Steven Greenhut over at the Reason blog had an excellent article last week on the really scary state of the California Public Employees’ Retirement System (CalPERS). It’s titled “What, Us Worry? California Lawmakers Still Ignoring Dark Pension Clouds,” Reason, December 13.
First, some facts that many Californians are familiar with but most non-Californians are not. Greenhut writes:
It’s been a little more than 20 years since the California Legislature passed, and Gov. Gray Davis signed, Senate Bill 400, which granted 50-percent pension hikes to employees of the California Highway Patrol. The law’s clear intent was for every other California agency to follow its model. They mostly did. So, these pension deals spread across the state like a contagion—leaving a debilitating level of pension liabilities that threaten to obliterate city and county budgets and push some less affluent localities toward insolvency.
Some details:
The legislation granted the pension increases retroactively, which meant that government employees didn’t just gain these additional benefits beginning on the day of its passage. The increases were granted back to the day the employee started on the job, even if it were 30 years ago or more. This was more than your garden-variety gift of public funds, but it passed overwhelmingly on a bipartisan basis, and with virtually no public debate. Those few officials who raised red flags were derided, even though their warnings were prescient.
I remember a breathless headline in the Monterey Herald in the early 2000s about how a huge number of firemen in Salinas who had 25 to 30 years of service were retiring en masse. The reporter didn’t seem to understand why. I did. The reason is in the second sentence of the paragraph just above. Those who had 30 years of service and had hit at least age 50 got as a pension 30*3, or 90 percent, of their top pay, inflation-adjusted. Those with 25 years of service got 25*3, or 75 percent. And so on.
I vaguely recall, although I can’t find on-line, the mayor of Vallejo, California, after that city declared bankruptcy, saying, “I can afford one police force; I can’t afford two.”
And how did the law sail through the legislature and similar pension increases sail through local city government council meetings? The advocates assured us that with stock market returns being as strong as they were, this wouldn’t cost taxpayers any more than we were paying.
Greenhut notes the obvious problem with that claim:
During the SB 400 debate, supporters said it wouldn’t cost taxpayers a dime because of ongoing boisterous stock-market returns. The California Public Employees’ Retirement System (CalPERS) promised that “no increase over current employer contributions is needed for these benefit improvements.” It would mostly be funded from excess returns on retirement systems that were so awash in cash that they really – I swear – had no other choice but to give it away to their union friends.
Obviously, these predictions never panned out as the stock market fell. The state’s pension funds now struggle with troublingly low 70-percent funding levels, even after a long-running bull market. There are no excess returns, but insufficient ones to pay for growing membership in the “$100,000 Pension Club.” Once the market falls again—and it will fall, as former Gov. Brown frequently warned—these funds could hit the skids. On hindsight, who could have ever believed those ridiculous assurances?
Note also the last sentence of the first paragraph in the two-paragraph excerpt above:
It would mostly be funded from excess returns on retirement systems that were so awash in cash that they really – I swear – had no other choice but to give it away to their union friends.
Greenhut is getting at the idea of opportunity costs. Even if the stock market had continued to rise at high single-digit rates, there would have been a problem. The reason: the government did have other choices besides giving “it away to their union friends.” The government could have cut its own payments to the PERS plan, thus freeing up money to cut other taxes or to increase other government spending. Even if the government officials had rosy expectations about stock market returns, they shouldn’t have ignored opportunity costs. They probably wouldn’t have done that with their own financial decisions. But their incentive to be careful about opportunity costs was almost non-existent.
I predict that at least every two years for the next ten years, local governments will propose tax increases to pay for the huge pension payments to government workers. I’m helping a friend fight one in Monterey; I expect to soon be fighting one in Pacific Grove.
READER COMMENTS
Andrea Mays
Dec 16 2019 at 10:54pm
Thank you, David, for keeping this on the radar.
Early retirement for some state employees means they (er…we) will collect those generous pensions potentially for 30 years. This is a timebomb.
David Henderson
Dec 17 2019 at 11:21am
You’re welcome, Andrea.
Thaomas
Dec 17 2019 at 6:45am
Sounds a lot like those who ignore and refuse to avoid the huge future costs of the continued increase in CO2 in the atmosphere!
Thaomas
Dec 17 2019 at 10:29am
It would be interesting to examine how politicians and potential pensioners came to prefer the particular benefit formulas chosen over more transparent and less risky forms of compensation. I think we have a pretty good understating of the political economy of bad trade and environment polices. This one not so much.
David Henderson
Dec 17 2019 at 10:34am
You wrote:
I disagree. It’s a standard concentrated benefits, diffused costs explanation that Anthony Downs came up with in the late 1950s.
David Seltzer
Dec 17 2019 at 5:18pm
Right David. One of the more egregious examples of concentrated benefits and socialized losses was the TBTF bailout of the banks. Bonuses were paid to banking officials even after the bailout.
Thaomas
Dec 17 2019 at 7:51pm
The Downs argument makes sense in a population of winners and losers, but why the preference of a less transparent and risky (the pensions may not be paid) for of compensation? And as with the 2008 financial crisis, were were the auditors (“Lotteries to be won” is an asset class that should not be valued at face value) and bondholders?
Mark Brady
Dec 17 2019 at 5:16pm
I have to ask this one. 🙂 What’s the story regarding pensions for past, present, and future employees at the Department of Defense? Stretching ahead for many decades, these liabilities are assumed to be covered by a fund invested in nonnegotiable government securities with any shortfall covered by future federal tax revenue. Or am I mistaken?
My source was this: https://www.rand.org/pubs/research_briefs/RB3005.html
Phil
Dec 18 2019 at 2:00pm
Mark,
You are correct. There is a military retirement trust fund for those in uniform. The civilian employees of the DoD fall under the same system as most other federal employees and there is a civil service retirement fund. As of October 31st, the military retirement fund stood at $931 billion the civilian fund at $926 billion. Each payday, the DoD or other federal agency takes part of the appropriation (not actual money, but simply Congressionally approved spending authority), and deposits a sum in the trust funds based on actuarial projections and legal requirements. The balances are then loaned to the Treasury in exchange for non-negotiable Treasury debt.
Similarly, the Social Security Trust Fund stood at $2,793 billion at the end of October and also is comprised of non-negotiable Treasury debt. At least much of it started as actual cash paid by employers and the self-employed.
David Henderson
Dec 18 2019 at 5:54pm
Thanks for handling this, Phil. It saved me researching it.
Mark Brady
Dec 19 2019 at 6:02pm
Thank you, Phil. That’s good to know.
Robert EV
Dec 23 2019 at 9:09am
I’ll vest into the UC pension plan this coming year.
I do not, and will never, understand why pensions are paid as a percent of the top, final pay (or average of the last three years), instead of based on the total sum of pay / years.
You were living fine 10 years ago on your pay 10 years ago, after all. There’s no realistic reason why you can only live okay on a percentage of your highest ever pay.
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