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California is facing serious economic and political problems. How we deal with these problems will affect both California and the nation.
In this second essay of our Advice to the Governor public policy series, the Claremont Institute's David Frisk emphasizes that elected officials have failed to act responsibly in dealing with public-employee pensions, the growing costs of which threaten to displace even basic health and safety services directed towards the common good. In addition to being unaffordable, generous public-employee pensions are also unjust, especially during an economic recession that is demanding disproportionate sacrifices from the private sector. Fixing the problem requires renewed fiscal competence and prudence in our government, along with a statesmanlike perspective and strong political leadership from California's next governor.
Frisk is a Fellow of the Claremont Institute and the author of If Not Us, Who?: William Rusher, National Review, and the Conservative Movement, forthcoming from ISI books.
Introduction
Respect for the common good is an essential characteristic of decent and limited constitutional government. In such a government, public policy must concern itself with society's long-term well-being. Public resources, and the private resources on which the public sector depends, are finite and can be exhausted. In addition, that which belongs to citizens in their private capacity is justifiably taken by government only for essential and limited public purposes. For all these reasons, responsible policy must be based upon serious consideration of what is and isn't affordable and prudent. That, in turn, depends on a sound philosophy of government.
A fiscal crisis like California's requires more than putting our financial house in order. This state and its citizenry must also think anew about the first principles of republican government. Public sentiment in California, as well as policy, must turn away from the prevailing view of government as merely a provider of public services, remembering both its proper constraints and its obligation toward society's long-term interests. A first step in the right direction, then, will be a frank acknowledgement and accounting of a spending and debt crisis in California that threatens to make impossible a restoration of something even more important than fiscal prudence itself: a limited, responsible and truly representative government.
California's unsustainable public-employee pension system is a perfect example of the disaster that results when government fails to respect its rightful relationship to society and to ground its policies in reality. Benefit formulas that are too generous, and retirement ages that are too low, have driven the costs of public pensions in our state to unsustainable levels. The pension policies that California legislators and local officials have put into place have become notoriously unfair and grossly irresponsible. They are unfair because they enrich public-sector employees at the expense of the people as a whole, especially California taxpayers; they are irresponsible because the financial commitments they require are such that essential public services are suffering as a result, and because these commitments could at some point become unpayable.
Costs for public-sector retirees, poorly controlled for years, are forcing cutbacks in one of government's fundamental obligations-general services to Californians. Our main pension fund, the California Public Employees' Retirement System (CalPERS), which covers state and many local government workers, is headed toward bankruptcy in a decade and a half.[1] Yet in many cases, state and local governments are paying retirees almost what they earned at peak salary, while pension reforms that could reduce the damage have been too slow and limited. The unconscionable salaries and benefits for higher officials in the small Los Angeles-area city of Bell, which provoked sharp public protest this summer, are an extreme case, but they accurately reflect the mentality that has dominated our state's public sector and politics.
The next governor of California must make the vast dimensions of the pension crisis fully known to the public. Voters must understand three key points:
- 1) this problem is long-term, and must be dealt with sooner rather than later if we are to prevent it from crippling state budgets indefinitely
- 2) public pensions are a special case: when they are excessive or overly generous it is the taxpayer who ends up footing the bill, since the taxpayer is the ultimate source of the revenue that must meet the financial obligations undertaken by previous legislatures and local governments
- 3) the level of benefits offered in public-employee pension plans is unjust when seen alongside comparable pensions in the private sector; and when seen in the context of a persistent economic downturn in which business profits, private-sector pay, and 401(k) accounts are all declining while high public-sector pay continues mostly unaffected
For these reasons, public pensions should be a major issue in the 2010 gubernatorial race and will certainly rank among the most important, urgent challenges the new governor must tackle.
The Current Crisis
The size of the public-employee and retiree population in California translates into great demands on pension funds (and would do so even if we had better policies). Because the stock market, where a good share of the funds are invested, now stands at a diminished level compared with its exceptional heights a decade ago, these burdens have become increasingly difficult to bear. Annual statewide payments to CalPERS skyrocketed over the last decade. Since fiscal year 1998-99, spending on pensions plus health care for retirees has quintupled; within the next decade, the amount is expected to triple again. This trend cannot continue.
The situation is even worse at the local level. A Sacramento Bee review of California's 80 largest city and county governments concluded early this year that their unfunded pension liabilities (the difference between what employees have earned and what's actually in a fund) total $28 billion, not counting another $8 billion in pension-related bond debt. The unfunded liability and debt amount to roughly $4,000 per household in those jurisdictions.[2] Los Angeles County public employee pension obligations have gotten so high that the late former Assemblyman Keith Richman quipped last year that the new Three Rs in the Los Angeles Unified School District are "reading, writing, and retirement benefits." Richman also pointed out that cities and counties were "currently paying about 15-20% of their operating budgets toward pension costs alone," a proportion "expected to grow to between 20% to 25% of budgets within the next couple of years because of the drop in asset value in the pension plans."[3] When nondiscretionary spending runs that high, local governments are less able to fulfill their responsibilities to the public-they are starved of the resources required to provide for basic, essential public services.
The pension crisis has spread widely in our communities. The Orange County system's payments to retirees have almost tripled, and the same is true of Contra Costa County. The San Diego County grand jury has warned that pensions could eat half the city of San Diego's budget by 2025 if there aren't substantial reforms. In San Francisco, the combined cost of pensions and retiree health benefits now stands at an estimated $413 million. In 2015 it is expected to reach $1 billion-one-third of the city's current general fund. Two years ago the economically troubled, blue-collar city of Vallejo filed for bankruptcy, staggering under the weight of pay and pension obligations. It had paid many of its employees so well that it had no choice but to let many of them go. Since 2005, the Vallejo police force has shrunk from 158 to 104. High-crime Oakland recently laid off 80 police officers, one-tenth of its force, to cope with its deficit. (The union had refused to agree that its members would make a 9% contribution to their pensions, as city officials believed was necessary.) The average pension for recently retired public-safety employees in Oakland has more than tripled since 2000 and now stands at nearly $84,000 a year; the average pay for police and fire employees has tripled as well. More than 25 of California's 80 largest city and county governments "now have unfunded [pension] liabilities that equal or exceed the size of their annual payroll." One of those, Fresno County, lost 10% of its employees from 2008 to 2009. It "drastically cut its mental health services budget, reducing care for the homeless and indigent, and, like many others...released a slew of jail inmates." As Supervisor Adam Hill told fellow board members in San Luis Obispo County: "The old joke is that General Motors is just a health insurance company that makes cars on the side. My concern is that the county government is becoming a pension provider that provides government services on the side."[4]
Origins
In 1968, a state law gave collective bargaining rights to local government workers in California. Teachers and other state employees were given these rights by the Dills Act in the late 1970s. Since that era (and in some cases earlier), more than 20 cities including Oakland, San Francisco, Sacramento, Vallejo, Stockton, Modesto and Anaheim have guaranteed binding arbitration to police officers, firefighters, or both.[5] This is significant because these employees account for a large share of a city's budget and because in cities with arbitration rights, the affected unions tend to lack an incentive to compromise. City officials make more generous offers than they often want to, fearing they might otherwise be saddled with even costlier arbitration awards. Collective bargaining and binding arbitration rights set the stage for the great power of public-sector unions-and for today's pension overload, which the unions helped create and can be expected to keep defending.
After Proposition 13 slashed property taxes in 1978 and tightly constrained their future growth, teachers' unions reacted to the tougher fiscal situation by taking a major role in school board races, often defeating targeted incumbents. Unionized state and local government employees called illegal strikes (until the California Supreme Court issued the dubious 1985 decision that they have a right to strike).[6] Various other state court rulings, including Betts v. Board of Administration (1978), define pension policies for current public employees as contractual under the state constitution. Their status as contracts gives these pensions special protection: they cannot be reduced unilaterally unless an employee is provided with a comparable new "advantage" in return. (It is unclear whether these rulings also prevent public employers from requiring increased contributions from workers.)[7]
When Proposition 98 was enacted in 1988, requiring that 40% of the state budget go to local education, schools received an annual windfall of some $450 million. School boards spent much of it on pay raises for teachers, adding to pension costs. Adding further to eventual pension obligations was the very expensive "one-year" standard enacted in 1990, under which state employees' benefit levels are calculated using a percentage of only the final-year (typically an employee's peak) salary. This ill-advised policy passed the legislature with only one vote against, Senator Tom McClintock.[8]
Then in 1999, the legislature and Governor Gray Davis authorized a large increase in the pension formulas for state employees. Like the final-year policy enacted nine years previously, Senate Bill 400 was a bipartisan blunder. It passed by votes of 39-0 in the Senate and 70-7 in the Assembly. This degree of long-term financial myopia has occurred at the local level as well. Orange County boards of supervisors composed entirely of Republicans approved, unanimously in one case, unwise retroactive pension boosts for public employees. At the state level, bad policy decisions continued. The fiscally irresponsible and notorious 2002 contract for prison guards authorized a 34% pay hike over five years, contributing to Governor Davis's unpopularity and perhaps even to his 2003 recall. With the economy cooling, voters had started to take notice of the employee compensation issue.
When passed in 1999, the retroactive state employee benefit increases were predicted to cost $650 million in 2010. Such estimates were based upon very high return-on-assets expectations by CalPERS during a brief period of exceptional stock market growth. These predictions have turned out to be disastrously wrong. We have a worse economy and a worse stock market than in the prosperous but short-lived "bubble" years when our pension obligations began running out of control. The actual price tag for those benefit hikes is not the projected $650 million, but $3.1 billion this fiscal year and $3.5 billion next year. The CalPERS board's actuaries had offered three scenarios, the most pessimistic of which predicted almost exactly what has happened. But the board chose the rosy scenario. CalPERS also invested heavily in housing and land speculation, another decision that proved damaging to its fund.[9]
Unfortunately, investment-return assumptions continue to obscure the true magnitude of the looming fiscal disaster. The one now used by CalPERS, notes Governor Arnold Schwarzenegger's special economic advisor David Crane, "implicitly forecasts the stock market to grow 40% faster than it grew in the 20th century, a period of unequaled economic growth." As Crane also points out: "by 2110 CalPERS implicitly forecasts the stock market to be nearly three times higher than implicitly forecast by super-investor Warren Buffett for his [own] pension plans... and CalSTRS [the teachers' fund] uses an even higher assumption."[10] Badly incongruous market projections have combined with questionable management and ethics at CalPERS to tarnish its once-excellent national reputation. As if this weren't enough, public employers in California haven't always made the contributions that sound actuarial principles require-many have skipped payments, a practice sometimes known flippantly as "pension holidays."[11]
A growing public sector with high salaries has not helped matters either. Generous pay and benefit packages have long been the norm in the state's public sector, due partly to fear among local government officials that other jurisdictions or the private sector would hire the most qualified applicants if they were offered anything less. In today's economy, of course, jobs are less available and people seeking them have fewer options. So in this respect too, as with expectations about the stock market, our public pension systems have fallen behind the times. Average local-government pay in California rose by 40% from 2000 to 2008, far more than the 25% needed to match inflation.[12] There are also many more public employees than there were a decade ago. Since 1998, the state work force has grown by a remarkable 31%. Government is paying many more salaries, and therefore pays into (and guarantees) pension plans for many more people. Still another factor in runaway pension costs is a highly questionable employee classification. "Public safety" officers used to consist of police and firefighters. Today, almost one out of three California state workers are classified as "public safety" employees, compared to about 5% in the 1960s.[13] This has increased the financial obligations of the state, because public-safety employees have especially liberal pension formulas and especially low retirement ages.
Even the people of California have contributed directly to the problem. In 1984 voters approved Proposition 21, which allowed pension funds to make more stock investments rather than the previously predominant bond investments-essentially telling, and expecting, pension authorities to invest prudently without ensuring that they would. Los Angeles city officials, wanting to match benefits offered elsewhere, persuaded voters to increase police and firefighters' pensions in 2001. Supporters stated in their ballot-pamphlet argument that the managerial reforms included in the measure would actually save the city money.[14]
While the task of funding public-employee pension benefits has been made more difficult by shortsighted policies enacted by voters and state officials, public-employee unions have also been very effective at blocking efforts to deal with the problem. State legislators and local officials, if elected with their backing, are unwilling to stand against the expressed interests of these groups. They receive union support financially and politically-well-advertised endorsements by the "teachers," "police" and "firefighters" are a very effective electioneering tactic. The unions are not shy about their expectations that full cooperation should follow such support. Recently a Service Employees International Union official, speaking into a microphone but perhaps unaware she was being videotaped, told California legislators: "We helped to get you into office, and we got a good memory. Come November, if you don't back our program, we'll get you out of office."[15]
Irresponsible policies of secondary importance add to the problem as well. The abusive but legal practice of "pension-spiking" lets employees inflate their final year's pay, and thus their pensions, by getting raises or bonuses and by counting things like unused vacation time, unused sick leave, excessive overtime, shift differentials, and cashed-in auto allowances. In a Bay Area sanitary district, more than two-thirds of the employees who left in the last five years spiked their pensions by 25 to 41%. In addition to manipulating their pension levels through spiking, retirees from California public employment can legally work up to half-time while still drawing a full pension. The term for this is "double-dipping." A rather small problem from a broad financial perspective, it is nonetheless unfair and contributes to the justified sense of grievance among taxpayers.
Although public-pension commitments have been rising dramatically nationwide, the Golden State's have been particularly generous. For example, a 2004 study by the nonpartisan state Legislative Analyst's Office found that a retiree drawing a $46,500 pension here would receive $28,000 to $30,000 in Oregon, Illinois, or Florida. In addition to high salaries, over-generous formulas, and low retirement ages, another large factor is the wide use, cited above, of only an employee's final year of pay in setting his or her pension (the recently enacted budget deal made by Governor Schwarzenegger and Democratic leaders in the legislature includes the elimination, for new state workers, of the one-year policy). Every other state bases its pension levels on an employee's last, or highest-paid, three or five years.[16]
Reactions to the Crisis
This problem is not politically insurmountable. The growing sense of the public-employee pension crisis offers a great opportunity for responsible leadership. Local government officials are paying attention to the issue and often speaking candidly about it. It has been receiving frequent media coverage this year, also getting significant attention in the governor's race. Organizations and websites are dedicated to the problem. The public has a basic grasp of it. The specific pension payments for retired public employees are increasingly being disclosed thanks to several newspapers, the California Foundation for Fiscal Responsibility or CFFR, the California First Amendment Coalition, and the Howard Jarvis Taxpayers Association. During the past year, court rulings in Orange, Sacramento, Contra Costa and Stanislaus counties have gone in favor of the media's right to reveal these payments by showing what individuals or categories of retirees actually receive. Also encouraging is the fact that several local ballot measures to reform pensions will be voted on this fall.
By an overwhelming majority, voters seem ready to support change. According to a Public Policy Institute of California poll from January, 76% of respondents and 78% of likely voters think the money being spent on public pensions is a problem. Sixty-seven percent (70% of likely voters) now favor 401(k)-like defined-contribution plans for new public employees. In fact, strong majorities in both parties say they back the idea.[17] Such a state of public opinion suggests that major pension reform is possible.
The next governor will also be able to draw on the example of other states, several of which have begun to reform their way out of problems similar to California's. These states have 1) moved away from the traditional defined-benefit pension in which the employer is responsible for the total amount a worker will eventually receive (not just for its own contributions, as in a 401(k) system); 2) required more contributions from employees; and/or 3) established more sensible retirement ages.
Michigan has required a defined-contribution plan for new state employees since 1997. In Florida, both a defined-contribution and a "hybrid" plan (which combines defined-benefit with defined-contribution features) have been available as alternatives since 2000. Oregon employees hired after 2003 are in a defined-contribution and a defined-benefit plan: their contributions enter the defined-contribution system while the employer's portion goes into the defined-benefit system. In Colorado, an optional defined-contribution plan was started in 2006. Alaska actually closed its traditional plans to new enrollment in 2006, replacing them with defined-contribution. Utah this year introduced a defined-contribution plan as a choice for new state and local employees, whose other choice will be a hybrid. Colorado, New York and other states have upped their employee contributions. New York and Rhode Island set a higher retirement age of 62 last year. New Jersey enacted a variety of reforms in 2008 and 2010. Perhaps most impressively, in Illinois-a state with dire financial problems-the Democratic governor signed a bill this year raising the retirement age for a full pension to 67, and basing new employees' pension levels on the last eight years of salary.[18]
In California, the modest statewide reforms adopted in early October, under the pressures of an even later-than-usual budget and an impending election, are a step in the right direction. The too-generous SB 400 pension formulas of 1999, which include excessively liberal retirement ages, have been rolled back for new state employees. In addition, their pension benefits will be figured from the three highest years of pay, not the final year. And current employees will have to contribute 2 to 5% more of their salaries toward pensions. (These reforms largely reflect concessions that Schwarzenegger obtained in negotiations with unions representing more than two-thirds of state workers. But members of one large union must still vote to ratify their agreement, and others may hold out for a better deal from the new governor.) Schwarzenegger had insisted that such reforms be adopted with the budget; the legislature managed to thwart his initial demand for a simple 5% contribution increase from current employees, insisting instead on the compromise of 2-5%. Also enacted with the budget were requirements for clearer justifications and financial forecasts from CalPERS when it wishes to impose higher state contributions.[19]
But it may be that the failure to pass reforms earlier this year more accurately reflects the attitude of the legislature's majority. SB 919, introduced by Senator Dennis Hollingsworth (R-Murrieta) and endorsed by the governor, would have made new state employees wait until 65 (or 57 for public-safety workers), instead of the current 55 and 50, to retire with a full pension. It would have used the three highest years instead of the final year in determining pension levels for new hires, and reduced the pension formula for new employees. It would also have enacted some changes in the state health-benefits program. That legislation failed in committee with a party-line vote by Democrats. On its own, the legislature did little. It produced a bill, signed at the end of September, to further regulate the agents who help make deals between investment funds and pension systems, a situation vulnerable to abuse. Schwarzenegger also vetoed three bills, to reduce pension-spiking and some high-level employees' runaway pensions, on the grounds that they did not go far enough.[20]
California localities, in contrast to Sacramento, have been addressing the problem more seriously this year. In San Jose, police and firefighter arbitration rights in place since 1980 were ended by a narrowly successful ballot measure in the June primary. Vallejo voters in that election repealed arbitration rights as well. San Francisco voters passed a measure that increases pension contributions by new employees. In Orange County, a new contract with the sheriffs' union raises the retirement age from 55 to 60 for new hires, also mandating employee contributions to pension costs. The city council in La Habra recently ended a furlough program while requiring in return that police department employees pay into their pensions-7% for current ones, 9% for new hires. City-employed SEIU members in Simi Valley agreed by an overwhelming vote to give about 4% of their salaries (7% for new hires) toward pensions, up from a previous contribution of zero; in return they are being protected from layoffs. In Los Angeles County, Supervisor Mike Antonovich has asked officials to look into the possibility of 401(k)s for new non-public safety employees. San Jose residents will soon vote on a measure letting the city council establish a two-tier pension plan, with more modest benefits for new employees.
Especially notable are further developments in liberal San Francisco. Proposition B on the November ballot would increase current city workers' pension contributions to 9 and 10% of their salaries, up from 0 to 7.5%. Spearheading the proposal is the city Public Defender, Jeff Adachi-who explains that pensions are draining money from services "we care about as progressives."[21]
Solutions
No single policy shift can solve the pension problem. Even the many adjustments needed to deal with it adequately, and those needed to make California solvent again, will only begin-rather than end-the more important discussion, which is about the purposes and scope of state (and local) government. Fixing the pension problem and other fiscal problems in California's public sector will require a variety of steps. Reformers must strike the best possible balance between pursuing substantial-meaning highly controversial-solutions and maintaining public support for change. Even thoughtfully selected small changes can help politically, in addition to being constructive and right. It is symbolically and politically important, for instance, to address the executive-compensation issue that has upset people at the local level. As an employee-association representative in Orange County said recently, the union wouldn't make more concessions unless higher officials agreed to modify their own retirement plans. That's a reasonable point.[22] At the same time, the next governor must be wary of incrementalism, of seeking only small or gradual changes.
The solutions most commonly suggested in what is now a national pension-reform discussion are for newly hired employees to get lesser or less-guaranteed pensions or a later retirement age, and for current workers to contribute more. This is, for the most part, what has occurred when states have taken action. Such reforms are helpful and tend to be politically safer than larger ones. But because these new policies, other than increased contributions, do not touch current employees, they are too quantitatively modest to be very effective. Major savings-and that is what states like California must seek in pension reform-will not occur until the distant future if these are the only changes.
There is much to be said for the recommendation by Girard Miller, a public-finance consultant and a columnist for Governing magazine. As he points out, a five-year pay freeze would also save substantial money on pensions due to the close structural connection between pensions and salaries. By immediately affecting the salaries of senior, higher-paid employees who will retire in the near future, a lasting freeze of this type would help reduce pension costs-not just liabilities-rather soon.[23] Miller has also suggested reforming arbitration rules, urging that states require arbitrators to "give equal weight to retirement benefits levels and compensation in the private sector for recruits with equal qualifications." As he explained: "Whether by statutory neglect or by practice, the private sector job market is too often ignored by arbitrators."[24] These reforms would do much to bring public-sector benefit packages in line with their more modest cousins in the private sector-and may have the added benefit of being easier to sell to the public.
The next governor must also reject, and counter effectively, any claims that the public pension problem is really part of a revenue problem. The repeated response by many to calls for belt-tightening is to target either Proposition 13 or the incomes of the wealthiest Californians. Raising property taxes, or taxing the highest income brackets more, or both, will not solve our long-term deficit problem. California already levies nearly the highest income tax in the nation on high earners. We have the highest tax on middle incomes. Our sales tax is the highest. Our gas tax is the highest. Our corporate income tax ranks among the highest.[25] Adding higher taxes to this existing heavy burden would drive more middle-class, affluent, and wealthy Californians out of the state. It would mean fewer job creators and providers, and in the long run less state revenue.
A requirement that employees work longer before qualifying for their generous pensions would more constructively address the problem. The reforms enacted with the recent budget begin to reverse the previous trend toward eligibility at younger ages, by hiking most new state employees' retirement age to 60 and that of new state law-enforcement personnel to 55, a five-year increase in each case. But if "40 is the new 30," why retirement at 60 and not 65? Even the retire-at-65 model, based on the original Social Security system, derives from outdated life expectancies. People aren't just living longer now; they spend more years in a relatively healthy condition as well. They can expect a better quality of life and more activity in their senior years. Those trends are likely to continue. They mean that pensions are and will be paid for longer periods, to retirees with higher lifestyle and therefore higher financial expectations than their parents had at a similar age. Yet these same trends toward a longer and healthier old age also mean that employees are able-and can decently be asked-to work longer. The federal government, thanks to a bipartisan Social Security commission, recognized higher life expectancy back in the 1980s. Because the Social Security retirement age was raised for young workers, a 48-year-old today must remain employed until 67 to collect full Social Security benefits. That's only fair. Taxpayers can't be expected to finance almost an entire second life for public retirees. Since pensions do not and should not terminate until death, they must begin at later ages in addition to paying less per year. Current ages for pension eligibility cannot responsibly be continued. Our state and local governments, our taxpayers and economy can't take it.
The possibility of moving public pensions away from defined-benefit plans and toward defined-contribution, 401(k)-type plans requires more analysis. Such pensions have solid advantages that the next governor can easily make clear to the citizenry. Because the payout is determined by investment performance over the years and by how much the employer and employee contribute, rather than by a formula, no unfunded liability exists in a defined-contribution plan. The employer, in this case the state or local government and thus the public, is responsible only for its own agreed-upon contribution rather than what the retiree eventually gets. Furthermore, defined-contribution plans operate on market principles. Defined-benefit pensions, in contrast, are not just paid and guaranteed by government but also run by government. That invites manipulation of investment decisions by interest groups, pension board members' political views, or most dangerously by insider dealing-all contrary to fiduciary responsibility. In May of this year, state Attorney General Jerry Brown's office filed a lawsuit accusing an investment or "placement" agent and former CalPERS board member, along with a former CalPERS chief executive, of fraudulently making and receiving gifts intended to influence the board's investment decisions. (Both have denied wrongdoing.)[26]
In addition to these advantages, a 401(k) is more flexible, allowing workers to take the benefit with them when they leave for private-sector jobs. In plans with a defined benefit, only the employee's contribution may be taken. People with long seniority who retire as public employees do extremely well under the current system. But those who stay in the public sector for relatively short periods lose most of their pension benefit, not having fulfilled what is normally the ten-year vesting requirement.
Capitalizing on Political Momentum
Elections are supposed to have consequences in our political system, and the next governor should push stronger pension reform as a high-profile priority. Continuing and amplifying the current dialogue seen in the campaign and elsewhere, without delay, would strongly associate the governor-elect and his or her political momentum with the issue. It would also politicize it in the best sense of the word, by helping to maintain public interest in and support for better policy. The legislature must be pressured to fulfill its responsibility to the people and pass meaningful pension reform legislation.
In theory, our elected representatives might do this for two reasons: either because they fear the voters' reaction as the problem continues largely unresolved; or because they acknowledge that spending for actual public services is in serious competition with payouts to retirees. In practice, such motivations have not proven very strong when it comes to fiscal issues in California. The incoming governor should add a third incentive to the equation by applying relentless political pressure. A governor has the advantage of a higher profile than the legislature, plus the broadest public constituency. In our American constitutional tradition, applicable throughout our political system, the executive branch is also intended to exert firm leadership on major issues affecting the true long-term common interests of the citizenry. But getting pension reform legislation passed will not be easy. It will take competent, persistent and fearless communication.
The new governor, on the day after being elected in November, should use the momentum of victory to call for some, or all, of the following reforms:
- Enact higher retirement ages, perhaps 65 for most new state employees and 57 for new public-safety employees. (Half-pensions could be available perhaps five years earlier.)
- Require new state employees' contributions to match those of their employers.
- Define new "public-safety employees" much more strictly for pension purposes. The category should include only actual law enforcement officers, firefighters, emergency medical personnel, and prison guards.
- Require pension formulas for new workers to use the salary paid in the last or highest-paid five, not just the highest three, years of employment.
- End pension-spiking. Only the base salary, excluding overtime and fringe payments, should be used in calculating pensions.
- End double-dipping. No publicly-funded pension should be paid to any retiree working more than ten hours a week.
- Begin a defined-contribution or hybrid plan, at the very least as an option, for all new employees including those in law enforcement.
Conclusion
As the state's chief executive officer, the governor is entrusted with and responsible for the public treasury in a way that legislators are not. A governor's deepest ongoing responsibility is to counter the great temptation in a legislature, any legislature, to serve influential interests first and the general population second. It is sometimes necessary to stand against the self-interested motives of legislative majorities, defending and promoting instead the "permanent and aggregate interests of the community," as James Madison called them in The Federalist. After standing against special interests, a responsible executive must persuade the people to back measures aimed toward long-term fiscal health and the public good. Successful pension reform in California will likely require a great public contest with the entrenched interests.
The next governor would do well to emphasize two themes. The first is the need to continue adequate public services without higher taxes, which stifle entrepreneurship and job growth. The second is the injustice of requiring taxpayers to provide public employees with excessively high levels of guaranteed benefits relative to the private sector, especially amid an economic downturn. It will be necessary to make voters in the private sector more keenly aware of the fact that their public servants tend to get a much better pension deal, and a better overall deal, than they do. This should include tireless insistence that in California's persistent recession, the situation is not only fiscally impractical (as it would be in better times too) but also shameful. There is no political issue as strong as one uniting self-interest with moral obligation. From the standpoint of the financially stressed, that is exactly what the conflict over public pensions does.
The next governor must turn the public-employee unions' predictably vehement opposition into a badge of honor, not a source of embarrassment. Their spokesmen and loyalists in the legislature should be identified so they are less able to shape the debate. Pensions and salaries for groups of employees and retirees should be more widely publicized, including those for law enforcement officers and others in the politically sensitive public-safety category. Pension-spiking and double-dipping should be exposed in detail. The governor must also respond effectively to sob stories about the supposed impact of reforms. If any are true, they must be frankly acknowledged but blamed on the unions and politicians who have fought pension reform or ignored the issue for years. The alleged hardship cases that are either false or highly exaggerated must be exposed unflinchingly as lies. The next governor must take command of the stark facts of California's fiscal mess and, fairly and firmly, voice them to the people so they will pressure the legislature.
The governor must also be prepared to "take a strike," as former state finance director Tom Campbell noted last fall at the Claremont Institute's California Public Policy 2009 conference. If public servants are determined to walk off the job, let them, and vigorously oppose them for doing so. A governor fighting to reform pensions should explain articulately to everyone that public employees are an interest group, with an agenda quite distinct from the public good. And the public unions as they now function, not just their pensions, must be identified as one of California's major problems-like our disastrous business climate, to which these unions indirectly contribute. It would be unfair to portray public employees as incompetent or unworthy of their pay. In addition, it would be too easy for the unions and their allies to make effective anecdotal responses. If voters are thinking of teachers and firefighters as individuals rather than collectively as a budgetary category, reform loses. In addressing the citizenry, the governor's focus must be on objective facts about pensions and on the unions as political forces, not on the employees themselves.
Finally, even the concept of public-employee unions is questionable. In private industry, the company pays. In government a third party, the taxpayer, pays. Private-sector unions have ongoing natural adversaries in the management and owners. In contrast, public-sector "employers" are elected officials with temporary, often very short-term stewardship of the public purse-a problem exacerbated by California's short legislative term limits. This leaves little personal incentive to defend the enduring interests of the taxpayer, the state, or the local community. Instead, a strong incentive toward irresponsibility exists. Elected officials often win and maintain their positions with significant, even pivotal, help from the major public-employee unions. These unions have a fundamental incentive to transfer wealth from the taxpayers to their members, along with the political clout to ensure that the legislature and local governments tend to be populated by officials who strongly cooperate toward that end.
Radical though it may be, the idea of a union-free public workplace ought to be openly and widely discussed. Public workers should, of course, be able to form voluntary associations. But a special entity institutionalized within the government, when its purpose is to make itself more prosperous, heightens the worst tendencies of public authority in a representative democracy. Limited government and our nation's constitutional design seek, among other things, to mitigate special-interest influence. Public unions are intrinsically an interest of the government itself, inclined toward exploiting its power for their own gain rather than the common good. Therefore, a plausible argument can be made that no organization should be allowed to bargain or officially speak for public employees-that ideally, their pay and benefits should be decided solely by the citizenry's elected representatives and officials directly responsible to them.
The pension mess, complicated and frustrating though it is, represents a good opportunity for Californians to begin redirecting their government toward its proper role as a servant rather than exploiter. A generation ago, Proposition 13 saved many people from losing their homes by cutting their bloated and growing property taxes. The spirit of fiscally limited government was not long sustained, even though Proposition 13 has been. But in today's environment dramatic pension reform, directed against the unsustainable spending habits of our public officials, can be an effective first step toward a badly needed restoration of both fiscal responsibility and constitutionally principled government.
[1] CalPERS could well run out of money in 2026, according to comparative state pension-fund research
by Joshua Rauh of the Kellogg School of Management at Northwestern University. Rauh, "The Day
of Reckoning For State Pension Plans," Mar. 22, 2010, http://kelloggfinance.wordpress.com/, accessed
Sept. 8, 2010.
[2] Phillip Reese and Brad Branan, "Pensions batter California's governments," Fresno Bee, http://www.fresnobee.com/, Apr. 12, 2010.
[3] Response by Keith Richman in "How Should California Pay for Retiree Health Benefits?," http://www.californiahealthline.org/, Oct. 5, 2009, accessed June 25, 2010.
[4] Reese and Branan, "Pensions batter California's governments."
[5] John Woolfolk, "Vallejo's experience with bankruptcy, arbitration reform may spur action in San Jose," Mercury News, http://www.mercurynews.com/, July 4, 2010.
[6] Steven Malanga, "The Beholden State: How public-sector unions broke California," City Journal, http://www.city-journal.org/, Spring 2010.
[7] Betts v. Board of Administration, 21 Cal.3d 859 (Supreme Court of California, Aug. 17, 1978);
Amy B. Monahan, "Public Pension Plan Reform: The Legal Framework," University of Minnesota
Law School, Legal Studies Research Paper Series, Research Paper No. 10-13, pp. 17-22 and 31-33, available at http://ssrn.com.
[8] John Hill and Dorothy Korber, "How law fattens state pensions," Sacramento Bee, Dec. 19, 2004.
[9] Ed Mendel, "SB 400 pension boost: uncanny forecast unheeded," Calpensions, http://www.calpensions.com/, July 27, 2010; Dan Walters, "Pension hike revelations show massive failure," Sacramento Bee, http://www.sacbee.com/, July 30, 2010.
[10] David Crane, "The Role of the Investment Return Assumption," http://www.foxandhoundsdaily.com/,
June 17, 2010.
[11] Testimony of Girard Miller CFA to the Little Hoover Commission, April 22, 2010, available at http://www.lhc.ca.gov/. The commission is a standing advisory and investigative agency on efficiency in California state government.
[12] Reese and Branan, "Pensions batter California's governments."
[13] Hill and Korber, "Pension jackpot: Many more winning safety-worker label," Sacramento Bee,
May 9, 2004.
[14] Mendel, "Pension ‘crisis': Did Prop 21 pave the way?," Calpensions, http://www.calpensions.com/,
July 1, 2010; and "LA pension plan to save money is now costly," ibid., Aug. 17, 2010.
[15] Malanga, "Beholden State."
[16] Adam B. Summers, "How California's Public Pension System Broke (and How to Fix It),"
Reason Foundation Policy Study 382, http://www.reason.org/, June 2010, pp. 9, 16.
[17] Public Policy Institute of California statewide poll released Jan. 27, 2010, www.ppic.org.
[18] Ronald Snell, "State Defined Contribution and Hybrid Pension Plans," National Conference of State Legislatures, http://www.ncsl.org/, June 2010; Andy Kim and Heather Kerrigan, "Pension Preparedness," Governing, http://www.governing.com/, August 2010; Stephen C. Fehr, "In some states, pension pain yields budget gains," Stateline, http://www.stateline.org/, May 20, 2010; Summers, "How Pension System Broke,"
pp. 26-27.
[19] Mendel, "Arnold gets new-hire pension rollback-for now," Calpensions, http://www.calpensions.com/,
Oct. 9, 2010; "Pension reform the one bright spot in a dismal budget," Mercury News editorial, http://www.mercurynews.com/, Oct. 12, 2010; Mendel, "Pension reform holdouts wait for next governor," Calpensions, http://www.calpensions.com/, Oct. 28, 2010. The "for now" caveat in the first Calpensions headline refers to the fact that, as the story points out, "the pension reform is only legislation, which unlike a constitutional amendment can be overturned by legislation." The article also notes: "What the governor is calling ‘historic' pension reform legislation might dampen a drive for an initiative that would switch new workers to a 401(k)-style individual investment plan ..." A California Highway Patrol union official said publicly back in January that "the last thing we want to do is leave it to the initiative process."
[20] Marc Lifsher, "Schwarzenegger signs pension fund transparency bill," and Patrick McGreevy and
Jack Dolan, "Schwarzenegger vetoes bills on pension limits," Los Angeles Times, http://www.latimes.com/,
Oct. 1, 2010; Jim Sanders, "Schwarzenegger on key pension bill: Taxpayers deserve better," Fresno Bee, http://www.fresnobee.com/, Oct. 1, 2010. See also "Pension spikers need not fear Legislature, Sacramento Bee editorial, http://www.sacbee.com/, Aug. 19, 2010.
[21] Susan Ferriss, "Willie Brown joins Schwarzenegger to argue for public pension changes," Sacramento Bee, http://www.sacbee.com/, July 9, 2010.
[22] Norberto Santana Jr., "County Seeking State Law That Allows It to Impose Pension Cuts,"
Voice of Orange County, http://www.voiceofoc.org/, July 7, 2010.
[23] Miller, "The Other Pension Fix," Governing, http://www.governing.com/, June 10, 2010.
[24] Miller, "The Arbitration Game," ibid., July 8, 2010.
[25] Tax Foundation, 2010 Facts & Figures: How Does Your State Compare?, ed. Justin Higginbottom, www.taxfoundation.org.
[26] Lifsher, "CalPERS may see more lawsuits," Los Angeles Times, http://www.latimes.com/, May 7, 2010.
