Farewell, My Lovely
How public pensions killed progressive California
The Democratic Party has folded Sacramento into one of the tightest one-party grips in contemporary American politics. In November, bucking the national trend, Democrats in California won not just the governorship but 51 Assembly seats to Republicans' 29, 24 state Senate seats to Republicans' 14, and every statewide office. With the passage of a referendum lowering the number of legislative votes required to approve a state budget (from a two-thirds majority to a simple majority), California is that rarest of land masses for the 2011 Democratic Party: conquered territory. State Democrats have freedom to rule virtually unchallenged by the scattered, rusticated Republicans.
As 72-year-old Jerry Brown enters his second governorship, he has an agenda to match that power, with visions even greater than those that haunted his two-term administration of the 1970s and '80s: building 20,000 megawatts of renewable power, laying a new high-speed rail network that will connect the state's major cities, forging a statewide infrastructure for alternative energy, hiring thousands of green employees. The new governor's environmental agenda is ambitious, untenably expensive, and indelibly popular with voters and lawmakers.
Yet when Brown looks out on Democrat-controlled California, he seems less like Caesar at the Rubicon than Wojciech Jaruzelski at the Gdansk Shipyard. Brown is champion of a workers' party with monopoly control, yet all his plans are being derailed by a labor movement nobody can harness.
At press time, California was being governed under a state of economic "emergency" declared by Brown's predecessor, Arnold Schwarzenegger, in light of a staggering $28 billion budget shortfall expected in the next 18 months.
It gets worse. Medium-term unfunded liabilities for government employee pensions are pegged by the Legislative Analyst's Office at $136 billion—and that's a lowball figure. Legislative analyst Mac Taylor acknowledges in his current fiscal outlook report that the estimate leaves out billions in funding shortfalls at the pension funds for public school teachers and University of California employees. In the next 10 years, taxpayers will most likely be on the hook for somewhere between $325 billion and $500 billion. (Over the past five years, state revenues averaged $94.5 billion per year.)
How did this happen?
California's state and local governments employ somewhere between 1.5 million and 2 million workers, representing 4 percent to 5 percent of the state's total population. When they retire, all of those employees are contractually entitled to generous pension benefits—so generous that, collectively, they can't be paid even by a pension system that ladles out more than $20 billion a year and is one of the largest investment pools on Wall Street.
California is not the only state infected by pension liabilities, but the size of its economy (generally described as the eighth largest in the world) and its union-dominated politics make it a gravely stricken, and potentially contagious, patient. Organized labor contributed tens of millions of dollars to Brown's campaign last year, and public-sector unions have long been the largest donors to the Democratic politicians who control the state.
"The unions have a stranglehold on this state," says Marcia Fritz, a Citrus Heights accountant who serves as vice president of the California Foundation for Fiscal Responsibility, a pension reform lobbying group. "To engage them you need your biggest strategy. It's like trying to topple a communist government." But like communism, which eventually ran out of other people's money, California is teetering on fiscal implosion.
Voters Demand Pension Reform
Union lobbying can occasionally be broken by direct democracy, although generally not when the stakes are high. In the November election, a total of 13 local ballot initiatives around the state promised to rein in excessive compensation, especially pensions, for government employees. Most of these measures were modest, applying only to future hires or instituting voter-approval requirements for future increases in benefits. In pension-crisis-wracked San Diego, Proposition D wasn't really a reform at all, just a half-penny sales tax increase pegged to a review of employment practices.
Even these half-measures were popular in towns ranging from Redding, a Republican hamlet of 100,000 in Shasta County, to California's third-largest city, the Democratic stronghold of San Jose. This popularity was consistent across economic bases: Eight out of Redding's top 10 employers are governments, schools, and health care establishments, while six out of San Jose's 10 biggest bosses are private tech companies. Out of the 13 pension reform measures on ballots, even in a pro-Democratic year, a dozen passed by wide margins.
But in San Francisco, where Proposition B would have made real progress by increasing employee contribution requirements for both current and future workers, the unions fired their heaviest weapons. Local firefighters sued to keep the measure off the ballot. The umbrella group Stand Up for Working Families spent more than $500,000 hiring Stearns Consulting and Burson-Marsteller to run a citywide anti-B campaign, and public unions pumped millions into the effort in the days before the vote.
"In San Francisco it's known that if you want to get into office you've got to have labor support," says Public Defender Jeff Adachi, the author of Prop. B. "Every elected official opposed Proposition B. Our opponents spent $2 million in the last two weeks. I'm told they bused in 400 people to protest, and it certainly appeared that way on the street." The measure ended up failing, with just 43.3 percent of the vote.
The Democratic Party Class Struggle
To say Jerry Brown has not been an ally of pension reformers would be an understatement. In his capacity as attorney general, a post he filled from 2006 until becoming governor in January, Brown consistently did the unions' bidding. In October 2009 he sued State Street Bank and Trust to the tune of $200 million for supposedly marking up the prices of interbank foreign currency trades made on behalf of two large and powerful pension funds, the California Public Employee Retirement System (CalPERS) and the California State Teachers' Retirement System (CalSTRS). In 2010, when Orange County sued its sheriff's deputies over a $500 million retroactive pension liability accumulated after a 2001 upgrade that had not been put up for a legally required popular vote, Brown weighed in with an amicus brief—on behalf of the deputies union. And throughout Brown's tenure as the Golden State's top cop, while the city of Bell's now-ousted-and-indicted city manager Robert Rizzo was racking up a $1 million annual compensation package and a commensurately inflated pension commitment, Brown ignored the crime. He didn't respond until the middle of 2010, after popular outrage and intense coverage by the Los Angeles Times forced him to intervene (with a lawsuit that now appears to be falling apart).
Yet it is to Jerry Brown that Republicans, Democrats, and California's 4.3 million non-major-party voters now turn. "Jerry Brown is cocky enough to say, 'Hold on guys,'?" says Orange County Supervisor John Moorlach. "Any movement would be helpful."
The Republican supervisor has reason to doubt that Brown will try to tame California's pension beast. It was Moorlach's board of supervisors that Attorney General Brown chose to stand against in their suit over retroactive government employee benefits. Yet Moorlach hopes Brown's involvement in that case may have opened his eyes. It may be wishful thinking, he acknowledges, but he thinks executive responsibility could change Brown's attitude.
"Now the Democrats have to deliver," Moorlach says. "They have to lead, and they have to pay for their initiatives, and I think that's why you're starting to see these guys standing up. From our lawsuit Jerry Brown has figured out what we're doing and why retroactively increasing benefits is a bad idea. If Jerry could bring in just a defined-contribution component to these plans, bring the camel's nose into the tent, if he could just get the ball rolling on that a little bit.…"
Moorlach alludes to a striking feature of the current pension reform movement: It is a revolt led by the supporters of big government. At every level, Californians want assertive government. Republican farmers demand cheap water and more than $2 billion a year in subsidies. Unionized TV and movie productions command incentives such as $500 million in tax credits. In popular referenda during the last five years, California voters have voted themselves nearly $100 billion in bonded debt. The acceptable question is no longer whether to spend but what to spend it on.
This is why the most aggressive lobbying for pension reform is coming not from fiscal conservatives but from progressives, who see the logarithmic cascade of pension liability as a threat to public parks, environmental programs, and rail transit.
Jeff Adachi, an attorney who has spent most of his career in government work, sees the problem strictly in terms of spending priorities. "Right now in San Francisco we're spending a billion dollars a year on benefits," he says. "That's one out of every six dollars we spend. Within five years that's going to double, to one out of every three dollars. I believe it's already that ratio in Los Angeles."
Adachi's allies on Prop. B included Willie Brown, a Democrat who was mayor of San Francisco from 1996 to 2004 and speaker of the California State Assembly from 1981 to 1995, and the Green Party's Matt Gonzalez, former president of the San Francisco Board of Supervisors and Ralph Nader's 2008 vice presidential candidate. Marcia Fritz, the head of the reform group, begins our conversation by saying how pleased she is at the Democrats' statewide sweep in the elections.
Similarly, Chuck Reed, the reform-minded mayor of San Jose, is a Democrat with a thirst for a Major League ballpark, an ambitious "Green Vision," and a background in pro-tenant law and restrictive land use policy. The list of progressive Democrats trying to reform pension spending goes all the way up to the most progressive Democrat in Sacramento: Republican ex-governor Schwarzenegger, who in 2006 muscled through Assembly Bill 32, the nation's first (and probably last) statewide attempt to stop global warming, and who won voter approval in 2008 for $9 billion in bond debt to build a fanciful high-speed rail line.
All of these people see money intended for infrastructure, stimulus, and earthly glory going instead to a public-employee bishopric. The pension fight is properly understood not as a liberal-conservative issue but as a class struggle within the Democratic Party.
Which Side Is Jerry On?
So it was dramatically appropriate, if credibility-straining, that Jerry Brown—who arguably created the problem in 1978 by signing the Dills Act, which gave California's public employees the power of collective bargaining—emerged as the more serious critic of public employee compensation in the 2010 gubernatorial campaign.
The difference was evident in the two major candidates' platforms. Republican neophyte Meg Whitman offered one page on solving the state's pension crisis, and her flagship proposal—moving new hires into a defined-contribution system akin to a 401(k) plan—was unworkable. More than 50 percent of California government employees (all public safety workers and teachers, along with about half of all miscellaneous workers) are free from the Social Security system. Instead, their retirement benefits come from a defined-benefit package. In contrast with a "defined contribution" plan such as a 401(k) or IRA—in which the person contributes to his or her own retirement and receives benefits based on the size of the total fund at retirement—a defined benefit package promises a specific payout that is calculated based on salary and is payable whether or not there's enough money in the fund.
In this, as in many other aspects of public employee compensation, California is out of sync with the rest of the country, where about 70 percent of government workers are subject to Social Security withholding. But the bottom line is that in the absence of Social Security, a 401(k) alone cannot solve the problem, and it didn't inspire confidence that the Republican candidate for governor, in her platform and on the stump, seemed unaware of this.
Brown, by contrast, offered four pages of pension reform detail, including a formula to prevent pension spiking (in which a government employee can rack up excessive overtime in his or her last year and thus boost a pension payout that is calculated based on an employee's final-year compensation); an increase in the percentage of annual salary an employee must contribute; and (surprisingly, given his amicus brief in the San Diego case) an end to retroactive application of benefit enhancements.
Finally, Brown flayed Whitman for a glaring deficiency in her reform ideas: They exempted public safety workers. By making this point, Brown broached one of the thorniest pension reform issues. Cops and firefighters account for more than a quarter of the total pension liability in California, and they tend to be quite ingenious at spiking their pensions. They are also uniquely immune to negative campaigning. The rough and tumble of recent union battles has driven many Californians to despise even such traditionally popular groups as nurses and teachers; but voters overwhelmingly like and want more cops and firefighters. That Brown is willing to discuss these details—and to be clear that a solution will require some powerful players to settle for smaller payouts—indicates that he is at least thinking seriously about the problem.
But the experience of his predecessor indicates how towering Brown's task will be. It's hard to imagine a mandate clearer than the one Schwarzenegger enjoyed after his displacement of Democratic Gov. Gray Davis in the 2003 recall. Yet it took until the end of his second term for Schwarzenegger to accomplish even a marginal correction of the Davis administration's most important fiscal error.
In 1999 Davis signed a law that retroactively increased pension benefits for all government employees by 25 percent to 50 percent—including all workers employed at the time and all new hires. Senate Bill 400 (S.B. 400) was, in the words of David Crane, Schwarzenegger's special adviser for jobs and economic growth, "the largest issuance of debt in California history, and it was issued without voter approval or voter knowledge." At the time the bill was passed (after a mere five minutes of debate, according to legend), returns on capital market investments were paying 75 percent of CalPERS benefits, with another large chunk coming from the state's general fund and a small portion from employee contributions. In a now-infamous prospectus for the bill, CalPERS told legislators the increase would leave state costs little changed for a decade.
A Long Road to Small Reform
It quickly became apparent that there were serious errors in those estimates. But it wasn't until 2008, when CalPERS lost somewhere between a quarter and half of its portfolio, that the vast taxpayer liability became too clear to ignore. Wall Street's subsequent series of fools' rallies has done little to restore CalPERS's solvency, and investments now cover only 63 percent of CalPERS' ongoing commitments, far short of the federal government's minimum threshold of 80 percent for basic pension plan health. Taxpayers are on the hook for the remainder.
The Golden State's 2010 budget shortfall included an additional $3.9 billion in unexpected charges for pension payouts. Legislative sources expect that gap to increase more than threefold, to nearly $14 billion, in 2011. The gap is increasing, at an accelerating rate, year by year; and there is no realistic scenario in which market performance can begin to close it. CalPERS, whose accounting house of mirrors is still built on projections of 7-to-8-percent annual returns indefinitely, claims to be untroubled. But it also continues to ask for more help from the state's general fund, citing market losses as well as longer retiree life spans.
Arnold Schwarzenegger, whatever his failings as a governor, quickly recognized the scope of the problem. He fought for public-sector compensation reform on several fronts—actuarial, fiscal, political, and financial. And he lost on all of them.
In 2005 the governor got ravaged by nurses unions when he tried to walk back a union-supported Davis-era law on nurse/patient ratios that was contributing to a shortage of open emergency rooms. Later that year, Schwarzenegger, having failed to push reform through the Democrat-controlled legislature, took the matter to voters in a special election that sought to undo union political influence in various ways. His slate of ballot initiatives included a spending cap mechanism, "paycheck protection" (which would have allowed union members to block the use of their dues for political campaigning), an increase in the teacher tenure requirement from two to five years, and a plan to redraw the state's noncompetitive electoral districts.
The ensuing defeat ended up defining the Schwarzenegger administration. Labor poured resources into a vehement, vituperative campaign against the governor's slate. The confrontational, hard-left California Nurses Association jeered Schwarzenegger at every public event, including commencement speeches at middle schools. All of the initiatives lost badly, and while Schwarzenegger went on to win a second term, he never regained the initiative. He hired a former Gray Davis staffer as his chief of staff, worked on what marginal improvements he could get by vetoing bills (and drifting toward the Democrats), and avoided engagement with his enemies in the unions—who nonetheless never lost their taste for demonizing him. It was not until the 2008 market correction revealed the depth of the pension problem that Schwarzenegger returned to the fight.
In his final-act struggle for reform, Schwarz-enegger attained something of the grace that had eluded him throughout his career in Sacramento. Showing an uncharacteristic nonchalance about public perceptions, the lame-duck governor fought ugly, allowing budget negotiations to drag out for months as the state experienced severe cash flow problems, its credit rating tanked, and public workers were furloughed, laid off, and threatened with massive temporary pay cuts. The goal was to bleed the Democrats and their union patrons until they accepted a reform.
David Crane, operating out of a quiet office (dubbed "The Crane-ium") off the governor's main digs in the state capitol, acted as the lead advocate on the issue, and he showed a talent for explaining pension reform in terms that liberals could appreciate. "This year we're spending 10 percent less on higher education than we did 10 years ago, parks and recreation 40 percent less, environmental protection 80 percent less," Crane told me in the fall of 2010, "while spending on pensions is up 2,500 percent. So when Democrats realize what is happening and act in the interest of the people they represent, they will address the pension problem in California." Like so many other reformers, Crane is a registered Democrat who supported Jerry Brown.
Public Opinion Shifts
In the renewed fight of 2009 and 2010, Schwarz-enegger had an unexpected ally: a recession-era shift in public opinion nationwide that saw support for unions drop (according to Gallup) from 58 percent in 2007 to 42 percent in 2010. The still-unfolding scandals over compensation and corruption in Bell, Maywood, and other towns in southeastern Los Angeles County helped stir the pot. Schwarzenegger also managed to peel off those public-sector unions attuned to popular attitudes.
"Highway patrol officers and firefighters care very deeply what the public thinks," Bob Wolf, president of the California Department of Forestry firefighters union, told me during the budget battle in October. "We believe our neighbors down the street, whom we protect, believe that we deserve fair retirement and fair wages and decent working conditions. That's all we're asking for. We're not asking for pie in the sky."
Along with the California Association of Highway Patrolmen and four other unions, Wolf's group agreed last summer to roll back some of the past decade's gains in public employee compensation—specifically, they supported a return to pre-1999 pension formulas for new hires and an increase in employee contributions. Through his scorched-earth campaign on operational spending and a threat to leave office without a 2010 budget signed, Schwarzenegger eventually won the war of wills with Democratic legislators as well. The budget that was signed in October contained concessions on pension payouts and a legislative fix that effectively brought an end to S.B. 400 largesse for future hires.
It's a step in the right direction, but it is a token effort given the scale of the unfunded pension liability during the next 10 years. "The rollbacks only go for future employees," Adachi points out. "We could have done that with Proposition B, and it might have passed. But it wouldn't have solved the problem."
Nor is it clear that anybody outside the universe of executive-branch Democrats (who have more direct responsibility to maintain all the state's fancy programs) realizes the problem is not solved. Schwarzenegger's win on S.B. 400 has already allowed complacency to settle in. A spokesman for State Senate President Darrell Steinberg told me after the election that the heavy lifting had already been done by Schwarzenegger. "The S.B. 400 thing was passed as part of the budget," he said. "The important thing now is to grow the economy, in particular to regenerate the stock market. The single best thing we can do to address pension and retirement problems would be to grow the stock market."
This attitude is shared by the unions themselves. "Most of the pension issues Governor-elect Brown and Whitman were talking about were implemented in the final budget," says Ryan Sherman, a spokesman for the California Correctional Peace Officers Association. "So I'm not sure what else they're going to be looking at. It has been rolled back for everybody."
This is the landscape the new governor of California is facing. Jerry Brown did not respond to repeated requests for an interview. His comments on the campaign trail indicate he has given serious thought to a public employee compensation crisis that threatens not just the prosperous California favored by free marketers but the technocratic, big-government California favored by progressives. His abysmal track record indicates something else. But Jerry Brown, for better and worse, is full of surprises. He could round out his storied career by becoming California's Gorbachev.
Tim Cavanaugh (tcavanaugh@reason.com) is a senior editor at reason.
