California’s new governor, Gavin Newsom, delivered an inaugural address earlier this week that accurately reflected the mentality of his supporters. Triumphalist, defiant, and filled with grand plans. But are these plans grand, or grandiose? Will Governor Newsom try to deliver everything he promised during his campaign, and if so, can California’s state government really deliver to 40 million residents universal preschool, free community college, and single payer health care for everyone? It’s reasonable to assume that to execute all of these projects would cost hundreds – plural – of billions per year. Where will this money come from?
While California’s budget outlook currently offers a surplus in excess of $10 billion, that is an order of magnitude less than what it will cost to do what Newsom is planning. And this surplus, while genuine, is the result of an extraordinary, unsustainable surge in income tax payments by wealthy people. California’s tax revenues are highly dependent on collections from the top one-percent of earners, and over the past few years, the top one-percent has been doing very, very well. Can this go on?
To illustrate just how unusually swollen California’s current state tax revenues have gotten, compare state tax collections in FYE 6/30/2017 (our most recent available data) to seven years earlier, in 2010. Back in 2010, California was in the grip of the great recession. Total state tax revenue was $94 billion, and $44 billion of that was from personal income taxes. Skip to FYE 6/30/2017, and total state tax revenue was $148 billion, and $86 billion was from personal income taxes. This means that 80 percent of the increase in state tax revenue over the seven years through 6/30/2017 was represented by the increase is collections from individual taxpayers, which doubled.
It isn’t hard to figure out why this happened. Between 2010 and 2017 the tech heavy NASDAQ tripled in value, from 2,092 to 6,153. In that same period, Silicon Valley’s big three tech stocks all quadrupled. Adjusting for splits, Apple shares went from $35 to $144, Facebook opened in May 2012 at $38, and went up to $150, Google moved from $216 to $908.
While California’s tech industry was booming over the past decade, California real estate boomed in parallel. In June 2010 the median home price in California was $335,000; by June 2017 it had jumped to $502,000. Along the California coast, median home prices have gone much higher. Santa Clara County now has a median home price of $1.3 million, double what it was less than a decade ago.
As people sell their overpriced homes to move inland or out-of-state, and as tech workers cash out their burgeoning stock options, hundreds of billions of capital gains generate tens of billions in state tax revenue. But can homes continue to double in value every six or seven years? Can tech stocks continue to quadruple in value every six or seven years? Apparently Gavin Newsom thinks they can. Reality may beg to differ.
Just a Slowdown in Capital Gains Will Cause Tax Revenue to Crash
The problem with Gavin Newsom’s grand plans is that it won’t take a downturn in asset values to sink them. All that has to happen to throw California’s state budget into the red is for these asset values to stop going up. Just a plateauing of their value – which, by the way, we’ve been witnessing over the past six months – will wreak havoc on state and local government budgets in California.
The reasons for this are clear enough. Wealthy people, making a lot of money, pay the lion’s share of state income taxes, and state income taxes constitute the lion’s share of state revenues. Returning to the 2017 fiscal year, of the $86 billion collected in state income taxes, $28 billion was from only 70,437 filers, all of them making over $1.0 million in that year. Another $7.3 billion came from 131,120 filers who made between a half-million and one million in that year. And since making over $200,000 in income in one year is still considered doing very, very well, it’s noteworthy that another 807,000 of those filers ponied up another $15.1 billion in FYE 6/30/2017.
There is an obvious conclusion here: if people are no longer making killings in capital gains on their sales of stock and real estate, California’s tax revenues will instantly decline by $20 billion, if not much more. And it won’t even take a slump in asset prices to cause this, just a leveling off.
Debt, Unfunded Pension Liabilities, Neglected Infrastructure
When considering how weakening tax revenues in California will impact the ability of the state and local governments to cope with existing debt, it’s hard to know where to begin. To get an idea of the scope of this problem, the California Policy Center just released an analysis of California’s total state and local government debt. As shown on the table, California’s total state and local government debt as of 6/30/2017 is over $1.5 trillion. More than half of it, $846 billion, is in the form of unfunded pension liabilities.
Calculating pension liabilities is a complex process, with controversy surrounding what assumptions are valid. In basic terms, a pension liability is the amount of money that must be on hand today, in order for withdrawals on that amount – plus investment earnings on that amount as it declines – to eventually pay all future pensions earned to-date for all active and retired participants in the fund. Put another way, a pension liability is the present value of all pension benefits – earned so far – that must be paid out in the future. The amount by which the total pension liability exceeds the actual amount of assets invested in a fund is referred to as the unfunded liability.
The controversy over what is an accurate estimate of a pension liability arises due to the extreme sensitivity that number has to how much the fund managers think they can earn. Using the official projection which is typically around 7.0 percent per year, the official pension liability for all of California’s government pension funds is “only” $316 billion. But Moody’s, the credit rating agency, discounts pension liabilities with the Citigroup Pension Liability Index (CPLI), which is based on high grade corporate bond yields. In June 2017, it was 3.87 percent, and using that rate, CPC analysts estimated the unfunded liability for California’s state and local employee pension systems at $846 billion. Using the methodology offered by the prestigious Stanford Institute for Economic Policy Research, California’s unfunded pension debt is even higher, at $1.26 trillion.
Where pension liabilities move from controversial theories to decidedly non-academic real world consequences, however, is in the budget busting realm of how much California’s government agencies have to pay these funds each year. California’s public sector employers contributed an estimated $31 billion to the pension systems in 2018. Extrapolating from officially announced pension rate hikes from CalPERS, California’s largest pension system, by 2024 those payments are projected to increase to $59 billion. And these aggressive increases the pension systems are requiring are a reflection more of their crackdown on the terms of the “catch up” payments employers must make to reduce the unfunded liability than on a reduction to their expected real rate of return.
Huge unfunded pension liabilities are another reason, equally significant, as to why California’s state budget is extraordinarily vulnerable to economic downturns. If assets stop appreciating, not only will income tax revenue plummet. At the same time, expenses will go up, because pension funds will demand far higher annual contributions to make up the shortfall in investment earnings.
A cautionary overview of the economic challenges facing California’s state government would not be complete without mentioning the neglected infrastructure in the state. For decades, this vast state, with nearly 40 million residents, has been falling behind in infrastructure maintenance. The American Society of Civil Engineers assigns poor grades to California’s infrastructure. They rate over 1,300 bridges in California as “structurally deficient,” and 678 of California’s dams are “high hazard.” They estimate $44 billion needs to be spent to bring drinking water infrastructure up to modern standards, and $26 billion on wastewater infrastructure. They estimate over 50 percent of California’s roads are in “poor condition.” In every category – aviation, bridges, dams, drinking water, wastewater, hazardous waste, the energy grid, inland waterways, levees, ports, public parks, roads, rail, transit, and schools, California is behind. The fix? Literally hundreds of additional billions.
What Governor Newsom might consider is refocusing California’s state budget priorities on areas where the state already faces daunting financial challenges, rather than acquiescing to the utopian fever dreams of his constituency and his colleagues.
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Every two years, around this time, political mailers inundate the mailboxes of California’s registered voters. This week, many Sacramento residents received “Vote No on Prop 6″ mailer. Prop 6 is that pesky, subversive citizens ballot initiative that, if approved by voters, will roll back the gas tax.
But Prop. 6 isn’t the topic here. Rather, the topic is all taxes in California. Why is there relentless pressure to increase them? And what special interests are paying for these campaigns to increase (or preserve) taxes across California?
In that context, this No on Prop. 6 mailer is instructive. Because blazoned across the cover of this four page, 8.5″ x 11” glossy full color flyer, is Darrell Roberts, representing the California Professional Firefighters. Roberts is the president of IAFF Local 2180, the Chula Vista Firefighters Union. In addition to his duties as president of Local IAFF Local 2180, Roberts is a Fire Battalion Chief for the Chula Vista Fire Department. In that capacity, he earned $327,491 in 2017, including $99,887 of overtime.
Now let’s back up for just a moment and make something perfectly clear. This isn’t about disrespecting firefighters in general, or Mr. Roberts in particular. Quite the contrary. Firefighters perform dangerous, challenging jobs that require years of intense training. Every year in California, a few of them die in the line of duty. In some years, more than a few. Furthermore, firefighters constantly witness trauma, often horrific, every time they respond not only to fires, but medical emergencies and automobile accidents. Their jobs are tough.
For these reasons, critics of public sector compensation trends should always temper their observations with respect. It is far too easy to observe, accurately, that many other jobs carry higher risk of injury or death, while forgetting that first responders stand between citizens and mayhem not just in normal times, but also in extraordinary times. In a truly cataclysmic event, and 911 is a perfect example, firefighters are obligated to occupy the front lines. They are the ones who must stop whatever destructive storms afflict our society. They are the ones who must go in before safety is restored, and rescue the stranded victims.
With that necessary preamble, and without diminishing it in any way, a difficult conversation remains necessary regarding public sector compensation, and the political power of the public sector unions who push for continuous increases in compensation.
A California Policy Center analysis published nearly two years ago, using 2015 data, calculated the average pay and benefits for a California firefighter at $196,370 for those employed by cites, $198,959 for those working for counties, and $145,938 for those working for the state. Those averages have not fallen in the past three years, and they do not include the additional cost per firefighter, if and when their retirement pensions are adequately funded.
Mr. Robert’s own City of Chula Vista provides an example of these rising pension costs. In 2017 the average pay for a Chula Vista firefighter was $189,715. That included, on average, $41,112 for overtime and $31,381 for employer contributions to their defined benefit pensions. But as they say, you ain’t seen nothin’ yet.
Using CalPERS own projections for the City of Chula Vista, the average normal contribution by the city to fund police and firefighter pensions is expected to grow from 20 percent of payroll in FYE 6/30/2017 to 22 percent of payroll by FYE 6/30/2025. Nothing terribly dramatic there. But, get this, the so-called unfunded contribution – that additional amount necessary to pay down the city’s unfunded liability for police and firefighter pensions – is expected to grow from 13 percent of payroll in FYE 6/30/2017 to 32 percent of payroll in 6/30/2025.
Put another way, the City of Chula Vista’s employer payments for public safety pensions are going to go from 33 percent of payroll to 53 percent of payroll by 2025. And if the stock market decides to end its already record breaking bull run, harming the CalPERS investment portfolio, these payments will go much higher.
It’s also important to recognize the relationship between excess overtime expenses and the cost of pension and health benefits (including retirement health benefits). When public employers pay more than 50 percent above regular salary to fund pensions and benefits, and in the case of public safety, they do, then it makes financial sense to pay time-and-a-half to existing staff, since that will cost less. Lost in that equation is the stress this excessive overtime inflicts on overworked personnel, as well as the lost opportunity to bring benefit overhead back below fifty percent.
Collectively California’s state and local employers, based on projections already released from CalPERS, are going to have to increase their total contributions to public employee pension funds from approximately $31 billion in 2017 to an estimated $59 billion by 2025.
Maybe veteran firefighters truly believe they are entitled to annual pay and benefits packages in excess of $200,000 per year, or in Mr. Roberts case, in excess of $300,000 per year. But with all the political power these unions wield, they ought to be thinking of ways to help lower the cost-of-living in California. That would help everyone.
And perhaps it may disturb even the most respectful and appreciative among us, when a public servant who made $327,491 last year, asks us to support higher taxes.
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2017 Salaries for Chula Vista – Transparent California
California’s Public Sector Compensation Trends – California Policy Center, January 2017
Comprehensive Annual Financial Report, FYE 6/30/2017 – City of Chula Vista
Safety Plan of the City of Chula Vista, Annual Valuation Report as of 6/30/2017 – CalPERS
Miscellaneous Plan of the City of Chula Vista, Annual Valuation Report as of 6/30/2017 – CalPERS
2017 City Data, Government Compensation in California – California State Controller
California Government Pension Contributions Required to Double by 2024 – California Policy Center, January 2018
When evaluating the financial challenges facing California’s state and local public employee pension funds, a compelling question to consider is when, exactly when, will these funds financially collapse? That is, of course, an impossible question to answer. CalPERS, for example, manages hundreds of billions in assets, which means that long before it literally runs out of cash to pay benefits, tough adjustments will be made that will restore it to financial health.
What is alarming in the case of CalPERS and other public sector pension funds, however, is the relentless and steep rate increases they’re demanding from their participating employers. Equally alarming is the legal and political power CalPERS wields to force payment of these rate increases even after municipal bankruptcies where other long-term debt obligations are diminished if not completely washed away. Until California’s local governments have the legal means to reform pension benefits, rising pension contributions represent an immutable, potentially unmanageable financial burden on them.
SOUTH PASADENA’S PAYMENTS TO CALPERS ARE SET TO DOUBLE BY 2025
The City of South Pasadena offers a typical case study on the impact growing pension costs have on public services and local taxes. Using CalPERS own records and official projections, the City of South Pasadena paid $2.8 million to CalPERS in their fiscal year ended 6/30/2017. That was equal to 25% of the base salary payments made in that year. By 2020, the City of Pasadena is projected to pay $4.3 million to CalPERS, equal to 35% of base pay. And by 2025, the City of Pasadena is projected to pay $5.9 million to CalPERS, equal to 41% of base pay.
Can the City of South Pasadena afford to pay an additional three $3.0 million per year to CalPERS, on top of the nearly $3.0 million per year they’re already paying? They probably can, but at the expense of either higher local taxes or reduced public services, or a combination of both. But the story doesn’t end there. The primary reason required payments to CalPERS are doubling over the next few years is because CalPERS was wrong in their estimates of how much their pension fund could earn. They could still be wrong.
Annual pension contributions are calculated based on two factors: (1) How much future pension benefits were earned in the current year, and how much money must be set aside in this same year to earn interest and eventually be used to pay those benefits in the future? This is called the “normal contribution.” (2) What is the present value of ALL outstanding future pension payments, earned in all prior years by all participants in the plan, active and retired, and by how much does that value, that liability, exceed the amount of money currently invested in the pension fund? That amount is the unfunded pension liability, and the amount set aside each year to eventually reduce that unfunded liability to zero is called the “unfunded contribution.”
Both of these annual pension contributions depend on a key assumption: What rate-of-return can the pension fund earn each year, on average, over the next several decades? And it turns out the amount that has to be paid each year to keep a pension fund fully funded is extremely sensitive to this assumption. The reason, for example, that CalPERS is doubling the amount their participating employers have to pay each year is largely because they are gradually lowering their assumed rate of return from 7.5% per year to 7.0% per year. But what if that isn’t enough?
IF THE RATE-OF-RETURN CALPERS EARNS FALLS, PAYMENTS COULD RISE MUCH HIGHER
It isn’t unreasonable to worry that going forward, the average rate of return CalPERS earns on their investments could fall below 7.0% per year. For about a decade, nearly every asset class available to investors has enjoyed rates of appreciation in excess of historical averages. Yet despite being at what may be the late stages of a prolonged bull market in equities, bonds, and real estate, the City of South Pasadena’s pension investments managed by CalPERS were only 73% funded. As of 6/30/2017 (the most recent data CalPERS currently offers by agency), the City of South Pasadena faced an unfunded pension liability of $35 million. Using CalPERS own numbers, if they were to earn 6% per year on their investments in the coming years, instead of their new – and just lowered – annual return of 7%, that unfunded liability would rise to $58 million.
As it is, by 2025 the City of South Pasadena is already going to be making an unfunded contribution that is nearly twice their normal contribution. Another reason for this is because CalPERS is now requiring their participating agencies to pay off their unfunded pension liabilities in 20 years of even payments. Previously, attempting to minimize those payments, agencies had been using 30 year payoff terms with low payments in the early years. Back in 2017, based on a 6% rate-of-return projection, and in order to pay off a $58 million unfunded pension liability on these more aggressive repayment terms, the City of South Pasadena would have to come up with an unfunded pension contribution of $5.0 million per year, along with a normal contribution of around another $2.4 million per year.
But why should it end there? Nobody knows what the future holds. These rate-of-return projections by definition have to be “risk free,” since otherwise – and as has happened – taxpayers have to foot the bill to make these catch up payments. How many of you can rely on a “risk free” rate-of-return,” year after year, for decades, in your 401K accounts of six percent, or even five percent? At a 5% rate-of-return, the City of South Pasadena would have to pay an unfunded contribution of $6.2 million, along with a normal contribution of $2.8 million.
These scenarios are not outlandish. Most everyone hopes America and the world are just entering a wondrous “long boom” of peace and prosperity, ushered in by ongoing global stability and technological innovations. But the momentum of history is not predictable. Imagine if there was an era of deflation. It has happened before and it can happen again. The following chart shows how that might play out in the City of South Pasadena. Notice how at a 4% rate-of-return projection, in 2017 the City of South Pasadena would have had to pay CalPERS $9.8 million; at 3%, $11.4 million.
City of South Pasadena – FYE 6/30/2017
Estimated Pension Payments and Pension Debt at Various Rate-of-Return Projections
And what about the rest of California? How would a downturn affect all of California’s public employee pension systems, the agencies they serve, and the taxpayers who fund them? In a CPC analysis published earlier this year, “How to Assess Impact of a Market Correction on Pension Payments,” the following excerpt provides an estimate:
“If there is a 15% drop in pension fund assets, and the new projected earnings percentage is lowered from 7.0% to 6.0%, the normal contribution will increase by $2.6 billion per year, and the unfunded contribution will increase by $19.9 billion. Total annual pension contributions will increase from the currently estimated $31.0 billion to $68.5 billion.”
That’s a lot of billions. And as already noted, a 15% drop in the value of invested assets and a reduction in the estimated average annual rate-of-return from 7.0% to 6.0% is by no means a worst case scenario.
To-date, meaningful pension reform has been thwarted by powerful special interests, most notably pension funds and public sector unions, but also many financial sector firms who profit from the status quo. But a case to be decided next year by the California Supreme Court, Cal Fire Local 2881 v. CalPERS, may provide local agencies with the legal right to make more sweeping changes to pension benefits. The outcome of that ruling, combined with growing public pressure on local elected officials, may offer relief. For this reason, it may well be that raising taxes and cutting services in order to fund pensions may be a false choice.
CalPERS Annual Valuation Reports – main search page
CalPERS Annual Valuation Report – South Pasadena, Miscellaneous Employees
CalPERS Annual Valuation Report – South Pasadena, Safety Employees
CalPERS Annual Valuation Report – South Pasadena, Miscellaneous Employees (PEPRA)
CalPERS Annual Valuation Report – South Pasadena, Safety Employees, Fire (PEPRA)
CalPERS Annual Valuation Report – South Pasadena, Safety Employees, Police (PEPRA)
Moody’s Cross Sector Rating Methodology – Adjustments to US State and Local Government Reported Pension Data (version in effect 2018)
California Pension Tracker (Stanford Institute for Economic Policy Research – California Pension Tracker
The State Controller’s Government Compensation in California – main search page
The State Controller’s Government Compensation in California – South Pasadena payroll
The State Controller’s Government Compensation in California – raw data downloads
California Policy Center – Resources for Pension Reformers (dozens of links)
California Policy Center – Will the California Supreme Court Reform the “California Rule?” (latest update)
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Voters in tiny, affluent Sierra Madre, three square miles of leafy neighborhoods nestled at the foot of the majestic San Gabriel mountains, had an opportunity earlier this week to repeal their utility tax. As reported in the San Gabriel Valley Tribune, by a margin of more than four-to-one, they decided to keep their tax.
Opponents of the utility tax repeal pointed out that Sierra Madre has very low per capita sales tax revenue (claiming 460th out of 481 California cities), and therefore depends on their utility tax. And in any case, the numbers are vanishingly small. Had Sierra Madre’s citizens voted to repeal their utility tax, it would have eliminated $2.6 million, or 24%, from the city’s annual revenue.
The real question facing Sierra Madre, and all of California’s cities, isn’t whether or not to repeal various local taxes, but how many new taxes to approve in the next few years. As documented by CalTax, every election cycle, hundreds of new local taxes are proposed, and they usually pass. For example, in November 2016, 224 new local tax increases were proposed, and 71% of them were approved by voters.
How these measures get approved by voters is nicely exemplified by the Sierra Madre ballot. Measure D, at the top of the ballot, presented the question to voters: “Shall the City of Sierra Madre adopt a measure repealing the City’s Utility Users Tax in its entirety?”
But below Measure D on this ballot was Advisory Measure A, which read “If Measure “D” passes, repealing the Utility Users’ Tax and eliminating approximately 24% or $2.6 million of the City’s General Fund Revenues, should the City Council eliminate paramedic services, reduce and outsource police services and library services, reduce code enforcement, and fire suppression services, in addition to other reductions which will be required to balance the budget?”
SIERRA MADRE SPECIAL ELECTION BALLOT – 4/10/2018
If that isn’t an anti Measure D campaign message masquerading as an “advisory measure,” then there’s a bridge for sale in San Francisco, and the moon is made of green cheese.
It’s worth wondering why the pro-repeal campaign didn’t just try to reverse Sierra Madre’s recent utility tax increase, instead of calling for its total repeal. After all, that tax has been in place since 1993. But in 2016, Sierra Madre’s voters approved an increase in the utility tax rate from 8% to 10%. Rolling back that increase, which equates to about a half-million per year in additional tax collections, would not have broken the city’s finances. It could have been marketed for what it would have been – a way to pressure Sierra Madre’s elected officials to finally confront their escalating pension payments.
ALL NEW TAXES ARE TO PAY MORE FOR GOVERNMENT PENSIONS
Beyond any serious debate by now is the fact that payments to CalPERS by California’s cities are set to nearly double in the next six years, from a projected total of $3.1 billion in 2017-18 to over $5.8 billion in 2024-25. This is based on recent “Public Agency Actuarial Valuation Reports” issued by CalPERS actuaries for each of their participating agencies, summarized here by the California Policy Center.
In the case of Sierra Madre, this year they will pay $1.5 million to CalPERS, which is 13.8% of their total general fund revenues. By 2024, they will be paying CalPERS $2.2 million, or over 20% of their total general fund revenues.
One in five dollars of Sierra Madre’s tax revenue will be paying for pensions. And that does NOT include (1) any payments for other post-employment benefits, (2) any increases to those payments based on investments deciding not to perform as well in the next ten years as they have in the past ten years (imagine that), or (3) any additional payments if Sierra Madre happens to have issued “pension obligation bonds” in prior years. We didn’t look into this, but plenty of cities have succumbed to the temptation to borrow money to make their pension payments.
One possible source of relief for this comes in the form of the CalFire vs CalPERS case that is working its way through the California Supreme Court. There is a possibility that a ruling could undermine the “California Rule,” which to-date has been aggressively – and successfully – interpreted by government union attorneys to mean that pension benefits cannot be diminished, even for work not yet performed.
If the outcome of that case tilts in favor of reform, you might see this “advisory measure” on a local ballot, right beneath the next proposed tax increase.
HYPOTHETICAL SIERRA MADRE SPECIAL ELECTION BALLOT
(including “advisory measure” that proposes reducing pension benefits)
That would be the day. When immediately below a proposed tax increase, an “advisory measure” proposes to reduce pension benefits if the tax increase does not pass.
And that certainly would not be an anti-tax campaign message, would it?
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Stampede: a mass movement of people at a common impulse.
– Merriam Webster dictionary
The pension reform stampede is about to finally overrun California’s political status-quo for three reasons.
(1) Pension debt is out of control. While official estimates are slightly lower, most reasonable estimates put California’s total unfunded liabilities for state and local pensions at around $500 billion.
(2) Required agency contributions are set to double. California’s two largest pension systems, CalPERS and CalSTRS, have both announced that within the next few years their participating agencies are going to have to at least double the amount they contribute to pensions.
(3) Active cases before the California Supreme Court, set to be decided within a year, will likely enable more meaningful pension reform measures at the state and local level.
Serious pension reform may soon become politically feasible, and it’s about time.
An indicator of how serious politicians are finally taking California’s pension crisis is exemplified by the California League of Cities Pension Project. A consensus is belatedly forming within this powerful organization that absent real reform, California’s public sector pensions are not financially sustainable.
Here are some of the groups and individuals in California who are either providing vital information, or engaging in activist efforts for pension reform:
A good place to start is the pensions section of Transparent California, a five year old website that has compiled the most comprehensive database of individual state and local government compensation and pension information possibly in the U.S., and certainly in California. On Transparent California’s All Pensions page, users can search through millions of individual pensions. On its Pension Plans page, users can search for recipient information by pension system. On its Last Employer page, users can search for recipient information by the last employer.
At least four regional groups scattered across California focus exclusively on pension reform, or devote a considerable amount of their resources to the issue of pension reform. From north to south, they are: Citizens for Sustainable Pension Plans (Marin County), New Sonoma (Sonoma County), the Contra Costa County Taxpayers Association, and the Ventura County Taxpayers Association. There are undoubtedly other regional organizations that have done important pension reform work – any suggestions for additions to this list are welcome.
Three heroic individuals who have dedicated years of volunteer time to educating the public, the media, and policymakers about public sector pensions are John Dickerson, publisher of YourPublicMoney.com, Jack Dean, publisher of PensionTsunami.com, and Ed Mendel’s CalPensions.com. If you want to learn the intricacies of pension finance, what John Dickerson has created is as good a place as any. If you want a daily archive of links to every significant report on pensions in the U.S., Jack Dean’s meticulously curated Pension Tsunami website is not only the best place to look, it’s the only place to find that information. Ed Mendel’s CalPensions offers deep analysis of pension developments in California.
Stanford University’s Institute for Policy Research issues regular assessments of California’s pension challenges including the recent Pension Math: Public Pension Spending and Service Crowd Out in California, 2003-2030, October 2017, and California Pension Tracker 2.0, an interactive database that reveals, among other things, by city or county, the total market pension debt per household. The Los Angeles based Reason Foundation presents ongoing analysis of the impact of pensions on the Pension Reform section of their website.
State-focused and national activist organizations in California include the Sacramento based Retirement Security Initiative, which is active in states across the U.S. fighting for pension reform, and the San Diego based Reform California, working for pension reform at the state level.
For continuing dialog with pension reformers the Facebook communities created by the Citizens for Sustainable Pension Plans and Californians for Pension Reform are both very good. The California Policy Center also has a Facebook page that includes extensive coverage of pensions, along with esposes of the most powerful special interest that opposes pension reform, government unions.
For years the California Policy Center has followed the pension crisis in California, and over the past few months has released several reports that, in aggregate, provide a reasonably complete summary of the challenges Californians face to get public employee pension costs under control.
Those reports, with titles that explain the specific topics, are the following: The Underrecognized, Undervalued, Underpaid, Unfunded Pension Liabilities, March 2018 – How to Restore Financial Sustainability to Public Pensions, February 2018 – How to Assess Impact of a Market Correction on Pension Payments, February 2018 – California Government Pension Contributions Required to Double by 2024 – Best Case, January 2018 – Did CalPERS Use Accounting “Gimmicks” to Enable Financially Unsustainable Pensions?, January 2018 – How Much More Will Cities and Counties Pay CalPERS?, January 2018 – If You Think the Bull Market Rescued Pensions, Think Again, December 2017 – Did CalPERS Fail to Disclose Costs of Historic Bump in Pension Benefits?, October 2017 – Coping With the Pension Albatross, October 2017 – and How Fraudulently Low “Normal Contributions” Wreak Havoc on Civic Finances, September 2017.
On the website for the California Policy Center’s “CLEO” (California Local Elected Officials) project, additional policy briefs are available to assist pension reformers, including: Graphics to Explain the Pension Crisis to Colleagues and Constituents, December 2017 – Explaining the Pension Crisis – Additional Graphics, December 2017 – Pension Questions To Ask Your Agency’s CFO, Actuary & Auditor, December 2017 – Did Your Agency Comply with the Law When Increasing Pension Formulas? – October 2017 – Pension Reform – The San Jose Model, September 2017 – and Pension Reform – The San Diego Model, August 2017.
Edward Ring co-founded the California Policy Center in 2010 and served as its president through 2016. He is a prolific writer on the topics of political reform and sustainable economic development.
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“It’s the economy, stupid.”
– Campaign slogan, Clinton campaign, 1992
To paraphrase America’s 42nd president, when it comes to public sector pensions – their financial health and the policies that govern them – it’s the unfunded liability, stupid.
The misunderstood, obfuscated, unaccountable, underrecognized, undervalued, underpaid, unfunded pension liabilities.
According to CalPERS own data, California’s cities that are part of the CalPERS system will make “normal” contributions this year totaling $1.3 billion. Their “unfunded” contributions will be 41% greater, $1.8 billion. As for counties that participate in CalPERS, this year their “normal” contributions will total $586 million, and their “unfunded” contributions will be 36% greater at $607 million.
That’s nothing, however. Again using CalPERS own estimates, in just six years the unfunded contribution for cities will more than double, from $1.8 billion today, to $3.9 billion in 2024. The unfunded contribution for counties will nearly triple, from $607 million today to $1.5 billion in 2024 (download spreadsheet summary for all CalPERS cities and counties).
Put another way, by 2024, “normal contribution” payments by cities and counties to CalPERS are estimated to total $2.8 billion, and the “unfunded contribution” payments are estimated to total almost exactly twice as much, $5.5 billion.
For starters, every pension reform that has ever made it through the state legislature, including the Public Employee Pension Reform Act of 2013 (PEPRA), does NOT require public employees to share in the cost to pay the unfunded liability. The implications are profound. As public agency press releases crow over the phasing in of a “50% employee share” of the costs of pensions, not mentioned is the fact that this 50% only applies to 1/3 of what’s being paid. Public employees are only required to share, via payroll withholding, in the “normal cost” of the pension.
Now if the “normal cost” were ever estimated at anywhere near the actual cost to fund a pension, this wouldn’t matter. But CalPERS, according to their own most recent financial report, is only 68% funded. That is, they have investments totaling $326 billion, and liabilities totaling $477 billion. This gap, $151 billion, is how much more CalPERS needs to have invested in order for their pension system to be fully funded.
A pension system’s “liability” refers to the present value of every future pension payment that every current participant – active or retired – has earned so far. In a 100% funded system, if every active employee retired tomorrow and no more payments ever went into the system, if the invested assets were equal to that liability, those assets plus the estimated future earnings on those invested assets would be enough to pay 100% of the estimated pension payments in the future, until every individual beneficiary died.
A pension system’s “normal payment” refers to the amount of money that has to be paid into a fully funded system each year to fund the present value of additional pension benefits earned by active employees in that year. When the normal payment isn’t enough, the unfunded liability grows.
And wow, has it grown.
CalPERS is $151 billion in the hole. All of California’s state and local pension systems combined, CalPERS, CalSTRS, and the many city and county independent systems, are estimated to be $326 billion in the hole. And that’s extrapolated from estimates recognized by the pension funds themselves. Scenarios that employ more conservative earnings assumptions calculate total unfunded liabilities that are easily double that amount.
With respect to CalPERS, how did this unfunded liability get so big?
An earlier CPC analysis released earlier this year attempts to answer this. Theories include the following: (1) Letting the agencies decide which type of asset smoothing they’d like to employ, (2) permitting the agencies to make minimal payments on the unfunded liability so the liability would actually increase despite the payments, (3) making overly optimistic actuarial assumptions, (4) not taking action sooner so the unfunded payment wouldn’t end up being more than twice as much as the normal payment.
One final alarming point.
CalPERS recently announced that for any future increases to the unfunded liability, the unfunded payment will have to be calculated based on a 20 year, straight-line amortization. This is a positive development, since the more aggressively participants pay down the unfunded liability, the less likely it is that these pension systems will experience a financial collapse if there is a sustained downturn in investment performance. But it begs the question – why, if only increases to the unfunded liability have to be paid down more aggressively, is the unfunded payment nonetheless predicted to double within the next six years?
CalPERS information officer Tara Gallegos, when presented with this question, offered the following answers:
(1) The discount rate (equal to the projected rate-of-return on invested assets) is being lowered from 7.5% to 7.0% per year. But this lowering is being phased in over five years, so it will not impact the 2018 unfunded contribution. Whenever the return-on-investment assumption is lowered, the amount of the unfunded liability goes up. By 2024, the full impact of the lowered discount rate will have been applied, significantly increasing the required unfunded contribution.
(2) Investment returns were lower than the projected rate of return for the years ending 6/30/2015 (2.4%) and 6/30/2016 (0.6%). Lower than projected actual returns also increases the unfunded liability, and hence the amount of the unfunded payment, but this too is being phased-in over five years. Therefore it will not impact the unfunded payment in 2018, but will be fully impacting the unfunded payment by 2024.
(3) The unfunded payment automatically increases by 3% per year to reflect the payroll growth assumption of 3% per year. This alone accounts, over six years, for 20% of the increase to the unfunded payment. The reason for this is because most current unfunded payments are calculated by cities and counties using the so-called “percent of payroll” method, where payments are structured to increase each year. CalPERS is going to require new unfunded payments to not only be on a 20 year payback schedule, but to use a “level payment” structure which prevents negative amortization in the early years of the term. Unfortunately, up to now, cities and counties were permitted to backload their payments on the unfunded liability, and hence each year have built in increases to their unfunded payments.
The real reason the unfunded liability has gotten so big is because nobody wanted to make conservative estimates. Everybody wanted the normal payments to be as small as possible. The public sector unions wanted to minimize how much their members would have to contribute via withholding. CalPERS and the politicians – both heavily influenced by the public sector unions – wanted to sell generous new pension enhancements to voters, and to do that they needed to make the costs appear minimal.
As a result, taxpayers are now paying 100% of an “unfunded contribution” that is already a bigger payment than the normal contribution, and within a few years is destined, best case, to be twice as much as the normal contribution.
Camouflaged by its conceptual intricacy, the cleverly obfuscated, deliberately underrecognized, creatively undervalued, chronically underpaid, belatedly rising unfunded pension liabilities payments are poised to gobble up every extra dime of California’s tax revenue. And that’s not all…
Sitting on the blistering thin skin of a debt bubble, a housing bubble, and a stock market bubble, amid rising global economic uncertainty, just one bursting jiggle will cause pension fund assets to plummet as unfunded liabilities soar.
And when that happens, cities and counties have to pay these new unfunded balances down on honest, 20 year straight-line terms. They’ll be selling the parks and libraries, starving the seniors, releasing the criminals, firing cops and firefighters, and enacting emergency, confiscatory new taxes.
Whatever it takes to feed additional billions into the maw of the pension systems.
Budget surplus? Dream on.
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Edward Ring co-founded the California Policy Center in 2010 and served as its president through 2016. He is a prolific writer on the topics of political reform and sustainable economic development.
How to Restore Financial Sustainability to Public Pensions, February 14, 2018
How to Assess Impact of a Market Correction on Pension Payments, February 7, 2018
How Much More Will Cities and Counties Pay CalPERS?, January 10, 2018
If You Think the Bull Market Rescued Pensions, Think Again, December 7, 2017
Did CalPERS Fail to Disclose Costs of Historic Bump in Pension Benefits?, October 26, 2017
Coping With the Pension Albatross, October 13, 2017
How Fraudulently Low “Normal Contributions” Wreak Havoc on Civic Finances, September 29, 2017
Pension Reform – The San Jose Model, September 6, 2017
Pension Reform – The San Diego Model, August 23, 2017