A series of recent revelations have brought the severity of the state’s pension crisis into sharper focus, but the state’s political system is broken so increased media scrutiny and urgency raised by experts does not necessarily translate into any meaningful action.
As pension reform pioneer Joe Nation, Stanford University Professor, first pointed out more than five years ago, the use of real “pension math” as opposed to “government math” holds the key to solving the state’s pension problem.
This has been clear to most reformers for a very long time, but something that has been all but ignored by most in the Democrat political establishment.
There are reams of data and math to sort through on this issue, but to cut through all this and make things very simple I would argue that the “silver bullet” to brining about change is lowering the so-called 7.5% discount rate used by public retirement plans.
One of the key causes of the pension problem is that California’s public agencies are able to get away with failing to fund all but a small fraction of true cost of the pension benefits they guarantee to public employees.
The level of current benefits provided by most public agencies is far in excess of what they can actually afford, yet they can continue to offer them because they are not forced to pay for their true cost.
For example, most public safety officials can retire at age 50 with 90% of their pay, which has pushed many pension payroll contributions to more than 50% for public safety plans (yes the retirement benefits cost 50 cents for every dollar of payroll, but this is only the required contribution, not what is actually needed to fully fund the benefit).
Pension reformers should focus their efforts on forcing the California Public Employees’ Retirement Fund (Calpers) and other independent retirement funds to lower their discount rates from 7.5% to at least as low as 6.5%.
This may not sound like much but based on my research and rough estimates I believe this would likely be enough to place a significant amount of increased pressure on the system, and bring about even the possible financial collapse of some public agencies in California.
The short answer is that lowering the discount rate from 7.5% to 6.5% would dramatically increase public agency contributions above what many public agencies can afford to pay.
Nation’s landmark 2011 study on the state’s pension crisis found that lowering the Calpers discount rate for state agencies would increase the employer contribution rate by more than 30% as a percent of payroll—from 23.6% of payroll to 36.6% of payroll. At that time, the impact on the state’s General Fund would be an increase in the state’s annual contribution from $4.1 billion to $6.4 billion.
Calpers’ consultant Wilshire Associates projects annualized returns of closer to 6% which would force even higher contributions but an immediate move to 6.5% would be a very substantive first step, according to Bloomberg.
The State of California could afford to make an increased contribution of this magnitude, because it would merely crowd out other program spending. But the real catch with this change is that it will likely push many of the state’s public agencies to the brink of bankruptcy, and many others into a state of “service insolvency,” whereby they can pay their bills but not fund any substantive public services.
For example, it is not uncommon for many public agencies in California to pay as much as 25% of their general fund towards pension costs, which they are barely able to do today even under good fiscal circumstances otherwise (i.e. City of Pacific Grove, City of Concord). But raising these costs by another 30% plus, coupled with a likely economic downturn, would surely force many into bankruptcy.
A second major wrinkle with this change is that most of these public agencies do not have the flexibility to reduce costs to the level that would be needed to meet the increased required contributions. There is just not enough discretionary spending in their budgets to cut, short of wholesale reductions in their workforce and core services.
Thus, ideally any reduction in the discount local agencies should coincide with increased power for local agencies to reduce public employee benefit costs, particularly pension benefits, to a level that is more affordable and therefore offset the increase in required contributions.
Under current interpretations of California law, this is not something that Calpers and its public agencies allow and could likely only be required by initiative unless the so-called “California rule” can be successfully overturned in court.
The bottom line is that public agencies need to be forced to pay for the full cost of the public pension benefits that they offer. And if they can’t afford to make those “contributions” then changes need to be made to the system.
Changing the “California rule” via initiative or court challenge is tricky and there is no guarantee that it can be done under the existing political system, short of a massive organizing campaign and successful ballot measure.
So the only viable option for pension reformers is to place additional pressure on the system by forcing public agencies to pay for the full cost of the benefits they offer, and not allow them to use bogus “government math” to pass those costs onto future generations in the form of mounting unfunded liabilities.
I believe that reducing the discount rate from 7.5% to 6.5% would likely be enough to facilitate the political pressure needed to bring about a chain of events that would at some point force systemic reform of the system. Such a change could put many public agencies on the brink of bankruptcy, but that will happen anyway at some point, so it’s better to force change now before the estimated $1.5 trillion in statewide public pension debt gets even higher.
If Calpers were a responsible and accountable public agency, it would approve such a change as soon as possible as others have called on it to do repeatedly. All reform efforts should focus on getting Calpers and other public retirement funds to lower their 7.5% discount rate, which is the only point of political leverage that is viable and open to reformers.
This could likely be required by ballot measure or some other legislative option, possibly through the budget process, that places increased leverage on Calpers to act.
Needless to say, Calpers and the political unions who control its board are aware of this pressure point will do everything in their power to continue the use of the artificially high 7.5% discount rate, and the mounting public debt that it has created.
David Kersten is the president of the Kersten Institute for Governance and Public Policy (www.kersteninstitute.org). He is also an adjunct professor of public policy at the University of San Francisco and independent consultant on public policy issues, particularly fiscal issues.