Billions of Reasons to Reform Pensions

Shifting to a 401(k) plan would stabilize skyrocketing CA pension costs

Just five years ago, California paid $160 million to support the retirement costs of state workers. This year, the state will kick in more than $2.6 billion, more than a 1,500 percent increase in five years. And by 2009, the taxpayer bill for state retirement costs is projected to hit $3.5 billion per year.

Despite the obvious fiscal dangers of this explosive growth, Gov. Arnold Schwarzenegger’s efforts to reform the pension system have run into a buzzsaw of opposition from angry public employee unions.

The governor’s critics claim lucrative pension plans for government workers are needed because government jobs pay less than private sector jobs, and without these high-paying pensions, the state would have to significantly raise salaries in order to attract a high-quality work force.

But according to the U.S. Bureau of Labor Statistics, the average wage for state and local government employees is $23.52 per hour, easily topping the $16.71 private-sector employees earn per hour. When you include benefits in the equation, state and local government employee compensation jumps to $34.13 an hour. In fact, a government employee – without benefits calculated – earns more ($23.52) than a private-sector employee with benefits included in their compensation ($23.41).

In comparison to the retirement benefits that state employees in 15 other states receive, the nonpartisan Legislative Analysts Office found California offers the highest retirement benefits and is “comparatively generous.”

But let’s set these facts aside for a moment. Even if new strategies are needed to recruit the future state work force, relying on pension promises to lure them in is arguably the most irresponsible way of doing it. When government pension promises are made, they are carved in stone. Unlike salaries which can be frozen or otherwise adjusted to cope with budget shortfalls, pension benefits are forever. That’s because courts have repeatedly ruled that once enhanced benefits are bestowed upon state employees, they can never be reduced.

Equally troubling, the state’s traditional pension plans are vulnerable to election-year pandering and campaign promises that lead to irresponsible benefit increases that taxpayers are forced to finance without any say in the decisions.

Perhaps the worst example of this occurred in 1999, when then- Gov. Gray Davis signed Senate Bill 400, ushering in massive benefit increases for many state employees. That one piece of legislation created an estimated $10 billion obligation over 20 years that the state, and taxpayers, clearly can’t afford. However, unlike a state-issued bond, the taxpayers didn’t get to vote on it – they were just handed the bill while Davis handed out gifts.

Over the past several decades private companies have increasingly concluded that “paycheck for life” pension guarantees are too risky and unsustainable. Businesses have shifted to the defined-contribution 401(k) plans that we are all familiar with. California needs to learn that lesson too and move to a system that prevents lawmakers from running up new unfunded liabilities.

Shifting new state workers to a 401(k) plan would stabilize the state’s skyrocketing pension costs, while still allowing state workers to retire with dignity. Schwarzenegger’s proposal would put newly hired state workers in 401(k)-style accounts that the employee contributes to, with the state also contributing a portion. Upon retirement, the size of each employee’s pension would depend on the contributions made and the personalized investment strategy the employee used – unlike today’s guaranteed pensions that can pay many state workers 80 percent to 90 percent of their annual salaries for life.

This way, the state could still offer attractive retirement plans, but lawmakers couldn’t make promises they can’t pay for.

Last spring, Schwarzenegger pledged to tear up California’s credit cards, and most of the Legislature actually said that was a good idea. If lawmakers are sincere in their effort to restore fiscal stability, they need to tear up the defined-benefit pension credit card as well – it’s the one hidden in the back of the wallet that continues to wreak billions of dollars of havoc on the budget.

George Passantino is director of government affairs at Reason Foundation. He served as a director on Gov. Arnold Schwarzenegger’s California Performance Review.