California Government Pensions and Opportunity Costs
By David Henderson
Steven Greenhut over at the Reason blog had an excellent article last week on the really scary state of the California Public Employees’ Retirement System (CalPERS). It’s titled “What, Us Worry? California Lawmakers Still Ignoring Dark Pension Clouds,” Reason, December 13.
First, some facts that many Californians are familiar with but most non-Californians are not. Greenhut writes:
It’s been a little more than 20 years since the California Legislature passed, and Gov. Gray Davis signed, Senate Bill 400, which granted 50-percent pension hikes to employees of the California Highway Patrol. The law’s clear intent was for every other California agency to follow its model. They mostly did. So, these pension deals spread across the state like a contagion—leaving a debilitating level of pension liabilities that threaten to obliterate city and county budgets and push some less affluent localities toward insolvency.
The legislation granted the pension increases retroactively, which meant that government employees didn’t just gain these additional benefits beginning on the day of its passage. The increases were granted back to the day the employee started on the job, even if it were 30 years ago or more. This was more than your garden-variety gift of public funds, but it passed overwhelmingly on a bipartisan basis, and with virtually no public debate. Those few officials who raised red flags were derided, even though their warnings were prescient.
I remember a breathless headline in the Monterey Herald in the early 2000s about how a huge number of firemen in Salinas who had 25 to 30 years of service were retiring en masse. The reporter didn’t seem to understand why. I did. The reason is in the second sentence of the paragraph just above. Those who had 30 years of service and had hit at least age 50 got as a pension 30*3, or 90 percent, of their top pay, inflation-adjusted. Those with 25 years of service got 25*3, or 75 percent. And so on.
I vaguely recall, although I can’t find on-line, the mayor of Vallejo, California, after that city declared bankruptcy, saying, “I can afford one police force; I can’t afford two.”
And how did the law sail through the legislature and similar pension increases sail through local city government council meetings? The advocates assured us that with stock market returns being as strong as they were, this wouldn’t cost taxpayers any more than we were paying.
Greenhut notes the obvious problem with that claim:
During the SB 400 debate, supporters said it wouldn’t cost taxpayers a dime because of ongoing boisterous stock-market returns. The California Public Employees’ Retirement System (CalPERS) promised that “no increase over current employer contributions is needed for these benefit improvements.” It would mostly be funded from excess returns on retirement systems that were so awash in cash that they really – I swear – had no other choice but to give it away to their union friends.
Obviously, these predictions never panned out as the stock market fell. The state’s pension funds now struggle with troublingly low 70-percent funding levels, even after a long-running bull market. There are no excess returns, but insufficient ones to pay for growing membership in the “$100,000 Pension Club.” Once the market falls again—and it will fall, as former Gov. Brown frequently warned—these funds could hit the skids. On hindsight, who could have ever believed those ridiculous assurances?
Note also the last sentence of the first paragraph in the two-paragraph excerpt above:
It would mostly be funded from excess returns on retirement systems that were so awash in cash that they really – I swear – had no other choice but to give it away to their union friends.
Greenhut is getting at the idea of opportunity costs. Even if the stock market had continued to rise at high single-digit rates, there would have been a problem. The reason: the government did have other choices besides giving “it away to their union friends.” The government could have cut its own payments to the PERS plan, thus freeing up money to cut other taxes or to increase other government spending. Even if the government officials had rosy expectations about stock market returns, they shouldn’t have ignored opportunity costs. They probably wouldn’t have done that with their own financial decisions. But their incentive to be careful about opportunity costs was almost non-existent.
I predict that at least every two years for the next ten years, local governments will propose tax increases to pay for the huge pension payments to government workers. I’m helping a friend fight one in Monterey; I expect to soon be fighting one in Pacific Grove.