Public Pensions and California's Fiscal Future

Governor Schwarzenegger wrote an op-ed piece for the WSJ, Public Pensions and Our Fiscal Future:

Recently some critics have accused me of bullying state employees. Headlines in California papers this month have been screaming "Gov assails state workers" and "Schwarzenegger threatens state workers."

I'm doing no such thing. State employees are hard-working and valuable contributors to our society. But here's the plain truth: California simply cannot solve its budgetary problems without addressing government-employee compensation and benefits.

As former Speaker of the State Assembly and San Francisco Mayor Willie Brown pointed out earlier this year in the San Francisco Chronicle, roughly 80 cents of every government dollar in California goes to employee compensation and benefits. Those costs have been rising fast. Spending on California's state employees over the past decade rose at nearly three times the rate our revenues grew, crowding out programs of great importance to our citizens. Neglected priorities include higher education, environmental protection, parks and recreation, and more.

Much bigger increases in employee costs are on the horizon. Thanks to huge unfunded pension and retirement health-care promises granted by past governments, and also to deceptive accounting by state pension funds (such as unreasonable projections of investment returns), California is now saddled with $550 billion of retirement debt.

The cost of servicing that debt has grown at a rate of more than 15% annually over the last decade. This year, retirement benefits—more than $6 billion—will exceed what the state is spending on higher education. Next year, retirement costs will rise another 15%. In fact, they are destined to grow so much faster than state revenues that they threaten to suck up the money for every other program in the state budget. (See the nearby chart.)

I've held a stricter line on government employment and salary increases than any governor in the modern era (overall year-to-year spending has increased just 1.4% on my watch). Nevertheless, employee costs will keep marching upwards because of pension promises, and they will never stop doing so until we get reform.

At the same time that government-employee costs have been climbing, the private-sector workers whose taxes pay for them have been hurting. Since 2007, one million private jobs have been lost in California. Median incomes of workers in the state's private sector have stagnated for more than a decade. To make matters worse, the retirement accounts of those workers in California have declined. The average 401(k) is down nationally nearly 20% since 2007. Meanwhile, the defined benefit retirement plans of government employees—for which private-sector workers are on the hook—have risen in value.

Few Californians in the private sector have $1 million in savings, but that's effectively the retirement account they guarantee to public employees who opt to retire at age 55 and are entitled to a monthly, inflation-protected check of $3,000 for the rest of their lives.

In 2003, just before I became governor, the state assembly even passed a law permitting government employees to purchase additional taxpayer-guaranteed, high-yielding retirement annuities at a discount—adding even more retirement debt. It's as if Sacramento legislators don't want a government of the people, by the people, and for the people, but a government of the employees, by the employees, and for the employees.

For years I've asked state legislators to stop adding to retirement debt. They have refused. Now the Democratic leadership of the assembly proposes to raise the tax and debt burdens on private employees in order to cover rising public-employee compensation.

But what will they do next year when those compensation costs grow 15% more? And the year after that when they've risen again? And 10 years from now, when retirement costs have reached nearly $30 billion per year? That's where government-employee retirement costs are headed even with the pension reforms I'm demanding. Imagine where they're headed without reform.

My view is different. We must not raise taxes or borrow money to cover up fundamental problems.

Much needs to be done. The assembly needs to reverse the massive increase in pension formulas to government workers (including already retired workers) that it enacted 11 years ago. It also needs to prohibit "spiking"—giving someone a big raise in his last year of work so his pension is boosted. Government employees must be required to increase their contributions to pensions. Public pension funds must make truthful financial disclosures to the public as to the size of their liabilities, and they must use reasonable projected rates of returns on their investments. The legislature could pass those reforms in five minutes, the same amount of time it took them to pass that massive pension boost 11 years ago that adds additional costs every single day they refuse to act.

And after they've finished passing those reforms, they could take another five minutes to pass legislation terminating the annuity give-away they passed in 2003 and ending the immoral practice of pension fund board members accepting gifts or even campaign contributions from lobbyists, salesmen, unions and other special interests.

Reforming government employee compensation and benefits won't close this year's deficit. It will, however, protect the next generation of Californians from overwhelming burdens. The same is true with respect to the other reform I'm demanding, including the establishment of a rainy-day fund so that legislators can't spend temporary revenue windfalls.

All of these reforms must be in place before I will sign a budget.

I am under no illusion about the difficulty of my task. Government-employee unions are the most powerful political forces in our state and largely control Democratic legislators. But for the future of our state, no task is more important.

Governor Schwarzenegger is in for the fight of his life. Reading the daily headlines on Jack Dean's Pension Tsunami gives you a flavor of just how dire the fiscal situation is. Without serious public pension reforms, California is heading towards fiscal hell.

And it's not just California. Other states will suffer the same fate if they refuse to reform public pensions. You simply can't promise more than you can afford to pay out. At one point, you have to address the problem or face much higher borrowing costs. Raising taxes is not a long-term solution to mounting pension costs. It's akin to placing a band-aid over a tumor.

With so much economic pain and uncertainty, it's irresponsible to ask more from the private sector to deal with public sector pension shortfalls. I sympathize with many hard working public sector employees who had nothing to do with the financial crisis, but I also realize that pension apartheid is not the solution. You can't expect people who lost considerable sums in their 401K plans to pay more in taxes to make up for public sector pension deficits.

Stakeholders need to sit down and figure out a way to reform their public pensions. And it's not just about cutting benefits, raising the contribution rate and retirement age. They need to introduce meaningful, comprehensive reforms which include world class governance standards so that the public and stakeholders are reassured that pension monies are being managed properly and in everyone's best interest.

Finally, listen to New Jersey's governor, Chris Christie, below on how he handled powerful public sector unions and introduced measures to address the state's fiscal woes. Nobody likes reforms, especially when it hits their pockets, but ignoring the problem is only delaying the day of reckoning.