Using pension funds to shrink the budget gap

Former Assemblyman Keith Richman of  Northridge, has an idea for closing part of a giant state budget gap: A one-year “holiday” on contributions to pension funds, saving about $4.6 billion.

It’s a desperate move, but these are desperate times.

Retirees would continue to get their checks. But to keep the money flowing, CalPERS and CalSTRS would have to dip into investment funds already hit hard by the stock market crash.

Richman, a Republican, said powerful public employee unions, whose labor contracts give pension benefits an ironclad legal guarantee, would have to agree to the state contribution holiday.

Richman said the break in contributions wasn't really a "holiday," but rather a change in the way years of service are calculated.He said the key point is that the year would not count as a "year of service" in the calculation of employee pension benefits.

"If someone worked 30 years that included this year, they would have to work 31 years to get 30 years of credit," Richman said. The state and the employees would not make pension contributions during the year

The incentive for employees would be bigger paychecks, because the holiday would allow them to keep their annual pension contribution.

Most state workers in the California Public Employees Retirement System contribute 5 to 9 percent of payroll, less than state contributions that range from 13 percent of payroll all the way up to 28 percent for the California Highway Patrol.

So in addition to replacing the state share, CalPERS and the California State Teachers Retirement System would have to take several billion more from their investment funds to make up for the loss of the employee contributions.

Richman thinks that the contribution holiday could be structured to avoid lowering pension benefits or adding to the shortfall in the funds needed to meet future pension obligations.

“It means they would have to wait a year more to retire,” he said. “It’s completely off the books. Yes, they (the pension funds) have an unfunded liability, but it doesn’t change that.”

Whether the actuaries that forecast pension fund obligations would see it that way is not clear. But pension contribution holidays have been used elsewhere — for example, in New Jersey.

Legislation passed in New Jersey earlier this year allows local government retirement systems to delay making half of their annual pension contribution, giving them 15 years to make up the missed payments.

CalPERS, which serves the state and about 2,000 local government retirement plans, has had contribution holidays in the past. But that was when a surging stock market boosted investments, providing enough funds to meet projected future needs.

“When the markets did extremely well we had 70 percent of the employers in California contributing zero,” Ron Seeling, the CalPERS chief actuary, told an asset allocation workshop this month, referring to the 1990s.

He said that when contributions from many employers were no longer flowing into CalPERS, there were projections about when investments might have to be sold to make payments to retirees.

“There’s nothing wrong with that,” said Seeling. “That’s the natural life of a pension fund. But the day was racing towards us. Some-times we got four and five years away, and we thought we were going to have to start selling stuff just to make the benefit payments each month.”

Then after the high-tech boom ended around 2000 a falling stock market bit into the investment portfolio, causing contribution rates to rise to the highest they had been in a quarter of a century.

“This day of having to sell something flew off into the distant future,” Seeling said. “It could have happened in my lifetime. And now with this downturn (the stock market crash last fall) that day will disappear into the remote future.”

As most state programs face cuts, the CalPERS board voted unanimously this month to increase the annual state contribution to CalPERS by $262 million, bringing the total in the new fiscal year that begins July 1 to $3.3 billion.

Because of a one-year lag in contribution calculations, the rate hike reflects an unexpected increase in the state payroll and number of employees in the fiscal year that ended last July 1.

The CalPERS board gave preliminary approval this month, on a split vote, for a “smoothing” plan to ease the impact of the market crash when it is reflected in contribution rates for the fiscal year beginning in July of next year. (See Calpensions 14 May 09: “CalPERS: smoothing costs, not cutting benefits”)

Court decisions and a voter-approved initiative allow the CalPERS board to set employer contribution rates. CalSTRS needs legislation to set its state contribution rate, currently about $1.3 billion.

Even though the stock market crash wiped out a third of their value, the two retirement systems still have giant investment portfolios — CalPERS $180 billion last week, CalSTRS $117 billion on April 30.

Just drawing attention to pension contributions makes a point for Richman, a leader in the movement to reduce what critics say are overly generous public employee pensions that are eating up too much of state and local government budgets.

Richman proposed a ballot measure, briefly backed by Gov. Arnold Schwarzenegger in 2005, that would have switched new state and local government employees to a 401(k)-style retirement plan increasingly common in the private sector.

Instead of a guaranteed monthly pension payment, the retirement plan for the new employees would have been an individually controlled investment plan, rising and falling with the market.

Richman is president of the Foundation for Fiscal Responsibility. Its website has a searchable database of the California government retirees who receive CalPERS pensions of more than $100,000 a year.

The foundation has proposed an initiative that would control the cost of public employee pensions by increasing retirement ages and capping benefits. (See the Jan. 26 issue of CalPensions at http://calpensions.com.)

A new version is being prepared that may surface first as legislation.

“We do intend to proceed with an initiative,” said Richman. “I can’t tell you the timing. We are building our organization and getting more interest all the time.”

Senate Republicans unveiled a budget “roadmap” last week that, among other things, calls for limiting public employee pensions and raising retirement ages “to bring them in line with the private sector.”

No details were available. But a spokeswoman, Melanie Reagan, said the broad concepts in the roadmap are expected to be developed into a legislative package in the weeks ahead.

The state is in deep financial trouble and facing devastating budget cuts. Voters rejected $6 billion worth of gap closures last week, and a troubled economy continues to erode tax revenue.

The estimated budget gap is a staggering $24 billion, despite legislative action in February that cut spending and imposed a $12.5 billion increase in the sales and income taxes and the vehicle license fee.

It’s a historic tailspin for state finances, a plunge not seen since the Great Depression of the 1930s.

A state budget enacted last September had a $103 billion general fund that pays for most programs. The mid-year budget action in February cut general fund spending in
the current fiscal year to $94 billion.

A budget proposed earlier this month by Schwarzenegger for the new fiscal year beginning July 1 had a $84 billion general fund. A news story about a budget meeting late last week said the new general fund target may be $76 billion.

The governor is talking about rolling back spending to 1999 levels, wiping out a decade of gains or unaffordable cost increases, depending on your viewpoint. Republicans, ousting their leaders over the tax increase, vow to block any more tax hikes.

There have been proposals to eliminate entire health programs for children and the needy. Schools face deep cuts. And thousands of state workers, who have already taken pay cuts through furloughs, are expected to be laid off.

Richman said a pension contribution holiday “would be an immediate action that could impact the budget and prevent furloughs and layoffs.”

Reporter Ed Mendel, an expert on state fiscal issues, covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. His stories can be viewed on his blog at http://calpensions.com.