SAN FRANCISCO (Reuters) – A radical plan to slash public employee pension benefits gets voted on by the residents of Silicon Valley’s San Jose on Tuesday – a decision that could set an important precedent for many other cities, not only in California but across the nation.
The nation’s 10th-largest city is also one of the wealthiest, but over the past several years it has cut its municipal workforce by a quarter, laying off cops and firefighters, shuttering libraries and letting street repairs fall by the wayside.
The problem? Mayor Chuck Reed says it’s simple: Retiree benefit costs eat up more than a quarter of the city budget – and are growing at a double-digit rate. The solution he is pushing at the ballot box, after city council approval, would slash benefits for workers, increase employee contributions – and almost certainly prompt a precedent-setting legal challenge from the public employee unions.
“The best metaphor is cancer,” said Reed, a Democrat known as more of a technocrat than a firebrand, who is now cast as public enemy No. 1 by public employee unions. “It started a long time ago, it goes for a long time, and then it becomes life-threatening.”
It’s a challenge other cities in California will soon face. “Our problem is nearly universal in the state,” he added. “It’s just a question of timing.”
Public finance woes are nothing new in California. The state budget deficit stands at an estimated $15.7 billion for next year, requiring further cuts in state services and, if Governor Jerry Brown has his way, higher income and sales taxes. Local governments and school districts have struggled for years to make ends meet.
The pension problem, though, may be the mother of all budget issues – for California, for its cities and counties, and for other states and municipalities across the nation. The main California state retirement systems have a total shortfall in pension-plan funding of close to half a trillion dollars, a Stanford University study estimated. The bill is not due at once, but payments on it grow steadily and can eventually squeeze out even basic services. Public officials like Reed, and academics who have studied the issue, say the day of reckoning is nigh.
San Jose is not the only city making tough choices. In San Diego, voters will also be asked to approve a pension-cutting ballot initiative on Tuesday. In Stockton, city officials, unions and creditors are engaged in a mediation process aimed at avoiding a municipal bankruptcy – and public employee pensions are an achingly large part of the problem.
San Jose, San Diego and the counties of Kern, San Mateo and Santa Barbara are among the worst-off of municipalities with their own retirement systems, based on calculations in the Stanford study; all pay double-digit percentages of their annual budgets to pensions and all face double-digit rates of increase, among other issues. The city of Los Angeles was only marginally healthier than the bottom of the pack.
Meanwhile, the giant California Public Employees’ Retirement System (CalPERS), the largest public pension fund in the country, has been engaged in a tortured debate about whether its rate-of-return assumptions are too optimistic.
The CalPERS plan covers state workers and dozens of cities that voluntarily joined its system.
It recently cut its annual return assumption to 7.5 percent from 7.75 percent, which would raise the shortfall it previously had estimated at $85 billion to $90 billion. CalPERS says it has easily met its return target for 20 years, but Stanford’s Joe Nation and other economists say a lower rate would better reflect the uncertain outlook for markets and a century-long record of market returns. On Friday the Dow Jones industrial average fell to its lowest level in 2012 – dropping into negative territory.
That explains why Nation calculates the collective shortfall at CalPERS, the smaller California State Teachers Retirement System and a state university plan at half a trillion dollars – he assumes lower returns than do systems run by the state and cities like San Jose.
It’s some consolation for California, perhaps, that the bill mounts slowly – and other states are in even worse shape.
“The pension situation in California is by no means the worst,” said Douglas Offerman, an analyst at Fitch Ratings. “We rate California lower than we rate any other state. We do not rate it at that level because of its employee obligations.”
Good times, bad times
The roots of the pension crisis can be traced to the 1990s, when CalPERS, flush with cash from the stock market boom, pushed state legislation to raise retiree benefits, including a retroactive bump for state employees.
The 1999 law, adopted overwhelmingly by legislators on both sides of the aisle, knocked five years off the retirement age for many workers, bumped up payments – or both. Every career government worker could quit at 50 or 55 with a solid, and sometimes lavish, pension.
Because CalPERS also manages pensions for so many local governments, the law set off a bidding war across the state, with employees and their unions insisting on parity, or better, with neighbouring jurisdictions.
“That eventually washed its way down into local government, and by 2006 our public-safety employees had 90 per cent retirement benefits at age 50,” Reed recalled. Half a century earlier a San Jose policeman had to work until age 55 to retire with half his pay.
Stanford’s Nation did a rough calculation to figure out how much it would cost to get comparable retirement benefits in the private sector. “You’d have to start putting away half your salary, starting at 25,” he said.