Governor Jerry Brown and the California Legislature have approved a scheme under which a special state fund filled with citizen-paid fees will lend money to the state General Fund, which in turn will contribute the proceeds to a state pension fund that in turn will invest in stocks in the hope of generating profits to help reduce pension deficits. In doing so, Brown and legislature haven’t disclosed to citizens that the same profits, if earned, could’ve been used for more citizen services. Here’s how:

Brown’s scheme transfers $6 billion from the Surplus Money Investment Fund, which is a fund that houses citizen-paid fees (eg, gas taxes, motor vehicle fees) until those fees are needed for government services such as road repair, etc. Brown says SMIF has more cash than it can use until 2030. Because current law limits SMIF from investing in anything other than short-term notes, he proposed that SMIF lend $6 billion at short term floating rates to the General Fund, which will contribute the proceeds to a state pension fund (CalPERS) that will invest for the longer term and use the hoped-for difference to reduce state spending on pension deficits.

Of course, another alternative would be to amend the statute that now limits SMIF’s investment options to allow SMIF to invest that cash on a longer term basis and generate those profits for itself. Brown expects his scheme to generate $11 billion in profits. If so, that’s an extra $11 billion that citizens could’ve added to funds to be used for road repair, etc.

Instead, Brown and the legislature have chosen to skim profits from citizens in order to pay past credit card charges; ie, to pay financing costs relating to past employee services that were charged to the future. Brown’s scheme also covers up past wealth transfers to employees. That wealth transfer occurs when “Normal Costs” — the only pension costs shared by state employees, as explained here and here — are artificially depressed by public pension fund boards setting artificially high investment return assumptions. For example, a decade ago in 2007 CalPERS used an 8 percent investment return assumption for setting Normal Costs. In contrast, the defined benefit plan at Berkshire Hathaway employed a materially-lower (6.9 percent) investment return assumption (see page 44 here). CalPERS’s use of the artificially higher rate reduced Normal Costs well below those of Berkshire’s — and also produced big pension deficits for citizens when, not surprisingly, actual investment returns fell well short of the inflated assumed rate. Now, Brown wants to skim profits from the investment of other citizen-funded monies to help address the deficits caused by insufficient Normal Costs. Citizens should feel battered.

Pension costs were relatively easy to address a decade ago. All that was necessary was a reasonable investment return assumption for setting Normal Costs. But state officials chose otherwise, leading to large and expensive pension debt that, as explained here, will continue growing fast. At this stage, the state should be seeking a reduction in pension debt, just as an indebted individual should seek to reduce credit card debt. One way to achieve that would’ve been for Brown and the legislature to tender an offer to employees to relinquish expensive future pension benefits in exchange for cash (or a market-rate note from the General Fund that tenderers could sell for cash). Just as a bank gives up expensive future interest earnings when credit card debt is paid off, employees should give up expensive future interest earnings when the state pays off pension debt. Instead Brown and the legislature have chosen a path that covers up past wealth transfers, allows the employees who benefited from those wealth transfers to keep earning expensive interest, and skims potential profits from citizens in order to fund that expensive interest.

Worse, there is no guarantee the loan will be paid back (the due date is on or before June 30, 2030; see the draft bill here). To understand how that might happen, try this thought experiment: How are a governor and legislature likely to act in 2030 when the terms of the loan require $6 billion to be transferred out of the General Fund to a special fund under their control for nothing in exchange? As a further thought experiment, just try to imagine Jerry Brown and the legislature transferring $6 billion this year from the General Fund to a special fund under their control in repayment of a borrowing drawn from a special fund long ago. What are the chances they would defer that repayment? Indeed, even quarterly interest payments are at risk to being skipped, especially in tough budget years. After all, the special fund is under the control of a governor and legislature who generally get credit for what they do with the General Fund, not with special funds. And if you’re thinking the designated source of loan repayment — a taxpayer-funded account established by Proposition 2 to accelerate payments on certain state debts— will make the payments, think again. That designation was just a fig leaf given that existingliabilities eligible for repayment by Prop 2 already dwarf the size of that fund.

Though Jerry Brown has not used his recent two terms in office to address core fiscal issues, until now he has generally avoided budgetary gimmicks. This time is different.