Schwarzenegger Plan: Borrow from Underfunded CalPERS to Patch Underfunded State Budget

According to a recent Sacramento Bee article, California Governor Arnold Schwarzenegger has privately proposed borrowing $2 billion from the state’s biggest pension fund (the California Public Employees’ Retirement System, or CalPERS) to help plug the state’s massive budget deficit. You read that right: the governor wants to fill a $19 billion budget gap by borrowing from a pension system that has an estimated unfunded liability of about $500 billion (see a couple of academic studies pegging the pension deficit around the half-trillion-dollar mark here and here, pp. 197-199). What could go wrong?

Gov. Schwarzenegger, who has rightly called the state’s pension system “unsustainable,” now wants to siphon more money from this unsustainable system. California has a history of relying on borrowing schemes to purportedly balance its budget. It has often been said that this is like taking out one credit card to pay off another. The current proposal is more like one broke person asking his even more broke brother for a loan, hoping that somehow, someday the brother’s ship is going to come in (all evidence to the contrary notwithstanding).

The logic is that the borrowing would be coupled with the governor’s proposal to roll back pension benefits for all new hires to pre-1999 levels, when a pension sweetener bill increased state employees’ pensions by as much as 50%. The administration estimates that this would save $93 billion in pension and retiree health-care costs over 30 years. Since the lower benefits would only apply to new employees, however, it will take a number of years for significant savings to materialize, as workers are incorporated into the new system. Thus, the governor wants to borrow this $2 billion in savings against all of the savings that would come later on—assuming, of course, that CalPERS and the legislature go along with the plan. (Note that if the aforementioned academic studies are anywhere even remotely accurate, the governor’s reform plan still would not generate nearly enough savings to cover the pension system’s unfunded liability.)

Just when you thought California was out of accounting gimmicks to “balance” the budget and put off the necessary difficult fiscal decisions yet another year, now the governor is contemplating borrowing against savings that have not actually been realized (not to mention the fact that borrowing against savings reduces the amount of savings and diminishes the impact of of the reform). Moreover, while the Schwarzenegger pension reform would represent somewhat of an improvement over the status quo, it does not go nearly far enough. The entire defined-benefit system is unsustainable. Besides, California tried to address pension costs by going to a two-tier pension system before, in 1991. We have seen firsthand how easy it was to undo that reform and raise benefits to levels more generous than ever in the infamous 1999 deal. The public sector needs to follow the lead of the private sector, which been switching to more reasonable 401(k)-style, defined-contribution retirement plans for the past 30 years or so. Tinkering around the edges of the current system would only leave in place the existing incentives to hide the true costs and fiscal health of the system, and maintain the moral hazard problem of allowing legislators to continue to reward union interests with greater benefits, knowing that the costs of those benefits will not be borne until they are long out of office.