California Governor Jerry Brown has filed a legal brief with the state’s Supreme Court arguing that pensions for government employees should work no differently than pensions for non-government employees. Students, citizens, taxpayers and future government employees would be better off if the court agrees.
At issue is a special treatment claimed by California government employee unions. To explain, let’s say you joined a non-government-sector employer when you were 25 years old and became entitled to a defined benefit plan that promised to pay you an annual pension after retirement equal to 2% of your final salary times the number of years worked. Then let’s say that after 20 years your employer decided to reduce the rate to 1.5%. Upon retirement at 65, your annual pension would equal [(20 x 2%) + (20 x 1.5%)] x final salary. In other words, the rate at which you accrue your pension benefit is the rate in place at the time you earn that benefit. The company can never take away the rate at which you’ve already earned your pension but has the right to raise or lower the rate going forward, just as it can never take away the salary you’ve already earned but has the right to raise or lower your salary going forward. That’s the way defined benefit plans are governed under the federal law known as ERISA.
In contrast, California government employee unions claim that government employers (eg, a local or state government or school district) can never reduce the pension accrual rate below the rate in place on the date the employee was hired. Accordingly, a government employee could earn at a 2% rate even if the rate is reduced to 1.5 % midway through the employee’s work life. But asymmetrically, government employee unions also claim employers may raise the rate and even make that increase retroactive. Eg, if the government boosts the rate to (say) 2.5% in the 39th year of a 40 year career, the employee would get a pension based upon the 2.5% rate applied to all 40 years even though that rate was in effect for only 1 of those 40 years. That actually happened in 1999.
The union approach is colloquially referred to as the “California Rule.” For more than 50 years California courts have upheld the California Rule — until now. The California Supreme Court is getting ready to hear arguments in a case in which a lower court ruled to the contrary. It is in connection with that case that Governor Brown submitted his brief.
The consequences are enormous. Because of corrupt management in the reporting and funding of pension promises, governments in California have built up huge unfunded liabilities, the costs of which are crowding out spending on education and other services and diverting tax increases to pension debt instead of productive purposes. Defined benefit plans work fine when honestly managedbut that hasn’t been the case in California. Now, for public services to survive, governments must be permitted to reduce unearned future benefits. Californians should hope the California Supreme Court agrees.
While Brown stepped up for citizens, local government employees were let down when the state’s largest pension fund manager, CalPERS, backed off a proposal to require employers to improve the funding securing pension promises. Unlike state employees, local government employees are at risk to insufficient funding of their pension benefits. That’s because, unlike the state government, local governments can go broke. As a result, the principal protection for local government employees is secure funding of pension promises. But CalPERS overstates funding status and now has backed off a proposal to boost funding.
This is dangerous stuff. We are in the eighth year of a bull market yet local governments are already hard pressed to boost pension funding to secure levels. Imagine the consequences when the bull market takes a pause. The consequences are dangerous for everyone.
California’s pension problem was easy to solve a decade ago but elected officials and pension fund board members chose to discourage truthful reporting and better funding. Now the problem is much bigger and the solutions are more difficult. The California Supreme Court should confirm government employees are not a special protected class of employee and CalPERS should encourage better funding.