Unfunded public pensions threaten the fiscal solvency of states and localities across the country. And California is not immune.
Thanks to an unelected state board, these gains are now in peril.
Without properly accounting for investment risks, the liabilities of California’s public pension plans — that is, the pensions promised to public-sector workers — exceed its assets by around $170 billion. That’s approximately equal to 125 percent of total state tax revenues as of 2014.
If this were the actual burden, the fiscal situation would be unsustainable. But California’s predicament is even more dire.
Just like private-sector workers saving for their own retirement, California’s state pension funds allocate the assets they hold into investments such as the stock market. While the value of stocks grows over time historically, such growth is not without risk. As the old saying goes, past performance is not a predictor of future results. Investments will sometimes provide sub-par returns over prolonged periods of time.
Private-sector workers typically have defined-contribution retirement plans. If their investments underperform the expected average growth rates over a prolonged period of time, then their retirement income will be smaller than expected.
Unlike most private-sector workers, public-sector workers have defined-benefit pension plans. Their retirement income is fixed regardless of the investment performance of the assets invested on their behalf.
Thus, if overall investment returns are less than expectations, private-sector workers in California will have smaller nest eggs for their own retirement, and they will have to pay higher taxes in order to ensure that the retirement nest eggs of their neighbors who work for the state or local governments are not impacted.
Effectively, California’s current pension systems require private-sector workers to bear market risks twice — once for their own retirement, and once for the retirement of public-sector workers.
Financial markets put a market value when someone bears risks on behalf of someone else. When these market risks are properly taken into account, the estimates of California’s current unfunded pension liabilities are more than twice as high as the official estimates.
This untenable financial position requires significant pension reforms by state and municipal governments alike in order to reduce the pensions’ unfunded liabilities.
In 2012, nearly two-thirds of San Diego voters supported Prop. B, an effective first step at addressing this problem. The voter-approved reforms offered most new government workers access to the same 401(k) retirement plans that private-sector workers typically receive, instead of the gold-plated pension guarantees that are bankrupting California’s state and local governments.
Despite the clear democratic mandate and the economic necessity of the reforms, members of an unelected “quasi-judicial administrative agency” are now trying to nullify the results.
If upheld, the ruling by the California Public Employment Relations Board undermines San Diego’s initial reforms to reign in out-of-control pension costs risking the city’s long-term fiscal solvency.
Obviously, this ill-considered decision is problematic for San Diego in the short term. If allowed to stand, the decision would require the city to backfill the pensions for the approximately 2,000 employees hired since the decision as well as pay a 7 percent interest penalty. Additionally, all future employees would once again become eligible for the current unaffordable pension plans.
Thus, in spite of implementing fiscally responsible reforms, this decision forces San Diego back into fiscal peril.
More broadly, the board’s decision will make it more difficult for the state and other California municipalities to implement the necessary pension reforms. California will essentially be trapped on a path toward fiscal insolvency.
Instead of allowing unelected bureaucrats to undermine the will of the voters, San Diego’s political leadership is indicating that it will defend Prop. B in court. This is the correct course of action.
San Diego’s Prop. B reforms illustrated that it is politically feasible to reform overly generous public-sector pensions. It is also fiscally required, if San Diego and California are going to avert the pending fiscal insolvency.
Winegarden, Ph.D. is a senior fellow in business and economics at the Pacific Research Institute. His study, “California’s Pension Crowd-out,” was recently released by the institute.