Coal Ban Would Boost Tax Cost of Pensions

December 20, 2014 By John Seiler 2 Comments

California public pensions already have a big problem with adequate funding. The nonpartisan state Legislative Analyst pegs the pensions’ unfunded liabilities at $340 billion.

It should be obvious what the investment strategy should be for the California Public Employees System, the California State Teachers Retirement System and other mammoth funds: maximize fund values through the most prudent and profitable investments.

Because if investments are not prudent and profitable, then the lower fund values will have to be made up by either increasing the cost to taxpayers, who ultimately are on the hook for the funds’ payouts to retirees; or by cutting retiree benefits.

That’s the background for new state Senate President Pro Tem Kevin De Leon’s proposal to ban coal from retirement investment portfolios. According to the Bee, De Leon said, “Coal is a dirty fossil fuel. I think that our values should reflect, you know, who we are as the state of California.”

But if coal is the best return on CalPERS and CalSTRS investment dollars; and these funds are forced to invest in something else; then the funds’ return on investment will be lower than it could have been. Which brings up the scenario above: taxpayers will have to pay more, or retirement benefits will have to be cut — or both.

Do state employees and retirees see this?

This article was originally published on CalWatchdog.com

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Stockton and Detroit Exit Bankruptcy Leaving Pension Systems As-Is

December 17, 2014 By Lance Christensen and Victor Nava 2 Comments

The landscape for public employee pensions shifted in 2014 as federal judges gave credence to the idea that pension benefits may be cut in bankruptcy. This challenges the long held idea that pension benefits are impervious to cuts and most observers are wondering just how significant this shift will be going forward.

This fall, city leaders watched as federal judges approved debt-cutting bankruptcy plans in Stockton and Detroit, ending two of the largest municipal bankruptcy cases in U.S. history. Many speculated both cities could do more to ease their fiscal problems by making significant cuts and structural changes to public pensions. However, both judges demurred and moved forward with plans that eased a portion of the cities’ financial obligations, but largely protected pensions. The failure to significantly address public pension debt and make structural changes to the pension systems in both Stockton and Detroit does not bode well for the economic future of either city post-bankruptcy. It also presents an interesting conundrum for other cities in dire fiscal distress that bear significant pension costs and unfunded liabilities. Are more cities to follow the path to pension cuts in bankruptcy?

In Detroit, the nation’s largest municipal bankruptcy case ended on November 7, fifteen months after it began. The restructuring plan approved by Judge Steven Rhodes slashed $7 billion in debts with bondholders receiving between 14 and 74 cents on the dollar back from the city. Public pensioners did not see cuts as deep, thanks in part to the likes of Van Gogh and Renoir. Detroit’s so-called “grand bargain” transferred ownership of part of the Detroit Institute of Arts collection from the city to the nonprofit running the museum for $816 million. The money, to be paid out over 20 years, comes from state taxpayers and privately-donated funds raised to offset deeper pension cuts. Pensioners in Detroit’s general retirement system are taking a 4.5 percent cut to their monthly pension check, will no longer receive cost-of-living adjustments, and will see a reduction in medical benefits. Some members who received excess annuity payments from the city will also be required to pay them back. Police and firefighter pensioners will only see a reduction in cost-of-living adjustments from 2.25 percent to 1 percent annually.

The pension cuts, which have been called “modest” by both the Wall Street Journal and NPR are exactly that. Detroit’s unfunded pension benefits are still a risk to the city’s fiscal health. And the system still relies on unrealistic rates of return when calculating required pension system contributions—the General Retirement System assumes a 7.9 percent annual return and the Police and Fire Retirement System assumes 8.0 percent, even though the city has only been earning an average of 5.89 percent for the general system and 5.5 percent for the police and fire system over the last 10 years, from 2004 to 2013.

In Stockton, even less was done to address the city’s pension problems despite a golden opportunity to make significant reforms. On October 1, Judge Christopher Klein ruled that the city could reduce its payments to CalPERS and exit its contract with the pension administrator if the city wanted. It was in his purview to cut the pensions if he saw that as the city’s best course of action. But the city chose not to modify its pension benefits or leave CalPERS. On October 30, the fourth largest U.S. municipal bankruptcy case was settled when Judge Klein approved Stockton’s bankruptcy plan, leaving existing pension benefits intact. The city agreed to pay most bond creditors between 50 to 100 cents on the dollar. Investment firm and Stockton creditor Franklin Templeton received only $4.3 million back from a $36 million loan (or 12 cents on the dollar).

Judge Klein noted the reason he left public pensions untouched was because public workers had already suffered other cutbacks, including having their salaries and healthcare benefits reduced, and because redoing current employee pensions would not be a simple task. Franklin Templeton disagrees and is appealing the judge-approved plan at the Ninth Circuit Court for further remedies.

The so-called “California Rule,” which means pension benefits cannot be reduced for current employees, was once thought to be ironclad, but Judge Klein’s ruling opens up the possibility for a future bankrupt California city to challenge it by choosing to cut pensions or leave CalPERS entirely if the city ends up in bankruptcy. Some thought that San Bernardino, another city battling with CalPERS, may take this route. Yet after Klein’s October 31 ruling on Stockton, San Bernardino decided to pay full fare despite the fact that they had previously tried to reduce their payments to CalPERS. Like San Bernardino, Stockton missed an opportunity to shrink its $29 million annual pension costs that have led to both reduced services for the citizens of Stockton and a new sales tax.

Granted, though there are not a lot of cities currently positioned to challenge the California Rule, Moody’s Investors Services points out that Judge Klein’s October 1 ruling allowing cities to cut pensions may give cities more negotiating power with public sector unions. In reality, reducing pension benefits is likely only an option for larger cities where pension obligations and general fund costs make it reasonable to wager tens of millions of dollars on the litigious process so that they can reduce their pension liabilities in the hundreds of millions or billions of dollars. Los Angeles and Chicago, anyone?

Both Stockton and Detroit are still saddled with billions in unfunded pension debt even after exiting bankruptcy. The bankruptcy plans that both cities presented and got approved did nothing to even chip away at existing pension debt. It is unlikely that either city will be able to contain the pension debt that devours their budgets unless structural changes are made to the current defined benefit pension systems they have in place. Other formerly bankrupt cities, like Vallejo, California, have struggled post-bankruptcy because of pension debt and the same type of budgetary problems affecting Stockton and Detroit.

This is only the first couple of rounds of a long bout, as we learned from the lengthy reform processes in San Diego and San Jose. Pension systems like CalPERS have deep pockets and one can sympathize with the city manager or attorney who decides not to go for the option of challenging the increasing costs of pensioners even though legal precedence is tilting in their favor. No doubt, without substantive reform that provides for an affordable and secure retirement system for both the retirees and taxpayers, that pays down the debts sooner rather than later and requires that these jurisdictions pay their full pension costs, Detroit and Stockton will likely be back before a judge begging for more protection. Just ask Vallejo.

Lance Christensen is Director of the Pension Reform Project at the Reason Foundation, and Victor Nava is a Policy Analyst at the Reason Foundation.

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Gov. Brown, CalPERS Face Off In 2015

December 6, 2014 By James Poulos 2 Comments

A piece of this year’s politics moving into 2015 is Gov. Jerry Brown’s tiff with the California Public Employees’ Retirement System. In particular, Brown remains steamed over CalPERS’ use of temporary pay to pad pensions. In a letter to CalPERS, he said the action “would improperly allow temporary pay resulting from short-term promotions to count towards workers’ pensions.”

Divisions on CalPERS’ Board of Administration, where Brown can count on allied appointees, opened around the controversy. Although Brown’s side in the controversy lost a close vote, plans have already been hatched for a rematch.

The bout has been a long time in coming. As summer turned to fall, Controller John Chiang took CalPERS to task for juicing up pensions while dishing them out at unsustainably high levels. Chiang was just elected state treasurer, so he will remain an ex officio member of the CalPERS board.

In late August, Brown tasked his team with doing all it could legally to prevent CalPERS from engaging in the pension spiking.

In that procedure, a public pension fund passes rules that allow pension levels to be adjusted significantly upward by taking temporary or exceptional kinds of work and pay into account. CalPERS had pushed the credibility of these measures to the breaking point, in effect securing special pension increases simply because employees did their jobs, such as librarians shelving books.

But Brown made a point to object only to CalPERS’ temporary pay rules, which allowed unique, fleeting raises for non-permanent work to be factored into pension setting.

By mid-September, Chiang had concluded that CalPERS’ pension spiking was unacceptable in theory, but unpunishable in practice. CalPERS’ “available resources” for spiking oversight, Chiang concluded, “limit its annual reviews to only 45, or 1.5 percent of the more than 3,000 reporting entities. At this current rate, pension spiking could go undetected for an extended period of time, as each reporting entity would be reviewed, at the earliest, every 66 years.”

The task of auditing CalPERS’ shenanigans had to fall, in other words, to the Legislature.

As a matter of common sense, it was much more attractive for Brown to try to exercise oversight by reforming the rules CalPERS used to set pensions, instead of by pouring the state’s time and energy into auditing those rules after scores of changes went into effect.

A tough matchup

That is why, as the Sacramento Bee reported, Brown’s appointees on the CalPERS board proceeded to force a vote on removing temporary pay from the fund’s cornucopia of pension-spiking sweeteners. Unfortunately for Brown, the vote failed, splitting 7-5 in favor of retaining the objectionable rule.

In an interview, state human resources head Richard Gillihan — a Brown ally on the board who voted against temporary-pay pension spiking — told the Bee that 2015 would offer another shot at reform. “What should or shouldn’t be included in final compensation is absolutely something that we think needs broader revisitation,” he said. “We hope to see that sooner rather than later.”

According to the fund’s website, “The CalPERS Board of Administration consists of 13 members — six elected ‘member representatives,’ three appointed representatives, and four ‘ex officio’ representatives. The elected candidates will serve a four-year term and represent active and retired members in all aspects of CalPERS’ business – including benefit and membership issues, and oversight and investment of Fund assets.”

But as the Bee observed, “The board’s composition will lean more heavily toward labor’s interests next year.” The Service Employees International Union shelled out some $250,000 to secure the election of incoming member Theresa Taylor.

Even though California taxpayers are on the hook for any CalPERS shortfall, they have no say in the six elected “member” representatives. Those representatives are chosen, according to CalPERS, by ballots “mailed to eligible, active state and public agency CalPERS members.”

Leadership trouble

A complication, however, has added further difficulties to the equation. September also saw the board approve the appointment of Ted Eliopoulos, former CalPERS senior investment officer for real estate, as its new chief investment officer.

That provoked the ire of J.J. Jelincic, a board member unable to vote against Eliopoulos because he was recused for being on leave. Jelincic told Pensions and Investments that Eliopoulos lacked “the temperament and management skills” needed for the job.

Pensions and Investments noted, “He said Mr. Eliopoulos relied too much on the advice of consultants, made the wrong decision to increase CalPERS’ exposure to riskier non-core real estate assets before the financial crisis, and played favorites with employees.”

The enmity has served to cloud Brown’s prospects even further for charting an effective course toward CalPERS reform.

This article was originally published by CalWatchdog.com

 

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More Taxes and Tuition Buy Time for the Pension Bubble

November 27, 2014 By CPR Editors 1 Comment

“The ‘recovery’ is largely an illusion created by the effects of zero percent interest rates, quantitative easing, and deficit spending. The asset bubbles that have been created as a result of these policies have primarily benefited the owners of stocks, bonds, and real estate (the rich), while simultaneously deterring the savings and capital investment that is needed to actually create good paying jobs and increased purchasing power.”

–  Peter Schiff, EuroPacific Weekly, November 6, 2014

The question everyone should be asking, especially the managers of public employee pension funds, is how much longer our economy can run on zero percent (adj. for inflation) interest rates, quantitative easing and deficit spending.

When asked how we unwind all of this debt and deficits in a manner that doesn’t trigger a collapse of collateral and potentially catastrophic deflation, i.e., how do we create the preconditions for sustainable economic growth, respected economics blogger Charles Hugh Smith emailed back this answer:

“Those who foisted the debt off as safe have to absorb the losses, as did those who were conned. As it stands now, the hapless taxpayers are having to make the perps and their marks whole—that is wrong, morally and financially. The US has about $90 trillion in net worth. If $10 T were wiped off the books, it would be bad for the banks and those who trusted them, but it would not sink the country.”

Which brings us to the topic of this post.

As reported on November 16th in the Sacramento Bee:

This year, UC will pay about $1.3 billion to the pension fund, about 5 percent of its overall operating budget. UC officials want the state’s general fund to pick up nearly a third of the payment, which would cover the university’s portion of pension contributions for faculty and other employees who are paid from state funds. ‘Frankly, if the state were to pay that, we would not be proposing a tuition increase,’ said Nathan Brostrom, UC’s chief financial officer. ‘That is money that could go to other resources.’”

Like nearly every public employee pension fund in the U.S., the University of California’s pension system is underfunded. According to the Sacramento Bee, the system is 79 percent funded, which equates to a $7.2 billion unfunded liability.

What is going to happen to the UC System’s pension fund when these asset bubbles deflate?

The precariously low funded ratio challenging America’s public employee pension systems is itself based on the dangerous assumption that we are not experiencing unsustainable asset inflation. A healthy correction would lower asset values, making the basic necessities of life – housing and energy – affordable again. But a healthy correction in asset values would render pension systems insolvent because the value of their investments – already on the brink of inadequacy – would decline further.

In the public debate over this issue, there is another assumption at work, pernicious and misleading. That assumption is that faculty on the various UC campuses are making common cause with the students by insisting that state taxpayers pick up the tab for these pensions. But there is no common cause. Beneficiaries of public sector pensions are shareholders. From funds that control nearly $4 trillion in investments, this privileged class of state and local government workers collect pensions that – at least in California – average four times (or more) what someone with similar compensation (and similar withholding) can expect to receive from Social Security. And unlike ordinary shareholders, when the shares held by their pension funds decline, they are empowered to force taxpayers to cover their losses.

The faculty that populate the campuses of the University of California, and by extension, every public employee who collects a pension at taxpayer – and tuition payer – expense, have interests that coincide with the one percent of the one percent, and the biggest banks, and the hedge funds, and the Wall Street firms they love to demonize. They benefit from the asset bubble that is destroying the economic aspirations of the rest of America. When financial policymakers encouraged cheap interest rates so ordinary people could borrow more than they could ever hope to pay back, just so they could own a home, shareholders – including the biggest shareholder class in the U.S., pension funds – profited from the debt-fueled economic growth. When asset bubbles rendered a middle class lifestyle unattainable to most Americans, the public sector exempted themselves through automatic cost-of-living increases and enhanced pension benefits.

The solution to the University of California’s money crunch is to suspend cost-of-living increases, increase payroll withholding for pension benefits, and lower pension benefit formulas. Only then will the people who teach California’s youth truly be making common cause with their students.

As it is, the roadblocks to sustainable economic growth are those who benefit from debt fueled asset bubbles – super rich shareholders and their fully co-opted partners, government workers.

Ed Ring is the executive director of the California Policy Center.

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CalPERS Numbers Attract Fresh Scrutiny

November 26, 2014 By James Poulos Leave a Comment

The California Public Employees’ Retirement System looks to see 2015 as another controversial year, especially around four budding controversies.

First, attention has focused in recent weeks around the way CalPERS pays its board members and executives. An investigation by the Sacramento Bee revealed that, for 15 years, CalPERS has reimbursed the “government pay and benefits of five board members who are on full- or part-time leave from their jobs to conduct fund business.”

While some board members receive little or even no money for their service, others received hundreds of thousands of dollars. Priya Mathur — recently stripped of her administrative posts, but not fired after repeatedly violating state ethics laws — was paid just shy of $300,000 during the last fiscal year. During the same period, John Chiang, an ex-officio board member in his capacity as the state controller, received nothing. He also will receive nothing when he remains on the board in January when he becomes the state treasurer, another ex-official CalPERS board membership.

Bonuses

Second, CalPERS executives received a substantial increase in lavish bonuses. The San Francisco Chronicle reported a 14 percent increase in bonus payments over the fiscal year before last, with $8.7 million going to investment staff and nearly $300,000 to the fund’s non-investment executives.

“The rewards are based on three-year performance verses a benchmark, as well as the earnings of each asset class and individual portfolios,” according to CalPERS spokesman Brad Pacheco. In an effort to deflect criticism for the windfalls, the Chronicle noted, CalPERS maintained it “must grant bonuses to help compete with the pay that employees could make if they went to work on Wall Street.”

According to Pacheco, “spending money on in-house investment management saves about $100 million a year that otherwise would be paid to Wall Street in fees.”

Secret deals

Third, in an area fraught with Wall Street competition of a different sort, CalPERS has proven itself willing to play political hardball to ensure financially stressed cities pay it first, and investor-creditors later. In an exclusive, Reuters cast a spotlight on how that process has played out secretly in the case of San Bernardino.

Speaking on condition of anonymity, a “senior city source” revealed details of CalPERS’ deal with the city that a judicial gag order had sought to keep under wraps. Although it hasn’t published a completed budget, San Bernardino has set aside over $10 million for an unnamed creditor — which the source identified as CalPERS.

The city’s decision “to strike a deal with CalPERS first, and begin paying arrears before a bankruptcy exit plan could be formulated, shows the reluctance of California cities to take on the pension giant,” concluded Reuters.

Demographic destiny

Fourth, CalPERS has faced a new round of investor skepticism over its approach to funding. The Moody’s ratings agency warned this week that cities like San Bernardino will face increasing pressure from CalPERS obligations, “even after the relief provided by the bankruptcy adjustments” authorized by the courts. “The ratings agency calculated that San Bernardino’s adjusted net pension liability for the 12 months to the end of June 2014 was $731 million — nearly 10 times its outstanding debt,” according to the Chief Investment Officer website.

CalPERS’ unfavorable demographics were likely responsible for the projected future increases in required contributions. At PublicCEO.com, Ed Mendel reported that “in a few years CalPERS retirees are expected to outnumber active workers, a national trend among public pension funds that makes them more vulnerable to big employer rate increases.”

CalPERS has managed in recent years to boost its funding level to some 77 percent. But now, Mendel observed, “some think getting to 100 percent funding may become difficult if not impossible. Employer contribution rates would have to be raised to an impractical level, crowding out funding for other programs, and investments would have to yield unlikely returns.”

According to prevailing interpretations of the California Constitution, taxpayers are on the hook for any fund shortfalls.

This article was originally published on CalWatchdog.com

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UC Pension Crisis Creates Teachable Moment

November 25, 2014 By Jon Coupal 2 Comments

Californians have abysmally low levels of civic engagement as evidenced by the recent election where voter turnout set an historic low.  And the widespread disengagement of California’s younger voters is even worse.

True, in 2008 California’s youth turned out in large numbers to elect Barack Obama as president.  And in 2012 they turned out again because, in addition to Obama being up for reelection, Proposition 30 was on the ballot.  Proposition 30, which gave California the highest income tax rate and highest state sales tax rate in America was, ironically, entitled Temporary Taxes to Fund Education.

During the Proposition 30 campaign, Governor Brown traveled to several university campuses to push the massive tax hike promising that passage would prevent tuition hikes. California’s college students, being as gullible as they are idealistic, believed the promise hook, line and sinker.  So much for critical thinking.

But perhaps California’s younger voters are finally getting wise to all the broken promises of tax-and-spend politicians and that might explain, in part, why they stayed home in this last election.  And sure enough, their increasing cynicism is proving to be well founded.

Despite the massive tax hikes ostensibly to keep higher education affordable, the University of California Board of Regents just announced a sizable increase in tuition.  And UC students are none too happy.

Turns out that the driving force behind these hikes is the growing unfunded liability of UC’s pension fund and other items of questionable compensation.  Allysia Finley with the Wall Street Journal explains:  “UCs this year needed to spend an additional $73 million on pensions, $30 million on faculty bonuses, $24 million on health benefits and $16 million on collectively bargained pay increases. The regents project that they will require $250 million more next year to finance increased compensation and benefit costs.”

Moreover, Finley reveals the extraordinary level of waste in the UC system:  “Ms. Napolitano [President of the University of California] says that the UCs have cut their budgets to the bone, yet her own office includes nearly 2,000 employees—a quarter of whom make six-figure salaries. An associate vice president of federal government relations earns $273,375 a year, plus $55,857 in retirement and health benefits, according to the state controller’s office.  Thirty professors at UC Santa Cruz rake in more than $200,000 in pay, and most faculty can retire at 60 and receive a pension equal to 75% of their final salary. More than 2,100 retirees in the university retirement system collected six-figure pensions in 2011.”

At the moment, the outrage expressed by students in their protests – one of which resulted in a shattered glass door outside a meeting of the UC Regents – seems a bit unfocused.  They’re angry but, aside from the mere fact that their education costs are rising, many are not clear about the causes.

In a weird way, UC’s pension crisis might be the ultimate teachable moment for college students who typically have little grasp of anything related to public finance.

So, students, here’s the scoop:  There’s no such thing as a free lunch.  Public employee compensation is expensive; especially pension costs that you will be paying long after those of us who are older are long gone. Government waste, fraud and abuse in California is a real problem.  Those who pay taxes – a lot of taxes – have choices where to live and move their businesses – and that may not be in California.  Debt means future costs.  You might like the idea of High Speed Rail but you might want to study both the costs and viability of any megaproject before you hop on board.

And finally, don’t buy into any promise by any politician about what they are going to do for you without first figuring out what they are going to do to you.

Jon Coupal is president of the Howard Jarvis Taxpayers Association — California’s largest grass-roots taxpayer organization dedicated to the protection of Proposition 13 and the advancement of taxpayers’ rights.

This article was originally published on HJTA.org

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The Amazing, Obscure, Complicated and Gigantic Pension Loophole

November 20, 2014 By Ed Ring 2 Comments

“The bottom line is that claiming the unfunded liability cost as part of an officer’s compensation is grossly and deliberately misleading.”

– LAPPL Board of Directors on 08/07/2014, in their post “Misuse of statistics behind erroneous LA police officer salary claims.”

This assertion, one that is widely held among representatives of public employees, lies at the heart of the debate over how much public employees really make, and greatly skews the related debate over how much pension funds can legitimately expect to earn on their invested assets.

Pension fund contributions have two components, the “normal contribution” and the “unfunded contribution.” The normal contribution represents the present value of future retirement pension income that is earned in any current year. For example, if an actively working participant in a pension plan earns “3 percent at 55,” then each year, another 3 percent is added to the total percentage that is multiplied by their final year of earnings in order to determine their pension benefit. That slice, 3 percent of their final salary, paid each year of their retirement as a portion of their total pension benefit, has a net present value today – and that is funded in advance through the “normal contribution” to the pension system each year. But if the net present value of a pension fund’s total future pension payments to current and future retirees exceeds the value of their actual invested assets, that “unfunded liability” must be reduced through additional regular annual payments.

Without going further into the obscure and complicated weeds of pension finance, this means that if you claim your pension plan can earn 7.5 percent per year, then your “normal contribution” is going to be a lot less than if you claim your pension plan can only earn 5 percent per year. By insisting that only the cost for the normal contribution is something that must be shared by employees through paycheck withholding, there is no incentive for pension participants, or the unions who represent them, to accept a realistic, conservative rate of return for these pension funds.

This is an amazing and gigantic loophole, with far reaching implications for the future solvency of pension plans, the growing burden on taxpayers, the publicly represented alleged financial health of public employee pension systems, the impetus for reform, and the overall economic health of America.

Governor Brown’s Public Employee Reform Act (PEPRA) calls for public employees to eventually pay 50 percent of the costs to fund their pensions, this phases in over the next several years. But this 50 percent share only applies to the “normal costs.”

In a 2013 California Policy Center analysis of the Orange County Employee Retirement System, it was shown that if they reduced their projected annual rate of return from the officially recognized 7.5 percent to 4.81 percent, the normal contribution would increase from $410 million per year to $606 million per year. In a 2014 CPC analysis of CalSTRS, it was shown that if they reduced their projected annual rate of return from the officially recognized 7.5 percent to 4.81 percent, the normal contribution would increase from $4.7 billion per year to $7.2 billion per year.

The rate of 4.81 percdent used in these analyses was not selected by accident. It refers to the Citibank Liability Index, which currently stands at 4.19 percent. This is the rate that represents the “risk free” rate of return for a pension fund. It is the rate that Moody’s Investor Services, joined by the Government Accounting Standards Board, intends to require government agencies to use when calculating their pension liability. As can be seen, going from aggressive return projections of 7.5 percent down to slightly below 5 percent results in a 50 percent increase to the normal contribution.

No wonder there is no pressure from participants to lower the projected rate of return of their pension funds. If under PEPRA, a public employee will eventually have to contribute, say, 20 percent of their pay via withholding in order to cover half of the “normal contribution,” were the pension system to use conservative investment assumptions, they would have to contribute 30 percent of their pay to the pension fund.

Moreover, these are best case examples, because the formulas provided by Moody’s, used in these studies, make conservative assumptions that understate the financial impact.

In another California Policy Center study, “A Pension Analysis Tool for Everyone,” the normal contribution as a percent of pay is calculated on a per individual basis. One of the baseline cases (Table 2) is for a “3 percent at 55″ public safety employee, assuming a 30 year career, retirement at age 55, collecting a pension for 25 years of retirement. At a projected rate of return of 7.75 percent per year, this employee’s pension fund would require 19.6 percent of their pay for the normal contribution. Under PEPRA, half of that would be about 10 percent via withholding from their paychecks. But at a rate of return of 6 percent, that contribution goes up to 31 percent. Download the spreadsheet and see for yourself – at a rate of return of 5 percent, the contribution goes up to 41 percent. That is, instead of having to pay 10 percent via withholding to make the normal contribution at a 7.75 percent assumed annual return, this employee would have to pay 20 percent via withholding at a 5 percent assumed annual return. The amount of the normal contribution doubles.

This why not holding public employees accountable for paying a portion of the unfunded contribution creates a perverse incentive for public employees, their unions, the pension systems, and the investment firms that make aggressive investments on behalf of the pension systems. Aggressive rate of return projections guarantee the actual share the employee has to pay is minimized, even as the unfunded liability swells every time returns fall short of projections. But if only the taxpayer is required to pick up the tab, so what?

Adopt misleadingly high return assumptions to minimize the employee’s normal contribution, and let taxpayers cover the inevitable shortfalls. Brilliant.

Public employee pension funds are unique in their ability to get away with this. Private sector pensions were reformed back in 1973 under ERISA rules such that the rate of return is limited to “market rates currently applicable for settling the benefit obligation or rates of return on high quality fixed income securities,” i.e., 5 percent would be considered an aggressive annual rate of return projection. If all public employee pension funds had to do were follow the rules that apply to private sector pension funds, there would not be any public sector pension crisis. And when public employees are liable through withholding for 50 percent of all contributions, funded and unfunded, that basic reform would become possible.

This is indeed an obscure, complicated, amazing and gigantic loophole. And it is time for more politicians and pundits to get into the weeds and fight this fight. Especially those who want to preserve the defined benefit. Until incentives for public employees and taxpayers are aligned, pension funds will cling to the delusion of high returns forever, until it all comes crashing down.

Ed Ring is the executive director of the California Policy Center.

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“Unfinished Business”: Chuck Reed’s Just Getting Started On Pension Reform

November 18, 2014 By Heidi Siegmund Cuda 2 Comments

All Chuck Reed needs is $25 million, and that’s all he needs.

“For me, it’s unfinished business,” says Reed, the outgoing mayor of San Jose, California. “I’m stubborn, persistent, whatever you want to call it.”

He’s talking about his plans for a statewide pension reform initiative in 2016; the $25 million is the cost of taking the message to the streets. While some observers may have thought he’d abandoned reform after his abortive 2014 attempt, Reed says he’s just getting warmed up.

“The fight will continue,” he says. “I’m going to work on fiscal reform issues, on the state and national level.”

For Reed, it’s personal.

“The problem is still threatening my city,” he says. “Retirement costs continue to go up, and this year the costs ate up all my revenue.”

And this was after voters in San Jose passed pension reform.

Since 2005, the number of retirees in the California Public Employees’ Retirement System (Calpers) with six-figure pensions has tripled, and pension debt for local governments is expected to increase by as much as fifty percent over the next five years.

Reed says something’s gotta give.

“The legislature is not going to take action,” he says. “So the best approach is working at the local level to create political momentum with a statewide initiative, allowing voters to go over the head of the legislature.”

Although he’s still hashing out what the initiative will look like, he says the main thrust will be to give state and local governments authority to alter future pension formulas for current employees.

“The retirees are the last people who should be impacted because they’re already retired,” he says. “That’s why I focus on current employees, because they still have the capacity to earn. The younger employees understand that it’s something that’s not sustainable, and they are the ones who are going to get hurt.”

Among the members of Reed’s reform posse are Stephanie Gomes, a former vice mayor of Vallejo, who was also a member of its city council while it clawed its way through bankruptcy.

“Our elected officials have to get off their behinds and represent the people who elected them,” says Gomes. “I don’t have faith that’s going to happen, so it’s got to be the will of the people to get our fiscal house in order, to get it right for the taxpayers and the employees, who still deserve a pension. It has to work for both.”

Like Reed, Gomes is a Democrat who says she’s been painted “as a Republican, against working families.”

“The public sector labor unions have become what they were formed to fight,” she says. “It’s about them protecting their own interests and they were lucky enough to get those high pensions and benefits, and they’re not going to let them go without a fight.

“This fight is not about ‘R’ or ‘D,’ it’s about services that we’re not getting any more because of these high pensions.”

“Calpers is raising rates,” she says. “They can just hold our their hand and say ‘give it.’ Cities at some point are going to have to cry uncle. When they can’t pay Calpers, it’s all going to topple down, because cities are in a straightjacket.”

A spokeswoman for Calpers says they won’t speculate on the proposed ballot measure, but in regards to the 2013 initiative, Calpers commented “that any changes to pension benefit levels should be determined by the employer and the employees, and not at the ballot box.”

Gomes believes the only chance for change is at the ballot box. A turning point came for her during an all-time low on her time in city government.

“It was the night the Vallejo city council, in the middle of bankruptcy, still approved a new police contract that had raises for two years and free medical,” she says. “I’m in the minority and watching the lights go up, and it was the most painful moment of my career in public service. They were serving the special interests that paid to get them in office.”

Protecting the status quo is big business in California. Unions spent $85 million in 2012 to support Governor Brown’s tax hike and to defeat a measure that would have prohibited collecting union dues for political campaigns. Since 2002, the California Teachers Association has spent about $170 million on political campaigns, according to the National Institute on Money in State Politics. The CTA just spent $11.2 million on independent expenditures to re-elect State Superintendent of Schools Tom Torlakson against an education reform candidate.

Another California mayor working closely with Reed, Anaheim’s Tom Tait, says it’s about gaining the power to act locally.

“To even begin to fix an unsustainable system, California cities need the ability to locally negotiate future pension earning formulas,” says Tait. “It is clearly in everyone’s best interest to address this problem sooner rather than later. The longer the state delays, the fewer options there are, and none of them easy.”

Marcia Fritz, a pension reform advocate and Democrat who advised Governor Brown on his 2012 pension reform law known as PEPRA, says Reed and his team should be meeting with Brown now. In 2012, she helped convince Brown’s advisors the only way they’d get their Prop 30 tax increase passed is if they enacted pension reform.

Fritz says today, the song remains the same.

“Brown needs to give the voters something in order to get them to agree to extend the Prop 30 tax increase,” she says. “He may ask to make the tax increase permanent to keep teachers’ retirement funds solvent. So, he might just embrace Reed’s measure to get buy-in.”

She says the recent Stockton bankruptcy decision, where a federal judge declared pensions can be cut during bankruptcy, is spooking unions and that Reed can capitalize on this fear.

In a written statement, Calpers CEO Anne Stausball commented that the federal ruling is not legally binding on any of the parties in the Stockton case, and when Stockton got the greenlight to emerge from bankruptcy without cutting pensions, Stausball noted: “The judge recognized that the city’s employees and retirees have already made significant concessions.”

While Reed’s hitting the trail to raise the major funds needed for a statewide initiative, he’s got a few items of business to clear up. He’s waiting for a hearing date on a lawsuit against California Attorney General Kamala Harris over the description of a previous pension initiative. The lawsuit claims the initiative’s wording was fatally biased.

He also initiated a federal corruption probe into the San Jose Police Association, claiming its union president fouled up recruitment efforts. The SJPD counterpunched, initiating an investigation of Reed.

It’s all bare knuckle politics, and it all takes time, something California may be running short on.

Reed says he’s undeterred.

“The pain of doing nothing is worse than the pain of taking on the issue,” he says.

This piece was originally published at Fox and Hounds Daily

Heidi Siegmund Cuda is a Former Investigative Producer for Fox 11 News in Los Angeles and the Creator and Host of the Economic Series, “Saving the California Dream.” She is currently directing a film on the nation’s public pension crisis.

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Californians Vote for More Taxes and More Borrowing

November 13, 2014 By Ed Ring 3 Comments

It has been argued that California’s voters defy their political stereotype when it comes to taxes. California’s property tax revolt in 1978 resulted in the passage of the historic Prop. 13, which limits property tax increases to 2 percent per year. As recently as 2009, California’s Legislature joined with Gov. Schwarzenegger to place Propositions 1A through 1E on the state ballot. All of them would have raised taxes, and all of them were defeated by voters.

That was then.

In 2012 Californians voted to raise sales and income taxes through Proposition 30, which supposedly was designed to collect an additional $6 billion per year to fund public education. And while 2014 did not include major new tax proposals on the state ballot, in cities, counties and school districts throughout California, tax and bond proposals were placed before voters. Most of them passed.

In the June 2014 primary, 47 local bond measures were proposed, with 36 of them passing. Also in June, 44 local tax increases were proposed, and 36 of them passed. That was just a warm-up for the November 2014 election, where 118 local bonds – most of them for public education – were proposed, along with a staggering 171 local tax increases. At last count, 72 of the bond proposals were passed, 15 were defeated, and 31 remain too close to call. Of the 171 local tax proposals, 98 were passed, 45 were defeated, and 28 are still too close to call.

These local tax proposals are necessary to meet runaway employee compensation costs, especially for pensions. These local bond measures are largely to fund deferred maintenance, activities that might have been funded through operations budgets if it weren’t for excessive compensation and benefit costs.

In Stanton, a city where local firefighters average $221,000 per year in pay and benefits, and local sheriffs average $112,000 per year in pay and benefits, a 1 percent increase to the local sales tax was approved by 54 percent of the voters. In Palo Alto, where the local firefighters “only” receive pay and benefits that average $181,000 per year, and the local police officers earn pay and benefits averaging $164,000 per year, a 2 percent increase in their hotel tax was approved by 75 percent of voters.

In California in 2014, based on returns so far, if a local city or county wants to raise taxes, there is a 72 percent chance voters will approve them. If a school district wants to borrow money – over $11 billion just this November – there is an 81 percent chance voters will approve them. And if the proponents of more taxes and borrowing are unlucky, they can always try again the next election. The odds are in their favor.

Local taxes and borrowing matter. California has relatively decentralized governance. Of the roughly $430 billion in estimated state and local spending in California for the fiscal year ending 6-30-2015, only $107 billion of that is state government spending. Estimating total state and local government debt in California is nearly impossible because the largest single borrower, K-12 school districts, have not submitted their financials to the State Controller for consolidation since 2002. But a California Policy Center study from April 2013 estimated total state debt from all sources at $132 billion, whereas the same study estimated total local government debt in California at over $250 billion. That estimate relied on 2011 and 2012 data, grossly underestimated K-12 bond debt, and did not include any unfunded liabilities for pension and retirement healthcare.

When it comes to taxes, borrowing, and overspending, most of the action in California is at the local level. And there should be no question that current spending levels are financially unsustainable. If all California’s state and local pension systems had to do was account for their liabilities according to the same rules that have governed private sector pension plans for years, California’s state and local debt – including unfunded liabilities – would be well over $1 trillion. Moreover, such reforms – playing by the same rules as the private sector – would grossly increase the ongoing normal cost to funding pensions for state and local government employees.

Sooner or later California’s taxpayers are going to wake up. Because the Government Accounting Standards Board, Moody’s Investor Services, and eventually the U.S. Congress, are being compelled by financial reality to enact reforms to pension and retirement healthcare accounting, asset management, and funding. Once government entities have to follow the same rules as the private sector, spending will skyrocket or services will be scuttled. What we’ve seen so far, grievous though it may be, is nothing compared to what is to come.

There is an alternative. A bipartisan will to defeat government unions by an awakened populace. It may take a few more years, but it is inevitable – the hidden agenda behind all of these tax increases and new borrowings will be plain for all to see.

Ed Ring is the executive director of the California Policy Center.

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Stockton Bankruptcy Ruling Backs Away from Pension Reform

November 3, 2014 By Heidi Siegmund Cuda 8 Comments

Jack Dean likes to tell the story of Prichard, Alabama, a city that declared bankruptcy not once, but twice.

“They were warned that the pension fund was running dry, and in 2009, it ran dry,” says Dean. “So they stopped mailing the checks.”

Dean, the editor and founder of PensionTsunami.com, tells the cautionary tale of Prichard in response to Thursday’s federal ruling that gave the California city of Stockton the green light to exit bankruptcy by paying bond investors chump change while protecting public pensions.

“Once again, Calpers has managed to intimidate a city government into not dealing with the pension issue,” says Dean. “So we’ll continue to careen down the pension crisis path, because they’re not paying attention to the elephant in the corner.”

While Stockton pensioners breathed a sigh of relief, an executive at Calpers, the nation’s largest pension fund, called U.S. Bankruptcy Judge Christopher Klein’s ruling “smart.”

“The city has made a smart decision to protect pensions and find a reasonable path forward to a more fiscally sustainable future,” Calpers Chief Executive Officer Anne Stausboll said in a statement. “We will continue to champion the integrity and soundness of public pensions.”

Earlier this month, Judge Klein issued the explosive decision that pensions can be reduced in bankruptcy, but on Thursday, he accepted the city council’s plan for Stockton, suggesting the workers had suffered enough.

“What it means is when you go into bankruptcy, pensions are not protected,” says San Jose Mayor Chuck Reed, who’s leading California’s pension reform movement. “But in this case, Judge Klein looked at the whole package, and decided that employees gave up their health care for pennies on the dollar… So you don’t necessarily have to cut pensions, you don’t necessarily have to cut health care, you don’t necessarily have to cut salary, but you have to do something to deal with the problem. Employees have to share the pain.

“The takeaway for California is it would be a whole lot better if we could deal with these problems outside of bankruptcy and before bankruptcy.”

Reed says local governments should be empowered to negotiate changes in future benefits as a means of controlling the costs in order to avoid the pain of bankruptcy.

“It’s certainly a knockdown, drag out fight in San Jose,” says Reed, who is calling for the U.S. Justice Department to investigate San Jose’s police union for corruption. “The good news is, we’re saving 25 million dollars a year due to our pension reforms and we’re putting that back into city services.”

In court on Thursday, Judge Klein suggested that Stockton’s plan was the best it could do and that bankruptcy was a dauntingly expensive proposition.

But attorney Robert Flanders, the municipal fix-it guy in Rhode Island, says when push comes to shove, don’t be afraid of the “B” word.

Flanders, a partner in the law firm Hinckley-Allen, was the state-appointed receiver in Central Falls, Rhode Island, which went through a bankruptcy restructuring in 2011 and came out the other side.

“It was plain that we were running out of cash to pay people,” says Flanders. “That’s when I had to go in front of them and say, ‘I’m sad to say this, but there’s a risk that you’re not going to get paid at all and we’re going to default. A haircut still looks a lot better than a beheading.’ It really was the true situation.”

Thirteen months later, the city was back in business and ultimately retirees ended up with a 25 percent haircut, down from a high of 55 percent.

“We took the opportunity of the bankruptcy to not only restructure the pension system, but get rid of the gamesmanship and make it much more favorable to the taxpayers,” says Flanders. “It can be done, and it can be done quickly. The beauty of it from a legal standpoint is all the arguments about breach of contract amount to a hill of beans in a bankruptcy proceeding because the only issue is what can a city afford.”

He says Judge Klein is giving Stockton the benefit of the doubt. But Stephanie Gomes, the former vice mayor of Vallejo, says Stockton missed the opportunity to learn from Vallejo’s mistake. Vallejo was the first California city to topple.

“If I were on the Stockton city council, I would’ve pushed for some sort of pension reform,” says Gomes, who was on the Vallejo city council before, during and after the city declared bankruptcy. “We didn’t have a majority willing to do that, and because of that, we are still saddled with crushing pension debt in Vallejo, and we’re still struggling with our exit plan.”

In effect, she says, Vallejo failed bankruptcy.

“I call Calpers ‘Hotel California,’” says Gomes. “Once you’re in, you can never leave. Until there’s statewide reform, there’s not much cities can do.”

For John Moore, a candidate for mayor in the seaside town of Pacific Grove, California, Thursday’s ruling was a bummer.

“Judge Klein led us on for about a year,” says Moore, a retired attorney whose run for mayor is an attempt to tackle Pacific Grove’s pension debt. “We thought something really big was going to happen, and now we have a plan that has no chance of working.”

Dean says nothing changes the fact that Stockton’s pension fund is millions in the hole.

“When the checks stop coming in the mail, maybe we’ll get reform.”

This piece was originally published on Fox and Hounds Daily

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