Detroit: The Future of California?
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Detroit: The Future of California?

Serious pension and budget reform needed to keep from going down the path of financial ruin

The legislature just passed a $96.3 billion state budget, which was approved on party-line votes in both the Assembly and the Senate. The new state budget is the third-largest ever, nearly matching California’s massive spending during the height of the housing and financial bubbles in fiscal years 2006-07 and 2007-08.

The budget is big, but it can only be considered “balanced” if the state continues to ignore its massive unfunded liabilities. The state ignores these debts at its own peril, as governments from Vallejo to Detroit have found out.

Detroit announced recently that it is defaulting on $2.5 billion in debt in a last-ditch attempt to avoid bankruptcy. More than 42 percent of the city’s revenues now go to required bond, pension, health care, and other payments, a figure that is expected to rise to 65 percent of the city’s spending by 2017 if nothing is done. Detroit Emergency Manager Kevyn Orr has devised a restructuring proposal that would cut back on government pensions, offering employees less than 10 cents on the dollar for unfunded pension claims.

“We’re tapped out,” Orr told WWJ-TV. “We need to come up with a plan to restructure our debt obligations and our legacy obligations going forward-that is: pension, other employee benefits, health care, so on and so forth.” Added Orr, “The average Detroiter has to understand this is a culmination of years and years of kicking the can down the road. We can’t borrow any more money. We started borrowing from our own pension funds.”

This should serve as a warning to California state and local governments-as if they needed another one. In April, the California Public Employees’ Retirement System (CalPERS) hiked pension contributions for the 1,576 local governments and special districts for which it administers pension and health benefits by up to 50 percent over the next seven years-about twice as much as was previously planned.

A February 2011 report by the bipartisan Little Hoover Commission sounded the alarm bell on California’s public pension systems. It noted that “government agencies in the CalPERS system will need to increase contributions into their pension funds by 40 to 80 percent from 2010-11 levels,” and predicted that required government pension contributions “will remain at heightened levels for decades.” The report described a world in which taxpayers essentially end up paying for two governments: one to provide the services they have come to expect from the government and another that pays for the retired public employees who no longer provide those services.

California is facing its own debt tsunami. This includes what Gov. Jerry Brown has identified as a roughly $30 billion “wall of debt” due to borrowing in past budgets, and over $10 billion the state has borrowed from the federal government to fund its unemployment insurance program. Most significantly, unfunded pension and retiree health-care liabilities total anywhere from $224 billion to $378 billion to $535 billion, depending on whom you ask.

Some legislative leaders just don’t want to deal with pension reform, however. After the passage of some modest pension reforms last year, Senate President Darrell Steinberg asserted, “I hope this puts this issue-which has so dominated the discourse for some time-if not away, at least off to the side so we can focus on some positive agendas.”

Mr. Steinberg can’t wish the state’s massive unfunded pension liabilities away. It didn’t work for Detroit, it didn’t work for local governments that have filed for bankruptcy, including Vallejo, Stockton, and San Bernardino, and it won’t work for California as a whole.

As Will Rogers once quipped, “If you find yourself in a hole, the first thing to do is stop digging.” Yet, judging by California’s new budget, politicians haven’t learned any lessons from the state’s deficit-riddled past.

Implementing 401(k)-style defined-contribution retirement plans and pegging government employees’ salaries and benefits to levels comparable to those earned in the private sector would correct the course. Even then, it will take serious budget reforms to address the liabilities that have already been racked up. These measures include implementing spending and debt limits, privatizing functions that can be performed cheaper by the private sector, eliminating duplicative and unnecessary programs and commissions, lowering taxes and regulation to spur economic growth, reducing the number of state employees, and avoiding boondoggles like the high-speed rail project.

Only by restraining spending and paying down the state’s debts can California keep from going down the path of Detroit.

Adam B. Summers is a senior policy analyst at Reason Foundation. This article originally appeared in the Orange County Register (paid subscription required).