California Gov. Jerry Brown (D) and the state legislature mostly have avoided tackling the state's unfunded pension liabilities, even though these taxpayer-backed debts to pay for pension promises to state and local employees have soared by 22 percent in the last year alone. Earlier this month, however, the governor introduced a plan to help pay down the liabilities, but recent analyses from prominent pension reformers have been mixed.
The governor's plan is similar to the idea of pension-obligation bonds. That's when a government borrows money to pay down escalating pension debts, in the hopes "that the bond proceeds, when invested with pension assets in higher-yielding asset classes, will be able to achieve a rate of return that is greater than the interest rate owed over the term of the bonds," according to an explanation from the Government Finance Officers Association.
The governor's plan, by contrast, would borrow money from the Surplus Money Investment Fund, a low-interest (around 1 percent) account where the state holds money to pay for short-term expenses. It would then make a supplemental $6 billion payment to the California Public Employees' Retirement System (CalPERS), which currently predicts a rate of return of 7 percent (even though last fiscal year it received only 0.61 percent). If the CalPERS fund performs as predicted, it will allow the state to save $11 billion in pension liabilities over two decades.
"Absent additional action to address these growing liabilities, paying off retirement liabilities will require an increasing percentage of the state budget. For example, the state's contributions to CalPERS are on track to nearly double from $5.8 billion ($3.4 billion General Fund) in 2017?18 to $9.2 billion ($5.3 billion General Fund) in 2023?24," according to the May budget revision's summary. This is purportedly a painless way to pay down growing pension debts.
The idea got a boost from one of California's best-known pension reformers, Sen. John Moorlach, an Orange County Republican who recently introduced a package of pension reform bills in the Senate. They were all killed by majority Democrats. Nevertheless, Moorlach wrote, in a column for Fox & Hounds, that he wishes the governor's prepayment plan had "a little more sizzle to make it an even more interesting opportunity."
"Governor Brown should ask the board of CalPERS what type of incentive they will give the state for the prepayment," he wrote. "CalPERS will benefit from the large influx and should provide at least a 3.75 percent reduction on the actuarially calculated required contribution." That's unlikely to happen, of course, but Moorlach wrote that he likes the Brown proposal and thinks the governor should move forward with it.
The idea follows the lead of the Orange County city of Newport Beach, explained Ed Mendel, in his May 29 Calpensions article. The city is paying down its pension debt to CalPERS as quickly as possible, helping it avoid the possible fate of other cities. Mendel quotes Modesto's acting city manager, who told the Modesto Bee "he is hearing that many cities are facing bankruptcy over rising pension costs." In the case of looming fiscal trouble, most say slashing at debt is a good idea.
But not everyone is so favorably disposed toward the governor's plan. David Crane, a Stanford University lecturer and president of Govern for California, argues in a column that the plan is terrible precedent that transfers more pension costs from the beneficiaries of the pension system to the state's taxpayers. When the state makes pension promises to employees, he wrote, both the state and the employees make contributions into the system, which he refers to as "normal costs."
By contrast, when agencies increase benefit levels or stock-market earnings go down, the pension funds face those "unfunded liabilities," which are the unfunded promises they've already made to current retirees and employees. CalPERS currently is 74 percent funded, which means that 26 percent of those promises are unfunded. "In contrast to joint sharing of normal cost, employees don't share in the cost of unfunded liabilities," he wrote. "One hundred percent of that cost falls on citizens, whose services get crowded out and taxes get raised to pay off the liabilities."
Borrowing these taxpayer funds to pay off the pension debt, he explains, would just let CalPERS continue to set these shared "normal costs" at an unfairly low rate. Furthermore, Crane notes that this special fund is funded entirely by taxpayers, so he fears the state will borrow from other special funds. The state could claim that these monies are going to pay for public services, when in reality they are being siphoned off for pensions.
As Former Republican Gov. Arnold Schwarzenegger's pension adviser, Crane wrote that he helped Schwarzenegger "engineer 'Deficit Reduction Bonds' as a way to address the deficit he acquired upon taking office." But he now regrets the move: "Those borrowings didn't solve anything. They just covered up the problem, with interest to boost."
State and local governments are understandably in a bind. They have "few ways to slow the rapidly climbing cost, among them: cut staff and services, lower pensions for new hires, get unionized employees to pay more for their pensions or cut salaries," explained Mendel. He noted the key obstacle limiting the ability of governments to cut pension accruals in the future is something called the "California Rule," which is making its way to the state Supreme Court.
For some, then, shuffling funds around to prepay a little pension debt seems like a cost-free no-brainer to likely limit the growth of the debts. But to others, it's just a shell game that evades the more politically dangerous course of tackling the size of those benefits head on—and running into powerful resistance from the state's public-employee unions