How to Fix California's Public Pension Crisis

How the state's public pension system broke and how to fix it

Full Study (.pdf) Summary (.pdf)

California’s $19 billion budget deficit seems to worsen by the day, but an even larger financial crisis is brewing in the state’s pension system. Over the last two decades, state lawmakers have bestowed massive pension and benefit increases upon government workers. Unfortunately, taxpayers are now getting the bills for these handouts. Recent studies estimate California has $500 billion in unfunded pension liabilities.  My new Reason Foundation report details how the state got into this pension crisis and how to fix it. This study highlights numerous problems, including:

  • California’s public pension and retiree health and dental care expenditures have quintupled since fiscal year 1998-99, from about $1 billion to $5 billion this year. Retirement spending is expected to triple again - to $15 billion - within the next decade.
  • Since 1998, California’s state workforce has grown by 31 percent and taxpayers now pay for more than 356,000 state workers.
  • Since 2008, California has added over 13,000 employees to the state payroll during this recession.
  • California taxpayers are paying pensions that exceed $100,000 a year to over 12,000 former state and local government workers, including more than 9,000 state and local employees covered by the California Public Employees’ Retirement System (CalPERS) and over 3,000 former school administrators or teachers covered under the California State Teachers’ Retirement System (CalSTRS).
  • In the 1960s, just one out of every 20 California state workers received “public safety” pensions. Now, one out of three state workers receives the lavish public safety benefits originally intended for the firefighters and police officers who put themselves in harm’s way.
  • California taxpayers pay 85 percent of the health care premiums for most active state workers, 100 percent of the health care costs for most state retirees and 90 percent of health care costs for their families.
  • CalPERS reported a loss of $56.2 billion for the fiscal year that ended June 30, 2009. CalSTRS posted a loss of $43.4 billion in 2009. California taxpayers are on the hook for funding shortfalls not made up by pension fund performance or employee contributions, so taxpayers will be paying more to make up for these pension investment losses.
  • The public pension benefit increases passed in 1999 via SB 400, which offered retroactive benefit increases to government workers, were supposed to cost $650 million in 2010. That figure was based on CalPERS’s assessment of its “superior return on system assets.” The actual costs of SB 400 to taxpayers: $3.1 billion this fiscal year and $3.5 billion next year. SB 400 passed by a 70-7 margin in the Assembly, and unanimously (39-0) in the Senate.
  • California is the only state in the nation that uses just one year – an employee’s final year salary – to determine their long-term pension benefits. Most states use three- or five-year periods to determine pension benefits, making their systems less susceptible to pension spiking.
  • SB 2465, which implemented the one-year final salary rule in 1990, has cost taxpayers more than $100 million a year. It was supposed to cost “only” $63 million per year.

Recommendations

This study makes several recommendations to improve the state pension system and reduce the burden on taxpayers:

  • Perform an evaluation of wages and benefits offered in the private sector and adjust all future state employee compensation so that it is in line with this standard. Repeat such an evaluation every five years.
  • Close the defined-benefit pension plans for state employees and enroll all new employees in defined-contribution plans for pensions and other post-employment benefits, such as retiree health care and dental benefits.
  • Adopt more conservative investment strategies and more conservative discount rate assumptions for current employees’ defined-benefit plans.
  • Begin pre-funding post-employment benefits liabilities for employees already in the current system, with the ultimate goal to achieve full funding.
  • Adopt an amendment to the state constitution requiring all future government employee benefit increases to be ratified by the state’s voters.
  • Adopt an amendment to the state constitution prohibiting retroactive benefit increases.
  • Eliminate “air-time” purchases to reduce pension spiking and discourage early retirement.
  • Require employees who have previously retired to forfeit their retirement checks while they are on the state’s payroll to avoid double-dipping, as over 5,000 former state employees are doing today.

California’s pension and retiree health care benefits are unaffordable and unsustainable. Governor Arnold Schwarzenegger and politicians, from both sides of the political aisle, are now calling for action on this tremendous problem. They’d better hurry. Taxpayers are sick and tired of being forced to pay ever-greater amounts of their hard-earned money towards increasingly generous benefits for government employees, all while their own retirement accounts shrink amidst the recession. To avoid bankruptcy, governments at all levels are going to have to switch from defined-benefit pensions to 401(k)-style defined-contribution systems.

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