Is Ruling Too Late to Fix California's Pension Mess?

Good news on the pension reform front

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An August 17 California appeals court ruling rejected a public employee union's claim that its members had a right to "pension spiking," which the court described as "various stratagems and ploys to inflate their income and retirement benefits." Public employees often will pad their final salary total with vacation leave, bonuses and "special pay" categories to inflate the pension benefits they receive for the rest of their lives.

That decision was good news not just for pension-reform activists, but for the Jerry Brown administration and legislators from both parties who had supported a 2012 reform law meant to shave the state's pension obligations. As Justice James Richman noted in his ruling, spiking "has long drawn public ire and legislative chagrin."

But pension reformers got even better news, given the nature of the judge's reasoning. The court ruled that employees have a right to a "reasonable pension—not an immutable entitlement to the most optimal formula of calculating the pension." That simple logic undermines the core obstacle to far-reaching pension reform in California, and which has been adopted in several other states. It involves something known as the "California Rule."

It's not actually a rule, but a precedent derived from a variety of rulings that date back to 1955. Ultimately, it says that once a legislative body (city council, board of supervisors, the state Legislature) grants a pension-benefit increase, that increase is indeed immutable; it can never be rolled back. Employees can never be forced to contribute more to their pension plan unless they get something of equal or greater value in return.

By contrast, the courts allow private-sector employers to roll back pension benefits on a forward-going basis. In other words, an employer can't reduce pension benefits that have already vested, but it can cut back future benefits that have yet to be earned.

Four years ago, California politicians from both parties acknowledged the depth of the state's public-employee pension crisis.Unfunded liabilities—i.e., the taxpayer-backed debt to pay for the state's pension promises—were rising. Localities were struggling to make ends meet as their pension obligations rose, with a handful heading into bankruptcy and others struggling with service cutbacks to afford their pension bills.

The resulting pension-reform law, called the Public Employees' Pension Reform Act (PEPRA) of 2013, has been criticized for not going far enough in its reforms. Some Republicans even alleged it was more about public relations than reform. Its passage in 2012, for instance, was used by supporters of the Proposition 30 tax increase measure to convince voters the state was serious enough about governmental reform that they should vote yes. But the Brown administration and legislators argue it was a serious step toward reining in pension problems.

Whatever their motives, legislators and the governor have dealt with the same problem faced by other local governments that have tried to reform pensions: the courts use the California Rule to stop most proposals that reduce benefits for current employees. PEPRA mostly made changes for future employees. The pension-spiking restrictions at issue in this ruling, Marin Association of Public Employees v. Marin County Employees' Retirement Association and the State of California, were found in a trailer bill that was passed after it became clear that PEPRA actually would "increase pension-spiking opportunities," as the East Bay Times' Dan Borenstein reported.

Despite the reform, however, massive pension problems remain. The Stanford Institute for Economic Policy Research produces a pension tracker that calculates the size of the pension debt for all of the state's employee-retirement systems. Depending on assumptions about rates of return, the debt ranges from $281 billion to $946 billion, or a range from $22,000 per California household to $75,000. In the ensuing four years, the debt problems have intensified, especially following the California Public Employees' Retirement System's recent returns, which were below 1 percent for the past year.

Unlike a 401(k) system, where the ups and downs of the market raise or lower the returns that an employee will receive, these governmental defined-benefit systems guarantee a payout to employees based on a formula. If the market goes down, then the taxpayer-backed unfunded liability, or debt, goes up. There's variation in the size of the debt based on how well the pension funds do. The main pension fund assumes their investments will earn an aggressive 7.5 percent. If it's wrong, agencies will need either to come up with more money or cut back public services.

Hence, the significance of the California Rule. The state and local agencies have cut back pension benefits for new and future employees. That's allowed. But most of those employees won't start retiring for 30 years. Many analysts believe the only way to get these debt numbers under control is to reduce benefits of current employees going forward. The courts have so far stopped that approach. A federal court in the Stockton bankruptcy case ruled that benefits can be cut for current employees, but cities have to go belly-up to take advantage of that process.

The latest ruling offers a possible way out of this conundrum. "(T)he Legislature may, prior to the employee's retirement, alter the formula, thereby reducing the anticipated pension," the judge ruled. "So long as the Legislature's modifications do not deprive the employee of a 'reasonable' pension, there is no constitutional violation. Here the Legislature did not forbid the employer from providing the specified items to an employee as compensation, only the purely prospective inclusion of those items in the computation of the employee's pension."

The judge pointed to a report from California's watchdog agency, the Little Hoover Commission, noting the size of the pension problem: "The money coming in is nowhere near enough to keep up with the money that will need to go out. The state must exercise its authority—and establish the legal authority—to reset overly generous and unsustainable pension formulas for both current and future workers." In other words, the promised benefits cannot be considered outside of the overall health of these public retirement systems.

The ruling will almost certainly be reviewed by the state Supreme Court. Pension-reform advocates have made progress in the past in addressing this rule (e.g., the 2012 passage of a San Jose reform that rolls back benefits for current employees) only to be rebuked in court. And even if it stands, the decision will leave no clear roadmap. How much can future pension benefits be cut or how much more can employees be expected to contribute before it becomes "unreasonable"?

It's unclear, but as a Santa Rosa Press-Democrat editorial opined, the "court ruling opens a path for pension reform." That's not a freeway, but it's a way forward that reformers didn't have before the 1st District Court of Appeal's decision.

This column first appeared in Calwatchdog.

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  1. A ‘reasonable’ pension? They can cut it as long as what’s left is reasonable?

    Wow. I know this is California, but when the government starts talking about leaving you with something ‘reasonable’ your ears perk up.

    1. Whatever, friend. Life is about hard choices. Either we take away thousands of dollars from the pension of some guy who taught screaming 5-and 6-year olds how to read for 30 years or we raise taxes on Twitter and Snapchat wunderkinds to the extent that they’ll probably pass on buying the 2nd Gulfstream. Hmm.

      1. Hmm, take the money of a usually incompetent state indoctrinator, or from a magnanimous peddler of technology.

      2. So how much will they have to raise taxes on the handful of snapchat “wunderkids” to cover a trillion dollar shortfall? Is a 300% tax rate enough or will it need to be 6000%. Bonus question. How long will it take for them to decide to tiptoe across the state line? Or do you plan to build a wall?

        1. Am_soc probably doesn’t understand the math. There aren’t enough billionaires in California to cover a 950 billion short fall.

          1. To put it in perspective, the entire net worth of every billionaire in the US is about 2.4 trillion. This is what happens when you make extravagant pledges to buy votes for a couple of generations. Eventually the math catches up with you.

            But hey, as I was told yesterday, Reality has a Liberal Bias!

            1. As Detroit has shown reality really does have a liberal bias. It singles out liberal policies for “special attention”.

        2. *am soc longing gazes toward Maduro*

          “We have a way….”

        3. You also have an issue with jurisdiction. There aren’t many wunderkinds to tax in places like Stockton and San Berdoo.

      3. The Socialist answer? Do both! And then when your bloated budget is still hurling toward collapse, go after those regular working people in private industry whom you hate so much.

      4. It never ceases to amaze me how programs that were supposed to be “self-sustaining” require continuous tax hikes to sustain. The California tax base is the largest it’s ever been and yet somehow it’s still not large enough.

      5. In the experience of people around me, “reasonable” is govspeak for “fuck promises.”

      6. This is probably not an accurate description of what might happen as a result of this ruling.

        Let’s say I was hired 20 years ago by the state, and the terms of the pension plan were that, upon completing 30 years of service, I would be able to retire and to receive 2% of my final salary for each year of service (i.e., 60% of my final salary) for the rest of my life. Further, if I were to quit working before reaching 30 years of service, I would instead be entitled at age 65 to receive 2% of my final salary at termination for each year of service (i.e., if I terminated with only 20 years of service, I would get 40% of final salary, but I’d have to wait to age 65 to begin receiving it).

        Let’s also say that the state is now trying to reduce benefits. Under the California Rule, my right to receive 60% of salary at 30 years of service is protected. This differs from a private sector pension in that, in a private sector pension, only 40% of my current salary, beginning at age 65, is protected.

        I can’t say with 100% certainty, but it is extremely unlikely that the benefit cuts that will be possible by this ruling would allow the state to reduce the 40% of current salary that I had already earned with service rendered before the cuts are made. However, the state may be able to change or reduce the benefits that I can earn with service rendered after the cuts are made.

        I can say with certainty that this ruling would not allow the benefits for current retirees to be reduced.

        1. Which is ridiculous. There’s no reason they shouldn’t be able to go back and recalculate someone pension payout without all the spiking that set it, and start paying them that.

          The only truly impossible thing would be collecting back overpayments to these people.

          1. It is also not true as a matter of how pension problems have been dealt with in the past. For example, in Detroit (where my father-in-law worked for the city for many years), pensioners did in fact get a cut in their pension.

            Again, these things are driven by arithmetic. Once you realize that you can’t cover the hole by just going after those who have yet to collect, you have to start going after those who are already collecting.

      7. If you put it that way, AmSoc… you’re right: let’s take it away from some guy who taught screaming 5- and 6-year olds how to read.

  2. Desire-based taxation. Reward a cool tax raise to the millions of naive progressive California fucks who breathlessly promote the violent monopoly of taxation as a governing right and necessity.

  3. Vice President Joe Biden reaches a new personal low, as he silences a protestor by implying that his son’s death had something to do with Iraq.

    Wow, what a piece of garbage.

  4. The Union Leader here in NH recently published a letter from a state police major in which he complained about recent reforms to the NH pension system. Apparently, they now have to contribute 11% to their pensions, work 25 years instead of 20, and can’t draw the pension till they are 52. They really do live in some alternate universe where they are entitled to a comfortable retirement that is quite likely longer than the years they worked. The math don’t work.

    1. Not their fault. If they can squeeze money out of the government, then why wouldn’t they?

      It is up to the rest of you to prevent it though.

      1. If that’s your standard of ethics, then sure

        1. Do you expect people to do illogical things? To do things against their self-interest?

          I know you don’t think that, but I probably should have been a bit more explicit in what I meant though.

          For the L’s (or even the R’s), it may be better to target changing the system.

          So rather than saying that so and so (or whichever group of people) is harming everyone else, perhaps consider saying that it is the Big Government harming the general population.

          1. Do you expect people to do illogical things? To do things against their self-interest?

            All the time, actually.

  5. Californians can choose to have a bankrupt state.
    If they don’t like it, they can always move to another state.

    I would be concerned if the Federal money is ever involved in bailing out (which I suppose that is something we should expect nowadays) because the Federal Government has the ability to print paper money.

    Then it becomes a tax on the rest of us over time.

  6. And if unionized public employees don’t like pension reform, we could go to the logical next step and hunt them down in the streets like the vermin they are.

  7. It’s questionable whether one of our largest States can weather hundreds of Billions shortfall in their underfunded defined benefit plans, but fifty of them together is supposed to overcome tens of Trillions shortfall with a reasonable few % tax increase and tiny increase in co-pays.

    Sure.

  8. “That decision was good news not just for pension-reform activists, but for the Jerry Brown administration”

    Only in that it causes some savings and moonbeam can still brag about passing the Dill Act to keep the unions bucks flowing to the Ds.

  9. Well, I contribute something like 10.3% of my pre-tax salary to the pension I’m enrolled in. So presumably, CA public workers could be expected to contribute at least that much.

    I’m kind of surprised (other than the fact that the deal was negotiated by unions) that the pensions have any provision for this sort of “spiking” at all. I’d expect the system to be set up to say “base pay is the calculated benefit input, alone.”

    1. It does seem insane to base the pension on late year earning padded with overtime, saved vacation and sick time. I work for a county government and our pension is based on our yearly salary and no overtime or any other compensation or benefits affect your pension. When the math does not work out how do the employees think this system can continue to operate? I guess they just believe everyone else in the state should pay for their nice retirement. I think all the recipients of these out of control union brokered pensions are in for a wake up call in the near future.

  10. RE: Is Ruling Too Late to Fix California’s Pension Mess?

    The clear choice to clean up Kalifornia’s pension mess to is to raise taxes on all the untermenschen. After all, money solves all problems. At minimum tax rate of 100% should do it. This way, the Kalifornia state employees will be given a hefty raise they all have earned and the little people of that enlightened state will finally enjoy the benefits of state sponsored poverty such as food rationing, living under bridges and using pine cones for currency. One has to wonder why the ruling elitist turds in Sacramento hasn’t thought of this wonderful idea before. But no matter. We all make mistakes, and one can be assured that total financial and asset redistribution among the Kalifornia masses will be launched in earnest for the sake of the collective.
    One must have faith in the system.

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  12. has been criticized for not going far enough in its reforms.

    I criticize it for going not too far enough!

  13. Can’t we do pension reform Obama-style?

    “If you like your public sector pension, you can keep your public sector pension!”

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