Federal Government Should Not Bail Out State Pension Systems

The following is prepared testimony that was delivered before the California Assembly Committee on Banking and Finance on May 6, 2013, concerning Assembly Joint Resolution 10, sponsored by Assemblywoman Shannon Grove (R-Bakersfield). The actual testimony was abridged slightly in the interest of time.

Good afternoon, Mr. Chairman and members of the committee. My name is Adam Summers and I am a senior policy analyst at Reason Foundation. I have authored a number of studies and columns on state and local budget reform, particularly in California, including two public pension studies-one national in scope called The Gathering Pension Storm: How Government Pension Plans Are Breaking the Bank and Strategies for Reform and another focused on California called How California’s Public Pension System Broke (and How to Fix It)-as well as a number of newspaper and other columns on the pension issue.

Reason Foundation is a nonprofit, national think tank that has produced rigorous, peer-reviewed policy research and advised presidential administrations and state and local governments on a wide variety of government reform and other political and economic issues for 35 years. Thank you for giving me the opportunity to address AJR 10 and the issues of state debt and the state’s pension systems. I know your time is precious so I will try to keep my remarks to about five minutes.

Let me begin by addressing pension debt, since this is the kind of state debt that AJR 10 is most concerned with-and rightly so. When I first started looking into the public pension issue in 2004, I realized that it was-and would continue to be-a huge problem for many state and local governments, but hardly anyone was talking about it, much less doing anything about it. Now it is in the news all the time and the public is much better informed about it, and sees the need for reform, which is encouraging.

According to a December 2011 PPIC Statewide Survey,

• 83% of California residents said that “the amount of money that state and local governments spend on public employee pensions or retirement systems” is a big problem or somewhat of a problem, and
• More than two-thirds (68%) supported changing the pension systems for new public employees from defined benefits to a defined contribution system similar to a 401(k) plan. (This included support from 64% of public employees.)

Similarly, in an October 2012 Reason-Rupe poll in California,

• 69% of Californians said that they would favor enrolling new government employees in 401(k)-style defined contribution retirement plans instead of the current defined-benefits plans, and
• 74% said the public should get to vote to approve increases in government employees’ pension benefits.
  (As you may know, San Francisco, San Diego, Orange County, and now San Jose all have such a law.)

I have occasionally heard some say that pensions are a partisan or ideological issue, pitting Democrats versus Republicans or liberals against conservatives, but I find that this is generally not the case. Two of the most significant public pension reform efforts in the nation, for example, took place in San Jose and San Diego, and were approved overwhelmingly despite the fact that there are significantly more registered Democrats than Republicans in both cities.

The truth is that, regardless of your political or ideological leanings-whether you would like to devote more spending to social programs or other priorities, or whether you would like to shrink the size and scope of government and return more of the taxpayers’ money through tax cuts or tax rebates-the fact is that pension and retiree health-care costs will eat up more and more of state and local budgets, leaving less and less for those government services, tax cuts, or other spending priorities.

Last year, AB 340 implemented a number of pension reforms for new employees, such as rolling back pension formulas, increasing retirement ages by two years or more, calculating pensions based on the average of an employee’s final three years of pay instead of the highest single year, and prohibiting retroactive benefit increases.

These reforms were a step in the right direction, but it would be folly to say that the problem is solved and that the Legislature washes its hands of the issue. CalPERS estimates that AB 340’s reforms will save between $42 billion and $55 billion over 30 years, and CalSTRS says it will save that system about $23 billion over the same period. But even this would only put a dent in the state’s unfunded pension liabilities.

• CalPERS has an unfunded liability of $87 billion and only has enough assets to cover 74% of its projected liabilities.
• CalSTRS has an unfunded liability of $73 billion and just a 66% funding ratio.
• Add to that $64 billion in unfunded retiree health-care liabilities and you’re looking at a $224 billion problem.
• That works out to a debt of $18,000 for every household in the state.

(And all this does not even include the $127.5 billion in general obligation bonds authorized or the $10 billion that the state borrowed from the federal government to keep its unemployment insurance program afloat.)

Several academic studies have argued that the pension systems’ investment return assumptions are overly optimistic, and that the unfunded liabilities are more likely to be on the order of $400 billion or $500 billion (which would put the tab at roughly $35,000 for every household in the state).

So what is the relevance of all this debt to AJR 10? Other states are dealing with similar pension and other debt problems. The concern is that a terrible precedent would be set if the federal government were to start bailing out state governments. This would be detrimental for several reasons.

1. It would undermine our federalist system, effectively turning sovereign states into wards of the national government.
2. It would create a serious moral hazard. Just as the federal bailout of the so-called “Too-Big-to-Fail” banks only rewarded irresponsible and risky financial behavior, a federal backstop for state debts would only encourage irresponsible and risky fiscal policies.
3. This would force citizens of states that do manage their finances well to pay for states that do not. Californians certainly would not want to pay the debts of Illinois or other states any more than residents of the other 49 states would want to pay for ours.
4. It could cause the Legislature to lose control over its own budget decisions. Federal funds already make up over one-third of the total annual budget. As I’m sure you all know better than anyone, federal funds often come with strings attached, and the strings that might be imposed by the current or future administrations and Congresses for a bailout might be very different from the ways the Legislature would want to spend the money.

AJR 10 represents a chance for California to take a stand to reinforce the state’s sovereignty and oppose a policy that would have many serious negative effects across the nation. I fear that failure to adopt a measure such as AJR 10 would not only be a missed opportunity to take a leading role in asserting California’s strength and fiscal responsibility, but would also indicate that the state is not even capable of taking a symbolic step to ensure that its own fiscal house is in order.

That concludes my remarks. Thank you very much for your time and attention. Now I’d be happy to take any questions you may have.