Dubious Investments Further Imperil California Pension Plan Already in Crisis

pension-2The California Public Employee Retirement System, known as CalPERS, is in crisis. And it sure looks like things are going to get a whole lot worse before they can get a whole lot better.

The system already has a $153 billion unfunded liability, one of the largest shortfalls of any state, and it only has funds to cover 68 percent of promised benefits into the future. And because CalPERS is already cash negative, paying out $5 billion more in benefits to retirees each year than it takes in, there aren’t many scenarios whereby the system would be able to make good on those promises absent outside intervention (read: taxpayer bailout).

Lawmakers and the fund’s board should be considering reforms to improve the system, but California voters and taxpayers faced another setback recently. Overseers of the pension plan — the nation’s largest — passed a funding plan earlier this year that projects shortfalls over the next decade but assumes rosy investment returns in coming decades to make up the difference. Given the high market valuations today, that assumption seems dubious.

When the CalPERS investment committee reallocated its investments recently, it assumed a 7 percent annualized rate of return. While CalPERS has enjoyed some good years — for example, its 2017 return may exceed 11 percent — that’s not the norm. The fund has averaged a 4.6 percent rate over the past decade, and its 2016 rate was an abysmal 0.6 percent.

CalPERS’ strategy — and to a large extent that of the state in general — seems crafted first and foremost to advance the interest of public sector labor unions. The high compensation for state government workers and the state’s munificent retirement benefits make it difficult for local government officials to find the money necessary to meet their obligations. Rising contribution rates for local governments mean that municipalities and schools have less money to educate children, build roads or provide other essential government functions.

CalPERS’s school district contribution rates to the pension plan are projected to skyrocket in the near future. The rates have risen to 15.5 percent from 11.8 percent in the 2015-2016 fiscal year, and are scheduled to reach 22.7 percent in 2020. School districts have little power to fight the increases, which are mandated at the state level. The only way to reduce pension contributions is to cut staff. Some layoffs may make sense for districts facing declining enrollment, but they can also harm educational outcomes.

Fund managers should be laser-focused on increasing investment returns for its beneficiaries, which would lessen the fund’s burden on taxpayers. But its board is more interested in pursuing a political agenda. For the majority of California taxpayers who hold a portion of their retirement assets in the stock market, CalPERS’ activism means that some of their money will be used to support a political agenda that hurts their investment returns.

CalPERS has played an increasing role in politicizing annual shareholder meetings in recent years. These elections are on the horizon—a majority of U.S. public companies hold the mandated meetings between March and July—and CalPERS is already planning to force votes on proposals on environmental and social issues.

Traditionally, these proxy votes have been about improving corporate governance with one goal in mind: improving shareholders’ returns. But CalPERS and other activist investors have aggressively pushed proposals irrelevant to companies’ missions that could have a harmful impact on shareholder value.

CalPERS has prioritized relatively poor-performing environmental, social and governance (ESG) investments at the expense of other options more likely to optimize beneficiary returns. As a recent study by the American Council for Capital Formation shows, four of CalPERS’ nine worst performing funds were ESG-focused.

CalPERS responded to the criticism by noting that the plan’s private equity portfolio, which includes the funds, has performed well overall. But CalPERS would serve its beneficiaries—and taxpayers—better if it focused on investment returns and not politics.

Making investment decisions based on social issues has real consequences. Last year CalPERS’ board expanded its ban on investing in companies that produce tobacco products, against recommendations by its professional staff. In an analysis of the cost of divestment produced for CalPERS, Wilshire Consulting placed the system’s total foregone investment gains at more than $3.6 billion.

CalPERS is facing a serious, long-term crisis that could cripple school districts and local governments while forcing tax increases to pay for the pension system. Getting the fund out of politics won’t alone fix the system’s fiscal woes. But it would be a good first step.

California pension funds likely to face new pressure to divest from fossil-fuel companies

Calpers headquarters is seen in Sacramento, California, October 21, 2009. REUTERS/Max Whittaker

New York Gov. Andrew Cuomo’s call for his state’s biggest government pension fund to stop new investments in fossil-fuel companies and phase out existing investments is likely to lead to renewed calls for the Golden State’s two massive pension funds – the California Public Employees’ Retirement System and the California State Teachers’ Retirement System – to do the same.

The Common Fund – New York’s pension fund for state and local public sector employees – has $200 billion in holdings. Cuomo, a Democrat who is expected to run for president in 2020, said it was time to craft a “de-carbonization roadmap” for the fund, which “remains heavily invested in the energy economy of the past.”

New York City Comptroller Scott Stinger agreed with Cuomo and called for changes in the investment policies of the city’s five pension funds, with holdings of about $190 billion.

The announcements were hailed on social media as a reflection of the mission statement of the 2015 Paris Accord outlining international efforts to address global warming.

It’s possible Brown could use his State of the State speech later this month to reveal his call for CalPERS and CalSTRS climate-change divestment. The pension giants have already been forced to end investments in coal companies because of a 2015 law signed by the governor, selling off shares worth less than $250 million, a tiny fraction of their overall portfolios.

But selling off stakes in energy companies would be a much more impactful event. Giant firms like ExxonMobil are among the most common holdings of pension funds around the world.

Some unions worry divestment will hurt CalPERS finances

And while the California Democratic Party has been largely unified behind Brown’s and the state Legislature’s efforts dating back to 2006 to have California lead the fight against global warming, such unanimity is unlikely should Brown follow Cuomo’s lead because some public employee unions are worried about divestment damaging the finances of CalPERS and CalSTRS.

As of July, CalPERS had $323 billion in assets and said it was 68 percent funded – meaning it had about $150 billion in unfunded liabilities. As of March, CalSTRS had $202 billion in assets and said it was 64 percent funded, leaving unfunded liabilities of about $100 billion.

CalPERS’ steady increase in rates it charges local agencies to provide pensions and the heavy costs facing school districts because of the Legislature’s 2014 CalSTRS’ bailout have taken a heavy toll on government budgets.

Corona Police Lt. Jim Auck, treasurer of the Corona Police Officers Association, has testified to the CalPERS board on several occasions, imploring members to focus on making money with investments, not making political statements.

According to a July account in the Sacramento Bee, Auck said public safety is hurt when police departments must spend ever-more money on pensions.

“The CalPERS board has a fiduciary responsibility to the membership to deliver the best returns possible,” Auck testified. “Whatever is delivering the return they need, that’s where they need to put our money.”

The International Union of Operating Engineers, which represents 12,000 state maintenance workers, has taken the same position, according to the Bee.

In New York, Gov. Cuomo also is not assured of success. The sole trustee of the Common Fund is State Comptroller Thomas P. DiNapoli. While he agreed to work with Cuomo in establishing a committee to consider possible changes in its investment strategies, his statement pointedly emphasized that there were no present plans to change the fund’s approach to energy stocks.

While DiNapoli cited his support for reducing global warming and the Paris Accord, his statement concluded with a sentence emphasizing his priorities: “I will continue to manage the pension fund in the long-term best interests of our members, retirees and the state’s taxpayers.”

City services slashed to fund pensions, but your taxes are still going up

PensionsIn the coming months and years, California voters can expect to see a variety of tax increases pop up on their local election ballots. They will be called “public safety” taxes to hire more police or firefighters or “parks” or “library” taxes to pay for those popular public services. But don’t be fooled. Any new tax proposal is in reality a “pension tax” designed to help the California Public Employees’ Retirement System make up for shortfalls in its investment strategy.

In fact, liberal interest groups are getting ready to circulate a statewide ballot initiative that will gut Proposition 13 – the 1978 initiative that has limited property tax increases to 1 percent of a property’s sales price. It also limits property tax increases to 2 percent a year. The new initiative would remove those protections from many commercial property owners, thus raising taxes by another $11 billion a year. Money is fungible, so this is partly about paying for pensions, too.

California has an enormous problem with pension costs. Many observers see it as a crisis that threatens the economic health of the state. A recent study from the well-respected Stanford Institute for Economic Policy Research, run by former Democratic Assemblyman Joe Nation, details how pension costs already are “crowding out” public services, especially at the local level. Cities pay so much for retired employees that they are cutting spending on everything else.

“California public pension plans are funded on the basis of policies and assumptions that can delay recognition of their true cost,” according to the report. Yet pension costs still are rising and “are certain to continue their rise over the next one to two decades, even under assumptions that critics regard as optimistic.” So they are cutting “core services, including higher education, social services, public assistance, welfare, recreation and libraries, health, public works, and in some cases, public safety.”

Aside from cutting public services and running up and hiding debt levels, there’s only one other way that localities can come up with the cash to pay for these overly generous pensions, especially as pension costs consume 15 percent or more of their general-fund revenue. They will raise taxes. Meanwhile, the state government has to backfill pension costs as well, which leads to constant pressure for legislators to promote additional state-level tax increases. It’s a “heads they win, tails you lose” situation, as Californians pay more to get less.

Much of the problem goes back to 1999, when the Legislature rammed through a law to provide 50-percent pension increases to the California Highway Patrol. Backers knew that once CHP received these overly generous deals (including retroactivity, which is a pure giveaway that hikes pensions back to each employee’s starting date), pension increases would spread across the state. Indeed, they did. CalPERS said it wouldn’t cost taxpayers a “dime” because of stock-market growth, but then the market crashed.

Under the current defined-benefit system, public employees are promised an irrevocable level of pension benefits based on a formula. For instance, most California “public safety” workers (police, fire, billboard inspectors, prison guards, etc.) receive “3 percent at 50.” If they work 30 years, they get 90 percent of their final three years’ pay (often higher, because of pension-spiking gimmicks) until they die. They can retire with full benefits at age 50. Non-safety workers often receive a pension formula that lets them retire with 81 percent of their final pay beginning at age 57. These are very generous benefits given their typically high final salaries.

CalPERS invests the money in the stock market. It calculates the “unfunded pension liabilities” (i.e., debt) based on a projected rate of return for their investments. Higher expectations enable the pension funds and cities to go along their merry way, not worrying about their ability to pay for all the promises and avoiding pressure to pare back pay levels. CalPERS just lowered its rate of return from 7.5 percent to 7 percent, which is still overly optimistic.

But the lowered assumed rates mean that cities have to pay the pension fund additional fees to cover the difference. This is cutting into their operating budgets. In fact, cities have faced four rate increases in the past five years and are expecting a fifth one. A recent article tells the stories of El Segundo and Arcadia, two Los Angeles County cities that are considering hiking their sales taxes to maintain their current level of service.

El Segundo’s mayor pro tem said that in five years “the payment to CalPERS is expected to be $18 million and 25 percent of general fund revenue as the employer rate for safety employees increases from 50 percent of pay to 80 percent of pay,” reported Calpensions’ Ed Mendel. He noted that cities face a statewide cap on the size of their sales tax, but that Gov. Jerry Brown in October signed a law that allows some localities to bust through that cap.

You can see what’s coming: A push by unions to eliminate the sales-tax cap across the state, and a torrent of sales tax increases to pay for soaring pension costs. The other thing to expect: Continuing efforts to hide the size of the pension debt.

“The nation’s largest pension system is expected to adopt a funding plan … that anticipates shortfalls during the next decade and then banks on exceptional investment returns over the following half century to make up the difference,” wrote Contra Costa Times columnist Dan Borenstein this week. “It’s an absurd strategy designed to placate labor unions, who want more public money available now for raises, and local government officials who are struggling to make annual installment payments on past debt CalPERS has rung up.”

The only other hope beyond debt and taxes is if the California Supreme Court guts the so-called California Rule, which forbids governments from reducing pension benefits even going forward unless they are provided with something of equal or greater value. That “rule” has made it nearly impossible to reduce costs for current employees. But there’s no guarantee the court will roll back the rule in a case it will soon consider –  or that the state and localities will bother to cut back benefit levels even if they are allowed to do so given union political power.

In the meantime, expect not only more of the same of hidden debt and reduced government services – but tax increases at every turn.

Steven Greenhut is a contributing editor for the California Policy Center. He is Western region director for the R Street Institute. Write to him at sgreenhut@rstreet.org.

This article was originally published by the California Policy Center

California cities look at tax hikes to pay rising pension costs

El Segundo and Arcadia were among two dozen cities urging the CalPERS board last month to avoid another employer rate increase, the fifth in the last five years, when adjusting its $344 billion investment portfolio this month.

Last week, the two well-funded cities, both with currently balanced budgets and high service levels, considered sales tax increases. Despite cutting costs, the cities now face deficits from a steep rise in CalPERS rates scheduled for the next seven years.

El Segundo’s mayor pro tem, Drew Boyles, told the California Public Employees Retirement System board last month the city’s required pension contribution this year is $11 million or 16 percent of general fund revenue.

In five years, Boyles said, the payment to CalPERS is expected to be $18 million and 25 percent of general fund revenue as the employer rate for safety employees increases from 50 percent of pay to 80 percent of pay.

“These increases are not sustainable and may result in the reduction or elimination of service to our community,” he said, “such as a hiring freeze, furloughs or even potential layoffs, reduction in parks and recreation services, library services, public safety, deferred maintenance on city infrastructure, and reduction to overall infrastructure.”

Steps already taken to “address the immminent financial crisis,” said Boyles, include a pension trust fund, advance payments of pension debt, no pay raises for some employee groups for the last five years, and deferring $2.3 million per year in facility repairs and maintenance.

The El Segundo city council considered a sales tax proposal last week (see video 1:26) for an unusual reason beyond maintaining the “exceptional level of municipal services” expected by residents and the business community.

A 3/4-cent sales tax or 0.75 percent is all that remains available for El Segundo under state law that caps the Los Angeles County sales tax at 10.25 percent. So, the city wants to get the 3/4 cent sales tax before the county takes it.

“It’s like the earthquake,” Mayor Suzanne Fuentes told the council last week. “It’s not a matter of if, it’s when the county puts the next tax item on the ballot. And it will pass, because every county tax ballot issue gets passed.”

Voters approved a 1/4-cent county sales tax increase in March to help the homeless, Measure H, and a 1/2-cent county sales tax in November last year to fund transportation projects, Measure M.

The original El Segundo proposal would ask city voters in April to approve a 3/4-cent sales tax generating $9 million a year that would not take effect until the county approved a new sales tax. If the county measure is rejected, the city tax would be suspended.

As a better defense against a legal challenge, the council told staff to prepare another option for consideration at its next meeting. The city tax would be triggered when the county places a measure on the ballot or on a date several years after the April vote, whichever comes first.

At the request of Boyles, who pointed to a pension debt of more than $100 million, the staff also was told to prepare a proposal to close a $400,000 budget deficit expected to open next October as a growing budget gap begins.

“I want to start with the mindset now because taxing is not going to get us there,” Boyles said. “There is no way we are going to continue to tax our way out of this hole we are in right now.”

Legislation can lift the state sales tax cap for local governments. Gov. Brown signed legislation (SB 703) in October that allows Alameda and Santa Clara counties and the city of Santa Fe Springs to impose limited sales tax increases outside of the state cap.

arcadia

“In every way we are the envy of everybody in the San Gabriel Valley,” the Arcadia city manager, Dominic Lazzaretto told the CalPERS board last month.

He said Arcadia has sales tax revenue from a thriving regional mall, increased property tax revenue from a luxury housing boom, and revenue streams not available to other cities from the Santa Anita Park thoroughbred racetrack.

“And still, in all, I cannot afford the flight path we are on,” Lazzaretto said, urging the board to avoid another employer rate increase. He said the city’s required CalPERS contribution, $11.6 million this year, is expected to increase to $17 million in five years.

Arcadia already has done “right-sizing,” negotiated “takebacks and pensions reforms,” maintained strong reserves that can cover a funding gap for a short time, and may like other cities ask voters to approve a sales tax increase, Lazzaretto said.

Last week, the Arcadia city council was told (see video 1:06) that a survey done by a consultant hired to explore a sales tax found residents are “extremely satisfied” with city services but “looming fiscal challenges are not well understood.”

The city council decided to shelve a tax proposal and extend the contract of the consultant, the Lew Edwards Group, to conduct a campaign to educate the public about the fiscal challenge and explore possible solutions.

“We should not be promoting one thing over another,” said council member April Verlato. “We should not be promoting that we are looking for a tax increase.”

Council members mentioned a state Fair Political Practices Committion probe into county television ads and social media posts appearing to support Measure H. The Howard Jarvis Taxpayers Association complained that campaign law had been violated.

Council member Roger Chandler reminded the council that Measure H used up some of the remaining sales tax allowed in Los Angeles County under the 10.25 cents state cap.

“Any new tax that is passed by the county will go against the city of Arcadia’s tax,” Chandler said. “We still have something left because our city has never used a sales tax to finance anything.”

More than a half dozen cities in Los Angeles County have approved sales taxes that, with the state’s 7.5-cent share and the county taxes, total 10.25 cents: Compton, La Mirada, Long Beach, Lynwood, Pico Rivera, Santa Monica, and South Gate.

Pension costs for cities are rising mainly because the CalPERS board lowered the investment earnings forecast used to discount future pension obligations from an annual average of 7.5 percent to 7 percent.

More money from employers is needed to fill the funding gap created by the lower investment earnings forecast. Rate increases for cities begin next year and are scheduled to continue until 2024.

The sharp drop in the discount rate last December was irregular, prompted by a 10-year forecast of lower investment earnings and the failure of CalPERS funding to recover from huge investment losses a decade ago.

Now as part of a regular four-year process, the CalPERS board is expected to choose one of four investment allocation options next week. One would leave the earnings forecast at 7 percent, requiring no additional change in employer rates.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. 

This article was originally published by CalPensions.com

California Cities Spiking Taxes to Pay Spiking Pension Costs

Calpers headquarters is seen in Sacramento, California, October 21, 2009. REUTERS/Max Whittaker

California cities are being forced to spike taxes to pay for spiking public employee pension funding costs.

California Public Employees’ Retirement System (CalPERS) has just reported that its $344.4 billion defined benefit pension plan, which covers most state and local government employees, has fallen from a $2.9 billion surplus in 2007 to a $138.6 billion deficit as of June 2016. The rate of funding decline accelerated over the prior year by $27.3 billion.

With the pension plan’s funded ratio — equal to the value of plan assets divided by present pension obligations — having fallen to 68 percent, far below what actuaries call the 80 percent minimum for adequate fund, CalPERS is demanding that cities increase payments.

A recent report warned that CalPERS’ poor investment return of just 4.4 percent over the last decade could be further reduced by large and politically motivated “environment, social and governance” investment strategies. These so-called ESG strategies have drastically underperformed other pension plan returns, which explains why CalPERS is “in the midst of a plan to lower its investment return assumptions to 7% from 7.5% by July 1, 2019.”

CalPERS will pay out $21.4 billion in benefits to retirees and beneficiaries in 2017, a 5.5 percent increase from 2016 and more than double the $10.3 billion in 2007. But most of the 1.93 million retirement system members and 1.4 million health care participants who receive administration services from CalPERS are associated with local governments that are directly responsible for paying spiking benefit costs.

At the September CalPERS meeting in Sacramento, eight cities told the pension plan’s trustees that they are experiencing spiking pension funding costs. Representatives from the largest local governments in the Sacramento area claimed that pension funding costs are set to spike by 14 percent next fiscal year.

The city manager of Vallejo, which recently emerged from bankruptcy, said that the city’s police pension funding costs are expected to jump from about 50 percent to 98 percent of payroll over the next decade. Both Lodi and Oroville officials stated that they have had to cut a third of their staff over the last decade.

El Segundo mayor pro tem Drew Boyles told the CalPERS board last month that his city’s CalPERS required pension contribution will be $11 million next year, or about 16 percent of the general fund’s revenue. But the cost in five years is expected to hit $18 million, or 25 percent of general fund revenue. He blamed the increase on funding for police and fire pension costs that are set to spike from 50 percent to 80 percent of payroll.

The California legislature passed SB 703, which will allow Alameda County and its local cities to raise about $148.9 million by exceeding the 2 percent local sales and use tax rate cap. The City Council of El Segundo plans to spike the local sales tax by an additional 3/4-cent to 10.25 percent to generate $9 million to pay for spiking pension funding costs.

All the local government representatives that have been addressing CalPERS’ monthly meetings complain that even after eliminating of services, slashing infrastructure spending, and planning for layoffs, they will still be forced to raise taxes to fund pension costs.

Despite California already being the highest-taxed state in the nation, the California Tax Foundation warned in June that Sacramento politicians were proposing another $16.9 billion in “targeted taxes and fees.” If passed, much of that tsunami of new cash could end up at CalPERS to fund pension shortfalls.

This article was originally published by Breitbart.com/California

Jerry Brown, with nothing to lose, defies unions on pensions

Photo courtesy Steve Rhodes, flickr

Photo courtesy Steve Rhodes, flickr

“Freedom’s just another word for nothin’ left to lose,” singer-songwriter Kris Kristofferson philosophized in his classic blues song, “Me and Bobby McGee,” a half-century ago.

Kristofferson’s tune would be an apt anthem for Gov. Jerry Brown as he winds down his own half-century-long career in politics – especially so since Kristofferson once campaigned for him.

Unless something very unusual happens, Brown will never face voters again. Therefore, with nothing politically to lose, he has the freedom to do whatever he wants.

Brown emitted a very strong clue to his unfettered status last week when he filed a brief with the state Supreme Court in a case affecting public employee pensions, in effect asking the justices to make it easier for state and local governments to reduce benefits.

Brown is supporting appellate court rulings that upheld two provisions of the modest pension reform bill he and the Legislature enacted in 2012, one ending “pension spiking” and the other repealing the ability of public employees to purchase additional retirement credits called “airtime.”

However, Brown appears to go even further, suggesting that the court set aside, or at least severely modify, the so-called “California rule.”

That rule, based on a 1955 state Supreme Court decision, is an assumption that public employee pension benefits, once granted, can never be modified, even for future work.

It is a bedrock issue for public employee unions and the union-controlled California Public Employees Retirement System, as demonstrated when they successfully pressured bankrupt cities not to reduce pension obligations, even though a federal bankruptcy judge said they could do so.

Not surprisingly, any Democratic politician who questions the rule’s legal validity or financial sustainability risks union wrath.

It explains why former Attorney General (now U.S. Senator) Kamala Harris and her successor, Brown appointee Xavier Becerra, have been reluctant to buck the unions by vigorously defending Brown’s pension reform and why the governor, with nothing to lose, decided to do it himself.

A key phrase in one of the appellate court rulings, reinterpreting the 1955 Supreme Court decision, frames the issue that the Supreme Court must decide.

“While a public employee does have a ‘vested right’ to a pension,” Associate Justice James Richman wrote, “that right is only to a ‘reasonable’ pension’ – not an immutable entitlement to the most optimal formula of calculating the pension.”

Were the Supreme Court to agree with Brown and uphold the appellate court rulings that seemingly repeal the California rule, it would be a huge setback for the unions – and a black eye for the local unions that opened the legal door by challenging the pension reform’s abolition of much-abused pension spiking and airtime.

A “reasonable pension” ruling would also be an avenue for local governments, which are now struggling to pay fast-rising “contributions” to CalPERS, to reduce the bite by guaranteeing current benefits for work already performed but reducing them for future work.

Conversely, were the Supreme Court to defy Brown and overturn the appellate courts, the California rule would be enshrined, even mild reforms would be thwarted and the state’s unsustainable pension system could either become insolvent itself or force many local governments into bankruptcy.

Obviously, these are big stakes.

This article was originally published by CALmatters

Cities reeling under the burden of growing pension debt

pension-2The California Public Employees’ Retirement System’s union defenders feign shock whenever pension reformers accuse it of “kicking the can down the road” in dealing with the state’s mounting pension debt. It’s like the scene from Casablanca, when Captain Louis Renault is absolutely shocked to find gambling going on in a gambling house.

CalPERS is never going to state the obvious: “We know these massive, underfunded pensions are not sustainable, but we’re going to do everything possible to push the problem into the future and blame everyone else for the problem.” But the pension fund’s board might as well have said as much after two actions it took at last week’s Sacramento meeting.

In one case, it decided to seek a legislative sponsor for a bill that would enable it to shift the blame to local agencies whenever such agencies decide to stop making their payments to the fund and retiree pensions are cut as a result. In the second case, at the urging of cities CalPERS decided to delay a vote on a more actuarially sound means of paying off pension debt – rather than risk a fifth rate hike to local governments, and risk a mutiny among hard-pressed local governments.

Both of these actions maintain the status quo and – you got it – kick the can down the road.

The first action involved the fate of two local agencies that have exited the pension fund because they couldn’t afford to keep making their payments. As California Policy Center previously reported, the tiny Sierra Nevada town of Loyalton in 2013 decided to exit the plan, but then was hammered with a $1.66 million termination fee that it couldn’t possibly afford. The town’s entire annual budget is $1 million and it couldn’t even make its $3,500 month payments to the fund.

Furthermore, the East San Gabriel Valley Human Resources Consortium, known as LA Works, shut its doors in 2014, but was likewise penalized by CalPERS for stopping its payments. The end result: Loyalton’s four retirees have their pension benefits sliced by 60 percent, and LA Works’ retirees lost as much as 63 percent of their pension checks.

In making an example of these small agencies, CalPERS revealed an ugly truth. The pension fund assumes a rate of return of 7 percent to 7.5 percent on its investments. The higher the assumed rate, of course, the less debt on its books. It’s in the union-controlled fund’s interests to assume the highest-possible rates and maintain the status quo – even if that means that taxpayers ultimately will have to pick up any slack.

When agencies decide to leave the fund, however, CalPERS puts them in a Terminated Agency Pool, where CalPERS assumes a rate of return of a measly 2 percent. Upon departure, these agencies can no longer expect future earnings or taxpayers to pick up the shortfall, so the 2 percent rate is the actual risk-free rate that CalPERS expects from its investments.

The legislation the fund seeks, facetiously referred to as the Anti-Loyalton Bill, would “require a terminating agency to notify past and present employees of its intention to terminate,” according to the language approved by the full CalPERS board last Wednesday. Bottom line: CalPERS wants local agencies to provide the bad news to employees and retirees so that they, rather than the massive pension fund, receive the brickbats.

The proposed bill is not a big deal per se, but it’s yet another example of how CalPERS is more interested in hiding – rather than dealing with – its pension debt. Basically, this is a public-relations strategy designed to discourage agencies from leaving the fund. It’s a way to tighten the golden handcuffs and punish agencies that want to exit the fund.

In reality, if 2 percent is the earning rate that CalPERS can safely expect on its long-term investments, then that should be the rate that it assumes for all of its investments. But lowering the assumed earnings to such a realistic number would cause mass panic, as municipalities would need to come up with dramatically increased payments. They already are struggling with their current payments.

Under that scenario, the state’s pension debt would be around $1.3 trillion, according to some estimates – and it would become implausible to push the problem down the road. Even with the current high assumption rates and even after a great year of earnings of 11.2 percent, CalPERS is only funded at a troubling 68 percent. (The California State Teachers’ Retirement System had even better returns last year, but is funded only at 64 percent.)

In its second major action last week, “CalPERS delayed action … on the chief actuary’s proposal to shorten the period for paying off new pension debt from 30 years to 20 years, a cost-cutting reform that would end the current policy not recommended by professional groups,” explained Ed Mendel, on his respected Calpensions blog.

Localities already have faced four major rate increases since 2012. CalPERS assesses the increases to make up for the unfunded liabilities, and recent studies suggest that local governments are slashing public services to come up with the cash. Had CalPERS decided to pay off new debt in a shorter time frame, it would have meant a fifth increase, according to Mendel. He quoted the League of California Cities’ official Dane Hutchings with these words of warning: “The well is running dry.”

It’s a mess. If CalPERS does the right thing, it exacerbates local governments’ current problems. But maintaining the status quo will make them worse down the road. As Mendel explained, under CalPERS’ current payment approach, “the debt continues to grow for the first nine years” with the payment not even covering the interest. “(T)he payments do not begin reducing the original debt until year 18, more than halfway through the period.”

In other words, I have a great 30-year plan for paying off your credit-card debt: You make minimum payments for the next 18 years and then worry about it then. Isn’t that the very definition of kicking the can down the road?

It’s hard to feel too sorry for these struggling cities. Do you remember when they warned about the impending disaster if the state Legislature passed a 1999 bill, promoted by the California Public Employees’ Retirement System, that would retroactively raised pensions across the state by 50 percent? Do you remember when city managers angrily resisted union-backed efforts to raise pensions at their city councils? Neither do I.

Unfortunately, their efforts to avoid another rate hike only helps CalPERS do what it likes to do most – remind us that all is well and that the stock market will pay for all the pension promises. It might, but then again it might not. If the market slows, there will be a lot of California officials shocked to find a dead end up ahead.

Steven Greenhut is contributing editor for the California Policy Center. He is Western region director for the R Street Institute. Write to him at sgreenhut@rstreet.org.

This article was originally published by the California Policy Center

Is California’s Tax Burden “Fair”?

TaxesA recent report by the highly regarded Calmatters.com found that the State of California has been on a “taxing binge” over the past few years, having enacted a whole slew of recent tax increases such as the “gas tax,” the “cap and tax” energy taxation scheme.

The Calmatters.com analysis found that the recent state tax increases “plus a slew of new local government levies and hikes in personal income and taxable retail sales, will raise total tax collections to just under $300 billion, or $50 billion more than they were just two years ago,” according to the report.

“Nearly $200 billion will go to the state and more than $100 billion to schools and local governments,” states the report, which concludes that California likely has the “highest” tax burden in the nation.   (Note:  As good as the original Calmatters.com revenue analysis is, there appears to be several major revenue sources excluded such as “fee” revenue, county revenue sources, and “special district” revenue to name a few.  Based on my rough estimations the total state and local burden is likely closer to $400 billion, possibly more, if “all” revenue sources are included) 

That puts the state’s total estimated tax burden at an estimated $300 billion, which is roughly 11.5% of the state’s economy, based 2016 California Dept. of Finance figures that peg the state’s total economic activity at about $2.6 trillion.

To put this into perspective, the federal budget recently approved by the Senate proposes about $4 trillion in spending, which is about 21% of the nation’s $19 trillion in estimated gross domestic product (GDP), according to figures produced by the Trump Administration.

It must also be noted that these figures fail to adequately account for significant “deficit spending” and “mounting debt” at all levels of government, which have the effect of pushing an increasing tax burden into the future.

Thus, while the federal government is considering a dramatic reduction in tax rates, California government continues on a “taxing binge.”

A new updated report by the California Taxpayers’ Association (Cal-Tax) found that the Democrat-run California Legislature has proposed “more taxes and fees in the first half of the 2017-18 legislative session than in all of 2015 or 2016,” states the report.

The Cal-Tax report found that California Democrat lawmakers have collectively introduced 89 proposals that “cumulatively would cost taxpayers more than $373 billion annually in higher taxes and fees,” states the report.

This “taxing binge” at the state level, has been copied at the local level of government in California in recent years with a record amount of tax and bond measures being proposed in the June and November 2016 elections.

According to a report by CaliforniaCityFinance.com, there was an “unprecedented” 452 tax increases and 184 separate bond measures placed on the November 2016 ballot by California local governments and school districts.  More than 80% of the local tax increases passed and more than 97% of the bond measures passed.

But these overall figures, don’t tell the whole story. The key policy questions that emerge are what are the factors driving this “acceleration” in the California tax burden? And how are California state and local governments spending all this additional tax revenue?

A third question that I believe must be asked yet often is not, is who is paying all these additional state and taxes?

As an expert in state and local finance, I have extensively studied the facts and evidence on all of these questions and drawn some overarching conclusions.

First, the key factor driving the recent “acceleration” in the state’s tax burden is “unchecked” and “unsustainable” increases in the “cost of government” in California at both the state and local levels.

The state’s “public employee pension crisis” is the biggest single driver of the “cost of government,” combined with significant baseline expenditure increases in current and retired public employee health care costs.

Given that labor costs typically compose more than 80% of public sector budgets, and more than 90% of the cost increases, the “cost of government” cannot be addressed without significant mitigation of public employee compensation cost increases.

Second, how are state and local governments spending this additional tax revenue?  This issue is connected to the first question and touches on perhaps one of the most disturbing trends in California public finance—this money is primarily being squandered on “unsustainable” increases in the cost of government, not on improving government services and infrastructure.

Unfortunately, the complex nature of public budgets makes it very easy to hide the nature and extent of cost increases.  But my overall conclusion is simple, the “driving forces” behind both the underlying “need” for the tax increase as well as the actual expenditures themselves are caused primarily by “unsustainable” increases in public employee compensation costs.

In short, baseline public employee compensation costs are rising at rates that far exceed average revenue growth for public agencies.  Based on my review of local and state budgets, during economic expansions stand and local revenue growth averages about 4-7% per year, compared to increases in public employee compensation costs that average between 10-25% of total agency costs.

Thirdly, who pays this increasing state and local tax burden?  This is also a complex question, but there is no question that the heaviest tax burden falls on average Californians and small businesses, particularly the poor.

A 2015 report by the California budget project, found that California’s lowest-income families pay the largest share of their income in state and local taxes, with the bottom 1/5 of all taxpayers paying 10.5% of their income in taxes.

Incidentally, these same low-income and poor families are paying nearly 70% of their income in housing costs, according to the California Legislative Analyst.

That is why the recent tax increases approved by the California Democrat Legislature are so “offensive” because they take a bad problem and make it even worse.

The $5-6 billion increase in the “gas tax” and vehicle fees is highly regressive, and so is the “cap and tax” scheme which creates a new energy tax burden that will be the heaviest on poorer individuals and families, along with small businesses.

As for the whole slew of local taxes, those also tend to fall disproportionately on “average” taxpayers, small businesses, and homeowners, as opposed to special interests who can afford to mount major opposition campaigns, thereby preventing such proposals in the first place.

Ironically, there continues to be calls for “tax reform” in California, but if you look behind these “tax and spend” efforts such as the “Make it Fair Campaign,” they all propose billions in additional taxes, particularly on individuals and small businesses.

But to truly make the state’s tax system “more fair,” that would require limiting future tax increases and lowering taxes on “average” Californians, homeowners, and small businesses.

Unfortunately, there are very few “well heeled” interest groups in Sacramento who are willing to champion that cause.

David Kersten is the president of the Kersten Institute for Governance and Public Policy—a Bay Area-based public policy think tank and consulting organization. Kersten is also an adjunct professor of public budgeting at the University of San Francisco. 

This article was originally published by Fox and Hounds Daily

Dems want to raise property taxes to fund government pensions

Pension moneyI guess I should use the old vaudeville line: Stop me if you’ve heard this one: the push to increase commercial property taxes is about government pension costs. Returning to this subject at this time (I wrote on the same subject for the Sacramento Bee last April) is prompted by the coming together of a couple of recent events.

There was the League of Women Voters and other groups hosting a meeting in Los Angeles this past weekend to “educate” people and advocate for a split roll property tax seeking to raise billions of tax dollars on the back of businesses. Also last week, Stanford University’s Institute for Policy Research issued a report by professor and former Democratic legislator Joe Nation describing the pension burden that is beginning to strangle state and local governments in California.

The services that are affected by both the split roll rally and the Stanford report are quite similar.

Supporters of the split roll say that raising taxes on commercial property will provide $9 billion a year needed for schools and services provided by local governments. Meanwhile, Joe Nation’s report says that because of pension contributions by employers (i.e. governments) increasing an average of 400% over the past 15 years, educational services, recreation, community services and others are squeezed for lack of money.

Many “core mission services,” as defined by the Stanford report, will be starved of money because of pension demands. The split roll advocates talk about the need for more money for local services. What they don’t tell you is that money for those services is being diverted to cover the pension requirements of state and local governments because these governments made generous promises to workers and accepted revenue projections to cover those promises that did not play out.

Instead of admitting that more money is needed to cover pension costs, split roll advocates create a false argument about business dodging its fair share of property taxes. They claim homeowners now pay a much larger share of the property tax burden than they did prior to Proposition 13. A Legislative Analyst’s Office report undercuts that false claim.

The report states in part, “Homeowners pay a slightly larger share of property taxes today than they did when Proposition 13 passed. Proposition 13 does not appear to have caused this increase. … In part, this may be due to faster growth in the number of residential properties than the number of commercial and industrial properties.”

The so-called grassroots activity seeking support for a split roll is backed by powerful public employee unions who support more revenues to cover the pension costs. Yet, you won’t hear anything from the split roll advocates about the pensions strangling local budgets or pushing some cities toward bankruptcies.

Meanwhile, the Stanford study makes it clear with numerous examples that pensions are absorbing greater and greater portions of local government budgets. The Stanford study states clearly there is “agreement on one fact: public pension costs are making it harder to provide services that have traditionally been considered part of government’s core mission.”

This piece was originally published by Fox and Hounds Daily

How pension costs reduce government services

A think tank at Stanford University, known for bringing investment earnings forecasts into the public pension debate in California, issued a new study last week that looks at how rising pension costs are reducing government services.

The study found that while pension costs in a large sample of retirement systems increased an average of 400 percent during the last 15 years, the operating expenditures of the government employers only grew 46 percent.

Because of the “crowd out” from soaring pension costs, money for services have been reduced, including some “traditionally regarded part of government’s core mission,” said the study by Joe Nation of the Stanford Institute for Economic Policy Research.

“As pension funding amounts have increased, governments have reduced social, welfare and educational services, as well as ‘softer’ services, including libraries, recreation, and community services,” said the study. “In some cases, governments have reduced total salaries paid, which likely includes personnel reductions.”

The Stanford institute drew national attention in 2010 when graduate students calculated state pension debt was much larger than reported. To discount future pension debt, they used earnings forecasts for “risk-free” bond rates, rather than stock-based investment portfolios.

Nation’s study uses both the actuarial assumptions baseline of the retirement systems and a bond-based alternative to project that pension costs, even without a big stock-market drop, will continue to crowd out funding for government services during the next decade.

“Employer contributions are projected to rise an additional 76% on average from 2017-18 to 2029-30 in the baseline projection and 117%, i.e., more than double, in the alternative projection,” said the study.

There have not been many attempts to show how rising pension costs reduce services. A report last year from a citizens committee appointed by Sonoma County supervisors found $269 million in “excess costs” in the county retirement system between 2006 and 2015.

With $10 million a year, said the committee, Sonoma County could fund 44 more deputy sheriffs or pay for 40 miles of road improvement. Some Sonoma officials said concern about pension costs played a role in voter rejection of a 1/4-cent sales tax for transportation.

A Los Angeles Times story last month said a big part of a tuition increase at the University of California is going for increasingly generous pensions, including $357,000 a year for a former president, Mark Yudof, who worked for UC only seven years.

David Crane, a Stanford lecturer ousted from the CalSTRS board a decade ago for questioning overly optimistic earnings forecasts, showed in April and July reports how rising retirement costs are “shortchanging students and teachers” despite large school revenue gains.

The new Stanford institute study has 14 separate case studies: the state, six local governments in CalPERS including formerly bankrupt Vallejo and Stockton, the independent Los Angeles system, three county systems, and three school districts in CalSTRS.

The study said their “pension contributions now consume on average 11.4% of all operating expenditures, more than three times their 3.9% share in 2002-03,” and by 2029-30 will consume 14 percent under the baseline, 17.5 percent under the alternative.

In contrast, a survey of the public retirement systems done for former Gov. Arnold Schwarzenegger’s Public Employee Post-Employment Benefits Commission found pension contributions had been stable for more than a decade prior to the report in January 2008:

“Even though State pension contributions have risen in the past decade, they have remained at a relatively stable 3.5% to 4% of total General Fund revenues from the mid-1990s to present. The exception is 1999 to 2002 when contributions were significantly lowered.”

Table - stanford2

The Stanford institute’s case study of state spending on CalPERS and CalSTRS said $6 billion was shifted from other expenditures to pensions this fiscal year, much of the money apparently coming from social services and higher education.

The calculation was based on the growing cost of pensions during the last 15 years that, despite an expanding state budget, took 2.1 percent of operating expenditures in 2002-03 and an estimated 7.1 percent of operating expenditures this fiscal year.

The pension share of state operating expenditures in the baseline projection reaches 10.1 percent in 2029-30 and 11.4 percent in the alternative, crowding out an additional $5.2 billion or $7.4 billion.

“This expansion in pension funding requirements could be accommodated with additional 27% reductions in DSS and Higher Education expenditures (or reductions in other agencies and/or departments), or with slightly more than 4% across-the-board budget reductions,” said the study.

In an unrelated coincidence of numbers, the state got a $6 billion low-interest loan from its large cash-flow investment fund this year to double its annual payment to CalPERS, saving an estimated $11 billion over the next two decades by more quickly paying down debt.

The big loan, criticized by some who wanted more study, was bolstered late last month by a state Finance department analysis of the cash management, repayment plan, interest rates, investment earnings, and expected savings.

Annual state payments to CalPERS are expected to average about 2.2 percentage points less over the next two decades. Peak miscellaneous rates would drop from 38.4 percent of pay to 35.7 percent, peak Highway Patrol rates from 69 percent of pay to 63.9 percent.

“It is expected that any deviation from assumed CalPERS returns, or projected U.S. Treasury rates, will still result in significant net savings, and that any issues with funds’ ability to repay its share of the loan can be absorbed by the repayment schedule and effectively resolved,” said the Finance analysis given to the Legislature.

The California Public Employees Retirement System, like many public pensions, has not recovered from huge investment losses in the financial crisis a decade ago. The CalPERS state plans only have 65 percent of the projected assets needed to pay future pensions.

CalPERS estimates the $6 billion extra payment will increase the funding level of the state plans by 3 percentage points. The Finance analysis also said the extra payment would “partially buy down the impact” of a lower CalPERS discount rate.

Last December CalPERS lowered the investment earnings forecast used to discount future pension costs from 7.5 percent to 7 percent, triggering the fourth employer rate increase since 2012.

The annual valuations CalPERS gave local governments this fall reflect a drop of the discount rate from 7.5 percent to 7.35 percent next fiscal year, the first step in a three-year phase in.

number of cities unsuccessfully urged the CalPERS board last month to analyze two ways to cut pension costs: suspend cost-of-living adjustments and give current workers lower pensions for future work.

The Oroville finance director, Ruth Wright, told the CalPERS board: “We have been saying the bankruptcy word.” Salinas Mayor Joe Gunter created a stir by using the “bankruptcy word” at a city council meeting on Sept. 26 while talking about rising salaries and pension costs.

“How do we get this under control? How do we keep this city sustainable so we don’t have to file for bankruptcy?” Gunter asked.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. 

This article was originally published by Calpensions.com.