Public pensions have attracted a great deal of public scrutiny recently. State budget problems add fuel to a problem that is decades old. The media and politicians love to politicize public pensions because the well being of retired workers evokes a lot of emotion with the public. Both sides can tell the public that the fate of many retired workers hangs in the balance and their side will protect their interests. Unfortunately, public pensions pin public workers against tax payers when it comes to funding their retirement pension and healthcare benefits. The higher and less restricted that public pensions are, the more the state is at risk of carrying large unfunded liabilities (i.e. mandated fiscal responsibilities without dedicated funding). The long term effects of unfunded pensions include chronic budget shortfalls, snowballing debt, State credit downgrades, and increased interest payments leading to larger budget deficits.
Public pension shortfalls are not specific to California, in fact, there are a number of smaller states that rival California in total pension debt (i.e. Illinois and New Jersey). CALpers, the public employee pension system is in trouble and for it to remain solvent for future generations, a number of problems need to be identified and and solved. Currently, CALpers has a funded ratio of 62 percent and the school employee retirement system has a funded ratio of 69 percent. The funded ratio measures the State's ability to cover the liabilities of the system. A funded ratio of 100 percent means that the system can match each dollar of liability with a dollar of asset. A retirement system does not need to maintain a funded ratio of 100 percent but if the ratio consistently decreases due to either growing liabilities or decreasing assets, the system will falter. In California the funded ratios have steadily dropped due to a large number of employees either leaving the system or retiring and a lower number of new employees taking their place. As the baby boomer generation approaches retirement age, pressure on the retirement system will continue to see decreasing assets and increasing liabilities. If this deficit continues over time the State risks a downgrade of its credit rating. A lower credit rating affects the cost of the debt service that the state must pay which further adds to its yearly debt accumulation.
| California spending on Pensions |
How did the state of California get to this point? Much like many other public sector issues, there isn't a straight forward answer or cause. Instead there are a number of factors that have clearly contributed to the problem and in aggregate, created a problem much bigger than their collective effect. The first issue is the influence and effect of public collective bargaining on the public pensions. Public unions state that they are the advocates for the public employees that they represent and that means ensuring that they negotiate the best deal for them. They are not in the business of protecting the tax payer, they see the Government as the employer and adversary. This occurs in the private sector as well, the unions advocate for the workers and accept the best deal possible and usually won't drive down their own price to help the business costs. The difference with public unions is that they all are heavy contributors to political campaigns. These donations create a conflict of interests within governmental agency. More often than not, the unions are top contributors to the politicians in charge of the agency whom they are negotiating against. So it is in the best interest for the agency to give the unions a better deal then they would have otherwise received. So it is a win win and lose for the parties involved. The loss of course is the tax payers who see more of their funds used to pay off public unions for their political support. A harder stance by the agency could save the tax payers millions of dollars because a large pension package without control on the payouts could max the system out of resources.
Once upon a time the lure of government jobs was job security and wealthier benefits in lieu of comparable salaries in the private sector. The higher benefits compensated for the lower pay, but as the progression of union influence on employee benefits increases, the benefits overtake the pay deficit. Critics say that public employees require higher pay and benefits to attract the best talent from the public sector. Given the State of California's economic crisis, it would be real scary if they didn't have the best money can buy on the job. Critics also say that Government jobs consist mostly of jobs that require higher education and thus must be paid higher on average. There are many jobs in the government that are paid high that do not require higher education that do get paid very well. For example a large majority of "administrative" jobs are based on the knowledge of the system not on outside education. Once an employee learns the nuances of the system they are interchangeable with a vast majority of the organization. The large number of administration jobs in the government is driven by the scope of many public agencies and the level of bureaucracy that exists. The vast majority of these administration jobs are union covered which drives up the costs to the tax payers.
In addition to the human factors to the pension spending problems, there is a technical problem with California state pensions. Traditionally there are two types of pension plans, defined benefit and defined contribution plans. For years the plan of choice for governments was the defined benefit plan which is a traditional pension where the retirement benefits are determined by a formula based on years of service and final salary. This pension plan has no limits to the benefits that can be earned and in some cases the benefits can be inflated by gaming the system. Salary spiking occurs when an employee works a lot of overtime to inflate their final salary to skew the calculation of their benefits. this results in much higher benefits paid out over the course of their retired life and costing the state much more than was put in to the system. Natural factors like longer life expectancy and demographic shifts also strain the fiscal condition of the system. The longer retirees stay on the system, the more the state will ultimately have to pay out while adjusting for inflation. The ratio of retirees to workers is growing with the baby boomer generation nearing retirement, and that means there are fewer workers paying in the the system then is needed to maintain fiscal stability. To make up for the shortfalls the state must use general fund resources. It is no surprise that California still predominantly employes this kind of pension plan. As of 2010, the CALpers system maintained a 65 percent funded ratio and trending downward. Last year alone the system saw a net loss of over 4 billion dollars.
Like the rest of the Country, California must address its entitlement spending sooner rather than later because the hole it causes in the budget can not be plugged with ad hoc tax increases. It is a systematic problem that must be addressed head on with a structural change in the system. The umbilical cord between the unions and elected officials must be severed for the fiscal future of the State. Sooner rather than later the State must transition all of its pension plans to alternatives that protect the States liabilities. These options include defined contribution plans, cash balance plans, or some combination thereof. The consequences of not acting now will have repercussions for decades and will continue the plague the budget of the State until true reforms are implemented.
Cited work and research:
http://www.fixpensionsfirst.com/docs/Full_Report.pdf
http://www.opensecrets.org/orgs/list.php
http://slge.org/publications/state-local-pensions-an-overview-of-funding-issues-and-challenges
http://www.usgovernmentspending.com/california_state_spending.html
http://www.calpers.ca.gov/eip-docs/about/pubs/cafr-2012.pdf
http://www.platteinstitute.org/docLib/20111212_Public_Sector_Pensions_in_Nebraska.pdf
http://www.taxpolicycenter.org/briefing-book/key-elements/savings-retirement/defined-contribution.cfm
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