During my four years as director of the state Department of Finance I signed off on the Legislative Analyst's Office analyses of hundreds of initiative proposals and I almost always agreed with their conclusions. I have the highest regard for the LAO, where my career in state government began. So, I was surprised and disappointed with its analysis of the two pension reform measures filed by the Californians for Pension Reform.
The LAO says, essentially, that both measures will create both costs and savings. While the potential to create billions of dollars of savings for taxpayers in California is obvious and acknowledged by the LAO it may be less obvious how such aggressive pension reform plans could create additional costs. The LAO suggests that costs would arise for two reasons, both of which are theoretically correct but, in my opinion, misleading.
First, the LAO notes that by reducing the generosity of public pensions, the initiatives could result in public employers having to raise salaries to attract workers. No economist would disagree that if the public employment market were in a state of perfect equilibrium, a reduction in any one component of total compensation would drive increases in the other components. On the other hand, no one in their right mind thinks public employment is now in a state of perfect equilibrium. You only have to look at the long lines of applicants for any public job to know that the demand for those jobs far outstrips the supply.
Studies merely verify what common sense tells us: Public employee compensation is far above market. But beyond that reality, who believes that state and local governments have the wherewithal to raise salaries, now or any time soon? (Well, apparently the leaders of our Legislature do, but we all know that they live in a different world than the rest of us.) So, when voters consider these initiatives they should ignore these entirely theoretical costs.
Second, the LAO says that the plans could increase employers' annual contributions over the next two or three decades. They cite two ways in which this might happen.
For both plans, the LAO says that moving new employees into the new, lower-cost system will result in less cash flow coming in to cover costs of existing employees and retirees, which in turn will require higher employer contributions. Gov. Jerry Brown rightly said that calling that a cost of a hybrid plan is tantamount to an admission that the current pension funds are Ponzi schemes.
He was right; these are not new costs at all. These are unfunded liabilities that already exist. They will have to be funded sooner or later, and the sooner the better. On the other hand, neither of the Californians for Pension Reform's proposals, as the LAO correctly notes, actually require public employers to pick up these costs any sooner than they would under current law.
For the defined contribution version, the LAO also sees a chance that pension plans will reallocate their investments in a way that would reduce their returns. The LAO seems to believe this could happen because of the need to have shorter term and lower-risk investments.
Of course, the other side of that coin is that the initiative shifts risks from the taxpayer to the employees. I think the LAO should have acknowledged that fiscal benefit as being equally as important as the potential to reduce investment returns.
Pensions are long-tailed obligations that currently impose risk only on the taxpayer. As the CalPERS actuary said three years ago, our current pension systems are unsustainable. To really understand the fiscal effect of pension reforms, one has to compare them to what will happen if we do nothing. In fact, with unfunded liabilities across the state somewhere between a quarter and a half a trillion dollars, we have no choice but to do something now.
CPR's two initiatives both go further than Brown's hybrid proposal. They will both reduce unfunded liabilities in the long run. They both shift more of the risks inherent in pensions from the taxpayer to the employee. They both bring new employees' pension benefits much closer to what federal employees and private sector employees receive.
While a careful reader can find all of that in the LAO's analyses of the governor's plan and the two CPR plans, I worry that the average voter will be misled too easily into thinking that our pension systems are like the Eagles' "Hotel California": You can check out any time you like, but you can never leave.