California’s Public Pensions Require Fundamental Reform

Wayne Winegarden
Wayne Winegarden, Ph.D. is a Sr. Fellow in Business and Economics at the Pacific Research Institute and the author of “California’s Pension Crowd-out” published by the Pacific Research Institute

The most recent attempt to reform California’s public pension systems has been pulled from the 2016 ballot by its own authors. Opponents tried to frame the proposal (inaccurately) as another “extremist measure.” But the state’s public pension systems are in deep financial trouble, and ignoring this reality will make the crisis even more difficult to resolve.

Tackling these problems is challenging. Pension reform elicits strong opposition from vested interests and many proposals to alter the system either require a constitutional amendment or would end up being adjudicated in court. Without changes, however, California’s pension crisis will diminish the state’s economic vitality for the next generation.

Future reform efforts should start by building off of San Diego’s Proposition B and switch all new public employees into 401(k) retirement plans – the typical retirement plans that most Californians working in the private sector currently receive. The 401(k) plan benefits should be equivalent to those benefits offered by large private sector employers, which typically make contributions (both matching and non-matching) equal to 8 percent of salary.

However, according to CalPERS’ 2015 annual report, the pension giant already covers 1.2 million members, and a defined contribution model for new state workers does not address the future costs of pensions for these existing employees.

Any changes to the pensions of these current workers would require a constitutional amendment to repeal the so-called California Rule. This unusual requirement mandates that once employees have been hired, they are entitled to both the retirement benefits they have earned for their years already worked, and the benefits they would earn under the current retirement system should they continue working for the state.

The California Rule is a bad policy that traps taxpayers in an unaffordable pension system and ensures unequal treatment for public and private sector retirees.

If the California Rule were changed, by the courts or through the ballot box, what would happen to current workers?

If such a change were to happen, California should implement a hard freeze across all defined benefit programs and switch all current employees into the newly established 401(k) plan with the same terms and benefits as new hires. As for the frozen defined benefit plan, no public employee should be able to accrue any more benefits in the program.

All vested public employees should be offered a choice: either receive a lump sum payment equal to the present value of their actuarially determined benefit, or remain in the frozen defined benefit plan. Employees that choose the lump-sum payment would transfer their share of the assets into an appropriate retirement account.

Although there would be transitional issues in a “cash-out” option that would need to be addressed, such as the impact these payments would have on pension program’s funded status, they pale in comparison to the difficult decision facing California if it fails to enact these reforms.

Without action, paying for current unfunded liabilities would require an annual $28.3 billion tax increase over the next 30 years. In my recent study, California’s Pension Crowd-Out, I calculated that such a tax increase would cause California’s economy to be 21 percent smaller over the next three decades compared to the baseline growth path. Alternatively, without such a devastating tax increase, California would be forced to cut $8.3 billion from schools and higher education, $4.9 billion from income support programs, and $1.9 billion from the state’s hospital systems.

Without necessary reforms, the next generation of Californian’s will endure fewer economic opportunities and fewer public services. Creating an effective transition plan away from failed pension policies will result in savings for all state taxpayers and is the fairest solution for public employees.

Wayne Winegarden, Ph.D. is a Sr. Fellow in Business and Economics at the Pacific Research Institute and the author of “California’s Pension Crowd-out” published by the Pacific Research Institute

Comment on this article


Please note, statements and opinions expressed on the Fox&Hounds Blog are solely those of their respective authors and may not represent the views of Fox&Hounds Daily or its employees thereof. Fox&Hounds Daily is not responsible for the accuracy of any of the information supplied by the site's bloggers.