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Soaring pension costs: should workers pay more?

There aren’t many ways to make quick cuts in public employee pension costs, but Gov. Arnold Schwarzenegger proposed one last week.

His new budget would divert an additional 5 percent of state worker pay to help the state cover pension costs, doubling the annual pension contribution already being made by most state workers.

The larger employee payment is expected to yield $406 million, allowing a similar reduction in the annual state payment to the California Public Employees Retirement System.
The shift would take a big bite out of the annual state pension payment, which the powerful CalPERS board increased from $3.3 billion currently to $3.5 billion in the new state budget year that begins in July.

The state pension payment for most state workers is 16.9 percent of payroll. The governor’s proposal would move the payments toward a more even split, the typical employee contributing 10 percent of pay and the state 11.9 percent.

“Another major area that we must reform is our pension system, whose costs have gone up by more than 2,000 percent in the last 10 years — from less than $150 million a year to more than $3 billion a year and growing fast,” Schwarzenegger said as he unveiled his budget proposal Friday (Jan. 8).

In his State of the State address on Wednesday, the governor renewed his call for a pension reform he proposed last June — a cut giving new hires the same pensions received by state workers before a major benefit increase a decade ago.

The cut would be limited to new hires because pensions promised current workers are vested rights, protected under contract law, and government also has an obligation to keep its word.

“Now, for current employees these pensions cannot be changed, either legally or morally,” Schwarzenegger said in his State of the State address. “We cannot break the promises we already made. It is a done deal. But we are about to get run over by a locomotive. We can see the light coming at us.”

Lowering benefits for new hires is perhaps the most common pension reform proposal A “two-tier” plan, with different benefits for current employees and new hires, would be created by an initiative proposed by a reform group led by Marcia Fritz.

One of the problems with a two-tier plan is that most savings are delayed until much of the current workforce is replaced, which can take decades. The governor’s two-tier plan, for example, would be expected to save $74 billion over the next three decades.

But his follow-up proposal to boost worker contributions, yielding immediate savings for the state, is part of the governor’s proposal for a new package of worker pay cuts to replace the current furloughs, three Fridays a month that reduce pay 14 percent.

The furloughs, saving the state $1.1 billion a year, would be replaced by a broader $1.4 billion package that includes a 5 percent pay cut, a 5 percent cut in the total number of state workers, and the 5 percent increase in pension contributions.

The state budget condition is dire, despite major spending cuts and tax increases last year. To help close a $20 billion shortfall over the next 18 months, the governor’s plan assumes the state will get an additional $6.9 billion from the federal government.

If there is no federal windfall, as some think is likely, the governor’s fallback list of additional cuts needed to close the budget gap includes another 5 percent pay cut for state workers, saving the state $508 million.

About two dozen lawsuits have been filed to overturn the furloughs. CalPERS and the California State Teachers Retirement System comply with the furloughs, even though cuts in their independent budgets do not directly aid the deficit-ridden state general fund.

The furloughs were done by the Republican governor through executive order. A switch to pay cuts and a pension payment increase requires action by the Legislature, possibly creating a dilemma for majority Democrats.

The state general fund has already had historic cuts, dropping from $103 billion in a budget approved less than a year and a half ago to $83 billion in the governor’s proposal for the new fiscal year beginning in July.

The governor and Republican legislators oppose additional tax increases. Lawmakers face painful decisions, perhaps including the outright elimination of some health and welfare programs.

For Democratic legislators, every dollar not taken from state workers, whose unions are their allies, may look like a dollar that could have been used to reduce devastating cuts in human services they strive to protect.

The governor’s budget proposal was not welcomed by the president of the largest state worker union, Yvonne Walker of Service Employees International Union Local 2000.
She said the furloughs have been counterproductive and costly for the state in many cases — cutting staff time for tax collection, aiding the unemployed, processing motor vehicle payments, aiding veterans, rehabilitating prisoners and other things.

Walker said members of her union, acknowledging the need to contribute to a budget solution, approved a pay-cut package that included one furlough day and the elimination of some overtime and holidays.

But the Legislature never approved the agreement the union negotiated with the Schwarzenegger administration, reportedly because Republican legislators thought the cuts did not save the state enough money.

“It’s not like the unions are not going to sit down and negotiate on their contracts,” said Walker.

The furlough days do not reduce the pensions of state workers, which are based on final pay and the number of years served. But the pay cut proposed by the governor could reduce pension amounts.

The governor is not the only one proposing that public employees pay more of their pension costs. Similar proposals were made last year by city manager groups in San Diego and several other counties.

Unlike state workers, many local government workers do not make pension payments. Their employers agreed in labor negotiations to pay the employee share, often ranging from 5 to 9 percent of pay under CalPERS formulas.

Many public pension systems, particularly after benefit increases that began with SB 400 in 1999, assume that most of the money needed to make payments to retirees will come from investment earnings, not contributions by employers and employees.

When investment earnings fall below their target, as happened in a big way during the recent stock market crash, higher annual payments to make up for the losses are required by law from the employers, not the employees.

To avoid a rate shock for the state, the CalPERS board last month approved an extraordinary “smoothing” method expected to leave the fund 65 percent funded after 30 years, well below the 80 percent some say should be the minimum.

Actuaries told the board that an additional $1 billion contribution from the state would be needed to push the estimated funding level above 80 percent three decades from now.
The smoothing method pushes the debt into the future. But CalPERS has $200 billion in assets and annual payments to retirees that currently are only a few billion above employer-employee contributions.

If the CalPERS board is willing to accept low funding levels (CalSTRS was at about 30 percent in the 1970s) the locomotive mentioned by the governor could be a long time getting here.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories can be viewed on his blog at htttp://calpensions.com.


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