By Steven Greenhut originally published for California Policy Center
In the coming months and years, California voters can expect to see a variety of tax increases pop up on their local election ballots. They will be called “public safety” taxes to hire more police or firefighters or “parks” or “library” taxes to pay for those popular public services. But don’t be fooled. Any new tax proposal is in reality a “pension tax” designed to help the California Public Employees’ Retirement System make up for shortfalls in its investment strategy.
In fact, liberal interest groups are getting ready to circulate a statewide ballot initiative that will gut Proposition 13 – the 1978 initiative that has limited property tax increases to 1 percent of a property’s sales price. It also limits property tax increases to 2 percent a year. The new initiative would remove those protections from many commercial property owners, thus raising taxes by another $11 billion a year. Money is fungible, so this is partly about paying for pensions, too.
California has an enormous problem with pension costs. Many observers see it as a crisis that threatens the economic health of the state. A recent study from the well-respected Stanford Institute for Economic Policy Research, run by former Democratic Assemblyman Joe Nation, details how pension costs already are “crowding out” public services, especially at the local level. Cities pay so much for retired employees that they are cutting spending on everything else.
“California public pension plans are funded on the basis of policies and assumptions that can delay recognition of their true cost,” according to the report. Yet pension costs still are rising and “are certain to continue their rise over the next one to two decades, even under assumptions that critics regard as optimistic.” So they are cutting “core services, including higher education, social services, public assistance, welfare, recreation and libraries, health, public works, and in some cases, public safety.”
Aside from cutting public services and running up and hiding debt levels, there’s only one other way that localities can come up with the cash to pay for these overly generous pensions, especially as pension costs consume 15 percent or more of their general-fund revenue. They will raise taxes. Meanwhile, the state government has to backfill pension costs as well, which leads to constant pressure for legislators to promote additional state-level tax increases. It’s a “heads they win, tails you lose” situation, as Californians pay more to get less.
Much of the problem goes back to 1999, when the Legislature rammed through a law to provide 50-percent pension increases to the California Highway Patrol. Backers knew that once CHP received these overly generous deals (including retroactivity, which is a pure giveaway that hikes pensions back to each employee’s starting date), pension increases would spread across the state. Indeed, they did. CalPERS said it wouldn’t cost taxpayers a “dime” because of stock-market growth, but then the market crashed.
Under the current defined-benefit system, public employees are promised an irrevocable level of pension benefits based on a formula. For instance, most California “public safety” workers (police, fire, billboard inspectors, prison guards, etc.) receive “3 percent at 50.” If they work 30 years, they get 90 percent of their final three years’ pay (often higher, because of pension-spiking gimmicks) until they die. They can retire with full benefits at age 50. Non-safety workers often receive a pension formula that lets them retire with 81 percent of their final pay beginning at age 57. These are very generous benefits given their typically high final salaries.
CalPERS invests the money in the stock market. It calculates the “unfunded pension liabilities” (i.e., debt) based on a projected rate of return for their investments. Higher expectations enable the pension funds and cities to go along their merry way, not worrying about their ability to pay for all the promises and avoiding pressure to pare back pay levels. CalPERS just lowered its rate of return from 7.5 percent to 7 percent, which is still overly optimistic.
But the lowered assumed rates mean that cities have to pay the pension fund additional fees to cover the difference. This is cutting into their operating budgets. In fact, cities have faced four rate increases in the past five years and are expecting a fifth one. A recent article tells the stories of El Segundo and Arcadia, two Los Angeles County cities that are considering hiking their sales taxes to maintain their current level of service.
El Segundo’s mayor pro tem said that in five years “the payment to CalPERS is expected to be $18 million and 25 percent of general fund revenue as the employer rate for safety employees increases from 50 percent of pay to 80 percent of pay,” reported Calpensions’ Ed Mendel. He noted that cities face a statewide cap on the size of their sales tax, but that Gov. Jerry Brown in October signed a law that allows some localities to bust through that cap.
You can see what’s coming: A push by unions to eliminate the sales-tax cap across the state, and a torrent of sales tax increases to pay for soaring pension costs. The other thing to expect: Continuing efforts to hide the size of the pension debt.
“The nation’s largest pension system is expected to adopt a funding plan … that anticipates shortfalls during the next decade and then banks on exceptional investment returns over the following half century to make up the difference,” wrote Contra Costa Times columnist Dan Borenstein this week. “It’s an absurd strategy designed to placate labor unions, who want more public money available now for raises, and local government officials who are struggling to make annual installment payments on past debt CalPERS has rung up.”
The only other hope beyond debt and taxes is if the California Supreme Court guts the so-called California Rule, which forbids governments from reducing pension benefits even going forward unless they are provided with something of equal or greater value. That “rule” has made it nearly impossible to reduce costs for current employees. But there’s no guarantee the court will roll back the rule in a case it will soon consider – or that the state and localities will bother to cut back benefit levels even if they are allowed to do so given union political power.
In the meantime, expect not only more of the same of hidden debt and reduced government services – but tax increases at every turn.
Steven Greenhut is a contributing editor for the California Policy Center. He is Western region director for the R Street Institute. Write to him at [email protected]