In the May revision to his 2013-14 budget, Gov. Jerry Brown announced an increase in state revenue, largely as a result of rising stock and real estate prices. Appropriately, the governor has counseled spending restraint because the state still hasn't addressed core budget issues and inevitably will face more shortfalls when markets revert to the mean. But there is a uniquely good spot for that revenue.
The California Teachers' Retirement System, CalSTRS, administers pension promises made to teachers by their employers, which are school districts. CalSTRS is an intermediary that collects contributions from districts, teachers and the state, invests those contributions to generate earnings, and uses the proceeds to pay out benefits to retired teachers.
Everything works fine when contributions + earnings = benefits. But when earnings fall short, a deficiency is created that, because defined benefit pensions are owed regardless of investment performance, must be paid off. To do that, CalSTRS is seeking a cash infusion from its contributors of $4.5 billion per year for 30 years, or $135 billion. That's on top of the $5.7 billion it already receives in contributions each year from those contributors.
Not meeting the request is the equivalent of borrowing money from a loan shark because, according to CalSTRS, the deficiency grows by $6.2 billion every year the $4.5 billion isn't contributed. It's also fatal, because without the infusion, CalSTRS says it will run out of money by 2044. Some observers believe that CalSTRS will run out of money in the 2020s and needs more than $135 billion but, either way, everyone agrees CalSTRS needs a lot of money and the sooner that money is contributed, the lower the cost.
When CalSTRS runs out of money, a huge wave will hit school districts. That's because districts will then be responsible for 100 percent of pension payments, which are owed in amounts far greater than contributions and for many decades after 2020 and 2044. Those pension payments will swamp district budgets, leaving less for the classroom. School districts will exist largely to pay retirement costs, not to teach children.
Unlike the California Public Employees' Retirement System, CalPERS, which administers retirement benefits for the state and other governments, CalSTRS can't just send a bill for the deficiency. Instead, CalSTRS' funding is set by state statute. The governor and Legislature haven't updated the statute to reflect the shortfall, so contributions have failed to keep up. As a result, the deficiency keeps growing as does the height of the wave that will hit the districts.
Brown has been silent on teacher pension funding. The cynic's view would be that's because he knows that the wave won't hit during his tenure. But that's terrible financial management since every $4.5 billion not contributed in cash means an additional $6.2 billion of debt and increases the height of the wave. If Brown doesn't act on CalSTRS' request before he likely leaves office, the wall of teacher pension debt will grow by $43 billion.
As with climate change, pension problems grow invisibly and then become unsolvable when they manifest. If CalSTRS' debt is allowed to keep growing, funding for classroom instruction will be destroyed. To restore that funding, citizens at that time will likely seek cuts in pension payments to retired teachers who rightfully expect to receive what they were promised. The only way to prevent these consequences is to fund in advance, and the further in advance, the smaller the payments.
That solution takes a courageous leader, one who acts before problems are visible and tells truths citizens don't want to hear. That's why the state should use its unexpected revenue this year to kick-start a global agreement on CalSTRS, which must include reforms and increased contributions from the state, school districts and employees.
Another reason to act now is that time is not on the state's fiscal side. It has extra revenue this year, but its own pension bills from CalPERS are going up by 50 percent in 2015, the state expects higher Medi-Cal costs, the Proposition 30 tax increase expires in 2019, and stock and real estate prices won't go up forever.
In 2002, Warren Buffett warned that derivatives were financial weapons of mass destruction. When later they exploded, we wondered why authorities did not act earlier. In 2008, the same Buffett warned about public pension-cost surprises. When that happens and wipes out K-12 education, people will ask why authorities did not act earlier. After all, they were warned.
Brown should use the new revenue to address the teacher pension shortfall. If not now, when?
David Crane is a former CalSTRS board member. He is a lecturer at Stanford University and president of Govern for California.