How Much Could California’s Government Pensions Cost Taxpayers?

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

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

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

CalPERS average final salary for 30 years work, retiring 2010: $82,884

CalPERS average pension for 30 years work, retiring 2010: $60,894  –

CalSTRS average final salary for 30 years work, retiring 2010: $88,164

CalSTRS average pension for 30 years work, retiring 2010: $59,580  –

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

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

If the pension fund’s return is 7.75%, the contribution rate is 22% of payroll.

If the pension fund’s return is 6.75%, the contribution rate is 28% of payroll.

If the pension fund’s return is 5.75%, the contribution rate is 37% of payroll.

If the pension fund’s return is 4.75%, the contribution rate is 48% of payroll.

If the pension fund’s return is 3.75%, the contribution rate is 63% of payroll.

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

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

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

If the pension fund’s return is 7.75%, the state pays $23 billion to pension funds each year.

If the pension fund’s return is 6.75%, the state pays $29 billion to pension funds each year.

If the pension fund’s return is 5.75%, the state pays $39 billion to pension funds each year.

If the pension fund’s return is 4.75%, the state pays $51 billion to pension funds each year.

If the pension fund’s return is 3.75%, the state pays $66 billion to pension funds each year.

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

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