Is California Going the Way of Detroit?

I suppose it was not surprising when Detroit announced recently that it was going to default on $2.5 billion in debt, raising the prospect of becoming the largest municipal bankruptcy in the nation’s history (yet another one!). The population has been fleeing the once-thriving city for decades, and it has been racked with corruption and an inability to even keep its street lights on (see here and here). With many other state and local governments struggling under the weight of unfunded pension liabilities and other debts, one can’t help but wonder if a similar fate will befall residents in places like California and Illinois in the not-too-distant future.

In a desperate attempt to stave off bankruptcy, Detroit Emergency Manager Kevyn Orr announced a plan that would offer creditors a mere 10 cents on the dollar. This includes unfunded pension claims. According to a news article,

More than 42 percent of Detroit’s 2013 revenues went to required bond, pension, health care and other payments. If the city continues operating the way it had before Orr arrived, those costs would take up nearly 65 percent of city spending by 2017, Orr’s team said.

“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.”

California may not be Detroit, but it certainly has done quite a bit of can kicking itself and is headed down a similar path. The state’s notoriously bad business climate (worst in the nation for nine years running, according to a Chief Executive magazine survey of business leaders) has been driving businesses and entrepreneurs out of state for years. In addition, its unfunded pension and retiree health-care liabilities have grown to the hundreds of billions of dollars, and yet there appears to be no appetite for serious reform among lawmakers in Sacramento. As my colleague, Sal Rodriguez, similarly noted in a recent blog post, California’s budget can only be considered balanced if its significant unfunded pension, retiree health care, and other liabilities are ignored.

In a column that originally ran in the Orange County Register a couple of weeks ago, I examined the Detroit fiscal mess and drew some parallels with California:

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.

[. . .]

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.

See the full column here.

As the bipartisan Little Hoover Commission’s February 2011 report on California’s public pension systems warned,

Actuaries estimate that in the next few years, government agencies in the CalPERS system will need to increase contributions into their pension funds by 40 to 80 percent from 2010-11 levels. Required government payments into pension funds will remain at heightened levels for decades, assuming that investments continue producing returns of nearly 8 percent annually, an optimistic scenario. [Emphasis added]

As the report noted, this means taxpayers will essentially be paying for a “second government”: one government to provide the services they have come to expect from the government and another government of retired public employees that no longer provide those services.

Regardless of one’s political or ideological leanings—whether they be a libertarian or fiscally conservative desire to shrink the size and scope of government and return more of the taxpayers’ money through tax cuts or tax rebates, or whether they be a progressive appetite for devoting more spending to social programs or other priorities—the fact is that pension and retiree health-care costs will eat up more and more of state budgets, leaving less and less for those government services, tax cuts, or other spending priorities. It is time for politicians to stop burying their heads in the sand and start implementing real reforms. If they don’t, before they know it, California will be Detroit.