California Pension Reform proposes two ballot initiatives

California can no longer afford its current retirement system. Estimates for unfunded pension liabilities range from 256 billion dollars to almost a trillion dollars. As a result, on October 27, 2011, Governor Jerry Brown introduced his 12-point plan to change pension and retiree health benefits for California’s state and local government workers. These changes mainly affect future employees by shifting more of the financial risk for pensions from public employers to the workers.

In his plan, Brown proposes that future public employees be enrolled in hybrid retirement plans in which employers and employees contribute to both defined benefit and defined contribution plans. These new benefits combine elements of traditional guaranteed pensions with a 401(k)-style savings plan.

Many public workers currently pay nothing to fund their pensions, but Brown’s proposal increases employee contributions to their pensions. It also raises the retirement age from 55 to 67, prohibits “contribution holidays,” and calls upon legislators to end the “spiking” that occurs when employers give their workers pre-retirement raises to inflate their salaries, thus driving up their pensions.

On November 2, 2011, a group called California Pension Reform (CPR) released two new plans to further scale back worker benefits. This group, led by former Schwarzenegger finance director Mike Genest and former state GOP Chairman Duf Sundheim, supports many of Brown’s anti-abuse provisions, but goes beyond his proposals to make some fundamental fiscal reforms.

Similar to Brown’s plan, both of the CPR proposals require government employers and their employees to equally share the cost of retirement benefits. However, the CPR plans to place a bigger burden on employees if their fund’s assets are less than 80% of its obligations. In this case, the government’s cost would be capped at 6 percent of an employee’s base pay and the worker’s contributions would increase to make up the difference until the fund recovers. Like Brown’s plan, they also raise the retirement age to 67, but define a full-service career as 35 years.

The CPR’s first ballot proposal called the “Government Employee Pension Reform Act of 2012, Option No. 1,” prohibits pension funds from incurring new debts or unfunded liabilities. The group also requires that future and current employees’ pensions be calculated on a three-year average of a worker’s highest base wages. Brown’s plan includes that same anti-spiking provision, but applies it to new hires.

The second plan called the “Government Employee Pension Reform Act of 2012, Option No. 2” resembles Brown’s hybrid proposal with its mandatory hybrid pensions for new hires. This option offers a larger defined benefit component for workers who do not participate in Social Security. It intends to provide new hires with 75 percent of their working income after a full career.

At first, labor unions strongly opposed Brown’s proposal, claiming it pushed boundaries too far. However, if CPR manages to get these plans on the November ballot, Brown’s proposal may become more palatable in comparison. Thus the CPR proposals may provide political leverage for the governor to implement his own plan.

According to the Legislative Analysts’ Office (LAO), Brown’s bold proposal could potentially produce significant long-term savings in billions of dollars per year because Brown’s plan does not make significant changes to pension benefits for current employees. However, achieving major near-term savings will be difficult or perhaps even impossible. In order to reduce public costs and transfers of obligations to future generations, there must be a sharp decrease in pension benefits for current employees and public-sector retirees. While there has been increased discussion of this topic for the past year, the LAO reiterates the fact that these proposals are not new. Most have been made and shot down before.

Besides raising employees’ pension contributions, the government can only lower pension costs through the negotiation process. The LAO states that reductions in past and present employees’ pensions benefits almost always result in the government provision of a comparable and off setting new advantage in return. For example, an employee would need compensation like a higher salary in order to let go of future pension benefits. These new compensations could create higher costs that would counterbalance the quantity of savings generated from the pension reductions. The LAO suggests that legislature devote less time in the attempt to lower current employee benefit costs, while focusing more on the future of California’s public retirement system.

The LAO insists that in the short run, state and local
pension and retiree health contributions will have to increase in order to fund liabilities accrued and earned by past and present employees. However, by reducing the retirement costs for future employees, the legislature will gain significant long-run savings and ameliorate the impact of the short-run cost increases.

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