A few numbers to remember: 1.9, 72, 24, 92, 25, 67 and 121. No, they are not related to last week’s lotto, nor are they the residual carnage of a Sudoku factory meltdown. But they are important numbers to remember as Gov. Jerry Brown and lawmakers prepare to tackle a fiscal liability that rivals or surpasses the size of its more high-profile cousins – the state’s unfunded pension liabilities. If left unaddressed, it will sow the seeds of a future budgetary crisis.
The state of California, like many governments, provides health care to its retirees. What the state does not have, regrettably, is a fiscally prudent plan for how to fund these benefits in a manner that minimizes costs for taxpayers and the civic workforce that serves them.
Instead, we pay the minimum amount due each year, or $1.9 billion. This is just enough to cover the state’s portion of annual premiums. As with only making the minimum payment on your credit cards while continuing to recklessly charge away, the shortcoming of this approach is that the debt will keep growing and, eventually, crowd out the household’s ability to pay for other vital needs.
My latest analysis reveals that the price tag for providing retiree health care to our existing state workers as well as current retirees is nearly $72 billion. In the past eight years, the number has ballooned by a stunning $24 billion – $7.2 billion in the last year, alone.
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In five years, if we continue to do nothing, experts conservatively project that this liability can easily exceed $92 billion.
Is this cause for panic? No, but Californians must surrender neither to complacency nor to the equally dangerous temptation of polluting the upcoming policy debate with over-the-top invectives or fear-mongering.
I encourage Californians instead to look to the numbers. The $72 billion liability can be cut by $25 billion, or 35 percent, if we can adopt a funding approach based on a quip most often attributed to Albert Einstein, “Compound interest is the most powerful force in the universe.” One dollar invested today at 7 percent interest will accumulate to two dollars 10 years from now.
Under this approach, California would “pre-fund” retiree health care benefits by systematically setting aside enough money in a trust fund where the moneys are invested. The resulting investment income would significantly offset what employees and taxpayers would otherwise have to pay.
The state’s pension funds have been following Einstein’s advice for more than 80 years to the benefit of taxpayers and public employees. Today, 67 cents of every dollar spent on retirees’ pensions are derived from investment income and the power of compounding interest.
Unfunded liabilities are a difficult political sell. They are harder to see and appreciate than potholes, overcrowded classrooms and barren agricultural fields. However, if we refuse to see what is clearly coming over the horizon, not only will we allow retiree health care costs to crowd out other spending priorities, but we will limit our ability to access the capital markets to finance our grossly unmet infrastructure needs – from building new schools to repairing levees to adding more capacity to our overcrowded roads and highways.
The Governmental Accounting Standards Board, which establishes state and local government accounting and financial reporting guidelines, is looking at these liabilities with greater scrutiny and held hearings this fall on proposals that would require greater disclosure regarding how this liability will affect the balance sheets of public agencies.
Credit analysts have been carefully watching what municipal bond issuers (of which California is the largest) are doing in the face of mounting unfunded liabilities, such as paying for retiree health benefits. A recent report from Standard & Poor’s found that only a handful of states come close to fully funding this liability, while California is among the worst with funding levels below 5 percent.
While the state has recently enjoyed several credit rating bumps and may be in position for another based on California’s improved economic conditions, there is growing consensus that we will soon reach a ceiling unless we adopt a meaningful plan.
Can we manage this emerging problem with fiscal discipline and stave off a future crisis? Can California improve its credit rating and, therefore, its ability to finance its capital infrastructure needs? In the coming months, 121 Californians – 40 senators, 80 Assembly members and the governor – will answer these questions. I encourage you to tell them what you think.
John Chiang, the California state controller, will be sworn in as state treasurer on Monday.