California’s Pension System is Headed Off a Cliff – Here’s How We Can Fix It

Here at Opportunity Lives, we’ve covered how Americans are hungry for news with a solutions bias. One bearer of such news is Lawrence J. McQuillan, author of “California Dreaming: Lessons on How to Resolve America’s Public Pension Crisis.”

McQuillan, a senior fellow and the director of the Center on Entrepreneurial Innovation at the Independent Institute in Oakland, California, lays out the drastic and unsustainable public pension problem the Golden State now faces. Millennials and their children are looking at a monstrous tab.

The book offers specific proposals to help bring the state back to financial solvency. His solutions could be applied to other states and municipalities with similarly imposing unfunded pension liabilities — states such as Illinois, New Jersey and Connecticut, as well as cities like Chicago, Philadelphia and New York.

Thanks in part to the power and influence of California’s government employee unions, pension officials and politicians of both political parties have increased promised benefits for years while deliberately underpaying contributions. California has 86 defined-benefit public pension plans with about 4 million members, or roughly 11 percent of the state’s population, McQuillan reports. Retired state and local government employees receive guaranteed monthly payments for life.

State and local government public pension plans officially report they need $158 billion more in assets today to get out of the red, but McQuillan argues that current estimates are severely flawed. The actual number is four times the official estimates: $576 billion, or nearly $15,000 per Californian. With such a massive funding shortfall, independent analysts estimate that California plans will only be 51 percent funded. Without serious reforms or massive tax hikes, retirement accounts will likely displace public services such as schools, roads, parks, libraries, police and fire departments.

“[W]hy should young people be forced to pay for services they never enjoyed?” McQuillan asks. “It is selfish and immoral for the current generation to burden future generations with debt and taxes to pay for services they never consumed such as past police protection or past public school teachers.”

“Also,” he continues, “it is impossible for future generations to participate in current tax, spending, and debt discussions, even though they must bear the burden of decisions arising from such discussions.”

McQuillan quotes Nobel laureate economist James M. Buchanan, who wrote: “‘Taxation without representation’ is literally descriptive of the plight of those who will face the debt-burden overhang in future periods.”

“With such a massive funding shortfall, independent analysts estimate that California plans will only be 51 percent funded”

McQuillan offers six reforms to help alleviate California’s pension problem:

Require Financial Integrity. This means no more budget and accounting gimmicks that hide the true scope of pension liabilities.
Fund to the Annual Required Contribution (ARC). That would require amending the state constitution to outlaw so-called pension contribution holidays. This would follow in the footsteps of Oregon, which requires a 100 percent ARC.

Fund the ARC Without Pension Obligation Bonds. California governments have issued more pension obligation bonds (POBs) than any state, which McQuillan describes as “the pension sector’s equivalent to a ‘Hail Mary’ pass in football and about as successful. All told, POBs typically do not yield net positive returns; keep politicians from having to fix the underlying pension problems; and delay action, thus driving up total costs.”

Abolish the “California Rule.” Under this rule, the state protects not only public employees’ pensions for past work, but also guarantees retirement protections for the same packages going forward. McQuillan argues that the state constitution should be amended to offer greater flexibility to local governments by letting them trim and refine plans to better meet their budgets.

Switch to Reasonably Priced Defined-Contribution Plans. Once the California Rule is rolled back, state and local governments would have the flexibility to switch to sustainable 401(k)-style defined contribution pension plans. McQuillan estimates that by freezing the state’s biggest three defined-benefit plans and moving toward defined benefits, taxpayers could save at least $6 billion a year, which would help pay off the old benefits over 30 years or so. These savings would also limit the intergenerational transfer of burdens, better protecting public services and providing pension benefits that are competitive with those offered in the private sector.

Require Voter Approval. Another amendment to the state constitution should require voter approval of any change to a state or local pension plan that would increase taxpayer obligations, including initial and subsequent defined-contribution rates. As McQuillan notes, San Francisco already has such a rule in place, which is partly why its finances are in better shape than other cities, including Los Angeles.

All of these proposed changes are certain to meet fierce resistance from California’s powerful government employee unions, a reality that McQuillan readily acknowledges.

“Courageous political leadership will be needed to get the reforms presented in this book adopted,” he writes.

But maintaining the status quo or making superficial reforms would be far worse.

“If Governor Brown, the state legislature, and local politicians refuse to act, they are effectively defunding classrooms, starving social services, endangering public safety, allowing roads and bridges to crumble, while increasing taxes and debts on our children and grandchildren,” McQuillan concludes. “The financial assault on future generations will escalate. And future generations will be innocent victims of our fiscal failures, which is why younger generations need political leaders with the courage to protect them today.”

Perhaps if California’s elected leaders won’t act, the voters will.