Pensions push state to insolvency
February 23, 2010
FEB. 23, 2010
By TROY ANDERSON
As the $17 billion annual taxpayer tab for government employees’ pensions and retiree health care increases at a rate of “several billion dollars” a year, Orange County Supervisor John Moorlach says California is heading for an “economic meltdown.”
Elected treasurer in the wake of Orange County’s 1994 bankruptcy, Moorlach predicts a confluence of events – an explosion in the cost of public pensions, retiree health care and salaries, plummeting tax revenues and stock market losses – will result in a growing number of municipal bankruptcies and an unprecedented financial nightmare for the state and local governments.
“Former state librarian (and California historian) Kevin Starr is talking about the potential of California being the nation’s first failed state,” Moorlach says. “We better start talking about this. What are we going to do when the entity (state government) above us crumbles? How do we avoid getting hammered by all the debris? I think we are already technically bankrupt.”
Moorlach’s warning come as cities and counties throughout the state are experiencing significant deficits and many are considering layoffs and cuts in salaries and benefits and public services. In recent years, the state has been able to avoid large budget cuts through borrowing, tax increases and accounting gimmicks, but it now faces a $20 billion shortfall and is running out of tricks.
Amid the worst downturn since the Great Depression, Moorlach and other officials say the geometrically-increasing tab for public pensions and retiree health is pushing the state to the breaking point. Government agencies now face massive unfunded liabilities for public pensions and retiree health care.
These obligations, including the state’s bond debts, are conservatively estimated at $237 billion – and perhaps double that amount, according to a recent policy brief by the Stanford Institute for Economic Policy Research entitled “California’s Mounting Budget Mess.”
Joe Nation, author of the brief and director of the graduate student practicum in public policy at Stanford, says the institute is planning to release an analysis on March 10 estimating how large the promises really are to California’s government workers — public servants who receive the highest salaries and most generous pensions in the nation.
“The initial run suggested there is potentially an enormous, and I think, insurmountable shortfall for the system over the next 30 years,” Nation says. “They have come up with some really startling numbers that suggest the hole we’re in is far deeper than we thought.”
Although officials at many public pension systems expect the stock market to rescue them, Nation says that won’t fix the problem because elected officials approved costly pension enhancements and overestimated earnings while underfunding the systems by $12 billion to $13 billion annually for years.
“Most of the money that pays for pensions comes from investment earnings, but if those earnings are overestimated, as our pension funds have done for decades, then you are left with a huge deficit,” says David Crane, special advisor to Gov. Arnold Schwarzenegger for jobs and economic growth.
The annual taxpayer contribution for the state government’s pensions and retiree health care alone is expected to increase from $5.5 billion this year to $15 billion within a decade, Crane says.
“But even the ($15 billion) estimate is still assuming CalPERS earns very high investment yields over that time,” Crane says. “That figure depends on the stock market doubling every 10 years, and if it doesn’t, those figures are even higher.”
If the annual bill in all government agencies in the state is tabulated, the amount contributed totals now $13 billion a year for pension benefits, according to a recent report by the Legislative Analyst’s Office. These government agencies also pay $4 billion per year for retiree health benefits. The combined total is expected to increase by “several billion dollars” each year, the LAO estimates.
Nationwide, there was a $1 trillion gap in 2007-08 between the $2.35 trillion states had set aside to pay for employees’ retirement benefits and the $3.35 trillion price tag of those promises, according to the “Trillion Dollar Gap” report released last week by the Pew Center on the States. This does not include the unfunded liabilities incurred by city and county pension systems.
And the Pew’s numbers likely underestimate the bill coming due because the most recent data available does not take into account the stock market and real estate losses incurred since the Great Recession began.
“While the economic crisis and drop in investments helped create it, the trillion dollar gap is primarily the result of states’ inability to save for the future and manage the costs of their public sector retirement benefits,” says Susan Urahn, managing director of the Pew center. “The growing bill coming due to states could have significant consequences for taxpayers – higher taxes, less money for public services and lower state bond ratings. States need to start exploring reforms.”
The genesis of the problems in California began in 1999 when its pension systems were well funded. Under pressure from public employee unions, state lawmakers passed Senate Bill 400 – allowing massive, retroactive and ongoing pension boosts to state employees. The bill led to the infamous “3 percent at 50” provision for California Highway Patrol officers. At age 50, they are eligible to receive 3 percent of their final year’s pay times the number of years worked. As a result, a public safety employee who began working at age 20 could retire at age 50 with 90 percent of their final salary. In 2002, lawmakers passed SB 183, expanding the “3 percent at 50” calculation to non-safety workers, including billboard and milk inspectors. The bills sparked a wave of public employee pension increases in cities, counties and other government agencies throughout the state.
“No single issue threatens the fiscal health of this state more than our exploding pension obligations,” Schwarzenegger told the Sacramento Press Club last month. “Over the last 10 years, our pension costs have gone up by 2,000 percent from $150 million per year to $3 billion a year (for state government workers). That means hundreds of billions in unfunded liabilities and it means the $3 billion we are spending now will go up to $10 or $12 billion.”
The “exploding pension obligations” are the result of a long pattern of “runaway spending” in state government, says Adam B. Summers, a policy analyst at the Reason Foundation and author of “California Spending By The Numbers: A Historic Look At State Spending From Gov. Pete Wilson to Gov. Arnold Schwarzenegger.”
This increase in spending was driven largely by an increase in the number of local and state government employees and pay increases of 50 percent to 70 percent in the last decade. The average wage for state and local government workers is now $26.24 an hour, compared to $19.45 for private-sector workers, according to the U.S. Bureau of Labor Statistics.
Since 1999-00, the number of state employees has grown from 296,076 to 356,435. During the same period, total state government spending, including federal funds, nearly doubled from $122 billion to $222 billion. Meanwhile, the number of public employees in California collecting $100,000-plus pensions has skyrocketed from about 2,500 in 2004 to 15,000 now.
Summers says the “extravagant spending” really began with the passage of SB 400 – a bill that encouraged local governments to approve similar pension and benefit increases now threatening the financial stability of cities throughout the city. Vallejo filed for bankruptcy in 2008, dozens of other cities are facing severe budget deficits and a growing number of officials throughout the state are discussing the possibility of more bankruptcies. In October, state Treasurer Bill Locker told lawmakers they needed to reform the pension system or “it will bankrupt the state.” The California Public Employees Pension System chief actuary has described the current pension system as “unsustainable.”
“I think we are starting to approach a tipping point,” Summers said. “There is talk of bankruptcy in San Diego. That is the largest city in danger of bankruptcy, but there are probably a number of smaller cities and county governments that are going to be in danger too.”
By law, the state can’t declare bankruptcy.
“The state has the power to tax and the ability to cut back on programs,” Crane says. “But I think these local governments are going to face incredibly draconian choices – shutting down parks and not hiring policemen.”
“CalPERS’ chief actuary, the state treasurer and the governor are all saying, ‘Mayday, mayday – We have to make changes or the pension system will not be sustained,’” says Marcia Fritz, president of the foundation. “When you’ve got the top three officials saying we can’t sustain our pension benefits then you’ve got to do something.”