California Foundation for Fiscal Responsibility


Issued November 14, 2008

Some Solutions to California's Fiscal Crisis

Estimated reduction in state budget deficit:
$5 billion annually; $300 billion over 30 years

California is crumbling fiscally because the mortgage mess has reduced tax revenues. The Legislative Analyst estimates the budget gap is over $1 billion a month and, in spite of bond sales, we will run out of cash in a few months if something isn’t done NOW. We’ve been here before, most notably in 1979 after Proposition 13 slashed property taxes. Because property taxes funded schools, thousands of teachers received pink slips. Some districts used a lottery to determine who would go and who would stay. Schools recovered with a property tax shift and state bailout that continues today.

But this time it’s different. Prior to 1979 government workers weren’t unionized. Extracting union concessions during a fiscal crisis is nearly impossible. Heavily unionized companies in the private sector—airlines, automakers, and steel industries—know that unions won’t budge even if it means bankruptcy. Vallejo’s unions are fighting a judge’s decision that the city is bankrupt to avoid renegotiating their contracts. The Governor’s proposal to increase sales tax and DMV fees while reducing services is politically possible, but will be very unpopular among citizens who are struggling. Citizens will be bitter that union labor hourly wages and benefits that are 37% higher than other states remain unchanged. Furloughing workers one day a month isn’t a cut. They will still earn their health care, pension, and other benefits. Wages will be lower, but so will production. And employees want to work and produce.

The California Foundation for Fiscal Responsibility (CFFR) is proposing sensible solutions to much of this crisis that won’t require an increase in taxes, an increase in fees, cuts in wages, layoffs, furloughs, or a reduction in services. Our solutions will work because they encourage work. Most of the cost of government goes toward salaries and benefits. If WORK isn’t exchanged in abundance by our most capable individuals during this crisis, California as we know it can’t survive.

Following are 10 recommendations to put this state back on the right fiscal track.

Temporarily suspend earning of service years for pension benefits.
Costs to state and local agency employees = $0 cash

All state and local employees are covered by defined benefit pension plans that provide retirement benefits based on a formula defined as a percentage of final pay multiplied by the number of years worked (or “service years”). The more years worked, the higher the pension. Today governments throughout California contributed $13 billion last year, plus many also picked up employees’ contributions. In his attempt to cut costs Governor Schwarzenegger encouraged legislative staff to take early retirement this year by giving them extra service years at no cost. That sweetened their retirements, but taxpayers will have to pay for this gift later. When Governor Wilson faced a similar fiscal crisis two decades ago, he didn’t make the state’s pension contribution, was sued, and forced to pay. Rather than encourage early retirement by granting expensive additional service years, we should encourage employees to keep working and temporarily suspend their ability to add service years for retirement.

Require employees to pay employer pension costs.
Costs to state and local employees (as an average % of wages) = 13% for general employees, 20% for safety

In years when the economy was doing well, many employers, including the state, began picking up the employee’s 5%-9% contribution. Since 1999 most workers also received increased benefits at younger retirement ages. Often these increases were granted outside of collective bargaining, and many workers did not work or pay extra for these increased benefits. Today’s crisis demands more. Benefits can’t be reduced, but employees should be asked to make higher contributions temporarily until the state’s fiscal conditions improve. Either choice, California saves billions and avoids layoffs or furloughs.

Savings to California = $3 billion annually

Discontinue purchases of service (“airtime”) credits.
Cost to state employees = $0 cash

Government employees can purchase risk-free annuities for five service years to tack onto their “years worked” formula. Because of a flaw in the government code the price is a bargain compared to what would be paid for a similar annuity in the private sector. Taxpayers get zero benefit, yet must guarantee the rate of return on the investment, and our most senior and valuable government employees are inclined to leave sooner. This expensive, unnecessary and lopsided benefit should be discontinued immediately.

Savings to California = Unknown, but in the millions when markets tank

Reduce compensated time off.
Cost to state employees = $0 cash

A reduction of at least 20% in sick leave, holidays, and vacation days would put state workers on par with private industry, reduce overtime and increase services.

Savings to California = $575 million annually

Tighten domestic partner labor rules for heterosexual couples.
Cost to state employees = $0 cash

On election night the majority voted that marriage is acceptable only for heterosexual couples. But most registered domestic partnerships in California are heterosexual as well. Some heterosexuals choose this over marriage because the federal government does not recognize domestic partnerships. Thus an individual can qualify for certain federal benefits, such as supplemental security income, in a domestic partnership but not in a marriage. Couples in domestic partnerships can also file federal tax returns as individuals and avoid the marriage penalty.

But California law requires employers to grant the same benefits (health insurance, pension survivor benefits) to domestic partners that they provide to married couples. Domestic partnerships are easy to form and easy to dissolve. If heterosexual couples are not willing to admit publicly in front of witnesses that they are joined in marriage for love, devotion, fidelity and sacrifice, then laws should not require the state to provide them the same benefits designed for married heterosexual couples.

Savings to California = $10 million annually

Adopt a second tier pension plan for new hires.
Cost to state employees = $0 cash

Today we are living healthier, longer lives and we can work longer. Most jobs have moved from factories and farms to offices, and are less physically grueling than in the past. It was fiscally irresponsible for the state to adopt retirement plans that encourage employees to retire at the peak of their careers, particularly since private sector workers must delay retirement until their 401(k) plans recover. New employees should be offered a second tier pension plan. Sworn officers and firefighters should be eligible for full retirement benefits no earlier than age 55. Retirement benefits for miscellaneous workers should be actuarially reduced if they choose to retire before age 65.
Financial planners universally agree that to maintain their pre-retirement lifestyle, retirees need 75% of final pay, not the 90-100% given now, so pension benefits for new workers should be reduced to a more sensible level.

Higher retirement ages for new workers will cut retiree medical premiums in half for safety workers, and it will almost eliminate retiree healthcare costs for miscellaneous workers who will qualify for Medicare at retirement.

Savings to California = $300 billion over 30 years

Eliminate employer pick-up of employee pension contribution.
Cost to most state employees = $0 cash

State pension plans were originally designed for both the employer and employee to contribute equally, just like social security. But today most safety workers and many miscellaneous workers in California pay nothing toward their pensions, nor do they pay social security taxes. Private employers are forbidden from paying employees’ social security tax; California taxpayers should not pay 100% of any public employees’ retirement.

Savings to California = $40 million annually

End reciprocity and pension spiking.
Cost to state employees = $0 cash

State and local government employees have an advantage over those who work in the private sector. Public employees are able to transfer among agencies, and their service years earned with every employer will continue to gain value as their wages increase. The few private sector employees in defined benefit pension plans cannot do this. Their benefits are frozen as a percentage of their average final salary when they switch jobs, and they may be years away from retiring. Their pension doesn’t continue to increase when their salary increases with another employer.
When workers leave state employment to earn higher wages in a local agency, the state must pay higher pension costs related to the years of service the individual worked for the state years earlier. Agencies that “raid” the state of its employees should also pay the higher pension costs related to the spiked salaries. It’s only fair.

Savings to California = unknown, but in the millions

Standardize disability processing, audit current disability recipients.
Cost to state employees = $0

Over $2.4 billion was paid for disability pensions to state and local government workers in 2006. The State Controller reports that disability rates range from 0% to 100% which “appears to be the result of differing policies and practices of individual retirement boards in administering disability retirements.” Disability recipients are rarely examined after retiring to determine if their physical conditions have improved to where they are no longer disabled. There are no repercussions if a board wrongly awards disability status to a retiree. The portion of a pension for the disability, up to 75% for some plans, is tax free. Disability awards also generally include a substantial tax-free lump-sum amount if the disability is deemed job related.

The state is likely losing tax revenues on unwarranted disability retirements. In light of scandals uncovered in other states and questionable disability rates among local agencies in California, processing disability claims should be standardized and criteria tightened. Additionally, a comprehensive audit of retirees in agencies with higher-than-average disability retirement rates could result in millions in additional tax revenue. It’s possible that one quarter of disability awards would be reversed if standard criteria were applied to everyone.

Additional revenue to California = $30 million

Retirees should pay a portion of their health premiums and additional tax on COLA increases.
Cost to state employees = $0 cash

State retirees are among the most fortunate in California. The state fiscal crisis, international credit crisis, and mortgage meltdown have no impact on their pensions. Taxpayers, whose own retirement portfolios have taken a beating, are on the hook to pay for market losses in state pension funds. The state should ask its 200,000 retirees to pay a portion of their pensions toward health care benefits.

Most plans include automatic annual cost of living increases after retirement of between 2% to 5%. With falling gas prices, lower home prices, and retail fire sales it is likely cost of living increases exceed the consumer price index in many parts of California. Wages for government workers will likely be depressed until the economy turns around. So it is highly probable that retirees, particularly retired cops and firefighters, will receive higher pensions than the wages of those who replaced them. Legislators should consider a “windfall pension tax” when COLA increases paid to public employee retirees exceed the consumer price index. A 1% tax would yield millions in additional tax revenue and still maintain most retirees’ purchasing power.

We are teetering on a depression that few retirees ever experienced during their careers. Taxpayers have done right by them, and retirees should do right by taxpayers in this time of serious need.

Additional revenue to California = $720 million annually

Stop questionable payments for extra pension benefits related to work performed years earlier.
Cost to state employees = $0 cash

Orange County, which declared bankruptcy a few years ago, is still struggling fiscally. The current Orange County board of supervisors recently filed a lawsuit to invalidate the retroactive portion of pension benefit increases that were granted by the prior board. Like Orange County, California increased pension benefits for its safety employees from 60% of final wages at age 50 to 90% (assuming a 30 year career—the formula increased from 2% per year worked to 3% per year worked). Retiring at younger ages, safety workers are draining pension funds and cashing in accrued sick and vacation pay. Despite the fact that the benefit recipients had already been paid in full for their services under the terms of earlier contracts, the state legislature awarded retroactive benefits to employees. They did not work any extra or pay for the windfalls. The citizens of California were never given the opportunity to vote or approve this pension giveaway. Payment of these additional pension benefits using future tax revenues violates the California constitutional limitations on incurring debt to be funded by future-year taxes. This multi-million dollar giveaway also violates the state constitutional limitations on granting extra pay to incumbent public employees for work already completed -- many call it a gift of public funds.

The legislature failed in its responsibility to uphold the law and protect the interests of taxpayers by providing a safe, healthy and fulfilling place to live, work, and play. In light of California’s fiscal crisis and although the current legislature did not award the benefits, they should discontinue these questionable payments immediately to avoid being sued individually by taxpayers. Discontinuing the retroactive portion of the benefit increases will save California about $600 million annually in pension costs and eliminate almost $7 billion in unfunded pension liabilities owed to CalPERS.

Safety workers who have already retired since 2000 will be effected because their benefits will, unfortunately, be reduced. But they should not be required to repay the questionable windfalls received to date, and many who returned to work part-time after retiring may need to work more hours. Current workers will still earn the benefits granted, but higher benefits will only apply to years worked since 2000.

The current rush to retirement will slow because many workers will see more benefit to staying on the job. Later retirements will reduce the medical premiums the state must pay before early retirees become eligible for MediCare.

Savings to California = $600 million annually

This summary is provided by and endorsed by the California Foundation for Fiscal Responsibility (CFFR).

Marcia Fritz, CFFR Vice President