Schwarzenegger on State Employee Pensions

George Rebane

California’s governor published a strong appeal for pension reform in the 27aug10 WSJ op-ed section.  In a piece titled ‘Public Pensions and Our Fiscal Future’ he lays out a case for why we are headed for disaster.  None of the arguments are foreign to regular RR readers.  They may come as a surprise though to those lefties claiming the “middle of the road”, and definitely to those of a hard list to port.  And specifically those who are of a strong opinion that all the past alarums posted here have been only from a fevered brain sequestered equally with theirs.

Let me begin with a pre-punch line, our governor flatly states that “government employee unions are the most powerful political forces in our state and largely control Democratic legislators.”  While this should come as no surprise to anyone who reads, it does explain away how the catastrophe has been catalyzed.  Willie Brown, that astute observer of the state’s political scene in which he formerly played a starring role, observed that “roughly 80 cents of every government dollar in California goes to employee compensation and benefits.”

Schwarzenegger makes the point that “spending on California’s state employees over the past decade rose at nearly three times the rate our revenues grew, crowding out programs of great importance to our citizens” that “include higher education, environmental protection, parks and recreation, … .”  This state of affairs has been difficult for the new hope and change students of socialism to pin on Bush, but God knows they’re still trying.

So here comes the punch line (actually punch line #1) – “Much bigger increases in employee costs are on the horizon. Thanks to huge unfunded pension and retirement health-care promises granted by past governments, and also to deceptive pension-fund accounting that understated liabilities and overstated future investment returns, California is now saddled with $550 billion of retirement debt.

The cost of servicing that debt has grown at a rate of more than 15% annually over the last decade. This year, retirement benefits—more than $6 billion—will exceed what the state is spending on higher education. Next year, retirement costs will rise another 15%. In fact, they are destined to grow so much faster than state revenues that they threaten to suck up the money for every other program in the state budget. (See the nearby chart.)”

Meanwhile, “since 2007 over one million private sector jobs have been lost in California.”  And the rest of us are having to guarantee $1M trust funds for every $36K annual pension paid to a 55 year old state retiree.  Do the arithmetic, over 15,000 state workers currently get pensions greater than $100K a year.  A, say, $118K pension means that there must $3M somewhere working hard to generate those checks for the expected longevity of the retiree.

The solution of Sacramento’s liberal left to all this is to raise tax and debt burdens on the private sector to cover the pension costs which have been increasing at over 15% per year during the last decade.  And there is no end in sight for these increases, the unions are not budging an inch.

But here is punch line #2.  There exists no feasible financial scenario for paying off the existing $550B of California’s retirement debt.  In ten years that debt (see chart) will be $28T (yes, T like in trillion).  At 5% just the annual interest on that sum will be $1.4T (yes, there’s that T again) which will amount to about the state’s entire annual budget.  No one in California will peaceably pay the tax rates required to service that debt.  That means that the state retirees are not going to get their pensions unless 1) California turns into a police state, AND 2) the state’s economy will grow sufficiently under these slave labor conditions to generate the needed cash.  I’m sure that some readers are going, ‘there he goes again’, and of those I ask for another scenario that can maintain currently contracted payouts.  If you can come up with one, then get your tux ready for a trip to Stockholm to make a speech and collect your well-deserved prize.

A more detailed accounting of the coming pension panic is found in the heavily documented book Plunder! by Steven Greenhut, head of Pacific Research Institute’s journalism center in Sacramento.

Exit question – If the state retirees took time to puzzle on it, would they vote for or against Prop23?

Comments

[Russ Steele]

George,

Thanks for writing this up. My son-in-law called me yesterday from Seattle to give me a head up on this article. We had discussed the growing pension problem in the past, especially after SESF published Unfunded Liabilities - Our Community’s Fiscal Time Bombs in December of 2007. It was the center of several conversations over the Christmas Holliday that year. Here is a link to the report that you and Mike McDaniel wrote: http://sesfoundation.org/reports.htm

I was looking at the graphic and noted the private sector unemployment stopped in Dec 2009, it would now be off the chart in July of 2010 and the public sector employment would still be a flat line. The public employees complain about not working several Fridays a month, but still have their job. This is unsustainable.

[Steven Frisch]

I think this is a great article, much needed, and is perhaps one of the 2 or 3 most significant issues in California.
We need to recognize this as an issue, take dramatic steps to reduce the future pension burden, and reform state government to avoid this disaster. I have been on record here and at other blogs to that effect.

It is important to note that this problem is not unique to California, nor is it unique to the public sector, nor is it unique to portions of the workforce that are unionized; the private sector is woefully underfunded to meet its liabilities as well. But the problem is most severe in the public sector, and it needs to be addressed.

However, much as you try to connect them, the pension crises has nothing to do with Prop 23.

Rather than getting into a debate about 23, lets talk about how we could fix this problem at the state level, and how either candidate for Governor could address it.

Pension benefits for incoming state government employees need to be adjusted to meet private sector levels, which, instead of the roughly 2.7% per year the average state employee gets, should be more like 1.5% per year. Public employee contributions to pension plans need to be significantly higher, some say as much as twice the current level. The practice of pension spiking (moving in to a higher paid position for the last year of employment to falsely inflate pension benefits) needs to be outlawed. Double dipping also needs to be severely limited. These practices have been bi-partisan in California.

George, and Russ, are right. This is an unsustainable financial liability and it needs to be addressed.

If moderates, democrats, liberals, union advocates, electeds of any stripe do not come up with a rational solution to this problem we are all in trouble.

[Steven Frisch]

By the way, Governor Schwarzenegger is demanding reforms to the pension system to sign a budget rather than as part of a rational public debate over this issue as part of a normal legislative process. By doing so he is doing us no favors. We need to both fix the pension crises, and get back to normal budget cycles. The ability to hold the political process hostage, on both sides, is another of the 2-3 most significant issues in California.

[George Rebane]

Even though I am among those who don't have a pat solution to the pension crisis - it has gone beyond the tipping point - I do believe that the state's economy and any solution to this crisis are related. From that is but a direct connection to the impact that AB32 implementation will have. And there stands Prop23.

Agreed on the budget aspect and gave my thoughts in the 'druthers' post.

[Steven Frisch]

I am actually with you on about three of the 'druthers' points.

I do however think you are either fundamentally misreading the message of the Tragedy of the Commons, or I am not understanding exactly what you are saying. Perhaps you could elaborate a little?

To me the essay, which has been incredibly influential to my thought, is a metaphorical story illustrating why we must come up with some rational way to control the inherent conflict between people's propensity to act in their self interest, which I do believe, and stewardship of the commons, or the assets that all people own and no one individual has an exclusive right over. To me the results of the conflict is not a rational for privatizing the commons, it is a rational for regulating the use of the commons. In the absence of enlightened self interest we must come up with some societal way to govern common resources.

[Steven Frisch]

By the way you have peaked my interest and I ordered a copy of "Exploring New Ethics for Survival - The Voyage of the Spaceship Beagle" today.

[George Rebane]

There are two primary means of preserving a commons - one is to 'privatize' it, and there are many beneficial ways of doing that; the other is to keep it in the collective, but manage it in an enlightened way. The first way is easier and has been successfully demonstrated for millenia. The second is hard, usually unsuccessful, and when successful, it deprives liberties.

Hardin gave an example of an enlightened approach to collective management of the commons called the Mississippi River. I'll try to expand.

To understand Hardin’s teaching on the natural fate of a commons, one has to include his operational definition of responsibility based on that of philosopher Charles Frankel. Frankel’s “social arrangements” impact a person who is responsible through very definite sanctions imposed as described in the arrangements. A person is responsible for some deed, thing, or belief only to the extent that he is subject to the arranged sanctions of the society in which he operates. Today we use confusing words such as ‘accountable’ and ‘caused’ in an attempt to buttress the true meaning of ‘responsible’.

In Hardin’s Mississippi River example of enlightened management of a commons he uses the towns of St Louis and its downstream neighbor Vicksburg. Both cities draw their drinking water from the river and discharge their waste water back into the river. Extensive regulations govern the treatment of the discharge to assure that the river is not polluted by each river city’s waste water, and a huge federal bureaucracy complete with multiple test laboratories is set up to guarantee performance.

The usual configuration for this system is that every city draws its water upstream of where it is treated and then consumed, and then the city discharges it downstream after again treating the waste water according to regulations. Treatment is expensive and often not up to par. Squads of federal inspectors are there attempting to keep the river from getting polluted. In spite of all this, St Louis does pollute the river thereby causing Vicksburg greater expense to make the water potable again. Lots of expenses, confusion, and marginal results at every step because each city is not responsible for the purity of its discharge.

Hardin suggests that each city would become a responsible consumer of the commons if the feds would just make one critical change to the regulations – namely, each city must discharge into the river at a point well upstream of where it takes in its drinking water. It is clear that now the citizens of every city on the river will make damn sure that they don’t pump their pollutants into the same water that they then have to treat and drink. An enlightened management procedure has made them responsible.

But it takes a desire and ingenuity to come up with such solutions for managing a commons. And an overarching government does not always want to save money, reduce staff, and thereby give up control. We are surrounded by a myriad examples of such governance.

[Paul Emery]

Very good concept. Do you propose this be managed by State or Federal law.

[Mikey McD]

I (and Rebane) highlighted several solutions to the pension crisis back in our 2007 report. Arnold held a commission of 6 dems and 6 repubs in 2006/2007 to report on the crisis...the findings of the commission... drum roll... 'the public labor unions were too powerful to mess with.' Governer Wilson all but solved the crisis years ago with a 2 tiered system... which Gray Davis promptly revoked to pay the unions back for getting him elected. We need drastic layoffs of public employees, drastic reduction to current employee benefits, and the a pension system (which does not exist in the private sector) needs to be abandoned for new hires. Many more solutions are in the report.

[Mikey McD]

I am in the biz of pension plans and only 2% of private companies with more than 5 employees have a similar (albeit not as lucrative) pension plan. These plans do not exist in the private (read real) world they are too expensive and carry too much liability.

[George Rebane]

Paul, not sure what the "this" to be "managed" you are talking about. If it's solving the pension crises in the various states, it has to be on the fed level. The states can neither print money nor be the final adjudicator of the grievances against the jurisdictions in arrears. There awaits the Supreme Court.

[Paul Emery]

I agree it's a pretty impossible situation with the current crew in Sacramento. I was all for a Constitutional Convention but the Republicrats killed that. They both work together if anything is proposed that will really change anything.

[Michael Anderson]

A Constitutional Convention sounds fine to me. I hope to get a seat (-;

George, that's a regulation you're talking about, mandating that the straw goes upstream instead of down. A good one at that.

Mikey D., I am ready to go back to California public employment levels per capita that we had during the Wilson term. And the pensions are ridiculous, this liability has to be adjusted ASAP.

Let's make a litmus test:
"Dear Meg and Jerry, how will you reign in the public trough problem?"