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In January, I was invited to give a presentation on the state of California’s public pensions at the annual meeting of the conservative Federalist Society. The experience proved to be extremely depressing. While my talk focused primarily on financial losses caused by risky investment strategies, my fellow co-panelists — conservative legal minds like John Eastman, a GOP candidate for attorney general — focused on legal theories that will soon be used to try to roll back existing pension benefits.
Put simply, not only did we disagree about the right solution to the problem, we couldn’t even agree on what the problem was.
Sitting in bumper-to-bumper L.A. traffic, I began to realize that what was needed is a new way to think and talk about public pension liabilities, a representation of the problem that can help us identify the problem’s source and, hopefully, lay the groundwork for a fair and politically viable solution. And so this column was born.
One picture is worth a thousand words, and so I hope the one below does the job. In the chart, the red line represents the pension liabilities facing the city of San Diego. It tracks the present discounted value of the pension benefits promised to city employees — essentially, how much money the city would need to put in the bank today to eventually pay off all of the benefits promised to employees up until now. The blue line, by contrast, represents how much money the city currently has in the bank. The dark gray shaded region is the fundamental problem — the gap between the liabilities racked up so far and the assets we’ve set aside to cover them. Currently, that problem exceeds $2 billion.
One fact stands out: The unfunded pension liability is a relatively recent phenomenon. Throughout most of the 1990s, pension assets pretty closely tracked pension liabilities. So what caused the change that produced the big gray blob starting in the early 2000s? The answers offered to that question define the two sides in the city’s pension wars.
One side, which I’ll call the “Liabs,” points to the red line in the chart. Pension liabilities, they say, grew far faster than the city’s ability to pay for them, and so the solution is to trim pension benefits back to levels we can afford. Councilman Carl DeMaio is the leader of the Liabs army, which includes the San Diego County Taxpayers Association and other leaders in the business community.
To make their case that pension liabilities are the problem, the Liabs point to decisions like the granting of retroactive benefit increases in the mid-1990s and the early 2000s, the systematic under-pricing of service credits, and outrageous abuses like “spiking” that increase pension benefits above levels ever contemplated by policymakers.
The other camp, who I’ll call the “Asses,” argues that the blue line is the problem. (I called the first group the “Liabs” because they blame the liab-ilities, and the other the “Asses” because they blame the ass-ets.) It’s not that pensions are too generous, they’d say, but rather that the city never funded them properly, allowing assets to grow far slower than they should have. The solution is for taxpayers to pony up the money they should’ve paid into the system long ago, preferably by raising taxes to levels already in place in other cities. The Asses include the city’s labor leaders and, to a certain extent, myself.
To make their case that inadequate assets are the problem, the Asses point to the city’s decades-old practice of diverting pension fund earnings to spend on other city programs and, starting in the mid-1990s, the city’s decision to systematically underfund the pension system.
Thus far, I hope both sides would be on board with my representation of their positions.
Though there is truth to both arguments, neither side is correct.
Despite the Liabs’ continued insistence that outrageous pension benefits are the entire problem, their argument was soundly rejected by San Diego’s Pension Reform Committee. In its 2004 report, the committee estimated that pension benefit enhancements — both retroactive and prospective — accounted for 40 percent of the $1.2 billion pension liability in place at the time. Most of the increase in the liability since then has been due to investment losses, meaning that pension benefit increases probably account for no more than a third of the total unfunded liability. (It is disturbing that former City Council candidate April Boling, who has become the leading spokeswoman for the Liabs, was the chairwoman of the Pension Reform Committee and should know better.)
The Liabs also seem to forget that the benefit increases were negotiated precisely to get the city’s labor unions to allow the city to underfund its pension contributions, sparing taxpayers a painful decision between raising taxes and cutting services. Can the Liabs really make a reasonable argument that taxpayers should not now contribute the money originally owed in the 1990s?
Of course, the arguments of the Asses deserve scrutiny as well. They are right that had “surplus” pension fund earnings stayed in the pension system during the 1980s and 1990s rather than being diverted to the city budget, and had the city made its full pension payments in the late 1990s, the recent investment losses would not have caused the massive increases in the city’s pension payment that we see today.
(The recent claim in a story by the U-T’s Craig Gustafson that the current pension system places all of the financial risk on taxpayers while giving workers all of the rewards is simply false. While taxpayers are on the hook to pay more when investment earnings fall short, they pocket all of the rewards when investment earnings top expectations by making smaller pension contributions. Over the years, larger payments during bad economic times are offset by smaller payments during good economic times, leaving the taxpayers whole.)
What the Asses ignore, however, is that the city used surplus pension earnings to pay for things that directly benefited city employees! These include the 13th check for retirees and retiree health care benefits, which for many years the city funded by raiding the pension system. They must also acknowledge that the retroactive benefit increases were a mistake and that, by signing off on the pension underfunding, labor leaders deserve as much blame as city officials and the taxpayers who elected them. Having given the city a subprime loan they knew it could never afford, labor unions cannot now expect the city to pay it back in full.
Closing the unfunded liability in an equitable way would require both sides to compromise. First, labor leaders need to make concessions to offset previously granted benefit increases, moving the liability line closer to the trajectory it was on during the 1990s. Second, DeMaio and his disciples need to agree that taxpayer contributions must make up for the pension underfunding of the late 1990s, a portion of the surplus earnings diverted from the pension system for more than two decades and the forgone investment earnings that resulted from both decisions. In other words, the blue asset line must go up dramatically as well. Both taxpayers and employees will feel significant amounts of pain.
To their credit, the Asses have moved toward compromise. Labor groups have agreed to significantly lower pension benefits for new hires, accepted wage concessions in recent years, and have taken large pay cuts by agreeing to increase employee pension contributions. By contrast, the Liabs have yet to budget. DeMaio’s recent plan, which calls for cutting pensionable pay, puts the entire burden of closing the unfunded liability on the backs of employees, letting the taxpayers off the hook.
I’ll conclude with another chart, this one taken from page 17 of SDCERS’ recent actuarial valuation, which highlights the temporary nature of our predicament. Absent any corrective action, the city’s pension payment will grow to an incredible 55 percent of payroll by the mid-2020s. Yet, by the late 2030s, it would fall again to less than 10 percent of payroll.
The chart should remind us to keep our eye on the ball. The challenge is to find a fair solution to get through the pain through the next two decades. Instituting a 401(k)-type retirement plan for new city hires, by contrast, will do absolutely nothing to close the current liability, and provides a permanent solution to what is a temporary problem.
Vladimir Kogan is a doctoral student at UCSD’s Department of Political Science and a former voiceofsandiego.org reporter. He is a co-author of a forthcoming book about San Diego politics and its pension crisis. His e-mail address is email@example.com.