or all of the District’s schools and associated facilities.
  3. LAUSD has been using bond funds for technology, including computers in the classroom, since after voters approved Proposition BB in 1997. In addition, voters were aware from the language in the ballot statements that bond proceeds would be used for technology.

On April 19, 2015, the Los Angeles Times reported that the Securities and Exchange Commission has opened an informal inquiry into LAUSD practices because the district did not mention in its Official Statements that bond proceeds would be used to purchase iPads.

The California Legislature Turns Its Attention to the Practice

In 2014, Assemblyman Curt Hagman introduced Assembly Bill 1754 in response to public criticism about using bond proceeds for personal portable technology. Under his bill, educational districts would have been prohibited from borrowing money from the sale of bonds authorized by measures passed under the criteria of Proposition 39 to purchase portable electronic devices, including laptops and tablets, unless the technology was closely connected to instruction within the classroom, was not assigned to individual students, and was not permitted to leave the school site for more than one school day.

AB 1754 also would have prohibited educational districts from using bond proceeds to buy basic or supplemental instructional materials. To supplement his bill, Hagman asked the Joint Legislative Audit Committee to hold an oversight hearing to review the LAUSD iPad program. In his letter to the committee asking for an audit, Hagman wrote that “there have been discussions on the legality of using 25-year construction bond money to purchase the iPads (which have a lifespan of only 3-5 years).”

The audit committee hearing did not happen. And the bill failed to pass out of committee despite no opposition votes. Three committee members voted for it and four others did not vote.

While this bill was under consideration, the California Legislative Counsel produced a letter defending the use of Proposition 39 bond money to buy laptops and tablets. It asserted that Proposition 39 generally allows an educational district to buy portable electronic devices using funds that voters approved the district to borrow via bond sales authorized in a ballot measure that complied with Proposition 39.

The letter provided three major reasons why educational districts can do this:

  1. Language in Proposition 39 states that bond proceeds may be used to provide access to information technology and specifically cites computers and the Internet. In addition, the argument in favor of Proposition 39 contained in the ballot pamphlet shows that voters were aware that bond proceeds would give schools access to information technology.
  2. “Furnishing and equipping” cited in Proposition 39 includes the purchase of goods that satisfy the broad purposes of the law. It is incorrect to narrowly interpret Proposition 39 as authorizing the sale of bonds only for construction activities that support information technology access.
  3. Courts reasonably regard laws as somewhat flexible to reflect changing conditions over time. Under this principle, a court would likely construe Proposition 39 to authorize the use of bond proceeds to purchase technological devices not in existence or wide use at the time of its passage, such as laptops and electronic tablets, so long as the intended use of those devices is similar to the use of desktop computers and is otherwise consistent with the purposes of the proposition. It is incorrect to narrowly interpret Proposition 39 rigidly limiting purchases of technology to desktop computers because that’s what voters recognized as technology when they approved the ballot measure in 2000.

Even Defenders of the Practice Admit There Needs to Be Limits

Are laptops and tablets analogous to desktop computers that were the prevalent technology in schools when voters approved Proposition 39 in 2000? Some would argue that laptops and tablets are more like textbooks than furniture or equipment.

Even more questionable is the software installed in the laptops or tablets. Can software be defined as “equipment” if it is bought together as a package with the hardware?

Another question: Is it proper to use bond proceeds to pay for personnel who train others to use the laptops or tablets and the software that comes installed in them?

Finally, does federal law allow a local government to issue long-term tax-exempt bonds to buy or replace items with an approximate three-year lifespan?

In 2015, Assemblyman Scott Wilk introduced Assembly Bill 882, which was originally a similar effort to Assemblyman Hagman’s Assembly Bill 1754 (in 2014) to stamp out the use of bond proceeds for portable electronic devices. But unlike Hagman’s bill, Wilk’s bill passed out of its first committee and moved through the Assembly. The bill was approved after Assemblyman Wilk agreed to an amendment requested by California’s Coalition for Adequate School Housing (C.A.S.H.), a primary backer of educational construction bonds.

As of July 14, 2015, Assembly Bill 882 declares that the term of a bond used for the purposes of furnishing and equipping classrooms, including purchasing electronic equipment, shall not exceed 120 percent of the average reasonably expected economic life of the furnishings and equipment. CASH says this provision conforms the practice to federal tax rules.

Assembly Bill 882 also clarifies that portable electronic devices, including laptops and tablets, may be purchased with Proposition 39 bond funds only for the equipping of school facilities and be used for instruction-related purposes in school facilities. Those devices cannot be assigned to individual pupils or removed from the school site on a daily basis.

Even if Assembly Bill 882 is enacted into law, it would only apply to bonds approved by voters after January 1, 2016. LAUSD and the San Diego Unified School District would still be able to fund their programs with bond proceeds, as long as voters allowed them to continue it.

Clarifying the Definition of “Furnishing and Equipment” in Proposition 39

Technology is not the only ambiguous aspect of “furnishings and equipment.” Board meeting agendas at the West Contra Costa Unified School District routinely include consent items to spend money to move equipment and furniture with proceeds of bond sales. Is this a prudent way to spend borrowed money that must be paid back over years, with interest? It’s another example of a school or college district taking advantage of a vague provision in state law.

Moving Services Paid by Bond Measure - West Contra Costa Unified School District

Office Equipment Paid by Bond WCCUSD

Sources

“Daniel Borenstein: Time to Slow West Contra Costa’s Deceptive School Construction Program,” Contra Costa Times, March 1, 2013, accessed June 28, 2015, www.contracostatimes.com/ci_22699375/daniel-borenstein-time-slow-west-contra-costas-deceptive

“Charles Ramsey’s Legacy in the West Contra Costa School District,” Contra Costa Times, December 12, 2014, accessed June 28, 2015, www.contracostatimes.com/richmond/ci_27126352/charles-ramseys-legacy-west-contra-costa-school-district

“Last Impediment Removed for WCCUSD Bond Program to be Completed,” City of Richmond Councilmember Tom Butt, May 10, 2013, accessed June 28, 2015, www.tombutt.com/forum/2013/1305010.htm

“Grand Jury Proceedings in State of California v. Alioto et al., December 6, 2012,” San Diego Union-Tribune, accessed June 28, 2015, http://media.utsandiego.com/news/documents/2013/06/07/Volume18.pdf

“Ed-Tech Bonds®,” Dale Scott & Company, accessed June 28, 2015, www.dalescott.com/what-we-do-2/ed-tech-bonds/

“Use of Los Angeles Unified School District Measures R, Y and Q General Obligation Bond Proceeds for Certain Costs Related to the District’s Common Core Technology Project Plan,” Los Angeles Unified School District, September 7, 2012, accessed June 28, 2015, http://bit.ly/1KplzTM

“The District’s Common Core Technology Project (“CCTP”) Phase 2 Proposal,” Los Angeles Unified School District, November 18, 2013, accessed June 28, 2015, http://bit.ly/1BQ3v1U

Letter from the Bond Oversight Committee Chair to William J. Johnston, Los Angeles Unified School District, February 14, 2014, accessed June 28, 2015, http://bit.ly/1LxtRZ5

“SEC Launches Informal Inquiry into LAUSD’s Use of Bonds for iPads,” Los Angeles Times, April 19, 2015, accessed June 28, 2015, www.latimes.com/local/education/la-me-lausd-ipads-inquiry-20150417-story.html

“Text – AB 1754 School Bonds: Portable Electronic Devices and Instructional Materials,” California Legislative Information, April 24, 2014, accessed June 28, 2015, http://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201320140AB1754&search_keywords=

Letter of Assemblyman Curt Hagman to California Joint Legislative Audit Committee, October 17, 2013, accessed June 28, 2015, laborissuessolutions.com/wp-content/uploads/2013/10/2013-10-17-Hagman-Letter-to-Joint-Legislative-Audit-Cmte-LAUSD-iPad-investigation.pdf

Letter of California Legislative Counsel to Assemblywoman Joan Buchanan, April 1, 2014, accessed June 28, 2015, media.utsandiego.com/news/documents/2014/05/09/LegCounseliPads.pdf

“Text – AB 882 School Bonds: Term of Bonds: Furnishing and Equipping Classrooms,” California Legislative Information, June 25, 2015, accessed June 28, 2015, leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201520160AB882&search_keywords=

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The System Is Skewed to Pass Bond Measures (Section 7 of 9)

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
More Borrowing for California Educational Construction in 2016 (2 of 9)
Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
How California School and College Districts Acquire and Manage Debt (4 of 9)
Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
You are here: The System Is Skewed to Pass Bond Measures (7 of 9)
More Trouble with Bond Finance for Educational Construction (8 of 9)
Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
Guide to all Tables and Appendices – Comprehensive Reference for Researchers


The System Is Skewed to Pass Bond Measures

Considering the advantages that supporters have in preparing and campaigning for a bond measure, perhaps it’s noteworthy that voters reject about 20% of local bond measures for educational construction. At every stage of the process, interests that will benefit from bond sales can take advantage of a system that favors passage of a bond measure. Some issues of concern include use of public funds to develop campaigns to pass bond measures, significant political contributions to campaigns from interests likely to benefit from construction, involvement of college foundations as intermediaries for campaign contributions, and conflicts of interest and alleged pay-to-play contracts.

It’s Not “Tough” Anymore to Pass Local Bond Measures for School and College Districts

Voters in 2000 who read the ballot argument in favor of Proposition 39 would have seen supporters claim that it would “require bonds to be passed by a tough 55% super-majority vote.” Perhaps a 55% threshold could be described as “tough” compared to approval by a simple majority of 50% plus one, but it certainly hasn’t meant passage is difficult to achieve in practice. Four out of five bond measures proposed under the criteria of Proposition 39 win voter approval. (See Section 3 for more information.)

Supporters might argue that the 80% voter approval rate for construction bond measures qualified under Proposition 39 simply reflects the view of a substantial percentage of Californians that school and community college districts need new and modernized facilities. But these views don’t develop in a vacuum.

An industry of campaign consultants helps educational districts to convince voters to approve bond measures. They have developed a formula that generally results in victory. Here are some of the most obvious tactics used to achieve that success rate of 80 percent.

Using Public Funds to Hire a Consultant for Voter Research That Is Subsequently Useful in the Election Campaign to Pass the Bond Measure

Many Californians would be astonished to learn that school and community college districts can use funds from their operating budget to develop a strategy to pass a bond measure. Yet this practice is common — and legal.

California law prohibits community college districts and K-12 school districts from using public funds or resources to campaign in support or opposition to bond measures. Education Code Section 7054 states “No school district or community college district funds, services, supplies, or equipment shall be used for the purpose of urging the support or defeat of any ballot measure…”

However, these same public resources CAN be used to provide information to the public about the possible effects of any bond issue or other ballot measure, as long as that information constitutes a fair and impartial presentation of relevant facts to aid the electorate in reaching an informed judgment regarding the bond issue or ballot measure.

A 2005 opinion from California Attorney General Bill Lockyer confirmed that it is legal for a college district (and a school district) to use district funds to hire a consultant to conduct surveys and establish focus groups to assess the following important conditions for a campaign:

  1. The potential support and opposition to a bond measure, by gathering information and evaluating the potential for the adoption of a bond measure by the electorate.
  2. The public’s awareness of the district’s financial needs.
  3. The overall feasibility of developing a bond measure that could win voter approval.

According to the Attorney General, this is not “partisan campaigning.”

Of course, this professional research and analysis — paid for by taxpayers — puts a school or college district at a significant advantage for a bond measure campaign. Consultants determine which words and arguments are most effective in motivating various demographic groups in the district to vote for a bond measure. Consultants also determine which arguments would be most effective for opponents of a bond measure and how the school district can neutralize those arguments.

Further research is needed to reveal how often a “feasibility study” concludes that a bond measure is not “feasible.” Considering that the firm evaluating the feasibility of a bond measure may often be seeking future contracts with the district or the campaign committee, there may be a conscious or subconscious inclination to manipulate the survey questions or the results to obtain a deceptively positive recommendation. In his book Win Win: An Insider’s Guide to School Bonds, Dale Scott of Dale Scott & Company cites a case in which he suspects a consulting firm had self-interested motivations when it recommended that a school board place a bond measure on a June primary ballot rather than a November presidential ballot with an apparent better chance of passage. Voters rejected the bond measure.

Considering that voters approve about 80% of educational bond measures at the 55% voter approval threshold, cynics would argue the real purpose of surveys isn’t to determine “feasibility” but to use public funds to develop election campaign strategy. Based on promotional material of firms that specialize in feasibility studies for bond measures, the argument is valid.

Here’s an excerpt from a consulting firm’s website about how information from taxpayer-funded surveys can be used to improve the chance of election victory:

…an initial baseline survey can determine the overall feasibility and voter acceptance of a bond or parcel tax measure at different funding levels. It can test how voters respond to different versions of the ballot title and summary, and – through analysis of respondent demographics and past voting patterns – it can help determine which election calendar promises the greatest likelihood of success. The same survey can also determine the effectiveness of the rationales and arguments that might be offered for and against a bond or parcel tax measure, thus helping shape the communications themes that will explain how the measure addresses voters’ concerns… [Name of firm] works with its clients to perfect ballot language and voter pamphlet arguments, using our empirical data to guide our advice.

A second example:

Public opinion research is critical to packaging a revenue measure for success. School districts can maximize the dollars that they raise through general obligation bonds, Proposition 39 bonds, and parcel taxes by collecting pertinent voter opinion data and using this information to solicit support. [Name of firm] can help maximize your measure’s potential by providing accurate and reliable results…We provide both qualitative and quantitative research services in the following areas:

•  Assessing baseline support for revenue measures

•  Identifying the highest achievable tax threshold and total bond amounts

• Determining the arguments and features of the measure that will increase support

•  Evaluating the need and content for a public information campaign

•  Determining the best election in which to place the measure on the ballot

•  Packaging a measure for success

A third example:

[Name of firm] understands that the research can be the first step not only in determining the feasibility of a potential revenue measure, but also in bringing together the various stakeholders and constituencies that will need to be involved and supportive in order for any ballot measure to be successful. We know that the issues facing the District do not exist in a vacuum and must be put into the context of the current political and cultural environment in the District. The voter opinion survey presents the District with an opportunity to hear from the administration, teachers, staff, Board, and other community stakeholders about their priorities. Involving key stakeholders in the research design leads to confidence in the research findings and helps ensure that the parties who are integral to a ballot measure’s success are on board and on the same page.

Even items scheduled on board meeting agendas to hire the consultant and then to review the survey results create a positive news opportunity for bond measure proponents. At this early stage in the process, potential opponents usually have not emerged to present a different perspective. And a finding of measurable strong support portrays a bond measure as something already broadly supported by community, thus convincing undecided individuals and organizations that the bond measure is worthy of support and discouraging individuals and organizations that might be inclined to oppose it.

Public Resources Used to Win a Bond Measure

A consulting firm for school bond measures has developed a “Finance Measure Checklist for Success” (see Tables 14 and 15) that outlines five steps for victory. A school district can fund and coordinate four of the five steps with public resources. Only the fifth and final step requires the district to “step away” from explicit political campaigning and pass primary responsibility to a separate political entity, such as a Political Action Committee.

By the time the “partisan campaign” begins, the community college district or K-12 school district has spent a year or longer obtaining polling data, alerting voters directly and through the news media to the need for school construction, and refining campaign themes and messages. A taxpayer-funded effort to pass it has been well underway, without a cent of money raised or spent by a campaign committee. Already the proponents have an advantage over any opposition to the bond measure.

Comparing the Election Campaigns of Supporters and Opponents

There is an existing network of professional political consultants who are experienced in establishing a campaign committee, collecting corporate campaign contributions, and communicating with voters using an effective message developed from the results of the district’s feasibility study. Political campaigning is a business, and fierce competition forces consulting firms to build and maintain a reputation for winning. Meanwhile, professional campaign vendors are ready to design, print, and mail campaign material. Endorsements can be quickly obtained from political, business, and community leaders. Participants in phone banks and precinct walkers can be recruited and even paid if a financial incentive is necessary.

In addition, potential district contractors are able to promote school bond measures through California’s Coalition for Adequate School Housing (C.A.S.H.), whose membership “contains over 1,500 school districts, county offices and private sector businesses, including architects, attorneys, consultants, construction managers, financial institutions, modular building manufacturers, contractors, developers, and others that are in the school facilities industry…C.A.S.H. has sponsored or supported over $52 billion in statewide school bonds to build and/or modernize thousands of schools.”

Contrast this to the typical opposition to a bond measure. Often there aren’t any formal opponents. Sometimes the opposition consists of a few individuals known in the community as gadflies or anti-tax or libertarian activists. Opposition can gain more credibility if there is an existing local community or taxpayer organization that provides a formal forum for fiscal critics to meet and strategize. That organization is almost always more effective if it employs full-time professional staff responsible to a board of directors.

Proposition Z for Zombie Tax San Diego United School District 2012In rare cases there is a well-funded opposition campaign backed by local business leaders and interest groups and run by professional political consultants. One example of this was opposition to Measure Z for the San Diego Unified School District in the November 2012 election.

Potential opponents must regularly monitor local news sources and the meeting agendas of local educational districts to know when an elected governing board is considering a bond measure and passes a resolution putting a bond measure on the ballot. Sometimes the board does this immediately before the legal deadline, thus providing very little time for opponents to respond before the election.

Concerned parties must meet to consider the bond measure and determine an appropriate position. Someone needs to know or obtain the various laws concerning the submission of an opposing argument in the ballot pamphlet, and someone needs to write the opposing argument and go through the process of getting group approval of the text. It needs to be submitted on time and in compliance with often-technical legal requirements. A few people in the organization must volunteer to write commentaries or letters to the editor of the local newspaper, and then follow through with the promise. Some people may chip in some money from their small businesses or personal savings to order some lawn signs, which have to be designed, approved, printed, and distributed.

Nonetheless, bond measures do fail almost 20% of the time despite the organizational and financial advantages of supporters. A 2003 report from the Public Policy Institute of California noted that big urban school districts in the San Francisco Bay Area and the Los Angeles area with high numbers of registered Democrat voters tended to propose more bond measures and win voter approval of those bond measures more often that smaller districts in rural areas, such as the Central Valley. This pattern appears to continue through 2014.

In some large urban school districts in California, especially in the San Francisco Bay Area, bond measures always win easily and opposition seems futile. As long as these districts don’t propose bonds too frequently, they rarely have to worry about opposition.

Top Donors Are Current or Potential Contractors for Finance and Construction

Generally, the public has poor access to records concerning the contributions to and expenditures of campaigns to pass bond measures. In some counties the campaign forms must be obtained in person and are provided as photocopies. Other counties have electronic databases that simply link to scanned documents. Trying to compile or analyze campaign finance patterns would be a tedious undertaking.

Nevertheless, compilations of contributors to four campaigns to pass five bond measures in November 2012 suggest that what is commonly assumed is accurate: these campaigns are mostly funded by companies likely to earn money from the proceeds of those bond sales.

Table 16: Categories of Major Donors to Campaigns to Pass Bond Measures
Construction management firms
Law firms involved with bond sales
Architectural firms
Engineering firms
Construction contractors
Construction trade unions
Union-affiliated labor-management committees
Bond underwriters
Community college foundations (for community college bond measures)
Charter school advocacy groups

Community College Foundations Entangled in Controversy

A 2005 opinion of the California Attorney General (also referenced above in relation to bond underwriters and campaigns) determined that a community college district’s auxiliary organizations (such as foundations and student body associations) are legally able to contribute their own privately raised funds to a political action committee established specifically to advocate voter approval of a bond measure. It is routine to see community college foundations contributing to bond campaigns. Like any 501(c)3 non-profit, college foundations are permitted to spend up to 20% of expenditures for influencing legislation, and that includes bond measures.

Controversy arose about this practice in 2004 after the Sierra College Foundation contributed about $100,000 to three bond measure campaigns for the Sierra Community College District. Neither the Political Action Committees nor the Sierra College Foundation reported the contributions to the California Fair Political Practices Commission.

At least two board members alleged that the college president, who estimated making 40 presentations to groups of prospective donors, had tried to hide the identities of contributors to the bond measure campaigns (including architects and engineering firms) using the Foundation as an intermediary. These board members also believed that people interested in contributing to the bond campaign were advised to make their contributions to the Foundation instead of the bond measure campaign committee in order to benefit from a tax deduction. The Placer County Civil Grand Jury ended up concluding there wasn’t any reliable evidence to support these accusations against the college president, but the incident exposed some of the potential problems with college foundations acting as a intermediary to fund campaigns to pass bond measures.

Alleged “Pay-to-Play” by Some Bond Underwriters Gets Attention

In the spring of 2012, there was a flurry of news media attention about some bond underwriters making contributions to campaigns for bond measures and subsequently making money through issuance fees as the underwriter for the bond sales. The news article that broke the story reported the following:

Leading financial firms over the past five years donated $1.8 million to successful school bond measures in California, and in almost every instance, school district officials hired those same underwriters to sell the bonds for a profit, a California Watch review has found. The practice is especially pronounced in California, where underwriters gave 155 political contributions since 2007 to successful bond campaigns for school construction and repairs.

Under an amendment to Rule G-37, adopted in 2010, the Municipal Securities Rulemaking Board (MSRB) requires each broker, dealer or municipal securities dealer to send a form quarterly to the MSRB reporting their contributions to bond ballot campaigns if those contributions exceeded $250. These contributions do not prohibit brokers from doing business with the entity proposing the bond measure, but the reporting requirements allow the public to identify these contributions as part of any effort to cross-reference them with contracts. Other rules prohibit brokers from doing business with entities if they have made campaign contributions to entity officials who make decisions related to selecting brokers for bond issues.

In 2009, the MSRB considered toughening Rule G-37 to prohibit brokers from doing business with government entities if those brokers contributed to campaigns to pass bond measures proposed by those government entities. California was cited as a particularly notorious location for the appearance of “pay-to-play” relationships. In the end, the MSRB declined to change the rule, citing constitutional First Amendment concerns.

The Bond Buyer reviewed broker contributions to 2010 campaigns to pass bond measures in California and identified “a nearly perfect correlation between broker-dealer contributions to California school bond efforts in 2010 and their underwriting subsequent bond sales.” A spokesperson for California State Treasurer Bill Lockyer responded to the review: “…it is probably time to end the days when underwriters, bond counsels or financial advisors fund, manage or provide other key support for local bond campaigns, then get paid to do work on the bond sales.” In 2013, the Los Angeles County Treasurer and Tax Collector Mark Saladino adopted “a complete ban on cash and in-kind contributions from all firms in our underwriter pool starting no later than when we renew our pool for another year in January 2014.”

Sources

“Opinion No. 04-211,” Legal Opinions of the Attorney General, April 5, 2011, accessed June 28, 2015, oag.ca.gov/system/files/opinions/pdfs/04-211.pdf

Win Win: An Insider’s Guide to School Bonds, Dale Scott & Company, accessed June 28, 2015, www.dalescott.com/dscpublishing

“School District Services,” Fairbank, Maslin, Maullin, Metz & Associates (FM3), accessed June 28, 2015, www.fm3research.com/services/School_District_Services

“Public Opinion Research for Today’s School Districts,” Godbe Research, accessed June 28, 2015, www.godberesearch.com/level2/pdf/School_BR_2006.pdf

“Approve TBWB Strategies/EMC Research Consulting Proposal to Conduct a Parcel Tax Feasibility Study (Phase 1 Only),” Soquel Union Elementary School District November 7, 2012, accessed June 28, 2015, www.soqueldo.santacruz.k12.ca.us/board_agendas/board_packet110712.pdf

“Finance Measure Checklist for Success,” Lew Edwards Group, accessed June 28, 2015, www.lewedwardsgroup.com/services/finance-checklist.html

California’s Coalition for Adequate School Housing (C.A.S.H.) www.cashnet.org

“Tax Group to Oppose San Diego School Bonds,” San Diego Union-Tribune, September 5, 2012, accessed June 28, 2015, www.utsandiego.com/news/2012/sep/05/tax-group-to-oppose-prop-z/

“Fiscal Effects of Voter Approval Requirements on Local Governments,” Public Policy Institute of California, January 27, 2003, accessed June 28, 2015, www.ppic.org/content/pubs/report/R_103KRR.pdf

Tables of contributors to campaigns to pass bond measures in the November 2012 election for Sacramento City Unified School District (Measures Q and R), Solano Community College District (Measure Q), West Contra Costa Unified School District (Measure E), and San Diego Unified School District (Measure Z) are provided on various posts of www.LaborIssuesSolutions.com

“Opinion No. 04-211,” Legal Opinions of the Attorney General, April 5, 2005, accessed June 28, 2015, oag.ca.gov/system/files/opinions/pdfs/04-211.pdf

“Final Report: Refutation of Trustee’s Charges Against Former Sierra College President,” Placer County Civil Grand Jury, March 21, 2006, accessed June 28, 2015, www.placer.courts.ca.gov/grandjury/2005-2006/2005-2006-gjfinalreport.pdf

With Campaign Donations, Bond Underwriters Also Secure Contracts,” California Watch, May 12, 2015, accessed June 28, 2015, californiawatch.org/money-and-politics/campaign-donations-bond-underwriters-also-secure-contracts-16032

“Rule G-37: Political Contributions and Prohibitions on Municipal Securities Business,” Municipal Securities Rulemaking Board, accessed June 28, 2015, www.msrb.org/Rules-and-Interpretations/MSRB-Rules/General/Rule-G-37.aspx

“Brokers’ Gifts That Keep Giving,” The Bond Buyer, January 13, 2012, accessed June 28, 2015, www.bondbuyer.com/issues/121_10/california-broker-dealer-contributions-school-bond-issue-1035266-1.html

“Proposed Underwriter Pool Changes” Los Angeles County Treasurer and Tax Collector, August 8, 2013, accessed June 28, 2015, http://ttc.lacounty.gov/proptax/docs/Underwriter%20Pool%20Memo.pdf

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More Trouble with Bond Finance for Educational Construction (Section 8 of 9)

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
More Borrowing for California Educational Construction in 2016 (2 of 9)
Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
How California School and College Districts Acquire and Manage Debt (4 of 9)
Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
The System Is Skewed to Pass Bond Measures (7 of 9)
You are here: More Trouble with Bond Finance for Educational Construction (8 of 9)
Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
Guide to all Tables and Appendices – Comprehensive Reference for Researchers


More Troubling Issues with Bond Finance for Educational Construction

While compiling the comprehensive information provided in this study, California Policy Center researchers identified numerous other troubling aspects of bond finance. School and college districts are evading compliance with the law and making irresponsible decisions. Ordinary voters lack enough data to make an informed vote. Community activists who seek deeper understanding find themselves stymied.

Bad Government Behavior

1. Some School and College Districts Don’t Comply with Proposition 39

Two examples of investigative reports on educational district compliance with Proposition 39 are the San Diego County Taxpayers Association 2015 School Bond Transparency Scorecard and a 2010 San Mateo County Civil Grand Jury report entitled “School Bond Citizens’ Oversight Committees, Prop 39.” These reports show some districts are close to full compliance while others don’t seem to be complying at all. It appears that two types of districts are broadly failing to comply: (1) small school districts, which may have limited capability to comply, and (2) large school districts routinely accused of fiscal irresponsibility and mismanagement.

2. Spend It Or Lose It? Districts Can Sell Bonds Decades After Voter Approval

Some school and college districts ask voters to approve new authority to borrow additional money for facilities construction even though much of the authority from previous bond measures to borrow money has not been used. This is a strategy to circumvent tax and debt limits imposed by state law on individual bond measures, and it leaves millions (and sometimes billions) of dollars in borrowing authority dangling for future school boards to exercise long after voters have forgotten the election.

3. Districts Sell Bonds at a Premium and Use the Extra Money to Pay Fees Related to Selling the Bonds

The California Attorney General’s office is preparing a legal opinion (14-202) on whether school and college districts can use a premium to pay bond issuance fees. The question asked is “May the ‘premium’ generated from a school district bond sale be used to pay for expenses of issuance and other transaction costs?” (See Table 8 for a list of such fees.)

In 2011, the California Attorney General warned the Poway Unified School District that “artificially inflating the interest rate to generate premium” to pay for costs of issuance would be illegal.

The California State Treasurer or a state agency needs to compile a list of bond issues for which buyers paid a premium that the district then used to pay bond issuance fees. How rampant is the practice and how much has it cost California taxpayers?

4. Firms Get Contracts to Prepare a Bond Measure Before the Election and Then Get Contracts to Implement the Bond Measure After the Election

The California Attorney General’s office is preparing a legal opinion (13-304) on whether a party that gets a contract with a school or college district for surveying voters and preparing a bond measure can then get a contract as the bond underwriter (bond broker) for issuances approved by that same bond measure. The question asked is “In connection with a school or community college bond measure, does a district violate state law by contracting with a bond underwriter for both pre-election campaign services and post-election underwriting services?”

5. Is There Exaggeration, Deception, or Outright Fraud When Districts Assess Needs for Another Bond Measure?

Some school and college districts seek to borrow more money for school construction even when their enrollment has been substantially declining for years and is projected to continue declining. Overcrowding would not seem to be a problem in such districts. Is the need legitimate?

A state agency should conduct random audits for several school or college districts to determine the credibility of their facilities plan based on their evaluations of safety, class size reduction and information technology needs. Numerous bond measures include the words “safety” and “security” in the ballot question and statement, insinuating to voters that students and teachers may be physically harmed unless the district can borrow money via bond sales for construction projects. Are there truly legitimate threats to safety and security in schools throughout the state?

6. A Handful of Voters in Future Development Areas Have Given School Districts Massive Authority to Sell Bonds and Put the Bills on Future Residents

When researchers for the California Policy Center developed preliminary charts now in the appendix to this report and began circulating them publicly early in 2015, two bond measures received unexpected attention on the list of 1,147 considered since enactment of Proposition 39.

In both of these cases, a school district created the boundaries of a School Facilities Improvement District — carved out of the entire district — in a sparsely-populated where future development will occur and future schools will be built.

Apparently the Folsom-Cordova Unified School District compared this option to the establishment of a Community Facilities District funded by Mello-Roos fees and chose this financing option. Its Improvement District had a population in 2006 of about 330 persons.

Table 17: Bond Measures Approved by a Handful of Voters for Huge Amounts
Educational DistrictFolsom Cordova Unified School District SFID No. 3Roseville Joint Union High School District SFID No. 1
Amount Authorized to Borrow$750,000,000$115,000,000
Date of Election2007-03-272007-04-24
CountiesSacramentoPlacer
MeasureMA
Needed to Pass66.7%66.7%
Yes6011
No141
Total7412
Passage81.1%91.7%
Amount Per Vote$12,500,000$10,454,545

Shortcomings That Hinder Voters

The California legislature recognizes that some ballot statements for bond measures do not contain enough relevant information for voters. In 2014, Governor Brown signed into law Assembly Bill 2551, introduced by Assemblyman Scott Wilk, which requires each bond issue proposed by a local government to include estimates from official sources of tax rates for certain years, the maximum annual tax rate, and total debt service (the principal and interest that would be required to be repaid if all the bonds are issued and sold). The bill never received a vote in opposition. In 2015, Assemblyman Jay Obernolte introduced Assembly Bill 809, which requires the ballot statement for local tax measures to include information on the amount of money to be raised annually and the rate and duration of the tax to be levied. As of July 13, 2015, the bill was moving through Senate committees after passing the Assembly 57-8 (with 15 not voting).

1. Ballot Questions and Statements Aren’t Useful to the Ordinary Voter

A 2009 Little Hoover Commission report on bond measures noticed the lack of “fundamental criteria for ballot measures” and recommended a “simple, easy-to-understand report card in the voter guide for all bond measures placed on the ballot.” The problem continues unabated today.

Bond measures tend to be presented to voters in a vacuum, with minimal context about the past history of the district’s bond measures and construction programs. Voters can misinterpret proposed bond measures as a desperate response to a long-standing unaddressed crisis of unsafe, decrepit, and overcrowded classrooms, laboratories, and athletic facilities.

Voters need a chance to consider whether they should approve millions or even billions in new bond authority, even if millions or even billions of money has already been borrowed and millions or billions in existing authority still remains to be spent. This would reveal any history of foolish bond issues or debt acquisition.

2. Information Provided to Voters Needs More Pictures, Charts, and Tables

As mentioned in Section 5 of this report, a possible reason why the public finally discovered the extreme Capital Appreciation Bond financing arrangements of the Poway Unified School District was the simple and colorful graphics in the Voice of San Diego articles about it. More than ever, American society depends on imagery, charts, and tables for information instead of prose.

3. Voters Need to See the Importance of Assessed Property Valuation and District Enrollment Projections

Projections of the rate of change for assessed property valuation in the district should be among the most important elements in decisions concerning bond issues. Voters need to consider a history of wild swings in assessed property valuation in the district and decide whether projections are realistic or exaggerated.

A report on Capital Appreciation Bonds from the 2013-2014 Orange County Grand Jury recognized “there has been virtually no publicity concerning the implications of debt service repayment for CABs, specifically the magnitude of potentially higher taxes. There is potential for some school districts, through the County, to increase property taxes well beyond what was presented when the bonds were issued in order to repay the CABs.” Results of the Grand Jury’s investigation were depicted in tables. At least three school districts in Orange County predicted assessed property valuation to grow at unrealistically high rates when they asked voters to approve bond measures. As a result, these districts will have to levy tax rates far beyond what was portrayed to voters in order to pay off the Capital Appreciation Bonds.

In addition, voters need to be aware if the school or college district asking to borrow money for construction is experiencing a long-term trend up or down in student enrollment. There are arguments for borrowing a lot of money for facilities construction during a time of dropping enrollment (Wiseburn Unified School District is an example of this deliberate strategy), but the message to voters needs to reflect actual circumstances.

4. Ballot Questions for Bond Measures Deceive and Manipulate Voters

Several ballot questions for proposed community college bond measures have specifically singled out veterans as beneficiaries. As noted in Section 2, polling shows that voters respond positively to the idea that a bond measure will help veterans. As a result, the possibility that veterans will be using facilities funded by bond proceeds gets prominent mention in ballot language.

On June 29, 2015, the Solano County Grand Jury issued a report highly critical of the ballot title and ballot statement for Measure Q, a November 2012 ballot measure that authorized the Solano Community College District to borrow $348 million for construction by selling bonds to investors. The Grand Jury asserted that voters were duped into thinking that proceeds from selling bonds would directly provide classroom instruction and job training for veterans and other students. It suggested that future bond measures conform narrowly to Proposition 39 language and focus on construction of educational facilities:

Finding 1

The language of Measure Q was misleading. While Proposition 39 generally authorizes funding of buildings and land purchases even the name of the measure, “The Solano Community College District Student/Veterans’ Affordable Education Job Training, Classroom Repair Measure,” suggests otherwise.

Recommendation 1

Language used in future school bond proposals be limited to that which is stated in the authorizing statute.

References to veterans is an example of how campaign consultants have developed ballot titles, questions, and summaries that manipulate the emotions of uninformed voters who are looking at a ballot and deciding how to vote. Another example is the claim that “all funds stay local” or “all funds benefit neighborhood schools.” This statement ignores how taxpayers will pay the financial services industry for issuance fees and may end up providing more funds for interest payments to wealthy bond investors than for principal spent on design and construction of neighborhood schools.

These clever campaign tactics would probably withstand legal challenges based on California Elections Code Section 9509, which establishes a standard for a legitimate challenge to a title, question, or statement of a school or college district ballot measure. A complaint must have “clear and convincing proof that the material in question is false, misleading, or inconsistent” with state law.

Grassroots Activism on Bond Measures Is Difficult

1. Municipal Finance Is Confusing, Even for People Motivated to Understand It

As stated in a 2013-14 Orange County Civil Grand Jury report on Capital Appreciation Bonds, “This topic required extensive research. Numerous newspaper articles were reviewed…An extensive Internet search was conducted to learn about the mechanics of bond financing and the related mathematics.” An ordinary person may have difficulty understanding concepts and jargon of municipal finance. It’s also a challenge for anyone without education or experience in accounting to identify and extract relevant information from financial audits and official statements.

In particular, Capital Appreciation Bonds are difficult to comprehend. To complicate matters, accreted interest for this type of debt instrument is portrayed differently depending on whether accounting is done on a “cash basis” or on an “accrual basis.” In the generally accepted accounting principles developed by the Financial Accounting Standards Board, each year’s interest payment is included as an expenditure for the year. This is accounting done on a cash basis. But in the generally accepted accounting standards for state and local governments developed by the Governmental Accounting Standards Board, accreted interest on Capital Appreciation Bonds is not recorded as a current expenditure until the bond matures. This is accounting done on an accrual basis.

Translating these concepts into something easy to understand is critical for the public to evaluate the wisdom of proposed bond issues.

2. Centralized Data Isn’t Available to Compare Debt Finance Conditions of School and College Districts

Where does the public go to find out how a school or college district funds facility construction and how it compares to other educational districts in the county or state?

In most cases, state law has not assigned any state or local agency with the responsibility to collect such information and provide it to the public in an accessible format. Even for information that state law requires to be collected and published — such as waivers from tax and debt limits — agencies are not providing the information in a way that alerts the public to existing or potential problems.

The California State Treasurer’s office has a “California Debt Issuance Database” administered by the California Debt and Investment Advisory Commission that allows the public to search for certain information about individual bond issues. School boards are required to submit certain information and reports regarding the sale or planned sale of bonds to the California Debt and Investment Advisory Commission. This database is better than nothing, but realistically it is not a useful tool for the ordinary citizen.

3. Basic Financial Information Is Inaccessible, Especially at Smaller School Districts

Many school districts are not posting their state-mandated financial reports on their websites for public access. Useful documents that the public should be able to readily access include PDF versions of annual financial audits and bond program audits.

For cases in which financial reports are not available on the web, adequate response to public records requests is often elusive. E-mailed requests to educational districts to get these reports do not always result in a prompt response. In particular, officials in small rural school districts do not seem responsive to an outside individual or organization requesting the district’s financial information. Researchers for this project struggled to obtain financial audits that would reveal details of Capital Appreciation Bond sales with ratios of debt service to principal that are much worse than the Poway Unified School District.

4. “Private Placements” Sometimes Eliminate Official Statements as a Source of Data

The Municipal Securities Rulemaking Board (MSRB) Electronic Municipal Market Access (EMMA) database was created and is maintained for the benefit of potential buyers of municipal bonds. Nevertheless, the Official Statements posted on the database are a valuable source of information for members of the general public who are interested in the debt finance and financial status of a state or local government agency.

Some school districts use “private placement” to sell bonds rather than using a more traditional method of selling bonds in the primary market to many investors. This is supposed to allow for lower interest rates on the bonds and save money for taxpayers. Because the individual private investors are considered qualified to do their own research into the credit and financial status of a district, “private placements” for bond sales by educational districts are exempt from the federal requirement to post Official Statements.

Researchers were unable to determine current debt service for several small school districts for which Official Statements were not posted on EMMA. At least two of them (Exeter Union High School District and Columbia Union School District) used private placements for their most recent bond sales. It is likely that every school district missing an Official Statement on EMMA for its most recent bond issue used private placement.

5. Public Information About General Obligation Bonds Varies in Formats and Completeness

In the annual Financial Audits for educational districts, information about general obligation bonds are presented in different ways. Some reports give details about each series of bonds that are issued, while some do not.

The same problem applies to the Official Statements on the EMMA database. Charts that indicate outstanding debt service are presented in different formats. Some charts provide details about principal and interest for each bond measure and some do not. A few Official Statements for educational districts that have substantial bond debt did not even add up the columns.

Official Statements are only produced when bonds are issued, so the most recent information available on the EMMA database can be more than a decade out of date. EMMA only became operational in the late 2000s, so information from the mid-1990s and earlier is often not available.

6. Refunding Bonds and Reauthorization Bonds Complicate Matters

When a school district refunds some of its bonds with a new bond issue, the record becomes fuzzy about how much principal is still owed for each bond measure and bond issue. Some districts have repeatedly issued refunding bonds, thus creating confusion about what bond measures are responsible for creating current debt. Taxpayers in some educational districts are still paying for bond measures approved in the late 1980s and early 1990s, but that fact is now hidden behind more recent refunded bond issues.

Since 2000, sixteen school districts have asked voters to reauthorize previously-approved bond authority, thus complicating the reporting of bond authority and bond debt. When voters reauthorize bond authority in a new election, they trigger new capacity for the district to levy taxes and accumulate debt. GO Reauthorization Bonds®, developed by the municipal debt financial advisory firm Dale Scott & Company, are marketed to districts that have reached their tax and debt limits, want to borrow more money for construction, but also want to avoid extensive sales of Capital Appreciation Bonds as the scheme to circumvent the tax and debt limits.

7. Critical Information Often Can Only Be Found in Old Board Meeting Packets Not Available for Easy Public Access

Perhaps the most important information to evaluate when considering bond issues are the projections of assessed valuation. If such projections are even recorded, they are often only found in presentations that financial advisors make to the board of trustees. Those presentations might or might not be included in old board meeting packets that might or might not be posted on a district website.

Sources

“2015 School Bond Transparency Scorecard,” San Diego County Taxpayers Association, www.sdcta.org/policy/policy-detail.html?id=1727

“School Bond Citizens’ Oversight Committees, Prop 39,” San Mateo County Grand Jury, https://www.sanmateocourt.org/documents/grand_jury/2009/prop39.pdf

“Re: Poway Unified School District v. All Persons Interested – Superior Court of California, County of San Diego, Case No. 37-2010-00106255-CU- MC-CTLAG,” California Attorney General letter to Poway Unified School District, Orange County Government, March 1, 2011, accessed June 28, 2015, http://cams.ocgov.com/Web_Publisher/Agenda11_05_2013_files/images/ATTORNEY%20GENERAL%20OPINION%20-%20POWAY%20BOND%20PREMIUM_9843497.PDF

“Resource Center,” California’s Coalition for Adequate School Housing, accessed June 28, 2015, https://www.cashnet.org/resource-center/resourcefiles/651.pdf

Text – AB 2551 “Local ballot measures: bond issues,” California Legislative Information, accessed June 28, 2015, http://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201320140AB2551

Text – AB 809 “Local initiative measures: ballot printing specifications,” California Legislative Information, accessed June 28, 2015, http://leginfo.legislature.ca.gov/faces/billTextClient.xhtml?bill_id=201520160AB809

“Bond Spending: Expanding and Enhancing Oversight,” California Little Hoover Commission, June 24, 2009, accessed June 28, 2015, http://www.lhc.ca.gov/studies/197/report197.pdf

“School Bonds: The Untold Story of Assessed Values,” Orange County Grand Jury 2013-14, accessed June 28, 2014, http://www.ocgrandjury.org/pdfs/2013_2014_GJreport/BondsReport.pdf

“Former Wiseburn Schools Chief Don Brann Will Take Reins of Troublec Inglewood Unified,” Daily Breeze, June 28, 2013, accessed June 28, 2015, www.dailybreeze.com/general-news/20130628/former-wiseburn-schools-chief-don-brann-will-take-reins-of-troubled-inglewood-unified

“We Have Your Money, Now What?” Solano County Grand Jury 2014-15, accessed June 30, 2015, http://solano.courts.ca.gov/materials/Measure%20Q.pdf

California Elections Code Sections 9500-9509, accessed June 28, 2015, http://www.leginfo.ca.gov/cgi-bin/displaycode?section=elec&group=09001-10000&file=9500-9509

California State Treasurer’s Office – “California Debt Issuance Database” administered by the California Debt and Investment Advisory Commission www.treasurer.ca.gov/cdiac/debtdata/database_text.asp

“How to Kick-Start a Stalled G.O. Bond Program,” Association of Chief Business Officials, May 21, 2013, accessed June 28, 2015, www.acbo.org/files/Conference/2013 Spring/GOReauthorizationBonds.pdf

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Improving Oversight, Accountability, and Fiscal Responsibility (Section 9 of 9)

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
More Borrowing for California Educational Construction in 2016 (2 of 9)
Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
How California School and College Districts Acquire and Manage Debt (4 of 9)
Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
The System Is Skewed to Pass Bond Measures (7 of 9)
More Trouble with Bond Finance for Educational Construction (8 of 9)
You are here: Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
Guide to all Tables and Appendices – Comprehensive Reference for Researchers


Improving Oversight, Accountability, and Fiscal Responsibility

To help fix the many deficiencies identified in this report concerning school construction finance, the California legislature and the executive branch are urged to adopt 23 specific recommendations organized into these five goals:

Five Categories of Recommendations
1Provide Adequate and Effective Oversight and Accountability for Bond Measures
2Enable Voters to Make a Reasonably Informed Decision on Bond Measures
3Eliminate or Mitigate Conflicts of Interest in Contracting Related to Bond Measures
4Reduce Inappropriate, Excessive, or Unnecessary Spending of Bond Proceeds
5Improve Understanding of Bond Measures Through Public Education Campaigns

Adoption of these 23 recommendations will help California voters to become more wary of borrowing billions more from wealthy investors for educational construction. Future generations will benefit when these five visions are advanced:

Five Visions
1Californians will know basic critical information about bonds and the meaning of bond measures. They will know that money from bond measures is borrowed from investors and must be paid back to investors with interest over time through taxes.
2Official election material provided to voters by the government will provide a more objective and balanced perspective of proposed bond measures, including information about the district showing the cumulative history of bond debt and showing changes in annual enrollment and assessed taxable property value.
3Voters will rely less on emotional language and unproven claims engineered by political consultants and focus more on charts, tables, and graphics that give context.
4School and college districts and their bond finance and campaign consultants will be compelled to adjust to a more informed voter pool with more caution, responsibility, and accountability in their proposals to accumulate more debt.
5California voters will use their much clearer understanding about bond measures to reward school and college districts that practice openness, transparency, and fiscal responsibility, while rejecting additional borrowing authority for school and college districts that unwisely borrow and spend money.

The introduction to a 2009 California Little Hoover Commission report entitled Bond Spending: Expanding and Enhancing Oversight claimed that government “must earn Californians’ confidence by demonstrating that it is providing oversight and accountability for the dollars put in their trust and delivering the promised value once a project is completed. Such confidence will be critical to the success of any future bond proposals.”

This warning was not heeded and the prediction was wrong. Oversight and accountability has not measurably improved, but Californians continue to vote for state and local bond measures.

The California Policy Center rejects the idea that additional oversight and accountability isn’t needed or desirable. Some legislative reforms and education programs (both public and private) can overcome voter cynicism, frustration, apathy, and ignorance. The following charts provide 23 recommendations for adoption by the California legislature, California executive branch agencies, and California local officials such as county treasurers.

Specific Recommendations to Achieve Goal 1: Provide Adequate and Effective Oversight and Accountability for Bond Measures
1Expand the statutory responsibilities of the Citizens Bond Oversight Committee to include an annual review of the district’s arrangements for issuing and repaying bonds.
2Assign the California State Treasurer or a state agency to produce an annual report to the legislature and the public about the status of bond measures. The data shall consist of eight categories for every community college district and K-12 school district, presented in a format that allows the public to download some or all data into a common spreadsheet software for easy sorting by type of data.

The name of the school district or college district.
The enrollment or average daily attendance of the district.
The total assessed valuation of the district.
The amount of bond authority approved by voters since 1986.
The amount of bonds issued since 1986.
The amount of outstanding bond authority for the fiscal year immediately proceeding the current year.
The amount of outstanding principal for the fiscal year immediately proceeding the current year.
The total amount of debt service (principal and interest owed over the terms of all outstanding bonds if they are not redeemed early or refunded).

This information should also be printed on a dedicated page of the district’s annual financial report required under Proposition 39. This would make the report more accessible to oversight committee members and other members of the general public who aren’t familiar with balance sheets or accounting principles.
3Require districts to obtain reasonable and informed projections of assessed property valuation from an independent source (NOT from their bond advisors and consultants) before placing a bond measure on the ballot.
4Assign and provide funding to a state agency or agencies for the following activities:

Ensure that every school or college district that administers a bond measure approved under Proposition 39 complies with legal requirements for a bond oversight committee, bond program performance audits, and bond program financial audits, including posting of required information on the district website.
Establish and maintain a centralized web-based database of California bond program performance audits and bond program financial audits for all districts.
Promote bond oversight committees to the public, educate and train bond oversight committee members and relevant district administrators, and provide resources and assistance to school and college districts to fill vacancies on the committees.
5Give a state agency or county official specific authority to block educational districts from selling bonds when their Independent Citizens’ Bond Oversight Committees are dormant or otherwise not compliant with state law.
6Require a school or college district to issue 85% of the bonds authorized by voters within three years after voter approval of the bond measure, and require 100% of the bond proceeds to be spent or redeemed within seven years after voter approval.
Specific Recommendations to Achieve Goal 2: Enable Voters to Make a Reasonably Informed Decision on Bond Measures
1Bond measure ballot titles should be more accurate and objective, perhaps using standard language similar to this that balances construction projects with debt finance plans:

Shall [NAME OF DISTRICT] be authorized to borrow up to [$xxxxx] in the next [x] years for construction, reconstruction, rehabilitation, replacement, furnishing or equipping of specified school facilities by selling bonds and paying the buyers back, with interest, within [xx] years after the bonds are issued?
2To provide proper historical context for the proposed bond measure, ballot statements should provide a table with a tally of each proposed bond measure approved by voters going back to 1987 with the following information:

Amount that voters authorized the district to borrow through bond sales.
Amount of the borrowing authority that still remains to be spent.
Amount of principal that the district still needs to pay back to investors.
Amount of debt service that the district will need to pay back to investors.
3Ballot statements should provide a chart with the history and projections of assessed property valuation for the district:

History:
Each year annually for previous 10 years.
The last two previous five-year periods.
The last previous ten-year period.

Projections:
Each year annually for next 10 years.
The next two five-year periods.
The next ten-year period.
4Ballot statements should provide a chart with the history of enrollment (or average daily attendance) in the district for the previous five years, the most accurate assessment of current enrollment, and the projected enrollment for the next five years.
Specific Recommendations to Achieve Goal 3: Eliminate or Mitigate Conflicts of Interest in Contracting Related to Bond Measures
1All campaign contribution reports for and against bond measures should be available to the public in easily-accessible electronic form on either the district website or the county elections office website.
2Prohibit corporations and individuals that obtain a contract from a district for feasibility studies or consultation on developing a bond measure from also obtaining a contract for services related to bond issuance, including bond underwriting services.
3California statewide officeholders and the California legislature should encourage the Municipal Securities Rulemaking Board (MSRB) to adopt a rule that provides more comprehensive reporting requirements and either restricts or bans the practice of hybrid bond campaign consultants/bond underwriters getting a contract for bond measure preparation and/or campaign services and then getting a contract (sometimes without competitive bidding) for bond underwriting.
Specific Recommendations to Achieve Goal 4: Reduce Inappropriate, Excessive, or Unnecessary Spending of Bond Proceeds
1Local education agencies should be explicitly prohibited from using proceeds from long-term bonds (bonds with maturities exceeding three years) to buy technological equipment such as portable personal electronics (iPads).
2The California Attorney General should issue a legal opinion on some of the ambiguities of “Furnishing and Equipment,” including portable personal electronics, software that comes in a package with electronics, and hiring companies to move furniture from one building to another.
3Bond premiums should not exceed 1% of the principal of the bond series or be used to offset transaction fees or costs of issuance.
4Criteria relevant to construction bond finance should be developed for the California State Board of Education to evaluate when considering applications from school districts for tax and debt waivers. Two grounds for rejecting waiver applications should be excessive indebtedness and insufficient evidence that new facilities are needed.
5A detailed history of tax and debt waiver requests and approvals from the California State Board of Education should be posted on its website.
6Following the 1994 example of Michigan, California school and college districts should be prohibited from issuing Capital Appreciation Bonds. Assembly Bill 182 has not sufficiently discouraged this kind of debt finance.
Specific Recommendations to Achieve Goal 5: Improve Understanding of Bond Measures Through Public Education Campaigns
1The California State Treasurer or another state agency should commission a study to determine if the state’s voters understand a bond measure, including how the government obtains money via borrowing from investors and pays back the money, with interest, over time to those investors by collecting taxes. County treasurers/tax collectors can conduct a similar survey for their counties.
2The California State Treasurer or another state agency should consider seeking funding for the development and implementation of a non-partisan public education campaign to increase voter knowledge about bond measures and public debt related to bonds. The funding could be appropriated in the state’s general fund or received as a contribution from foundations or other private sources. County treasurers/tax collectors can do the same on a county basis.
3The California State Treasurer should use the position to warn the public to be thoughtful and cautious about how much debt is being imposed on future generations — our children and grandchildren — through excessive borrowing and extreme methods of debt finance such as Capital Appreciation Bonds. County treasurers/tax collectors can do the same on a county basis.
4Information about bonds and bond measures should be added to the suggested “Financial Literacy and Mathematics Education” component of the California Department of Education Curriculum Frameworks.

###

Table A-2 California Community College District Enrollment Fall 2014 Ranked by Number of Students

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
More Borrowing for California Educational Construction in 2016 (2 of 9)
Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
How California School and College Districts Acquire and Manage Debt (4 of 9)
Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
The System Is Skewed to Pass Bond Measures (7 of 9)
More Trouble with Bond Finance for Educational Construction (8 of 9)
Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
You are in this section: Guide to all Tables and Appendices – Comprehensive Reference for Researchers


Table A-2California Community College DistrictEnrollment Fall 2014
Ranked by Number of Students
RankDistrictTotal
1Los Angeles Community College District151,141
2Los Rios Community College District73,093
3San Diego Community College District71,704
4North Orange Community College District56,215
5Rancho Santiago Community College District55,022
6San Francisco Community College District46,734
7Coast Community College District43,150
8South Orange County Community College District38,727
9Foothill Community College District37,639
10State Center Community College District36,854
11Riverside Community College District35,889
12Contra Costa Community College District35,393
13Mt. San Antonio Community College District35,280
14Ventura Community College District33,350
15Santa Monica Community College District32,166
16Pasadena Community College District29,545
17Peralta Community College District28,605
18Sonoma Community College District26,288
19Kern Community College District26,190
20Grossmont Community College District26,085
21Palomar Community College District25,989
22San Mateo Community College District24,927
23Long Beach Community College District24,889
24El Camino Community College District24,263
25Cerritos Community College District24,053
26Chabot-Las Positas Community College District21,717
27Chaffey Community College District20,226
28Yosemite Community College District20,216
29Santa Barbara Community College District20,155
30Southwestern Community College District19,917
31Glendale Community College District19,502
32West Valley Community College District18,967
33Sierra Community College District18,635
34San Bernardino Community College District18,519
35San Joaquin Delta Community College District17,864
36San Jose Community College District17,859
37Santa Clarita Community College District17,344
38Rio Hondo Community College District17,059
39MiraCosta Community College District16,175
40Mt. San Jacinto Community College District15,925
41Antelope Community College District14,460
42Cabrillo Community College District13,444
43Allan Hancock Community College District13,211
44Citrus Community College District13,101
45Butte Community College District12,824
46Victor Valley Community College District11,432
47Merced Community College District11,072
48Ohlone Community College District11,065
49Sequoias Community College District10,908
50Desert Community College District10,782
51Solano Community College District9,718
52Hartnell Community College District9,628
53San Luis Obispo Community College District9,533
54Yuba Community College District9,082
55Shasta Tehama Community College District8,475
56Monterey Community College District8,464
57Imperial Community College District8,067
58Compton Community College District7,716
59Napa Community College District6,583
60West Hills Community College District6,429
61Marin Community College District6,418
62Gavilan Community College District6,298
63West Kern Community College District5,051
64Redwoods Community College District4,797
65Mendocino Community College District3,830
66Palo Verde Community College District3,266
67Lake Tahoe Community College District2,521
68Siskiyous Community College District2,420
69Lassen Community College District2,194
70Barstow Community College District1,970
71Copper Mountain Community College District1,818
72Feather River Community College District1,705
TOTAL1,571,553

Analyzing the Cost and Performance of LAUSD Traditional High Schools and LAUSD Alliance Charter High Schools

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Summary:  This study examines cost-per-pupil for high school students in the Los Angeles Unified School District (LAUSD), comparing its traditional public schools to those attending its largest charter school network, the Alliance College Ready Public Schools. It also examines the educational achievement outcomes for traditional and charter high school students, focusing on nine LAUSD traditional schools and nine LAUSD Alliance charter schools. The schools were chosen because of their close proximity to each other and similar demographic makeup, limiting extraneous variables from corrupting the study, and making for as close to an “apples-to-apples” comparison as is possible. 

Charter schools have a lower cost per pupil than traditional schools:  Based on an analysis of relevant school costs and the number of enrolled high school students, the data shows the per pupil per pupil costs for Alliance charter high school students to be $10,649 per year, compared to $15,372 per year for students at traditional public high schools within LAUSD, that is, we find a per pupil cost differential of 44% in favor of Alliance charter schools.

Charter schools have higher API scores and graduation rates than traditional schools:  Academically, comparing LAUSD Alliance charter high schools to LAUSD traditional high schools located in the same neighborhoods, we found the Alliance schools have decisively higher API scores, 762 vs. 701, and higher graduation rates, 91.5% vs. 84.1%.

Charter schools have higher normalized SAT scores than traditional schools:  With respect to SAT scores, when we normalized the comparison between the LAUSD Alliance charter and LAUSD traditional schools under consideration to equalize the rate of test participation, we found that the Alliance charter students outperformed the LAUSD traditional students with average scores of 1417 vs. 1299 – a significant difference. Among college bound students, an SAT score of 1299 puts the student in the bottom 27% nationally. A score of 1417, by contrast, places the student at 41% nationally.

We have reached these conclusions by collecting district and school level data, and making common-sense adjustments where appropriate, and as noted in the text. Throughout this report, and especially in the footnotes, we have explained and documented our sources and calculations. We invite other researchers to conduct similar analysis and believe they will come to similar conclusions.

The academic comparisons we have made involve 18 high schools, nine LAUSD Alliance charter high schools, and nine LAUSD traditional high schools. Our financial comparisons are somewhat broader in scope – involving the cost per high school pupil attending one of the largest public school districts in the nation and those attending a large charter school system.

We can conclude from this data that an effective charter school operator can better learning outcomes at lower cost than traditional public schools serving a similar population. Ultimately, this finding supports the educational choice concept: by replacing a “one size fits all” solution with an array of educational choices, we can provide better results for California’s children and taxpayers.

INTRODUCTION

The purpose of this study is to help assess to what extent charter schools have the potential to provide a higher quality, more cost-effective educational solution for California K-12 students over traditional schools, particularly those in low income communities. Our study is not meant to provide a comprehensive assessment of the comparative quality of all traditional public schools vs. all public charter schools, but rather to focus on high school education in one of the most challenging parts of California for delivering quality educational outcomes, the low income communities of Los Angeles.

The students in these communities fall within the Los Angeles Unified School District (LAUSD). The charter schools we selected for analysis are part of the Alliance College Ready Public Schools (Alliance), a nonprofit company that operates 26 charter middle schools and high schools, all of them part of LAUSD, and most of them located in south-central Los Angeles. The first section of this study will analyze the per pupil costs for LAUSD traditional schools vs. LAUSD Alliance charter schools.

The second section of this study will analyze the educational performance of LAUSD traditional schools vs. LAUSD Alliance charter schools. We will look at SAT scores, API scores, dropout rates, and rates of college admission. A critical element of this analysis will be to reduce the data for LAUSD to those traditional schools that are in the same neighborhoods as the LAUSD Alliance charter schools. A district-wide LAUSD performance score would be distorted upwards by (1) the performance in many of the wealthier neighborhoods in the San Fernando Valley and elsewhere, and by (2) the upward skew represented by the presence of the three charter school operators within LAUSD (many of them in wealthier neighborhoods), enrolling nearly 40,000 students in 59 senior high schools [1], since they are formally part of LAUSD.

PREVIOUS STUDIES OF PER PUPIL COSTS

As Tom Rutten and Richard Riordan argue in a 2013 Los Angeles Daily News column entitled “The mysterious case of LAUSD’s finances,” LAUSD per pupil spending estimates vary widely [2]. They quote a district “baseline” estimate of $7,000, going on to discuss how that baseline is supplemented by numerous earmarked funds and categorical grants aimed at various segments of the student population.  And at the other extreme, Adam Schaeffer, in a 2010 Cato Institute study entitled “They Spend WHAT? The Real Cost of Public Schools,” reported that the “real” cost of public education per pupil at LAUSD was $25,208 [3].

We believe that Schaeffer’s number is overstated for three reasons. The first factor is the simple passage of time. His estimates were based on 2008 data. Between the 2008-2009 school year and the 2013-2014 school year, authorized expenditures in the LAUSD budget fell from almost $18 billion [4] to just over $13 billion [5]. Although part of this reduction can be attributed to declining enrollment, much of it is due to state spending cuts in the aftermath of the Great Recession that are just now being reversed. Second, Schaeffer uses authorized budget figures rather than actual expenditures. As we will see in the next section, LAUSD spends far less than its budgetary authority, and so it is more accurate to use actual instead of budgeted amounts. Finally, the budget figures referenced by Schaeffer includes some double-counting as we also discuss below.

Perhaps the closest thing we have to an official number is the 2013-14 “Current Expense per ADA” reported by the California Department of Education [6], which is $10,442. ADA stands for Average Daily Attendance which means the number of students marked “present” at all LAUSD’s schools on an average day. ADA is less than enrollment because some students are absent on any given day. To us, enrollment seems to be a more appropriate denominator for a cost per pupil calculation. If a student is absent 18 days during a 180-day school year, the district is still educating a student – and not nine-tenths of one.

On the other hand, “Current Expense” does not include all the costs school districts incur. Among the items excluded from current expense are facilities construction and retiree health benefits [7]. Since schools require buildings and teachers unions often demand post-employment benefits, public education cannot be provided by LAUSD without these types of expenditures. We thus find that both the numerator and denominator of the “Current Expense per ADA” are understated if the purpose is to calculate the cost of educating a single pupil.

In the analysis that follows, we use fully loaded numerators and denominators, finding that the two alterations largely cancel out. However, as will be seen, further adjustments needed to make LAUSD’s costs comparable to those of Alliance, significantly raise our LAUSD cost per pupil estimate.

PER PUPIL COSTS FOR LAUSD TRADITIONAL VS. CHARTER

In this section, we estimate per pupil costs for LAUSD traditional vs. Alliance charter. Because LAUSD is a complex entity and because we wish to fully justify our calculations, this section is quite long. While we believe policy specialists will find this discussion rewarding, more casual readers may wish to skip to the end of this section to see our bottom line.

As discussed in the previous section, cost analysis is more properly based on actual expenditures in audited financial statements rather than on budgets. Actual expenditures may vary substantially from budgeted amounts in either direction. In the case of LAUSD, the budget total substantially overstates actual expenditures.

For the fiscal year ending June 30, 2014, LAUSD’s budget (available at http://laschoolboard.org/sites/default/files/LAUSD2013-14FinalBudget.pdf) shows total authorized amounts of just over $13 billion [8]. This contrasts with actual expenditures of less than $8 billion [9] in the district’s audited financial statements. The audited statements are included in the district’s Comprehensive Annual Financial Report (CAFR) available at http://emma.msrb.org/EA696060-EA545171-EA941437.pdf.

This large discrepancy between the budget and audited financial statement amounts has two main causes. First, the budget total double-counts over $1 billion of Internal Service Fund expenditures. Quoting from page 19 of the budget:

Internal Services Funds, which total approximately $1.08 billion, account for the payment of employee health & welfare benefits, workers’ compensation, and liability insurance. These funds are for accounting purposes as required by State law. They serve as “pass-through” accounts. In other words, the $1.08 billion in expenditures here already show up in other funds, and to count them in addition to the other funds would be counting them twice. For this reason, Internal Service Funds should not be considered as part of the funds that help operate District schools.

Second, actual spending in all major governmental funds was substantially below authorized amounts in the budget. The biggest discrepancy occurred in district capital funds which had total authorized expenditures of $3.2 billion and actual expenditures of $0.7 billion. Operating and debt service funds also saw substantially less spending than authorized [10].

The audited financial statements contain two expenditure totals – one in the Statement of Activities and the other in the Governmental Fund Statement of Revenues, Expenditures and Fund Balances. Although they are not substantially different – $7.98 billion and $7.83 billion respectively – the relatively small discrepancy masks fairly large differences in how they are calculated. These differences warrant our attention.

Expenses in the Statement of Activities are presented according to the accrual basis of accounting while Governmental Fund presentation uses the modified accrual basis – an accounting style that is much closer to the cash basis. Cash accounting focuses on the actual expenditure of funds during the fiscal year, while accrual accounting focuses on the financial obligations accrued by the district during the year.

A reconciliation of the modified accrual and full accrual expenditure totals for LAUSD follows (amounts shown are in thousands of dollars):

Table 1 – LAUSD 2013-14 Expenditure Reconciliation,
Modified Accrual vs. Full Accrual Bases [11]

20150515-CPC_LAUSD-1b

Under the accrual basis, the repayment of bond principal is not considered an expenditure nor are capital outlays. However, the accrual method involves depreciating assets, which largely offsets the absence of capital expenditures.

It may be argued that capital outlays and/or bond principal should be added back to LAUSD’s total. The cost of building facilities is part of the overall cost of education and should not be excluded from per pupil costs. However, including both capital outlays and bond principal repayments in the total would be a form of double-counting, because the capital outlays are made with borrowed funds. The money should be captured either when it is borrowed and spent, or when it is repaid – not both times. Inclusion of the depreciation amount in the accrual expenditures serves the purpose of incorporating capital expenditures. Since LAUSD does not issue pension obligation bonds, virtually all of its borrowing supports capital expenditure. Thus everything financed with LAUSD’s bonds will be depreciated on the district’s books. Inclusion of the depreciation amount thus provides a reasonable proxy for capital expenditure, and we do not see a strong case for altering LAUSD’s accrual accounting expenditures for our calculations.

LAUSD’s accrual basis expenditures also include retiree healthcare benefits that current employees have earned but will not claim until they retire. These OPEB accruals are excluded from the modified accrual totals. Alliance does not offer retiree healthcare benefits – providing it with a significant cost saving relative to LAUSD. (Both LAUSD and Alliance offer pension benefits largely through CalSTRS – so accruals for cash retirement benefits should not be a major differentiating factor between Alliance and LAUSD).

Because Alliance only reports expenditures in accordance with the accrual method of accounting, we use LAUSD’s accrual method expenditure total of $7,967,671,000 for our comparisons. Alliance’s total expenditures for the fiscal year ending June 30, 2014 were $102,789,813 as shown on page 5 of its audited financial statements available at http://emma.msrb.org/ER822375-ER640652-ER1042507.pdf.

LAUSD reports total enrollment of 726,371 on page 157 of its CAFR, yielding a per pupil cost of $10,969. Alliance reports total enrollment of 10,020 students in its 2013-14 performance dashboard available at http://www.laalliance.org/performance/13-14/dashboards/Alliance-wide%20Performance%20Dashboard%202013-2014.pdf, yielding a per pupil cost of $10,258.

Thus, before making adjustments, we find that per pupil expenditures using the accrual basis, are $711 higher for LAUSD traditional than for Alliance charter – a difference of almost 7%. The calculations are summarized below.

Table 2 – Alliance Charter/LAUSD Traditional Expenditure per Enrolled Student Comparison (Initial)

20150515-CPC_LAUSD-2b

LAUSD’s enrollment total of 726,371 includes 95,381 students [12] enrolled in independent charter Schools. However, LAUSD expenditures shown in its financial audit do not include charter school expenses. As noted on page ii of the CAFR: “This report includes all funds of the District with the exception of the fiscally independent charter schools, which are required to submit their own individual audited financial statements”. Thus the 95,381 charter school students should be removed from the denominator of the cost per pupil calculation.We now make adjustments to these reported totals to increase their comparability.

LAUSD provides adult education while Alliance does not. By removing the adult education cost and enrollment from LAUSD data, we can more nearly achieve an apples to apples comparison. LAUSD’s audit reports adult enrollment of 32,267 and adult education costs of $75,993,000 [13].

Similarly, LAUSD provides early education services to pre-kindergarten children and infants. Alliance does not provide similar services. Consequently, we remove 12,829 early education enrollees and $128,407,000 in Child Development Fund expenditures [14] from the LAUSD totals.

In addition to Adult Education, LAUSD offers Career Technical Education (CTE) and Regional Occupational Programs (ROP). These two programs had combined enrollment of 29,779 and a total budget of $43.6 million [15], implying a per-student cost of $1464. The CAFR does not provide actual expenditures for these two vocational programs which are not offered by Alliance. But unless actual expenditures were far greater than budget, the two programs are much less expensive on a per student basis than LAUSD’s traditional K-12 program. Since LAUSD’s actual spending overall was below budget, using budgeted expenditures for the two programs is a conservative approach.

The adjustments made to LAUSD to eliminate enrollees and costs not associated with K-12 traditional public school students are summarized below. The Adult Education and Pre-K expenditure totals are based on the modified accrual accounting method; governmental financial statements do not break down accrual accounting data to the fund level.

Table 3 – Adjustments to LAUSD Amounts to Improve Comparability with Alliance

20150515-CPC_LAUSD-3b

After these adjustments, LAUSD per pupil costs rise to $13,881 or about 35% higher than the Alliance amount.

The adjusted cost comparison is summarized in the table below.

Table 4 – Alliance/LAUSD Expenditure per Enrolled Student Comparison (Adjusted)

20150515-CPC_LAUSD-4b

A further adjustment to these numbers is needed to reflect differences in grade profiles and differences in educational costs between elementary and high schools.

LAUSD and Alliance have substantially different grade profiles, because Alliance does not operate elementary schools. In the 2013-14 school year, all of Alliance students were in grades 6-12. Because most Alliance facilities are high schools, 72% of Alliance students were in grades 9-12 [16]. By contrast, 49% of LAUSD students were enrolled in elementary schools and only 23% were enrolled in high schools [17].

High school education is more expensive on a per pupil basis than elementary school education, largely due to the many extra programs that high schools offer. Although, per pupil costs within LAUSD are hard to obtain, we were able to find comparative data elsewhere[18]. Our review of Texas public school data showed per pupil expenditures averaging $6,654 in elementary schools and $10,323 in high schools [19]. The California Department of Education reports current expense per ADA for elementary and high school districts, i.e. districts which consist of all elementary schools or all high schools, respectively. For 2013-2014, California elementary school districts had an expense of $8,336 per ADA while high school districts had an expense of $9,569 per ADA [20].

This last observation suggests that educating a high school student in California is about 15% more expensive than educating an elementary school student. If we apply this differential to LAUSD and Alliance and if we assume that elementary and middle school students have equivalent costs, we can infer costs per high school student at LAUSD and Alliance from the overall per student costs presented in Table 4 above. The results of this calculation are shown in the table below.

Table 5 – LAUSD Traditional / Alliance Charter Expenditure per Student by Grade Level

20150515-CPC_LAUSD-new5

Taking into account the grade profile and assuming that high school students are 15% more expensive to educate than elementary and middle school students, we find a per pupil cost differential of 44% in favor of Alliance charter.

One other potential adjustment would benefit LAUSD in per pupil cost comparisons. Although we do not have enough data to quantity this adjustment, we describe it here. The issue involves special education students – those who require special accommodations due to various disabilities, and are thus more expensive to educate than children learning in traditional classroom environments.

A recent report on KPCC [21] states that LAUSD has 82,000 special education students and a $1.4 billion special education department budget – implying a per pupil cost of about $17,000. The LAUSD CAFR shows a somewhat lower expenditure amount – $1.318 billion [22] – and does not provide a figure for total special education enrollment [23].

Assuming the 82,000 special education enrollment figure is correct, that number accounts for about 15% of the district’s K-12 enrollment [24]. By contrast, Alliance reports that 9% of its students are in special education [25]. The organization does not break out costs for special education students in its financial reporting.

Thus, we can conclude that a comparison of costs aside from those associated with special education would be more favorable to LAUSD, but it is not clear how large the adjustment would be.

In conclusion, we find that LAUSD spends 44% more to educate each high school student than Alliance, but that a part of this differential may be explained by the greater proportion of special education students at LAUSD.

*   *   *

ACADEMIC PERFORMANCE COMPARISONS

While cost per pupil is a key variable in comparing the effectiveness of differing approaches to public education, it is not the whole story. The quality of various educational solutions, measured in terms of outcomes for students, taking into account various degrees of preexisting adversity faced by the students, forms an essential part of any comparative analysis.

When comparing academic performance in LAUSD traditional high schools vs. LAUSD Alliance charter high schools, district-wide comparisons are easy enough to gather, and offer some insights. But a more meaningful set of comparisons may be derived by presenting academic results between individual LAUSD traditional and LAUSD Alliance charter high schools that are located in close proximity to each other. This is based on the assumption that schools in the same neighborhoods will have student bodies that have similar characteristics, which we will attempt to verify using available data.

Accordingly, we have identified 18 high schools, nine that are part of the LAUSD Alliance charter network and nine that are LAUSD traditional public schools, organized into seven matches, where schools that are in the same neighborhoods are considered to be a match. In four cases, one Alliance charter high school is compared to one traditional high school located in the vicinity. In two cases (#4 and #5 on the list below), there are two traditional high schools that are both located very close to an Alliance charter high school, so both of them are considered. In one case (#3), there are two Alliance charter high schools that are both located very close to a traditional high school; both Alliance schools are considered. The maximum distance for any comparison is 3.4 miles, in most cases the schools being compared are about 2.0 miles apart.

List of LAUSD Traditional and Alliance Charter High Schools in Close Proximity:

(1) Alliance High School, Cindy and Bill Simon Technology High School, 10770 Wilmington Ave., Los Angeles. LAUSD High Schools, 1.6 miles away: South East Senior High, 2720 Tweedy Blvd., South Gate, and, 2.9 miles away, South Gate Senior High, 3351 Firestone Blvd, South Gate.

(2) Alliance High School, Patti & Peter Neuwirth Leadership Academy, 4610 South Main St., Los Angeles. LAUSD High School, 0.7 miles away, Dr. Maya Angelou Community High School, 300 E 53rd St, Los Angeles.

(3) Alliance High School, Collins Family College-Ready High School, 2071 Saturn Ave., Huntington Park. LAUSD High Schools, 2.8 miles away, Bell Senior High, 4328 Bell Ave, Bell, and, Maywood Academy Senior High, 3.3 miles away, 6125 Pine Ave., Maywood.

(4) Alliance High Schools, Environmental Science & Technology High School, 2930 Fletcher Drive, Los Angeles, and, Tennenbaum Family Technology High School, 2050 North San Fernando Road, Los Angeles. LAUSD High School, 2.4 miles and 3.4 miles away, respectively, John Marshall Senior High, 3939 Tracy St., Los Angeles.

(5) Alliance High Schools, Health Services Academy High School, 10616 South Western Ave., Los Angeles, and, Judy Ivie Burton Technology High School, 10101 South Broadway, Los Angeles. LAUSD High School, Middle College High School, 0.8 miles and 2.7 miles away, respectively, 1600 Imperial Highway, Los Angeles.

(6) Alliance High School, Marc & Eva Stern Math and Science High School, 5151 State University Drive, Los Angeles. LAUSD High School, 1.6 miles away, Woodrow Wilson Senior High, 4500 Multnomah St., Los Angeles.

(7) Alliance High School, Media Arts and Entertainment Design High School, 113 South Rowan Ave., Los Angeles. LAUSD High School, 3.2 miles away, James A Garfield Senior High, 5101 E Sixth St., Los Angeles.

Alliance (green) and LAUSD (red) High Schools

20150515-CPC_LAUSD-map1

Demographic Comparisons for LAUSD Traditional and LAUSD Alliance Charter High Schools in Close Proximity

The fact that two high schools are in the same neighborhood doesn’t prove they have a demographically similar student body. Before making academic comparisons it is important to review other variables. The next two tables examine the demographics of the 18 high schools, comparing the Alliance charter high schools to the LAUSD traditional high schools.

As can be seen in Table 6, the ethnic makeup is very similar between LAUSD Alliance charter and LAUSD traditional schools. Both groups of student bodies are 91% Latino. Of the remaining students, the Alliance schools are 5% African American compared with 2% in the Traditional schools, and the traditional schools have slightly more Asian (2% vs. 1%) and White (2% vs. 1%) students compared to Alliance [26].

Table 6 – Ethnic Composition of Alliance vs. LAUSD Students

20150515-CPC_LAUSD-6n

The other primary demographic variables that are relevant when assessing the similarity of student bodies are those that may present challenges to individual students. Using available per high school data, the next table attempts to make this assessment by examining the percentages in each group of schools of students who have learning disabilities, students who are English language learners, and students who are on the free or reduced lunch program (in both LAUSD Alliance and LAUSD traditional the percentage of students on the lunch program who get a free lunch vs. a reduced lunch are around 90%).

As shown in Table 7, LAUSD traditional has slightly more English language learners, at 17% vs. 16%. LAUSD Alliance has more students on the free/reduced meal program, 90% vs. 85%. LAUSD traditional, on the other hand, has significantly more students who are identified as having learning disabilities, 13% for LAUSD traditional vs. 8% for LAUSD Alliance charter.  It is difficult to conclude too much from this data. It would probably be reasonable to conclude that overall the student bodies at these 18 schools are very similar ethnically and demographically [27].

Table 7 – Other Demographic Characteristics of LAUSD Alliance vs. LAUSD Traditional Students

20150515-CPC_LAUSD-7n

Educational Outcomes:  LAUSD Alliance Charter Schools vs. LAUSD Traditional Schools

To evaluate the academic performance of students in LAUSD Alliance charter schools compared to LAUSD traditional high schools located in the same neighborhoods with similar student demographics, we focus on four variables, each school’s rate of attendance, their API (Academic Performance Index) score, the average SAT score per school, and the graduation rate per school.

These comparisons are displayed on Table 8. As can be seen, the reported average attendance at the LAUSD traditional schools, 95%, was nearly identical to the reported average attendance at the Alliance schools, 96%. On the other hand, the LAUSD Alliance schools display a distinct edge in their average API scores, 762 vs. 701, and in their graduation rates, 91.5% vs. 84.1%. With respect to average SAT scores, the raw data for the LAUSD traditional schools actually shows them outperforming the Alliance schools, 1299 for LAUSD vs. 1122 for the Alliance schools [28]. But this bears further analysis.

Table 8 – Academic Performance Indicators, Alliance vs. LAUSD

20150515-CPC_LAUSD-8n

To accurately compare the SAT scores of students in LAUSD Alliance charter schools with those attending LAUSD traditional high schools located in the same neighborhoods with similar student demographics, it is necessary to consider the relative proportions of students taking the test. While the LAUSD traditional students averaged 1299 on their SAT vs. 1122 for the Alliance charter students, outperforming them by 177 points, a much lower percentage of LAUSD traditional juniors and seniors actually took the test. As reported on Table 9, only 31% of the juniors and seniors enrolled in the LAUSD traditional schools took the SAT, vs. 72% of the Alliance charter school students.

To appreciate what an apples-to-apples comparison might reveal, imagine what the average SAT score would be in the LAUSD traditional schools if 72% of the juniors and seniors took the test. In this hypothetical example, also consider the fact that because the LAUSD traditional schools have a drop-out rate of 15.9% vs. 8.5% at LAUSD Alliance, an apples-to-apples comparison would have to actually assume a cohort of juniors and seniors whose numbers have not succumbed to a much higher rate of attrition. Put another way, taking into account attrition, more than 72% of LAUSD’s traditional still-enrolled juniors and seniors would have to take the SAT to properly compare their performance to LAUSD Alliance’s.

While data cannot exist for tests that were not taken, we can achieve something closer to an apples-to-apples comparison by excluding a portion of the LAUSD Alliance test results. If we assume that LAUSD traditional students who didn’t take the SAT would have had lower scores than the LAUSD students who did take the test, we can match up the LAUSD traditional and LAUSD Alliance charter samples by dropping the lower scores from Alliance. Since the LAUSD traditional schools had a test participation rate of 31%, we can get a comparable Alliance SAT average by only considering the top 686 scores – which corresponds to 31% of the 2189 enrolled juniors and seniors (see Table 9). According to data provided by Alliance, the top 686 SAT scores at the eight Alliance schools was 1417 – 118 points higher than the LAUSD traditional average [29].

Table 9 – SAT Performance Comparisons, Normalized Based on Rate of Participation20150515-CPC_LAUSD-8

 

CONCLUSION

Overall, we conclude that LAUSD Alliance charter high schools provide better outcomes at lower costs than comparable LAUSD traditional operated public schools in the same area. We estimated the per pupil costs for Alliance charter high school students to be $10,649 per year, compared to $15,372 per year for students at traditional public high schools within LAUSD, that is, we find a per pupil cost differential of 44% in favor of LAUSD Alliance charter schools.

Academically, comparing LAUSD Alliance charter high schools to LAUSD traditional high schools located in the same communities, we found the Alliance schools to have decisively higher API scores, 762 vs. 701, and measurably higher graduation rates, 91.5% vs. 84.1%. With respect to SAT scores, when we normalized the comparison between the LAUSD Alliance and LAUSD traditional schools under consideration to equalize the rate of participation, we found that the LAUSD Alliance students outperformed the LAUSD traditional students with average scores of 1417 vs. 1299. This differential is significant. Among college bound students, an SAT score of 1299 puts the student in the bottom 27% nationally. A score of 1417, by contrast, places the student at 41% nationally [30]. Alliance high schools have succeeded in producing academic achievers in the upper 1/3rd of their student body whose SAT scores are within striking distance of the national average, despite operating in some of the most disadvantaged communities in the United States.

We have reached these conclusions by collecting district and school level data, and making common-sense adjustments where appropriate, and as noted in the text. Throughout this report, and especially in the footnotes, we have explained and documented our sources and calculations. We invite other researchers to conduct similar analysis and believe they will come to similar conclusions.

Finally, we want to reiterate that the academic comparisons we have made are fairly narrow, involving 18 high schools, nine LAUSD Alliance charter high schools, and nine LAUSD traditional high schools. Our financial comparisons are somewhat broader in scope – involving the cost per high school pupil attending one of the largest public school districts in the nation and those attending a large charter school system. Because the sample size is still relatively limited, our study thus cannot support a categorical conclusion that charter schools are always better than public schools, or vice versa, but we can conclude from this data that an effective charter school operator can deliver better learning outcomes at lower cost than traditional public schools serving a similar population. Ultimately, this finding supports the educational choice concept: by replacing a “one size fits all” solution with an array of educational choices, we can provide better results for California’s children and taxpayers.

 

About the Authors:

Marc Joffe is a policy analyst for the California Policy Center. He is also the founder Public Sector Credit Solutions, established in 2011 to educate policymakers, investors and citizens about government credit risk. PSCS research has been published by the California State Treasurer’s Office, the Mercatus Center and the Macdonald-Laurier Institute among others. Prior to starting PSCS, Marc was a Senior Director at Moody’s Analytics. He has an MBA from New York University and an MPA from San Francisco State University.

Ed Ring is the executive director for the California Policy Center. Previously, as a consultant and full-time employee primarily for start-up companies in the Silicon Valley, Ring has done financial accounting for over 20 years, and brings this expertise to his analysis and commentary on issues of public sector finance. Ring has an MBA in Finance from the University of Southern California, and a BA in Political Science from UC Davis.

FOOTNOTES

1 – For a list of LAUSD charter Schools, refer to Los Angeles Unified School District, Charter Schools Division, “2014-15 Charter Schools Directory:
http://notebook.lausd.net/pls/ptl/docs/PAGE/CA_LAUSD/LAUSDNET/SCHOOLS/ADD_SCH_DOCS/CHARTER%20SCHOOLS%20DIRECTORY%202014-15%20PARENTS.PDF

For enrollment by LAUSD High School refer to California Department of Education, Analysis, Measurement, and Accountability Reporting Division (this table also includes SAT scores by school):
http://dq.cde.ca.gov/dataquest/satactap/sat.aspx?cyear=2013-14&cchoice=SAT3b&year=1314&cdscode=19647330000000&clevel=District&ctopic=sat&level=District

2 – Richard J. Riordan and Tim Rutten (November 1, 2013). The mysterious case of LAUSD’s finances. Los Angeles Daily News, http://www.dailynews.com/opinion/20131101/the-mysterious-case-of-lausds-finances-richard-j-riordan-and-tim-rutten

3 – Adam Schaeffer (March 10, 2010), They Spend What? Cato Institute Policy Analysis Number 662. http://object.cato.org/sites/cato.org/files/pubs/pdf/pa662.pdf

4 – LAUSD 2008-2009 Final Budget. Page I-51. http://notebook.lausd.net/pls/ptl/docs/PAGE/CA_LAUSD/LAUSDNET/OFFICES/CFO_HOME/ALL%20SECTIONS%20091108.PDF.

5 – LAUSD 2013-2014 Final Budget. Page 49. http://laschoolboard.org/sites/default/files/LAUSD2013-14FinalBudget.pdf.

6 – California Department of Education, 2013-14 Cost Per ADA spreadsheet, http://www.cde.ca.gov/ds/fd/ec/documents/currentexpense1314.xls.

7 – California Department of Education, Current Expense of Education. http://www.cde.ca.gov/ds/fd/ec/currentexpense.asp.

8 – LAUSD 2013-14 Budget, Page 49.

9 – LAUSD 2013-14 Comprehensive Annual Financial Report, Pages 15 and 18.

10 – The CAFR contains budget to actual comparisons for most funds at Page 20 and Pages 66-89.

11 – Adjustments described here were gathered from Pages 15, 18 and 19 of the LAUSD CAFR.

12 – This and other LAUSD enrollment numbers cited below are on page 157 of LAUSD’s CAFR.

13 – LAUSD CAFR page 74.

14 – LAUSD CAFR, Page 165.

15 – LAUSD Budget, Pages 25 and 29.

16 – Derived from the Alliance Performance Dashboard referenced earlier.

17 – Enrollment data by type of school is included in the LAUSD CAFR on Page 157. About 11% of LAUSD students are enrolled in K-12 schools, so the actual proportions of elementary and high school students are slightly higher than the numbers provided above. Later, we use an estimate of 26% high school students in LAUSD by proportionately allocating back those enrolled in K-12 schools.

18 – As this study was being completed, the authors found a set of LAUSD School Accountability Report Cards that contain per pupil costs by school site. Our preliminary analysis of these report cards shows average per pupil costs of $7,854 for elementary schools and $8,407 for high schools. These amounts generally exclude special education schools which have much higher costs and typically offer grades K-12.

19 – Author’s analysis of data downloaded from Texas Education Agency’s Academic Excellence Information System. http://ritter.tea.state.tx.us/perfreport/aeis/2012/xplore/DownloadSelData.html.

20 – California Department of Education, Cost per ADA Spreadsheet 2013-2014, ref. summary tab “Average by LEA Type.”
http://www.cde.ca.gov/ds/fd/ec/documents/currentexpense1314.xls

21 – Annie Gilbertson, Costs for LAUSD special ed services climb as parents feel the pinch, 89.3 KPCC, December 19, 2014. http://www.scpr.org/blogs/education/2014/12/19/17698/costs-for-lausd-special-ed-services-climb-as-paren/

22 – LAUSD CAFR Page 121.

23 – The CAFR only shows the number of children in special education schools, but does not include the number of special education students enrolled in traditional schools.

24 – K-12 enrollment totaled 556,115 as shown on Page 157 of the LAUSD CAFR. This is the 585,894 LAUSD students net of early education, adult education and independent charter schools shown in Table 3 above minus the 29.779 students in Career Technical Education and the Regional Occupational Program.

25 – 2013-14 Alliance-Wide Performance Dashboard, http://www.laalliance.org/performance/13-14/dashboards/Alliance-wide%20Performance%20Dashboard%202013-2014.pdf.

26 – The ethnic breakdown of the enrolled students at each of LAUSD high school, including the charter high schools, can be found from the CA Dept. of Education,
Educational Demographics Unit:
http://dq.cde.ca.gov/dataquest/Enrollment/EthnicEnr.aspx?cType=ALL&cGender=B&cYear=2013-14&Level=School&cSelect=Alliance+Gertz-Ressl–Los+Angeles+Uni–1964733-0106864&cChoice=SchEnrEth

27 – English Language Learner:
CA Dept. of Education, Selected District Level Data, Los Angeles Unified for the year 2013-2014
http://dq.cde.ca.gov/dataquest/cbeds3.asp?FreeLunch=on&PctEL=on&cChoice=DstProf2&cYear=2013-14&cTopic=Profile&myTimeFrame=S&cSelect=1964733–Los^Angeles^Unified

Free/Reduced Lunch Program:
CA Dept. of Education, Selected District Level Data, Los Angeles Unified for the year 2013-2014
http://dq.cde.ca.gov/dataquest/cbeds3.asp?FreeLunch=on&cChoice=DstProf2&cYear=2013-14&cTopic=Profile&myTimeFrame=S&cSelect=1964733–Los^Angeles^Unified

Students with disabilities data was provided by Alliance and LAUSD’s Office of Data and Accountability
http://notebook.lausd.net/portal/page?_pageid=33,131762&_dad=ptl

28 – CA Dept. of Education, API Reports
http://www.cde.ca.gov/ta/ac/ap/apireports.asp

CA Dept. of Education, SAT Scores
http://dq.cde.ca.gov/dataquest/satactap/sat.aspx?cyear=2013-14&cchoice=SAT4b&year=1314&cdscode=19647330111658&clevel=School&ctopic=sat&level=School

CA Dept. of Education, Cohort Graduation Rate
http://dq.cde.ca.gov/dataquest/CohortRates/GradRates.aspx?Agg=S&Topic=Graduates&TheYear=2013-14&cds=19647330106864&RC=School&Subgroup=Ethnic/Racial

Daily attendance data was provided directly by Alliance and LAUSD’s Office of Data and Accountability
http://notebook.lausd.net/portal/page?_pageid=33,131762&_dad=ptl

29 – Individual SAT scores for the nine schools under analysis were provided by Alliance. The overall averages were corroborated with CA Dept. of Education data. The top 686 scores, as calculated, were then extracted from that data.

30 – National percentile rankings for SAT 2014 for College Bound Seniors
https://secure-media.collegeboard.org/digitalServices/pdf/sat/sat-percentile-ranks-composite-crit-reading-math-writing-2014.pdf

Rolls Royce Health Care Plans for L.A. County Public Agencies

SUMMARY:  The price of health insurance in America has consistently risen faster than the rate of inflation and, despite the intentions of the Affordable Care Act (ACA), is projected to continue to do so for the foreseeable future.

A provision of the ACA known as the ‘Cadillac Tax’ is designed to discourage employers from purchasing excessively priced health insurance plans; which is intended to reduce at least one of the factors that contribute to the dramatic increase of price.

This paper draws on a wide array of research that demonstrates government employers are most likely to be affected by the ‘Cadillac Tax’ due to their propensity to purchase the most expensive forms of health insurance available for their employees.

A particularly striking form of excess – a $42,942 plan – for an employee of a small water district in Los Angeles County prompted an inquiry into the health costs for other public agencies in the County.

This analysis reveals that the largest Los Angeles County public employers are paying approximately 71% more for their employees’ health insurance than private employers, at an estimated cost of $676 million a year.

*  *  *

INTRODUCTION

Despite the warning from the Government Accountability Office (GAO) of the impending burden to state and local governments from rising healthcare costs, many Los Angeles governments are purchasing wildly exorbitant health insurance for their employees, at taxpayers’ expense.

Last year the Water Replenishment District of Southern California (WRD) paid $42,942 for a single employee’s health insurance plan. Nearly half of the District’s full-time employees received a plan that cost at least $30,000 apiece.

In 2011, the WRD had four employees receiving plans that cost at least $30,000. By 2014, that number increased three-fold, demonstrating the $42,942 plan is not a remote outlier, but part of an agency-wide practice of vastly overpaying for health insurance.

Surprisingly, WRD employees are also part of the coveted “3% @ 60” pension plan – which calculates the retirement benefit by multiplying the number of years worked by 3 percent, and then multiplying that number by the employee’s highest salary.

Typically, plans with the generous 3% multiplier are reserved for police and fire employees. In fact, the 3% plan is so expensive that the Pension Reform Act of 2013 eliminated it completely for new hires. New employees at the WRD would be under the reduced, but sustainable, “2% @ 62” formula.

The total compensation package for WRD employees is quite generous as well – full-time WRD employees received an average $180,636 in 2013.

As the data available on TransparentCalifornia.com is making clearer, it is in the often-overlooked smaller, local government agencies where the most dramatic levels of excessive public compensation can occur.

Table 1: Water Replenishment District of Southern California Employee Compensation

Healthcare Graph 2

The problem is widespread

Unfortunately, California governments overpaying on health insurance goes well beyond the WRD. Transparent California previously reported on the numerous $20k+ health plans in Corte Madera and the Contra Costa Community College District, as well as the $30k+ plans found in the cities of Beverly Hills and Sierra Madre.

Pew Research confirms that the problem is nationwide – over the past 25 years, state and local government spending on health insurance increased 447% in inflation-adjusted dollars, and is projected to rise further.

This dramatic increase can be attributed, in part, to government wastefulness – government employers not only purchase the most expensive plans, they also ask their employees to contribute the least to help fund them.

In California’s public sector, this problem is accelerating at an alarming rate. From 2011-2013 the amount spent on health insurance by the State increased by 8% as compared to the average 1% decrease nationwide, according to Pew Research.

While the WRD’s excess is the highest in absolute terms, its impact is limited due to their small size. As such, it is more meaningful to analyze the larger districts in the state.

This analysis will incorporate data from the State of California and the largest government agencies in Los Angeles County – home to both the largest city and county in the state.

Table 2 compares two of the biggest special districts – the Los Angeles County Sanitation Districts and the Metropolitan Water District of Southern California – as well as the Los Angeles Department of Water and Power, the City of Los Angeles and the Los Angeles County government.

The Bureau of Labor and Statistics (BLS) provides comparable information for private employers. However, the information is only reported by geographical region, not individual state. As such, the Pacific regional data, of which California is the largest component, is used in this comparison.

The BLS data is by coverage type only. Therefore, the average employer cost is estimated assuming a 50/50 split between employees selecting single or family coverage plans, consistent with the trend found by the Medical Expenditure Panel Survey.

Table 2: Average Employer Cost of Health Insurance
Healthcare 1 Graph

Consistent with the nationwide data, Los Angeles governments pay significantly more for health insurance than the average private sector employer.

For just the five Los Angeles governments analyzed, the total amount paid in excess of the average private employer’s cost is approximately $676M, as shown in Table 3 below.

Table 3: Average Public vs Private Cost of Health Insurance and Total Cost of Public Excess, Los Angeles

Healthcare Graph 3


A bad problem gets worse

The forthcoming ‘Cadillac tax‘ provision of the Affordable Care Act is expected to pose a significant burden to government employers – due to their propensity to purchase Cadillac-style plans for their employees. Beginning in 2018, employers must pay a 40 percent tax on the excess of plans that cost more than $10,200 for single coverage and $27,500 for family coverage.

It must be noted that the threshold for the Cadillac Tax applies to the total cost of the plan. The values reported here are only the employer costs. If employees also contribute towards the cost – meaning the total cost is higher than just the employer’s share – the number of plans affected will rise significantly.

The WRD, for example, will have to pay at least $41,000 a year in penalty taxes for just the twelve employees with health care plans over the $27,500 cap at their current rates. Virtually the entire full-time staff – over 1,400 employees – of the Metropolitan Water District of Southern California received health plans that cost more than $10,200; if any of those plans are for single coverage only, they would be hit by the tax too.

Los Angeles County had 56,366 employees – about 67% of staff – who received health insurance that cost at least $10,200. Outside of the WRD, the County had the greatest individual cost – with 192 plans costing $37,148 each. For just these 192 employees, the County would have to pay a penalty tax of at least $740,966 a year beginning in 2018.

Given the recent, and projected, double digit increases in health insurance premiums, merely holding costs to the present level by 2018 would be a remarkable feat.

Finally, the City of Los Angeles appears best positioned to avoid being affected by the tax. In addition to having the lowest average cost, there was not a single plan with a cost of more than $16,400.

CONCLUSION

The increasing cost of healthcare is certainly much more complex than merely being the result of government wastefulness. A comprehensive solution would require an entire rethinking of how healthcare should be provided. Still, having a consumer as big as government routinely overpay for a product will contribute to its rising cost.

As taxpayers are struggling to pay their own health insurance premiums, government should be doing all it can to rein in costs. As bad as the healthcare situation is at the moment, there is simply no justification for a government agency to consistently pay over $20,000 a year, or more, for their employees’ health insurance.

*  *  *

About the Author: Robert Fellner is Research Director for TransparentCalifornia.com, a joint project of the California Policy Center and the Nevada Policy Research Institute.

*  *  *

Unrecognized Legacy of Prop 39: $137 Billion in Payments Due for Money Already Borrowed and Spent

How much debt has accumulated as the State of California and its local K-12 school and community college districts relentlessly borrow money for school construction by selling bonds to investors?

No one seems to know. In April 2013, the California Policy Center published a report entitled Calculating California’s Total State and Local Government Debt, which attempted to calculate a reasonable estimate of debt obligations of the State of California and its local governments. The report estimated an astonishing debt total of $1.1 trillion, but researchers could not identify any recent sources to estimate the debt from general obligation bonds issued to finance educational construction.

There is a way to determine the amount of debt service (principal + interest) outstanding for educational districts. Researchers for the California Policy Center were able to add up total aggregate debt service for almost all California local educational districts in which voters approved a bond measure since the November 7, 2000 election.

Debt service for those California local educational districts is $136,500,250,898 as of January 2015.

Put in plain English, between now and 2055, California’s taxpayers will make $137 billion in principal and interest payments to pay back funds that have already been borrowed and spent.

Add this number to the $56,668,673,695 in debt service resulting from the three statewide bond measures for educational construction approved by voters, and the total debt service is $193,168,924,593.

See Appendix I – All California Educational Bond Measures Approved by Voters Since November 2000 Enactment of Proposition 39 – Ranked by Aggregate Debt Service

Obviously this debt is substantial, even after accounting for all of the caveats listed below.

As noted below in “Limitations on Using Debt Service Data for Educational Construction,” debt service for some school districts could not be determined, which makes the number determined by the California Policy Center to be lower than exact. In addition, numerous districts are now calling their bonds and issuing refunding bonds, which makes the number determined by the California Policy Center to be higher than exact. We believe these circumstances balance each other out.

Total debt service is about $137 billion for local educational districts where voters approved bond measures since the November 7, 2000 election. Including the three statewide bonds that voters approved since the November 7, 2000 election brings the total debt service to $193 billion.

How Were These Numbers Determined?

Municipal bonds are not bought and sold on Wall Street. Instead of using a centralized place (such as an “exchange”), issuers and investors buy and sell bonds “over the counter” through dealers and brokers registered with the Municipal Securities Rulemaking Board (MSRB), a quasi-governmental organization overseen by the U.S. Security and Exchange Commission. These dealers and brokers act as underwriters or intermediaries between issuers and investors.

Federal law generally requires underwriters in a primary offering of municipal bonds of $1 million or more to obtain and review an “Official Statement” from the issuer of those bonds. Those statements disclose financial information meant to inform a potential buyer and reduce the chance of “fraudulent, deceptive, or manipulative acts or practices.” By law these statements have to be posted on a publicly-accessible and free-to-use website: the Municipal Securities Rulemaking Board Electronic Municipal Market Access system, or EMMA.

Official statements include a chart that indicates how much aggregate principal and interest the issuer of the bonds would owe each year if the bonds weren’t refunded (called in so new bonds can be issued at a lower interest rate) or paid off early. Different official statements may place the aggregate debt service chart in different locations in an Official Statement. Charts may differ in title, format, or details of content. A few charts may not even total up the annual debt service. But the information is usually available. (Issuers of bonds through “private placement” do not need to post official statements on EMMA, because the information is provided directly to the private buyers.)

California Policy Center researchers used the EMMA database to determine debt service for each educational district where voters approved borrowing money for construction through bond sales after November 7, 2000. (That is the election date when California voters approved Proposition 39 and reduced the threshold for voter approval of bond measures for construction from two-thirds to 55 percent.) Researchers entered each district name into the EMMA system, identified the most recent bond offering or bond refunding from the list of bond issues, downloaded the associated Official Statement, located the aggregate debt service chart, and calculated the total debt service for 2015 and/or later years.

Limitations on Using Debt Service Data for Educational Construction

This data is a big step forward in informing Californians about the tremendous debt accumulated by educational districts that borrowed money for school construction by selling bonds. Nevertheless, the data has limitations. Here are 14 warnings about assessing the data out of context:

1. Some local educational districts have not yet borrowed any money as authorized by voters. Other districts have issued some bonds and plan to issue more bonds soon. Some districts have issued all of their bond authority. This means that debt service may be deceptively low in some districts that haven’t yet begun borrowing with gusto.

2. As mentioned above, educational districts in some circumstances can call in existing bonds and issue refunding bonds at a lower interest rate, thus reducing debt service. For this reason, school districts can argue that they intend to regularly issue refunding bonds, and therefore the amount that taxpayers will end up paying is somewhat less than what is listed for the current debt service.

3. For some educational districts, the current debt service will be paid off in a few years. For other school districts, the current debt service will be paid off in 40 years, thus allowing for a presumption that a long period of steady inflation and substantial increase in total assessed property value will mitigate the debt burden on property owners.

4. An argument can be made that borrowing a lot of money now at currently low interest rates is wise financial management, and debt service therefore is not an important issue to consider.

5. An educational district in a wealthy area can have significant debt service but also have high and stable total assessed property value. That debt service may be foolish, but it is not as dangerous as the same debt service in an less affluent educational district with unstable property values and an uncertain economic future.

6. Debt service becomes foolhardy and dangerous as the amount of interest owed increases relative to the amount of principal owed. Educational districts that issued a lot of Capital Appreciation Bonds in the past 15 years have debt service out of proportion to what they obtained through their construction program.

7. As mentioned above, some California educational districts are now issuing bonds through negotiated placement or private placement, which do not require official statements because the investors are qualified to perform their own assessment of the district’s financial status. Keep in mind that official statements are intended for the benefit of potential public investors, not for the benefit of taxpayers or other interested parties.

Private placements seem to be growing in popularity. Researchers were unable to determine current debt service for several small school districts without official statements on EMMA, and at least two of them (and probably all of them) used private placement for their most recent bond sales. It’s notable that the West Contra Costa Unified School District – perhaps the California educational district taking the most risks with school construction finance – apparently issued $135 million in bonds – including bonds with 40-year maturities – in February 2015 through private placement.

8. Debt service can accumulate from bond issues that occurred decades ago. California’s educational districts were winning approval for bond sales under the Proposition 13 two-thirds threshold for 20 years before Proposition 39, and some of that borrowed money is still being repaid back, with interest. For those school districts, debt service may look disproportionately high relative to the amount of money borrowed from 2001 to 2014.

9. There are a handful of local educational districts that have debt service from bond measures approved in 2000 or earlier but have not asked voters to authorize additional borrowing since the November 7, 2000 election. That debt service is not included in the total reported here. In addition, there are statewide bond measures for educational construction approved before November 7, 2000, including a $9.2 billion bond measure approved by voters in 1998 that included $6.7 billion for K-12 school districts and $2.5 billion for community college districts and California State University and the University of California campuses. The actual total debt service for all statewide bond measures and all local educational districts likely exceeds $200 billion.

10. Several K-12 school districts have merged in the past 15 years. Some official statements segregate debt service for the districts before they merged, and some combine the debt service.

11. Several community college district and K-12 school districts have created “School Facilities Improvement Districts” embedded within the complete jurisdiction of the districts. Some official statements segregate debt service for these subdistricts, and some combine the debt service for the subdistricts with the debt service for the complete district.

12. Certificates of participation, lease revenue bonds, and other schemes for educational districts to borrow money while evading Proposition 13 and Proposition 39 requirements are not included in official statements.

13. Community Facilities Districts funded by Mello-Roos bonds are not included in official statements.

14. Debt service is best considered in conjunction with information in annual financial statements prepared for the educational districts.

Despite these limitations, the debt service amounts available through the official statements posted on EMMA provide new insight into the debt owed by California local educational districts. Voters need to know that borrowing additional money via bond sales for school construction is adding to already existing debt.

How Much Have California Voters Recently Authorized to Borrow for School Construction?

Next year California voters may be asked to authorize the State of California to borrow another $9 billion to help K-12 school and community college districts pay for more educational construction. This $9 billion would be obtained by selling bonds to investors and paying it back – with interest – over several decades using the state’s general fund.

Polling has allowed the backers of this initiative to identify the most effective arguments for winning support among voters. Those arguments are listed as “findings and declarations” in the language of the bond measure itself. (See the Request for Title and Summary for Proposed Initiative.) They are cited in various opinion pieces that have appeared in newspapers. And the arguments are heard in the promotional patter of professional signature gatherers at shopping centers.

Most of the arguments are platitudes, facts presented without context, or anecdotes. And no one would know from the arguments that California voters have already approved borrowing about $150 billion in recent years for educational construction.

Voters have approved borrowing about $150 billion for California school construction since Prop 39 passed in 2000. This virtually unknown fact is worthy of highlighting in future public debates.

Recognizing that a lack of balanced factual information compromises the democratic process, the California Policy Center continues to collect, synthesize, and analyze data regarding California educational construction finance. “It’s for the kids and the veterans” is no longer sufficient information for voters considering authorization for the state to borrow another $9 billion.

The State of California alone has $56.7 billion in debt service accumulated from the last three statewide educational bond measures that authorized borrowing a total of $35,766,000,000. Community college districts and K-12 school districts have accumulated an additional $137 billion in debt service. The public needs to know what has already happened before deciding what will happen next.

Part of that understanding includes the impact of Proposition 39. Prop 39 inaugurated a new era of generous borrowing for educational construction in California. Approved by 53.4% of voters in the November 7, 2000 election, it reduced the voter approval threshold for educational construction bond measures (under certain conditions) from two-thirds to 55 percent.

This lowered obstacle encouraged local educational districts to take the risk of proposing many more bond measures at much higher amounts for voters to approve. As shown by the data below, dropping the voter threshold from 66.67% to 55% transformed the approval of educational bond measures from a 50-50 chance to a commonplace outcome.

The California Policy Center believes it is the first and only entity to painstakingly research and present an accurate and comprehensive record of all state and local educational construction bond measures considered by voters from 2001 through 2014.

Some Facts on Voter Consideration of Local and State Bond Measures for Educational Construction

See Appendix A – All California Educational Bond Measures Considered by Voters Since November 2000 Enactment of Proposition 39 – Ranked by Percentage of Voter Approval

See Appendix F – All California Educational Bond Measures Repurposed or Reauthorized Since November 2000 Enactment of Proposition 39 – Listed by Election Year

1. Since the passage of Proposition 39, voters in California have been asked 1147 times to authorize local K-12 school districts and community college districts to borrow a total of $124,350,056,744 for educational construction.

2. Of those 1147 bond measures, sixteen (16) were to reauthorize already approved bond authority totaling $730,365,000. If those bond measures are included with the 1131 bond measures to authorize new borrowing authority, the total amount California voters have been asked to authorize or reauthorize is $125,080,421,744.

In most of these 16 cases, school districts reauthorized bond measures during the late 2000s-early 2010s decline in assessed property values in order to circumvent tax and debt limits in state law and allow the further sales of bonds. These reauthorizations were usually depicted in a simple way to voters as continuing an already-approved construction program without increasing debt.

3. Since the passage of Proposition 39, voters in California have been asked three (3) times to authorize the state to borrow a total of $35,766,000,000 for educational construction.

4. What are the grand totals? Since the passage of Proposition 39, voters in California have been asked to authorize the State of California and local K-12 school districts and community college districts to borrow $160,116,056,744 for educational construction. If reauthorized bond authority is added to that amount, the total amount voters have been asked to authorize or reauthorize is $160,846,421,744. (That is $160.8 billion.)

Some Facts on Approval of Local and State Bond Measures for Educational Construction

See Appendix B – All California Educational Bond Measures Approved by Voters Since November 2000 Enactment of Proposition 39 – Ranked by Amount Authorized to Borrow

1. Voters approved 911 of the 1147 local educational bond measures, for a 79.42% approval rate for bond measures.

2. Voters approved $109,620,418,737 out of the $124,350,056,744 proposed to voters, for a 88.15% approval rate for the amount of bond authority.

The amount of authority approved by voters is a higher percentage than the number of bond measures approved by voters because larger bond measures proposed by larger educational districts passed at a higher rate than smaller bond measures proposed by smaller districts.

3. Voters approved all sixteen (16) bond measures (among the 1147 bond measures) to reauthorize bond authority that voters had already approved in early elections. If reauthorized bond authority is included, voters approved $110,350,783,737 out of the $125,080,421,744 proposed to voters, for a 88.22% approval rate for the amount of bond authority.

4. Voters approved all three (3) statewide educational bond measures, for a total of $35,766,000,000 to match with local educational bond expenditures.

5. What are the grand totals? Since the passage of Proposition 39, voters in California have authorized the State of California and local K-12 school districts and community college districts to borrow a grand total of $145,386,418,737 for educational construction. If reauthorized bond authority is added to that amount, the total amount voters have authorized or reauthorized is $146,116,783,737.

Some Facts on Rejection of Local and State Bond Measures for Educational Construction

See Appendix C – All California Educational Bond Measures Rejected by Voters Since November 2000 Enactment of Proposition 39 – Ranked by Amount NOT Authorized to Borrow

1. Voters rejected 236 of the 1147 local educational bond measures, for a 20.6% rejection rate for bond measures.

2. Voters rejected $14,729,638,007 out of the $124,350,056,744 proposed to voters, for a 11.85% rejection rate for bond authority. If reauthorization of bond authority is added to the amount proposed to voters, the rejection rate for bond authority is 11.78%.

The amount of authority rejected by voters is a lower percentage than the number of bond measures rejected by voters because, as noted above, larger bond measures proposed by larger educational districts passed at a higher rate than smaller bond measures proposed by smaller districts.

3. Of the 236 rejected local educational bond measures, 56 needed two-thirds voter approval and 180 needed 55% voter approval.

The 55% Voter Threshold Instituted by Proposition 39 Makes a Big Difference in Approving Bond Measures

See Appendix D – All California Educational Bond Measures Approved With a Two-Thirds Threshold Since November 2000 Enactment of Proposition 39 – Listed By Election Year

See Appendix E – All California Educational Bond Measures Approved With a 55 Percent Threshold Since November 2000 Enactment of Proposition 39 – Ranked by Percentage of Voter Approval

See Appendix G – All California Educational Bond Measures Approved by Voters Under 55% Threshold Since November 2000 Enactment of Proposition 39 – Results if Proposition 39 Had Not Been Law

See Appendix H – All California Educational Bond Measures Approved by Voters Under 55% Threshold Since November 2000 Enactment of Proposition 39 – Failures Under Two-Thirds Threshold

1. A cumulative approval percentage of 60.8% is calculated by dividing the total number of Yes votes by the total number of recorded votes for all 1147 local educational bond measures and the three state bond measures since Proposition 39 was enacted. Obviously 60.8% is higher than 55% and lower than two-thirds.

2. Of the 911 local educational bond measures approved by voters, 857 were approved with a 55% threshold and 54 were approved with a two-thirds (66.67%) threshold. Most of these bond measures under the two-thirds threshold were approved in 2001 and 2002, during the first two years after voters approved Proposition 39. Since the November 2008 election, voters have only approved two local bond measures for educational construction under the two-thirds threshold. In 2014 elections, only one bond measure was subject to two-thirds voter approval (a bond measure for Vallejo City Unified School District that failed because it received only 61.5% voter approval.)

The few educational districts that now propose bond measures that require two-thirds approval instead of 55% approval do so only to evade certain requirements in Proposition 39 or in state law. A common motivation is avoiding legislative requirements imposed in the California Education Code that limit the amount of bonds issued as a percentage of total assessed property value of the district and limit the amount of tax required to pay off the debt from the bond measure.

12. If the 857 bond measures approved under a 55% threshold were considered under the old Proposition 13 two-thirds threshold in place before Proposition 39, only 369 of the 857 local educational bond measures approved by voters would have passed, while 488 of those bond measures would have failed. Those 488 bond measures authorized educational districts to borrow $57,628,510,725.

1147 Local Educational Bond Measures: Results If Proposition 39 Wasn’t Law

Under Prop 39

If Prop 39 Not Enacted

Total Number of Bond Measures on Ballot

1147

1147

Total Amount Authorized to Borrow on Ballot (includes reauthorizations)

$125,070,421,744

$125,070,421,744

Number of Bond Measures Approved

911

423

Percentage of Bond Measures Approved

79.42%

36.88%

Total Amount Authorized to Borrow

$110,340,783,737

$52,712,273,012

Percentage of Bond Authorization Amount Approved

88.22%

42.15%

Comparison of Election Results: 55 Percent versus Two-Thirds Voter Approval

55% Approval Under Prop 39

Two-Thirds Approval

Total

Number of Bond Measures on Ballot

1037

110

1147

Number of Bond Measures Approved

857

54

911

Number of Bond Measures Rejected

180

56

236

Percentage of Bond Measures Approved

82.64%

49.09%

79.42%

Percentage of Bond Measures Rejected

17.36%

50.91%

20.58%

Debt and Tax Limits Always Waived When School Districts Want to Borrow More Money

Research by the California Policy Center now allows the People of California to see – for the first time – a chart listing all California K-12 school district requests to the state for waivers to sell bonds for school construction. These waivers allow school districts to circumvent state laws meant to protect property owners from excessive public debt and taxes.

State law allows the California Board of Education to grant waivers from numerous sections of the California Education Code, including bond indebtedness limitations. This power is obscure but significant, and until now a compilation of the history of bond indebtedness waivers has not been available to the public.

Out of the 51 waiver requests from 2000 through 2014, only one received notable public attention. In 2013, the fourth waiver request since 2002 from the West Contra Costa Unified School District became controversial when some local taxpayer activists and a columnist for the Contra Costa Times criticized the district for repeatedly seeking waivers to borrow yet more money for construction through bond sales.

To develop a bond indebtedness waiver chart and provide the public with comprehensive information about the waivers, the California Policy Center obtained a document from the California Department of Education listing the bond indebtedness waivers granted by the California Board of Education since 2000. Staff indicated that this listing was an “internal working file and has not been reviewed or validated for accuracy.”

California Policy Center - School District Requests to California Board of Education for Waivers from Tax and Debt Limits, 2000-2014 - Listed by DistrictCalifornia Policy Center researchers checked the data, corrected various inaccuracies, and expanded on the data using meeting agendas, staff reports, and meeting minutes. Now the public finally has a useful resource for considering public policy related to bond indebtedness waivers.

The link below goes to a PDF chart detailing the complete history of school district requests to the California Board of Education for waivers from tax and debt limits in order to borrow money for school construction by selling bonds to investors. Preliminary activity in the first three months of 2015 is also included.

History of Bond Indebtedness Waivers for California K-12 School Districts

The PDF chart includes linked citations of source documents on the California Department of Education website.

At the end of this article is the same chart in JPG format.

Initial Policy Recommendations Concerning Release of Information to the Public on Bond Indebtedness Waivers

As a result of this exercise, the California Policy Center recommends that the state legislature improve government transparency by amending the section of the California Education Code that requires the California Department of Education to produce and submit an annual report about waivers.

[California Education Code Section] 33053. The State Department of Education shall annually submit a report to the Governor, Legislature, State Board of Education, and make the report available to the superintendent and board president of each school district and county office of education. This report shall include a description of the number and types of waiver requested of the board, the actions of the board on those requests, and sources of further information on existing or possible waivers.

As of April 1, 2015, the California Department of Education has only posted reports from 2010, 2011, 2012, and 2013 on its web site. And these reports have limited value because the Department of Education provides the bare minimum of information required by law. Reports provide a spreadsheet with a tally of the number of waivers requested and approved for various provisions in the California Education Code. They do not name specific school districts that requested the waivers. Reports provide annual statistics in isolation, with very limited effort to compare tallies to past years to show trends. Links to the charts are here:

California Department of Education Waiver Reports for the Years 2010 Through 2013

Waivers from the California Education Code are an obscure area of public policy, and even if people know about waivers, they must perform time-consuming research to determine what is going on in their school district or statewide. If the California legislature chooses not to amend this inadequate law, the California Department of Education could (and should) choose to make an administrative decision to provide more details about the waivers in the annual reports.

What the California Policy Center Discovered

From 2000 through 2014, California K-12 school districts have requested 51 waivers from sections of the California Education Code that do the following:

  1. Prohibit the total amount of bonds issued (the total amount of principal) from exceeding 1.25 percent or 2.50 percent of the most recent assessed aggregate value of taxable property in the district. (Elementary and high school districts have a 1.25% limit; unified school districts have a 2.5% limit.)
  2. Prohibit the total amount of bonds issued as authorized by one bond measure from requiring a property tax that exceeded $30 or $60 per year per one hundred thousand dollars ($100,000) of taxable property.  (Elementary and high school districts have a $30 limit; unified school districts have a $60 limit.)

Out of these 51 waiver requests, school districts ended up withdrawing three of them. The State Board of Education approved all 48 other waiver requests, without one dissenting board vote.

The 100% approval rate for waiver requests is not surprising. In 2013, the State Board of Education took action on 518 waiver requests for all sections of the California Education Code and approved 97% of them. Under state law, the California Board of Education is generally obligated to grant such waivers as long as the request is submitted correctly and the waiver doesn’t violate seven criteria specifically listed in state law:

  1. The educational needs of the pupils are not adequately addressed.
  2. The waiver affects a program that requires the existence of a schoolsite council and the schoolsite council did not approve the request.
  3. The appropriate councils or advisory committees, including bilingual advisory committees, did not have an adequate opportunity to review the request and the request did not include a written summary of any objections to the request by the councils or advisory committees.
  4. Pupil or school personnel protections are jeopardized.
  5. Guarantees of parental involvement are jeopardized.
  6. The request would substantially increase state costs.
  7. The exclusive representative of employees, if any…was not a participant in the development of the waiver.

None of those seven criteria relate to local fiscal policies, meaning there is no obvious justification in state law for the Board of Education to deny a waiver from state laws related to bond indebtedness. Nonetheless, the Board of Education has chosen to impose conditions on bond indebtedness waivers and sometimes incorporated changes from the original requests at the recommendation of California Department of Education personnel. But the Board of Education has also rejected recommendations from the Department of Education, most notably in 2013 when the board repeatedly rejected a staff recommendation that school districts applying for waivers should not be permitted to sell Capital Appreciation Bonds.

More Comprehensive Reform Is Needed for the Process for Bond Indebtedness Waivers

Some people would describe these waivers as appropriate; others would condemn them as evasions. Whichever perspective is accurate, California law is inadequate in its current requirements regarding bond indebtedness waivers for school districts. The process for considering waivers is flawed and the results of that consideration are not transparent.

The California Policy Center is preparing a large, comprehensive report for publication about the astonishing bond indebtedness that has resulted from educational construction in California. This report will include numerous public policy recommendations, including several related to bond indebtedness waivers.

One obvious recommendation is shifting responsibility for approving bond indebtedness waivers from the California Board of Education to the State Allocation Board, which makes decisions for state funding of school district construction and directs the Office of Public School Construction. Of course, there also needs to be serious deliberation about whether school districts should even have the right to request and get waivers from state limits on debt and taxes.

Since the enactment of Proposition 39 in 2000, California voters have approved borrowing $142.4 billion for school construction, including $35.8 billion through three statewide ballot measures. And as of March 1, 2015, the State of California and almost 600 local educational districts have borrowed enough money since the enactment of Proposition 39 to accumulate approximately $188 billion in debt service – that is principal and interest owed to bond investors over the full term of the bonds – including $56.7 billion through three statewide ballot measures.

Before California voters approve another proposed statewide bond measure or more local bond measures for school construction, they need to be better informed about the current state of bond indebtedness. Rhetoric about “helping the kids” needs to be balanced with fiscal reality.


California Policy Center - School District Complete Waiver History from Tax and Debt Limits, 2000-March 2015

California Policy Center – School District Complete Waiver History from Tax and Debt Limits, 2000-March 2015

Examining Public Pay in California: The Los Angeles Department of Water and Power

Summary:  The Los Angeles Department of Water and Power (DWP) is the nation’s largest municipal utility, but it may also be one of the clearest examples of excessive public pay driven by powerful public sector unions. This paper analyzes the pay received by DWP employees to their non-DWP counterparts and finds that the average DWP employee receives total compensation that is 155% greater than their non-DWP counterpart.

The largest premiums are found in generic jobs such as custodians, garage attendants, security officers, and the like. The average DWP security officer, for instance, makes 288% more than a non-DWP security officer working in the Los Angeles Metropolitan area. Overall, the weighted average wage premium for DWP employees performing generic jobs was 90% over their counterparts in the Los Angeles area. For all jobs, and including the value of benefits such as pensions and employer paid health insurance costs, the premium for DWP employees as estimated to be 155% higher – that is, 2.5 times as much – than for employees performing work with similar job descriptions in the Los Angeles area.

Applying these premiums to the number of employees at the DWP, the total cost to rate-payers of the DWP paying above market wages is estimated to be $392.8M a year.

*   *   *

INTRODUCTION

The issue of comparing public pay to private pay has challenged academics and sparked fierce debate for years. A serious gap in the academic literature was filled by Andrew Biggs and Jason Richwine’s groundbreaking paper, Overpaid or Underpaid? A State-by-State Ranking of Public-Employee Compensation. Biggs and Richwine found that California State employees receive a total compensation premium of 33% versus their private sector counterpart. Given the scope of their paper, their analysis was limited to state employees only.

However, roughly 90% of all public employees in California work for local agencies. Further, state employees are paid less in wages and receive less generous benefits than local public employees do, suggesting that the bulk of public employees in California receive compensation greater than the 33% premium found at the state level. This paper is the first in a series that will analyze the level of pay for individual public agencies in an attempt to fill this gap.

The Los Angeles Department of Water and Power (DWP) is the nation’s largest municipal utility, serving over four million residents. It is also a powerful example of the above market wages received by California’s public employees. The DWP made national headlines in 2012 and 2013 when Bloomberg reported that their garage attendants were making nearly four times the national average. The Los Angeles Times found that the average total pay for DWP employees was over $100,000 in 2012, approximately 50% higher than other city employees. With recently published 2013 data available on TransparentCalifornia.com, this analysis will update and expand upon the Times’ previous findings.

First, DWP pay is compared to the market in general, as represented by the Bureau of Labor and Statistics (BLS) average wage for the same or similar job, not merely to other government agencies. Secondly, the weighted average of the pay premium found is used to project the total cost associated with the systemic practice of paying above market wages for the department as a whole.

Finally, the value of retirement and health benefits provided to the DWP employee are contrasted to the comparable retirement and health benefits received by a non-DWP employee.

*   *   *

METHODS

The methodology used is known as the “positions approach” in the economics literature. This approach searches for matching job descriptions and then compares the pay between each. Adjusting for the traits of the underlying people holding the position, also known as the human-capital model, is not utilized. Given the extremely narrow focus of this paper to a single agency in a specific region, as opposed to a state or nation-wide analysis, the “positions approach” is sufficient.

Additionally, the singular focus allows for findings that are based on the actual wages paid, not an estimate based off of a regression analysis.

The DWP employs just over 10,000 people. However, this paper only analyzes employees who worked for a full-year by eliminating any employee with a base salary less than the reported annual salary minimum, leaving 8,318 full-time, year-round employees in 2013.

Twenty-three DWP job titles were selected for analysis, accounting for a total of 3,476 employees. This sample size represents 42% of 2013 full-time, year-round employees and 39% of total payroll expenditures. Job titles were selected by the degree of total employment they represented as well as the ability to reasonably identify a corresponding job title in the BLS report. While identical or similar job title names served as a starting point, the determination in matching a DWP job title to a corresponding BLS title was made entirely on whether or not the job description and responsibilities reasonably corresponded to each.

Modifications were made in the following two cases. First, while the DWP job of customer service representative correlated to the BLS job of the same name, the required skills and job responsibilities for the DWP position appeared much higher than average. Consequently, the corresponding BLS wage was increased to the BLS 75th percentile wage.

A similar adjustment was made for the job of “senior clerk typist.” The DWP job description for both “clerk typist” and “senior clerk typist” correlated to the BLS job of “office clerks, general.” The BLS average wage was used as the comparison for the DWP job of “clerk typist” and the 90th percentile wage was used for the comparison against the DWP’s “senior clerk typist” position.

An appendix listing the exact comparisons made is included at the end of the paper. The analysis was able to incorporate the seven most populated job titles held within the DWP, along with 16 additional job titles of various sizes.

*   *   *

COMPENSATION COMPARISONS

Regular Pay

The DWP wage is compared to the average wage for the same or comparable job as reported in the May 2013 wage estimates by the Bureau of Labor and Statistics for the Los Angeles Metropolitan area.

The BLS wage does not include overtime pay, but does include a variety of additional pays such as longevity, hazard, and incentive pay. As such, only the DWP wages without overtime pay (Regular Pay) should be considered as analogous to the BLS wage. Regular Pay is defined as base pay plus the multitude forms of routine “other pay” that DWP employees receive. In 2013, the average non-OT earnings (Regular Pay) of a DWP employee were $99,900.

 Table 1  –  Average DWP Regular Pay vs Average BLS Wage by Job Title

20150318-CPC_Fellner_LADWP-1

Overtime Pay

Overtime pay was excluded from this analysis to create parity between the DWP wage and BLS estimates. However, the DWP provides overtime pay at a higher rate than even firefighters or police, which casts serious doubts about the management structure and the necessity of the overtime pay issued. Including overtime pay increases the average 2013 total earnings of a DWP employee by 15% – to $114,941.

Additionally, an incomprehensible 92% of DWP employees receive overtime pay of some kind. The Los AngelesTimes discovered at least one particular example which confirms that at least some of the overtime pay is the result of union-friendly contracts, not necessity, when they revealed that DWP employees receive overtime pay for work that an outside contractor performs. This bears repeating: DWP employees can receive overtime pay for work that others do. Such a provision is unheard of in typical labor contracts, according to the expert cited in their article.

Despite the fact that the overtime pay at the DWP is at least partially excessive and not reflective of a genuine staffing need, it is impossible to quantify the proportion that is driven by abuse, as compared to that which is driven by legitimate need. Consequently, overtime pay is omitted from this comparison. Still, it must be noted that the average DWP employee receives a non-trivial benefit, averaging 15% in 2013, from the department’s atypically generous overtime policy.

A 90% pay premium for regular jobs

Many of the jobs with the smallest degree of DWP premiums are likely due to the fact that the DWP essentially is the market for that position in the Los Angeles Metropolitan area. Electric distribution and electrical mechanics and their comparable BLS job titles (listed in the Appendix) are jobs unique to a utility company. Obviously the DWP is, by far, the largest utility in the Los Angeles Metropolitan area. Consequently, the BLS comparable wages are going to be overwhelmingly represented by DWP employees, making a comparison less meaningful.

To have a more accurate picture of the above market wages paid by the DWP it is necessary analyze generic jobs that have a robust, non-DWP market such as custodians, security officers, and the like. When filtering for jobs not unique to a utility company, the Regular Pay received by a DWP employee is 90% greater than the market average.

Table 2  –  Average DWP Regular Pay vs BLS Wage for Generic Jobs Only

20150318-CPC_Fellner_LADWP-2

Benefits

It is well documented that public sector defined benefit plans provide more generous benefits than a defined contribution plan; typically the public employee shares in the cost of funding this plan to some extent. In CalPERS, for instance, many public employees pay half of the required contribution rate, which can range from 10-30% of salary, depending on the individual employing agency.

DWP employees, however, participate in their own pension plan and contribute only a maximum of 6% of salary towards their defined benefit plan, with earlier employees paying even less than that. While the DWP plan offers benefits slightly lower than CalPERS in absolute terms, the ability to receive these benefits at a reduced cost to the employee greatly increases the net value of the DWP pension plan.

However, most employees, particularly private employees, participate in a defined contribution plan, which is vastly less generous than the defined benefits plans California’s public employees participate in. A comparison to the type of benefits typically received from a contribution of 6% of salary is illustrative in that regard.

Given private employees must contribute 6.2% of their salary in Social Security taxes, any 401(k) style matching retirement benefits available to the non-DWP employee are only available if they incur an additional cost. Consequently, the following will compare the retirement benefits available based on the assumption that each employee is contributing the same level of salary (6%) towards their retirement.

Take, for instance, the average DWP custodian receiving an average base pay of $52,734 vs. the BLS average wage of $26,810. Many custodial positions outside of the DWP are hourly and do not offer benefits of any kind. However, the DWP custodian receives employer-paid medical benefits and is enrolled in a “2.3% @ 55” defined benefit plan. Assuming the DWP custodian retires at the age of 60 with 30 years of service, they will begin receiving an annual pension of $36,386. By contrast, the private sector custodian will not be able to receive anything from Social Security until the age of 62, at which point they will receive a yearly benefit of $8,880 based on a wage of $26,810.

Using an average life expectancy of 85, a discount rate of 3.75%, and an annual Cost of Living Adjustment (COLA) of 2%, the net present value of the DWP custodian’s pension benefit is $706,841. The net present value of the non-DWP custodian’s Social Security benefit is $161,250. This represents a retirement benefit for the DWP employee nearly 340% greater than that of what their non-DWP counterpart can expect to receive, despite having contributed the same percentage of salary towards their retirement plan.

The wages used to compute the DWP’s pension are base salary only and do not include the various forms of “other pay” that are included in Regular Pay for the salary comparisons done above.

The table below displays the results of the same analysis for five of the most populated job titles in the DWP.

Table 3 – Net Present Value of Avg Full-Career DWP
Retirement Benefit vs Comparable Social Security Benefit

 20150318-CPC_Fellner_LADWP-3

While it may seem initially counterintuitive that the largest pension premium is not found in the position with the largest wage premium, it makes sense when you remember there is a cap on the maximum Social Security benefit. As such, the key driver is the absolute value of the wages used for the DWP employee.

The comparison in Table 3 assumes an employee had worked 30 years and retired at the average wage reported, which is unlikely. Granted, this weakness applies to both sides equally in that both the DWP and non-DWP employee would likely retire at a higher wage than the average. Still, it is sufficient to illustrate the enormous disparity in pension benefits offered to DWP employees in relation to the cost of an annual contribution of no more than 6% of salary.

Total Compensation Premium

An alternative and more robust measure of comparison would be to calculate the value of employer-paid benefits as a percentage of annual wages.

To do so, we rely on the model pioneered by one of the nation’s leading experts on public sector pay and pensions, Andrew Biggs. An explanation as to how we calculated the value of the DWP’s defined pension benefits can be found starting on page 26, with an explanation on how we treated the value of the Social Security benefit beginning on page 40. The most pertinent section is reprinted below:

“To calculate pension compensation paid from state government pensions, we must convert normal costs as published by those plans to a measure using risk-appropriate discount rates. To do so, we gathered data on over 20 plans from California, Florida, Colorado, Washington, and Rhode Island in which pensions’ own actuaries have calculated pension costs under different discount rates. The median result indicates that a 1 percentage point reduction in the discount rate raises the normal cost of a plan by around 36 percent. As a check, we performed our own calculations using workers stylized to be typical of state government employees, which produced similar results.

The factor to convert a normal cost would equal 1.36(re – rra), where re equals the expected return on plan assets and rra the risk-adjusted discount rate. For instance, the factor to convert a normal cost calculated at 8 percent to a 4 percent discount rate would be 1.364, = 3.42. From this risk-adjusted total normal cost we subtract the value of employee contributions to arrive at net pension compensation. For instance, a plan with a total normal cost of 10 percent of wages at an 8 percent discount rate would have a normal cost of 34.2 percent of pay using a 4 percent discount rate. If the employee contributes 5 percent of pay to the plan, his net pension compensation would be equal to 29.2 percent of wages.”

In a nutshell, public pension systems understate the true cost, and value, of their benefits by using an inappropriately high discount rate in their actuarial calculations. Experts from the Congressional Budget Office, Federal Reserve Board, federal Bureau of Economic Analysis, Moody’s Investment Services, and across academia agree that an appropriate discount rate is one that matches the risk characteristics of the benefit (sidebar 1.)

The most commonly used discount rate for benefits that have little to no risk is the yield on a 20 year Treasury. Currently, the 20 year Treasury rate is at historic lows in the low 2 percent range. Therefore, we will again follow Biggs’ lead and use 4 percent as our discount rate, roughly the average yield over the past decade of a 20-year Treasury.

The DWP pension plan has a normal cost of 23.85% of wages (page 12.) The plan also uses a discount rate of 7.5% for its actuarial calculations (page 40.)  However, given the DWP’s pension benefits are guaranteed, and thus have no risk, it is necessary to adjust this cost to a 4 percent discount rate for the reasons outlined above. This represents a discount rate reduction of 3.5%. Per Biggs, every 1 percent point reduction increases the normal cost of a plan by around 36%. Therefore, the factor to convert to a risk-adjusted total normal cost would be 1.363.5,= 2.93. Multiplying 2.93 by the normal cost of 23.85% = 69.96%. After subtracting the contribution rate for DWP employees of 6%, the net pension compensation is worth 63.96% of wages.

For health benefits, the DWP’s 2013 payroll report stated the average cost per employee was $16,230. Therefore the total compensation for the DWP employee is: (Regular Pay * 1.6396 + $16,320.)

For the BLS counterpart, data from the BLS Employer Costs for Employee Compensation (ECEC) Survey was used to estimate the cost of employer-paid health insurance at 11% of wages. The total cost of Social Security and employer contributions towards a matching 401(k) was estimated at 9% of wages, also using data from the ECEC Survey. The formula for BLS Total Compensation is: (BLS Wage * 1.2.)

The chart below is a graphical representation of the total compensation premium for 10 of the most heavily populated positions in the DWP. Table 4 documents the total compensation premium found for all job titles analyzed in this paper. The average DWP employee receives compensation that is 155% greater than their non-DWP counterpart.

  20150318-CPC_Fellner_LADWP-4

 

Table 4  –  Total Compensation for DWP Employee vs. BLS Counterpart

20150318-CPC_Fellner_LADWP-5

*   *   *

LIMITATIONS

This paper is limited in that no attempt to compare the value of retiree health benefits, fringe benefits, or job security is made. However, it is extremely likely that doing so would only inflate the compensation premium already found.

These benefits, particularly things like job security, a generous (unlimited until mid-2013) sick day policy, and so forth are all extremely likely to weigh in favor of the DWP employee.

Another limitation was that many jobs in the DWP do not have a meaningful non-DWP counterpart in the Los Angeles area. Most notably, the jobs of “Water Utility Worker” and “Electric Station Operator” were omitted, despite being the eighth and ninth most populated jobs in the DWP, given the lack of a suitable BLS counterpart.

*   *   *

THE COST TO RATE-PAYERS

In order to project the total cost estimated with the DWP’s routine policy of paying above market wages, it is necessary to look at the actual dollar cost found as a percentage of total payroll.

For instance, the actual total cost of the pay premium received by the 3,476 DWP employees analyzed in this paper was: $116,668,950. This number was created by multiplying the difference between the BLS wage and the DWP Regular Pay by the total number of employees for each job title, as displayed in Table 1.  After which, one can simply sum the actual cost found for each of the 23 job titles for a total cost.

The total non-OT payroll for these employees is $323.8 million. As such, the total pay premium found represents 36.02% of payroll. If we assume these findings hold true for the rest of the DWP, the total cost can be estimated by multiplying the total (including PT employees) non-OT payroll of $927.6 million by 36.02% for a total cost of $334.1 million.

Further, the savings associated with reducing pay to the market average would expand beyond the immediate reduction in payroll expenditures; as doing so would simultaneously reduce the cost of pension benefits.

The DWP estimates their total normal cost for 2014 to be 17.56% of payroll (page 12.) As a result, every dollar reduction of payroll would save the DWP an extra 17.56 cents in pension contributions.

Assuming the DWP was to pay market wages, the total savings would rise to $392.8M when including the savings from the reduced pension contributions.

New Salary Contract

The public pressure from the Los Angeles Times’ exhaustive work in exposing the DWP’s unlimited sick day policy, overtime pay abuse, and high levels of pay led to a new contract being signed in late 2013.

Revealingly, the “concession” by the DWP only further demonstrates the power of their union. The deal slightly reduced benefits for new hires only; salaries were not reduced at all. Current employees received no benefits or pay reduction of any kind and merely saw their yearly base salary raise delayed until 2016.

As mentioned above, the DWP employee receives over 600 forms of other pay beyond their base salary, not to mention overtime pay that accounted for an average 15% increase in total earnings in 2013. The deal did not touch any of these forms of pay.

*   *   *

CONCLUSION

The above analysis makes clear the DWP’s primary motivation in setting employee compensation is political in nature – specifically, to accommodate the union and its members at the expense of ratepayers.

Particularly alarming is that the DWP is funded via what amounts to a regressive tax by being able to set the cost of water and power for their over 4 million customers. Consequently, Los Angeles area residents are being forced to subsidize lavish compensation packages that dwarf their own incomes.

The theoretical case against public sector unions is strong, with many of the Left’s greatest heroes having previously warned of the danger and impossibility of collectively bargaining with the public at large. The DWP offers a specific, real-world example of just how egregiously public sector unions can enrich themselves at the expense of the public.

*   *   *

About the Author:  Robert Fellner is Research Director for TransparentCalifornia.com, a joint project of the California Policy Center and the Nevada Policy Research Institute.

*   *   *

APPENDIX

Please click here to go to the BLS’ Los Angeles Metropolitan Area May 2013 overview page, which contains the wage estimates listed below. Clicking the link for the individual job titles provides a description of the job’s duties and responsibilities, but wage data on a national level only.

DWP Job TitleBLS WageBLS Job Title
Senior Clerk Typist$45,960Office Clerks, General (90th percentile)
Customer Service Representative$44,800Customer Service Representatives (75th percentile)
Electric Distribution Mechanic$97,210Electrical Power-Line Installers and Repairers
Electrical Engineering Associate$61,530Electrical and Electronics Engineering Technicians
Electrical Mechanic$88,680Electrical and Electronics Repairers, Powerhouse, Substation, and Relay
Civil Engineering Associate$62,080Civil Engineering Technicians
Security Officer$26,640Security Officers
Meter Reader$46,930Meter Readers, Utilities
Custodian$26,810Janitors and Cleaners, Except Maids and Housekeeping Cleaners
Heavy Duty Truck Operator$42,210Heavy and Tractor-Trailer Truck Drivers
Clerk Typist$31,350Office Clerks, General
Electrical Engineer$110,620Electrical Engineers
Secretary Legal$54,010Legal Secretaries
Plumber$65,350Plumbers, Pipefitters, and Steamfitters
Air Conditioning Mechanic$54,690Heating, Air Conditioning, and Refrigeration Mechanics and Installers
Truck Operator$42,210Heavy and Tractor-Trailer Truck Drivers
Civil Engineer$95,250Civil Engineers
Custodian Supervisor$42,210First-Line Supervisors of Housekeeping and Janitorial Workers
Garage Attendant$29,175Approximated this value*
Mechanical Engineer$98,330Mechanical Engineers
Management Analyst$90,040Management Analysts
Maintenance and Construction Helper$44,930Helpers, Construction Trades, All Others
Mechanical Engineering Associate$62,520Mechanical Engineering Technicians

*The BLS reported a mean wage of $21,320 for a parking lot attendant. However, the Garage Attendant for the DWP entails additional non-skilled auto mechanic responsibilities and the wage was increased to reflect that by averaging the wage for a parking attendant and automotive service mechanic.

Alameda County Water District Rate Increase Driven by Labor Costs, Not Drought

With California facing a significant drought, many water districts are raising rates on customers who have been asked to significantly reduce water use.   Water districts cite the lack of rainfall, the rising cost of imported water, and reduced demand as reasons why customers must pay more.  However, many districts fail to explain the role labor costs play in the rising cost of water.

On February 12, 2015, the Alameda County Water District (“ACWD”), a special district serving the southern Alameda County cities of Fremont, Union City, and Newark and governed by a publicly elected Board of Directors, proposed to increase the service charge portion of most water bills by 30%.  A public hearing has been set for April 14. This will be at least the 16th consecutive year of rate increase and the third rate increase in the last 15 months. [1]

In 2010, the bimonthly service charge for a single family residence with a 3/4” meter (the most common) was $11.62. [2] The ACWD Board is proposing to increase the service charge to $41.54, a 257.5% increase in just five years.

The service charge is the fixed portion of the water bill all customers pay regardless of water use.  Raising the service charge does not create any incentive for customers to save water, which is what most water districts are encouraging their customers to do during this drought.  According to ACWD, customers who use 30 ccf (hundred cubic feet) of water will see their bill increase 6.2%.  However, customers who use only 5 ccf of water will see their bill increase 19.6%. [3]

Increasing this fee disproportionately harms low income households and households who use less water, including many seniors living on fixed income.  Given that households most impacted by this rate increase are the ones who can least afford it, ACWD has a high burden to justify its increased expenses that necessitates this rate increase.

ACWD’s expenses are budgeted to increase $6.0 million in fiscal year 2015. [4] On several occasions, ACWD said that its water supply costs are the main reasons for the increased expenses. In December 2014, ACWD’s Budget and Financial Analysis Manager said, “The primary reason for the [increase in operating budget] is the increase in water supply costs during this drought period.” [5] In a presentation to the public, ACWD said that 70% of their increased expense are due to water supply costs. [6] In a notice mailed to all property owners detailing the proposed rate increase, ACWD again said that 70% of the $6.0 million of increased expenses are due to water supply costs. [7] However, ACWD has been misleading the public for months by failing to mention that labor costs are included in the 70% water supply figure.

To separately examine labor costs, one must compare ACWD’s fiscal year 2014 actual labor costs and its fiscal year 2015 budgeted labor costs. In 2014, ACWD’s actual labor costs were $38.4 million. For 2015, ACWD budgeted $42.9 million, a $4.5 million increase (or 11.6% increase), for labor costs. [8] In other words, 75% of ACWD’s $6.0 million budgeted increase in expenses are due to labor costs. It is clear that the main reason for this 30% increase on the service charge will be used to pay for the significant increase in labor costs and not to help alleviate water supply costs as ACWD would like customers to believe.

To understand whether a budgeted $4.5 million increase in labor costs is justified, here are some facts about ACWD’s employee compensation:

–          More than half of employees received at least $150,000 in total compensation in 2013. [9]

–          Employees have received annual raises since at least 2003. [10]

–          Employees received a cumulative 21.7% raise during the Great Recession years of 2008 through 2012 (tied for the highest raise given in Alameda County government agencies). [11]

–          Employees will receive a 2.5% raise in 2015, a 3% raise in 2016, and a 3% raise in 2017. [10]

–          Up until July 2014, employees received free medical, dental, and vision insurance for their entire family.  Employees currently pay only one quarter of one percent of their salary for full insurance. [12]

–          Management employees are reimbursed 2.5% of the employee’s share of the CalPERS retirement contribution. [13]

–          Management employees are reimbursed $500 a year for personal Internet and cell phone bills. [14]

–          Employees can earn an unlimited number of sick hours, which can then be converted to pension credit at retirement. [15]

–          ACWD has $66.4 million of unfunded pension liability. [16]

–          ACWD has $37.1 million of unfunded retiree health care liability. [17]

In addition to employee compensation, ACWD gave $6,500 to a slush fund for employees to use how they please, including to attend baseball games, and paid $1,140 for employees to enter a sports tournament, which included 9 holes of golf. [18] Although inconsequential to its finances, both payments were made after ACWD implemented a drought surcharge.  Also, ACWD’s former General Manager, who receives an annual pension of about $250,000 a year, will receive $60,000 to write a book about ACWD’s 100 year history. [19]

When a government agency faces a difficult financial situation, some citizens are willing to share in the sacrifice to ease the financial burden.  In early 2014, ACWD declared a water shortage emergency [20] and asked customers to reduce water usage by 20% [21], which customers have done. [22] In mid 2014, ACWD implemented a drought surcharge.  Ratepayers, who have reduced water use and faced higher water rates, have done their part to share in the sacrifice during this drought.

ACWD employees, on the other hand, have done nothing to share in the sacrifice during this drought (and during the Great Recession).  Employees are generously compensated, receive generous benefits, have received annual raises for over a decade, and will continue receiving raises through 2017.

Yet, ACWD is still seeking to raise the service charge by 30% on the backs of the most financially vulnerable, including seniors living on fixed income, families collecting food stamps, families living paycheck to paycheck, the unemployed, and households who strive to conserve water, to pay for a 11.6% increase in labor costs.

If ACWD believes water rates must rise to support higher labor costs, ACWD needs to make the case on its merits rather than using the drought and water supply issues as a distraction.  It is dishonest to ratepayers and especially those who can least afford another significant rate increase.

About the Author:  Eric Tsai is a Fremont resident.

FOOTNOTES

(1)  See “Tsai-1_Rate-Increases.pdf” for history of rate increases.  From 2009 and 2014 CAFRs.

(2)  See “Tsai-2_2010-Service-Charge.pdf” for service charge fee in 2010.

(3)  See “Tsai-3_Rate-Proposal-Presentation.pdf” for rate increases by water use (page 19).

(4)  See “Tsai-4_Budgeted-Expenses.jpg” for budgeted expenses for fiscal year 2015.  From Public Records Act request.

(5)  Dec. 2014 article about consideration of rate increase: http://www.insidebayarea.com/news/ci_27156807/fremont-water-district-considering-another-rate-hike

(6)  Feb. 2015 presentation about rate increase (page 7): http://acwd.org/DocumentCenter/View/923

(7)  Notice mailed to all property owners about rate increase (page 2): http://acwd.org/DocumentCenter/View/927

(8)  See “Tsai-8_Budget.pdf” for 2015 budgeted labor costs.

(9)  See “Tsai-9_2013-Payroll-Records.xlsx” for calendar year 2013 employee compensation data.  The first and last names were removed from the file.  128 employees earned over $150,000 in total compensation while ACWD had 215 employees as of the end of 2013.

(10)  See “Tsai-10_Employee-Pay-Increases.pdf” for history of employee raises.  From three previous MOUs.

(11)  See “Tsai-11_Survey-Pay-Increases.pdf” for survey of 30 government agencies. From 2014 Alameda County Grand Jury final report.

(12)  See “Tsai-12_Employee-Health-Insurance.pdf” for employee medical coverage information.  First page is from prior MOU stating employee will receive full coverage and second page is from most recent MOU stating employee contribution for coverage.

(13)  See “Tsai-13_Management-Benefits.pdf” for employer pick up of employee retirement contribution (page 2, Retirement).

(14)  See “Tsai-13_ Management-Benefits.pdf” for employee allowance for personal Internet and cell phone bills (page 1, Management Allowance).

(15)  See “Tsai-13_ Management-Benefits.pdf” for management employee sick leave policy (page 3, Sick Leave) and “Tsai-15_Union-Benefits.pdf” for union employee sick leave policy (page 2, Sick Leave).

(16)  See “Tsai-16_Unfunded-Pension-Liability.pdf” for unfunded pension liability as of June 30, 2013 (page 12).

(17)  See “Tsai-17_Unfunded-OPEB-Liablity.pdf” for unfunded OPEB liability as of June 30, 2013 (page 10).

(18)  See “Tsai-18_Employee-Association.pdf” for payment to a slush fund and “Tsai-18_Sports-Reimbursement.pdf” for payment for employees to enter a sports tournament.

(19)  Jan. 2014 article about history book: http://www.insidebayarea.com/news/ci_24912579/fremont-based-water-district-paying-280-000-history

(20)  See “Tsai-20_Water-Shortage-Emergency.pdf” for water shortage emergency ordinance.

(21)  See “Tsai-21_Reduce-Water-Use.pdf” for request asking customers to reduce water use.

(22)  Confirmation from ACWD’s Twitter page stating ACWD water use is down 20%.

California City Pension Burdens

SUMMARY:  This study estimates the burden of pension costs on 459 California municipalities. The primary measure we consider is the ratio of required pension contributions to estimated total revenue for each city.  We also look at contribution rates per employee and at pension funding levels.  We find a wide variation in the impact of pension costs on city finances. While several cities spend more than one-eighth of their revenues on pension contributions, many spend far lower proportions and ten municipalities have no defined benefit pension plans at all.

The most heavily burdened cities are San Rafael, Costa Mesa and San Jose, which have pension cost / revenue ratios estimated at 17.58%, 14.36% and 13.88% respectively. As we discuss in the study, all three of these cities are taking measures to reduce future pension costs, so their rankings are not necessarily a reflection on currently sitting elected officials. Using an alternative measurement of total pension debt (unfunded liability plus pension bonds outstanding) / revenue, the most heavily burdened cities are Oakland, Costa Mesa, and Richmond, which have pension debt / revenue ratios of 203.3%, 182.0%, and 180.9%, respectively.

Prospectively, using data from recently released CalPERS actuarial reports, we project pension costs for most cities through to fiscal year 2020, identifying two cities – Monrovia and Fremont – that may face troubles in the years ahead. Monrovia and Fremont have 2015 pension cost / revenue ratios greater than 10% AND they will both experience dramatic cost growth.  Between 2015 and 2020 and assuming a 7.5% CalPERS return, Monrovia is projected to see a 64.15% cumulative increase in pension costs, while for Fremont, the number is 46.51%. 

The weighted average funding ratio across all 459 cities was just over 75% as of June 30, 2013. Given strong stock market performance since that time, it is likely that the funding situation improved significantly over the last 18 months. Overall, CalPERS reported that its assets increased by 15% between June 30, 2013 and June 30, 2014. Its actuarial liabilities probably rose during this period as well, but likely at a slower rate.

Download Print Version of Study

*   *   *

INTRODUCTION

California cities that participate in defined benefit pension plans are expected to make a total of $5.1 billion in contributions during fiscal 2015, accounting for nearly 7% of their total revenue. As of June 30, 2013, the average funded ratio for these plans was 75%. Underneath these averages, we observe a great diversity of pension cost burdens and funding rates.

Study data by city and by plan may be found here. This Google Spreadsheet model contains multiple tabs including a city summary and plan details.

California City Pension Burdens – City Summaries
(click on image to view GoogleDoc spreadsheet, select tab “city_summary”)

20150205-CPC_Joffe_City-Summary

California City Pension Burdens – Plan Details by City
(click on image to view GoogleDoc spreadsheet, select tab “plan detail”)

20150205-CPC_Joffe_Plan-Detail

*   *   *

The city level data can also be viewed on a map:

California City Pension Burdens – Plan Summary by City
(click on image to view Google Map, then click circles to view individual summaries)

20150205-CPC_Joffe_CA-Map

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METHODS

We collected most of the cost and funding data for this study from CalPERS plan-specific actuarial valuations. The vast majority of city pension plans are administered by CalPERS, but several large California cities operate their own plans. In these cases, we gathered data from actuarial valuations and audited financial statements published by the plans themselves, and from the State Controller’s Office retirement plan data set. Large cities that maintain their own plans include Los Angeles, San Diego, San Jose, San Francisco, Fresno, Oakland and Sacramento (some of these cities have both internally administered plans and CalPERS plans). A few cities participate in county pension systems. In these cases, we consulted actuarial reports and financial statements provided by these county plans.

In all cases, we derived revenue estimates from State Controller Office data posted at http://bythenumbers.sco.ca.gov. We used the total of general and functional revenues reported in the controller’s data set.  This provides a larger denominator and thus lower pension/revenue ratios than one might derive from considering only general fund revenue. Dividing pension costs by general fund revenue is inappropriate because public employees may be paid from special governmental funds or enterprise funds controlled by the municipal government. When evaluating total pension costs, it is best to consider total governmental revenue.

Total 2015 revenues were estimated by adding 6.25% to 2014 city revenue data recently published by the State Controller.  According to the SCO data set, the median city’s revenue increased by 6.25% between 2013 and 2014.  We applied this rate of increase to the 2014 data as a proxy for fiscal 2015 actuals, which won’t be available until late this year.  Ideally, the 2015 revenues would be taken from individual municipal budgets, but many cities do not forecast total revenues. Budgets often include only general fund projections.

*   *   *

FINDINGS

In general, pension costs do not represent a near-term threat to municipal solvency, but in many cities, the burden of financing pension benefits is crowding out other spending priorities or adding to pressure for tax increases. A number of cities are spending more than 12% of total revenue on pension contributions.

A city’s pension burden relative to revenues is a product of a number of factors including:  (1) the generosity of plan benefits, (2) the size of the municipal workforce relative to the city’s size and wealth, (3) growth rates and (4) tax rates. Thus, a city may be able to support very generous pension benefits if it has a small workforce, has rapidly growing revenue and/or imposes additional sales taxes.

The study includes data for 459 of the state’s 482 towns and cities. Of the 23 cities not in our list, ten offer retirement plans that do not provide defined benefits. As discussed later, these cities provide employees with defined contribution and/or deferred compensation plans. Most of the remaining 13 are small towns that do not issue audited financial statements or provide retirement plan information on their web sites.

*   *   *

MOST HEAVILY BURDENED CITIES

Cities with the highest pension expenses relative to revenue are listed below:

Rank City or Town County 2015 Pension Contributions 2015 Estimated Revenue Pension Cost / Revenue Ratio
1 San Rafael Marin County 18,422,967 104,823,893 17.58%
2 Costa Mesa Orange County 18,997,065 132,253,907 14.36%
3 San Jose Santa Clara County 253,967,345 1,829,814,350 13.88%
4 San Gabriel Los Angeles County 5,124,429 38,198,183 13.42%
5 Sonora Tuolumne County 892,361 7,108,772 12.55%
6 West Covina Los Angeles County 10,304,114 84,893,591 12.14%
7 El Cerrito Contra Costa County 4,837,781 40,189,354 12.04%
8 Hemet Riverside County 7,083,161 60,907,403 11.63%
9 Montclair San Bernardino County 4,267,343 36,721,464 11.62%
10 Eureka Humboldt County 5,507,187 48,722,417 11.30%
11 Corona Riverside County 20,593,975 183,906,784 11.20%
12 El Cajon San Diego County 11,781,843 105,802,628 11.14%
13 Hermosa Beach Los Angeles County 4,330,474 39,374,676 11.00%
14 Foster City San Mateo County 5,185,144 48,319,867 10.73%
15 Richmond Contra Costa County 24,795,689 234,178,451 10.59%
16 Orange Orange County 17,353,503 164,072,449 10.58%
17 Los Gatos Santa Clara County 4,566,479 43,225,331 10.56%
18 Chico Butte County 10,017,258 94,967,151 10.55%
19 Monrovia Los Angeles County 6,231,567 59,132,054 10.54%
20 Fremont Alameda County 26,777,512 255,758,600 10.47%

Cities with the highest burdens typically have responsibility for both safety and non-safety employee pensions. Cities with relatively low burdens generally do not have a safety plan, perhaps because they rely on the County or another authority for police and fire services.

The city with the highest pension contribution/revenue ratio is San Rafael, which spends more than one-sixth of its revenue on retirement fund contributions.  This burden is partially a legacy of generous retirement benefits. Police officers and firefighters were entitled to pensions equal to 3% of salary per year employed with a retirement age of 55. Miscellaneous employees – those who are not uniformed public safety officers – received 2.7% per year at age 55. While San Rafael’s pension formula for safety employees is not unusual (in fact, some cities provide 3% of salary per year at age 50), the formula for miscellaneous employees is more generous than most California cities. As of June 30, 2013 the city had 220 active and 202 retired employees in the miscellaneous category.

Recent reforms have resulted in less generous benefits for new employees. The city has documented its efforts at pension reform at http://www.cityofsanrafael.org/pensions/.

In 2011, San Rafael lowered the benefit for new miscellaneous employees from 2.7% to 2%. It did not lower the benefit rate for new public safety employees, but reduced their cost of living allowance (COLA) in retirement from 3% to 2%. It also changed the Final Average Pay (FAP) used for to calculate the pension benefit from the last year’s salary to the average of the final three years’ salary. This reform reduces pension spiking, a practice under which employees work substantial overtime in their final year or are awarded extraordinary salary increases to maximize their pension benefits.

In 2013, the city further reduced new employee benefits after the implementation of California’s Public Employees’ Pension Reform Act (PERPA).  New miscellaneous employees must wait until age 62 to receive benefits, which continue to be based on 2% per year times final average pay. For new safety employees, the rate is now 2.7% instead of 3% while the retirement age has risen from 55 to 57.

It is worth emphasizing that these changes apply only to new employees – hired from 2011 onwards. Most employees will be eligible for the more generous, pre-2011 retirement benefits for many years to come, implying that San Rafael’s high pension burden will be a fact of life for some time.

Also contributing to San Rafael’s relatively high annual pension costs is the aggressive approach its plan administrator, the Marin County Employee Retirement Agency (MCERA) is taking toward paying down unfunded liabilities. Most plans, including those administered by CalPERS and other county systems, amortize their unfunded balances over a period of 30 years; MCERA has implemented a 17-year amortization period. More rapidly amortizing UAAL promotes fiscal sustainability, so, at least to this extent, San Rafael’s high pension contributions could be seen as positive.

The second most burdened city is Costa Mesa. Like San Rafael, the city has a legacy of generous benefits. By 2011, police and fire employees were in plans that paid 3% at age 50, while miscellaneous employees received 2.5% at 55. In some cases, existing employees had benefitted from plan enhancements after being hired. For example, in 2010, the fire union negotiated a reduction in retirement age from 55 to 50. This change applied to current employees even though the enhanced benefit had not been funded by previous contributions made by the firefighters or the city.

The City’s Mayor Pro Tem, Jim Righeimer, noted that another factor contributing to Costa Mesa’s high pension burden is its inability to outsource services to the private sector. California cities fall into two legal categories under state law:  chartered and general law. As a general law city, Costa Mesa, operates under many more rules specified under the state’s government code (section 34000).  In Costa Mesa City Employees Assn. v. City of Costa Mesa, 209 Cal. App. 4th 298 (Cal. App. 4th Dist. 2012), the Court of Appeals found that Costa Mesa could not outsource services to private companies, unless these services required specialized training or expertise. The ruling only applies to general law cities; charter cities have the flexibility to reduce future pension costs by outsourcing basic functions like street sweeping and animal control.

Although the city has been unable to outsource miscellaneous positions, it has taken some steps to limit pension costs. The council made some reductions for new employees starting after March 2012, and made further cuts after PERPA took effect in 2013. The benefit formula for new safety employees is 2.7% at 57; new miscellaneous employees receive 2% at 62.

Costa Mesa has also established a Pension Oversight Committee whose work is documented at http://www.costamesaca.gov/index.aspx?page=1603.

The city with the third highest pension burden is San Jose, with fiscal 2015 contributions of over $250 million accounting for almost 14% of total revenue. Public employee retirement costs have been an issue in San Jose for a number of years now, and the city’s experience illustrates the difficulty municipalities encounter when they try to limit these expenditures.

According to a city presentation, total retirement costs for San Jose have quadrupled since fiscal 2003. In that year, San Jose contributed $72 million to pension contributions and retiree health benefits. In the current fiscal year, that cost has risen to over $300 million (including $50 million in health costs).

In 2012, Mayor Chuck Reed placed Measure B on the ballot. Among other changes, the proposal gave currently employed city workers the option of accepting lower pension benefits or substantially increasing their own contributions to retain existing benefits. Most proposed reforms only apply to new employees, because there is a presumption that existing employees have a contractual right to the pension benefit formula available at the time of hire (unless the formula is enhanced as we saw in Costa Mesa’s case). Because the San Jose reform threatened to reduce the benefits of existing employees, it drew substantial union opposition.

Despite this opposition, Measure B passed with a 69% majority. Unions and other opponents then attempted to overturn the measure in court. In December 2013, Superior Court Judge Patricia Lucas ruled that the increased employee contributions were unlawful. But the judge agreed that the city could obtain the same cost savings by reducing employee pay. As of this writing, the city has not attempted to implement such a pay cut.

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FUNDING LEVELS

There was less variation in funding levels across cities and differences appeared to be idiosyncratic. The vast majority of plans are administered by CalPERS, which requires all member cities to pay the full Actuarially Required Cost (ARC) it computes each year. CalPERS uses the same calculation procedures for each member. Thus there should not be issues with deliberately skipped or reduced payments, as we see in other states. Cities with large non-CalPERS plans also appear to pay their full ARCs each year.

The weighted average funding ratio across all 459 cities was just over 75% as of June 30, 2013. Given strong stock market performance since that time, it is likely that the funding situation improved significantly over the last 18 months. Overall, CalPERS reported that its assets increased by 15% between June 30, 2013 and June 30, 2014. Its actuarial liabilities probably rose during this period as well, but likely at a slower rate.

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CITIES WITHOUT DEFINED BENEFIT PLANS

A review of audited financial statements identified ten California cities that rely exclusively upon defined contribution and deferred compensation plans to provide for their employees retirement needs. Because the city makes its contribution upfront or makes no contribution at all, it cannot have an unfunded actuarially accrued liability. Further, it could be argued that many of these cities do not have a pension burden at all, because matching contributions can be suspended during a fiscal emergency.

The list of cities relying exclusively upon defined contribution and/or deferred compensation plans is as follows:

City County
Danville Contra Costa County
Holtville Imperial County
Huron Fresno County
Lafayette Contra Costa County
McFarland Kern County
Mendota Fresno County
Orinda Contra Costa County
Rio Dell Humboldt County
San Juan Bautista San Benito County
Trinidad Humboldt County

While most of these cities are small, Danville and Lafayette have populations of 43,000 and 25,000 respectively, suggesting that medium sized cities can attract employees without offering defined benefit retirement programs.

Steven Falk, City Manager for Lafayette told us via e-mail:

“… Lafayette’s non-PERS status has little or no apparent impact on the City’s ability to hire and retain lower-skilled and administrative employees, such as caretakers, landscape workers, recreation workers, administrative assistants, etc. The lack of a PERS program, however, does appear to have some impact on the City’s ability to attract and retain higher level professionals with skill sets that are particular to the municipal operation, such as urban planners, civil engineers, transportation planners, community development employees, etc. We have had occasions where candidates have retracted their job applications upon learning that Lafayette does not participate in PERS.”

The city contacts out public safety services to Contra Costa County, so it has not had to test whether it could recruit police officers and firefighters without the benefit of PERS membership.

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EMPLOYER CONTRIBUTION RATES

Thus far our analysis has focused on total employer contribution amounts. Historically, CalPERS and other multi-employer plans have quoted contribution rates. The contribution rate is the percentage of current employee payroll that must be contributed to the pension plan. For example, if a public employee has a salary of $100,000 and the employer’s contribution rate is 40%, the city must pay CalPERS $40,000 to keep the covered employee in the defined benefit plan. This rate excludes employee contributions, which are typically withheld from each employee’s salary but have been paid –partially or fully – by municipal employers.

The plans with the highest contribution rates tend to be smaller plans with declining balances. In these cases, contributions are primarily funding pension payments to members that have already retired and there is a small, declining numbers of active employees across which these payments may be allocated. For example, Taft’s First Tier Police plan has a 227.5% contribution rate. As of June 30, 2013, the plan had only one active member and 28 retirees.

Among larger plans, Rialto’s Safety Plan has one of the highest contribution rates:  48.8% in fiscal 2015, with a projected increase to 50.3% in fiscal 2016. The city’s contribution rate appears to be especially high because of a 2008 decision to increase the plan’s benefit formula to 3% at 50. Because the increase applied to existing employees (whose contributions had been based on less generous benefits), the plan has required catch-up contributions to avoid greater underfunding. After the new formula took effect in 2011, the employer contribution rate jumped from 19.3% to 38.3% and has continued to rise.

Another large plan with a relatively high contribution rate is Berkeley’s police plan with a 2015 rate of 46.6% rising to 48.6% in 2016. Police have been eligible for the 3% at 50 benefit formula for several years. A new contract negotiated in 2012 scaled back the formula for new hires to 3% at 55.  This change should slow the increase in contribution rates as more new hires join the force. One aspect of the Berkeley plan that pushes up contribution rates is the provision of a “sick leave credit”. This plan feature allows retirees to add unused sick pay to their length of service at retirement. Each sick day adds 0.004 years to the employee’s service period for purposes of calculating his or her pension benefit rate.  For example, if a police officer retires with 100 sick days and a $100,000 final average pay, she would be entitled to an extra 100 x 0.004 x 3% x $100,000 = $1200 per year.

As one might expect, the most heavily burdened cities also have plans with high contribution rates. San Rafael’s overall contribution rate is 57.7%, Costa Mesa’s fire plan has a 47.5% rate and San Jose’s public safety plan has a 70.8% rate.

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MOST HEAVILY INDEBTED CITIES (INCLUDING PENSION OBLIGATION BONDS)

No discussion of California’s city pension burdens would be complete without taking into account Pension Obligation Bonds. This is the practice of borrowing money to make an annual employer contribution to the pension system, on the assumption that the interest rate paid on the bond will be less than the earnings that will accrue to investing the bond proceeds in the pension fund. We have identified 58 cities that had outstanding pension obligation as of June 30, 2013. These cities are listed below along with the face value of POBs they issued. These amounts include principal that has already been repaid.  Also, some cities, including Oakland and Richmond, have issued zero coupon capital appreciation pension obligation bonds that do not pay any interest. The issuance amounts shown below often reflect the maturity value of these zero coupon bonds rather than the proceeds each city received.

City County Amount Issued
Auburn Placer County 4,965,000
Azusa Los Angeles County 7,215,000
Baldwin Park Los Angeles County 12,810,000
Bell Los Angeles County 9,225,000
Benicia Solano County 13,972,596
Berkeley Alameda County 12,415,000
Brisbane San Mateo County 4,745,000
Burlingame San Mateo County 32,975,000
Capitola Santa Cruz County 5,170,000
Carmel-By-The-Sea Monterey County 6,280,000
Claremont Los Angeles County 6,000,000
Colton San Bernardino County 31,149,399
Daly City San Mateo County 36,235,000
Fairfield Solano County 36,865,000
Fresno Fresno County 205,335,000
Hawthorne Los Angeles County 30,700,000
Huntington Park Los Angeles County 23,000,000
Inglewood Los Angeles County 64,986,301
La Verne Los Angeles County 8,380,000
Long Beach Los Angeles County 164,500,000
Marina Monterey County 4,315,000
Merced Merced County 7,355,000
Mill Valley Marin County 6,775,000
Millbrae San Mateo County 11,521,660
Monrovia Los Angeles County 12,750,000
Monterey Park Los Angeles County 17,405,000
Novato Marin County 18,296,066
Oakland Alameda County 757,930,000
Oceanside San Diego County 42,780,000
Oroville Butte County 7,260,000
Pacific Grove Monterey County 19,365,355
Pacifica San Mateo County 20,510,000
Palm Springs Riverside County 19,832,588
Paradise Butte County 10,918,154
Pasadena Los Angeles County 159,380,000
Pinole Contra Costa County 16,800,000
Pittsburg Contra Costa County 39,566,055
Pomona Los Angeles County 42,280,684
Port Hueneme Ventura County 10,679,956
Porterville Tulare County 3,765,000
Redlands San Bernardino County 25,862,392
Richmond Contra Costa County 239,500,729
Riverside Riverside County 150,480,000
Sacramento Sacramento County 183,365,000
San Bruno San Mateo County 13,175,000
San Leandro Alameda County 18,305,000
San Marino Los Angeles County 7,095,000
San Rafael Marin County 4,490,000
San Ramon Contra Costa County 17,650,000
Santa Cruz Santa Cruz County 24,150,000
Santa Rosa Sonoma County 32,715,000
Scotts Valley Santa Cruz County 4,460,000
Seaside Monterey County 6,880,000
Sonoma Sonoma County 2,925,000
South Gate Los Angeles County 24,400,000
Stockton San Joaquin County 125,310,000
Union City Alameda County 22,997,973
Yuba City Sutter County 7,685,000

Finally by combining unfunded actuarially accrued liabilities and outstanding pension obligation bond debt, we find the cities that have the highest overall pension debt burden – based on 2013 total revenue. In the table that follows, we have used 2013 revenues from the State Controller’s Office, except in the case of Oakland which had an anomalous value in the SCO data set. The 2013 POB column reflects our calculation of unpaid principal plus unamortized premia on zero coupon bonds as of June 30, 2013.

California Cities, Ranked by Pension Debt as Percent of Total Revenue – Top 20

Rank City 2013 Total Revenue 2013 UAAL 2013 POB Outstanding Total Pension Debt Debt / Revenue
1 OAKLAND 902,343,411 1,336,731,344 497,326,504 1,834,057,848 203.3%
2 COSTA MESA 120,941,625 220,088,382 220,088,382 182.0%
3 RICHMOND 229,667,716 213,851,021 201,590,579 415,441,600 180.9%
4 WEST COVINA 75,202,992 129,009,677 129,009,677 171.5%
5 SAN RAFAEL 98,069,848 161,297,000 4,490,000 165,787,000 169.0%
6 NEWARK 42,011,267 70,674,444 70,674,444 168.2%
7 PARADISE 16,283,406 13,598,638 11,809,914 25,408,552 156.0%
8 PACIFIC GROVE 24,393,663 24,510,771 12,451,649 36,962,420 151.5%
9 FOSTER CITY 36,608,718 52,461,839 52,461,839 143.3%
10 INGLEWOOD 159,019,773 166,164,169 58,076,302 224,240,471 141.0%
11 MAYWOOD 9,228,259 12,978,485 12,978,485 140.6%
12 EL CAJON 99,209,121 137,565,731 137,565,731 138.7%
13 STOCKTON 362,091,530 370,970,850 125,310,000 496,280,850 137.1%
14 BERKELEY 296,093,704 401,733,284 1,865,000 403,598,284 136.3%
15 PLEASANT HILL 25,049,832 33,041,047 33,041,047 131.9%
16 WHITTIER 66,526,402 86,998,800 86,998,800 130.8%
17 FREMONT 211,801,362 275,568,580 275,568,580 130.1%
18 DOWNEY 100,912,444 130,989,072 130,989,072 129.8%
19 ORANGE 147,030,133 190,178,031 190,178,031 129.3%
20 CONCORD 111,190,625 142,421,844 142,421,844 128.1%

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As can be seen on the above table, some cities, such as Richmond, actually have more debt carried in the form of pension obligation bonds than they have in the form of an unfunded pension liability. Omitting consideration of pension bond debt clearly favors a city like Richmond, but in reality their pension contributions are significantly understated unless the pension bond debt is taken into account. Using this ratio also validates the precarious situation Costa Mesa finds themselves in, since even though they have no pension bond debt, their unfunded liability is 66% greater than their entire annual revenue. It is also interesting to see that some of California’s larger cities, including Oakland and Stockton, have relied heavily on the use of pension obligation bonds to finance their annual pension fund contributions.

WHAT THE FUTURE HOLDS

In February, 2014 CalPERS adjusted its actuarial assumptions with the effect of further increasing employer contribution rates.  The rate increase will be phased in over five fiscal years.  When the change is fully implemented, in fiscal 2020-21, CalPERS projects a further increase in safety officer contribution rates of between 5.3% and 9.3%.

In addition to listing contribution rates for the upcoming fiscal year, CalPERS actuarial valuation reports have also provided projected rates for future fiscal years to assist agencies with multi-year financial planning. In theory, this data could be used to compare projected future burdens among cities.

Unfortunately, there are complexities inherent in creating such a comparison and these challenges have been exacerbated by a change in this year’s CalPERS actuarial reporting.  In some cases, the reports provide an employer contribution rate, but, in most others, they list both a normal cost rate and a lump sum Unfunded Actuarial Liability (UAL) payment. This makes comparisons across plans more difficult. Further, non-CalPERS plans often do not provide projected rates at all. Consequently, a systematic comparison of contribution rates across plans and cities is impossible, but we can consider some specific cases.

One city that can expect to face sharply increased pension burdens is Monrovia, a medium-sized community northeast of Los Angeles. Between fiscal 2016 and 2020, the city’s UAL payment is projected to rise from $1.6 million to $2.9 million. During the same period, contribution rates for the city’s miscellaneous plan are projected to rise from 30.9% to 38.8%.

Assuming that CalPERS estimated 2016 covered payroll increases three percent annually, Monrovia’s actuarially required contribution is projected to rise from $6.2 million in fiscal 2015 to $10.2 million in fiscal 2020.  Since the city’s 2015 pension burden already exceeds 10%, the city will be hard pressed to find this additional $4 million.

CalPERS projections assume a 7.5% annual increase in the value of system assets. This assumption – which is closely related to the discount rate applied to unfunded liabilities – is controversial.  However, the system easily exceeded this rate in four of the last five years – benefitting from the bull market in stocks that followed the Great Recession.

Since future portfolio returns are unpredictable, CalPERS provides a sensitivity analysis that shows contribution rates (or UAL payments) under different return scenarios.  The worst scenario reflects a -3.8% annual return between July 1, 2014 and June 30, 2017. Under this scenario and using a 3% covered payroll growth assumption, Monrovia’s fiscal 2020 contribution would rise to almost $12.5 million.

Of course, the city’s pension burden would not grow as much if the market continues to do well.  CalPERS most rosy scenario calls from an 18.9% annualized returns during the same period. If this were to happen, Monrovia’s fiscal 2020 ARC would be $6.4 million – little changed from the fiscal 2015 level.

A larger city facing a sharp increase in an already heavy pension burden is Fremont in Alameda County. The city’s safety plan has a contribution rate of 40.7%.  In fiscal 2016 this will rise to 44.7%, and by fiscal 2020, the rate will reach 55.3% assuming median CalPERS returns. If CalPERS underperforms, the 2020 rate will stabilize at 43.0%; in the event of underperformance the rate will escalate to 65.8%.

The city’s miscellaneous plan has an employer contribution rate of 24.1%.  This is expected to rise to 25.8% in fiscal 2016 and 31.3% in fiscal 2020.  Once again, the range of potential 2020 outcomes is wide: from 23.3% under bull market conditions and 38.1% if the bears prevail.

In absolute dollars and assuming 3% covered payroll growth, Fremont’s pension cost is expected to rise from $26.8 million in fiscal 2015 to $39.2 million in fiscal 2020. Under the bull market scenario, the 2020 cost would be $30.0 million; while it would reach $47.1 million in the bear market case.

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CONCLUSION

The impacts of public employee pension costs vary widely across California cities. By offering new employees defined contribution plans or more modest defined benefit formulas, heavily burdened municipalities can gradually reduce the share of their budgets devoted to this legacy cost. Substantial towns including Lafayette and Orinda show that it is possible to fill openings – at least among non-safety employees – without offering defined pension benefits.

There are cautionary lessons as well. As San Jose has learned, it is very difficult to pare back generous pension benefit packages once they have been granted.  And, as Costa Mesa has discovered, sweetening benefits for existing employees is a recipe for trouble.

Given prevailing court rulings to date, there is little municipalities can do to lighten their pension loads in the near term. By projecting pension contributions for the next several fiscal years, CalPERS has provided a way for cities to anticipate and hopefully reserve for the obligations they face shortly beyond the current budget year. We hope that systems outside CalPERS will provide similar multi-year projections in their own actuarial valuation reports.

The CalPERS projections are buried deep inside plan-specific valuation reports available only in PDF form. By extracting the relevant data from these valuation reports and then aggregating them by city, we hope we have provided policymakers and citizens with an accessible tool that they can use to assess and address growing pension costs in their respective communities.

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Marc Joffe founded Public Sector Credit Solutions in 2011 to educate policymakers, investors and citizens about government credit risk. PSCS research has been published by the California State Treasurer’s Office, the Mercatus Center and the Macdonald-Laurier Institute among others. Prior to starting PSCS, Marc was a Senior Director at Moody’s Analytics. He has an MBA from New York University and an MPA from San Francisco State University.

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