California Pension Promises Exceed 550% of State Tax Revenue by 2012; A Look at Solutions

To put a little perspective on the pension crisis, please consider the Bloomberg article California Pension Promises May Top Taxes Fivefold

To keep their promises to retirees, the California Public Employees Retirement System, the biggest plan, the California State Teachers Retirement System, the second-largest, and the University of California Retirement System may have combined liabilities of more than 5.5 times the state’s annual tax revenue by fiscal 2012, according to the study released today by the Milken Institute. Levies are forecast to reach about $89 billion in the year that began July 1.

Debts to government retirees including those in California, the biggest state by population, have grown into a national crisis as pension plans strive to meet obligations to more than 19 million active and retired firefighters, police officers, teachers and other state workers. Fewer than half the plans had assets to cover 80 percent of promised benefits in fiscal 2009, according to data compiled for last month’s Cities and Debt Briefing hosted by Bloomberg Link.

“California simply lacks the fiscal capacity to guarantee public-pension payments, particularly given the wave of state employees set to retire” in future years, said researchers Perry Wong and I-Ling Shen in the Milken report. “Structural shifts, coupled with the financial design and the accounting practices of state pension funds, all point to the fact that reform is imperative.”

Addressing California’s Pension Shortfalls

The study the above article referred to is Addressing California’s Pension Shortfalls: The Role of Demographics in Designing Solutions from the Milken Institute.

Concurrently raising the retirement age and increasing employee contributions is only the first step in addressing California’s looming public pension liabilities, according to a new report, Addressing California’s Pension Shortfalls: The Role of Demographics in Designing Solutions from the Milken Institute. The situation will eventually call for even bolder action, such as shifting to hybrid plans with only a partial defined-benefit component.

Some of the key findings in the report include:

• By around 2012 or 2013, the three major state pensions’ obligations will be more than five times as large as total state tax revenue.
  
• Not only will California’s growing senior population depend on Medi-Cal and other state services, but public school enrollment is likely to rise in the coming years. The state can ill afford to fund pensions by cutting back on these services.
  
• In 2009, the pension liability came out to $3,000 per working-age adult in the state. By 2014, it will triple to over $10,000 per working-age Californian.
  
• Raising employee contributions alone will be less effective over time as the ratio of actively contributing members to benefit recipients continues to decrease.
  
• Currently, the average state employee contributes to the system for 25 years, but will receive benefits for 26 years — and the number of benefit-receiving years is increasing as longevity improves.

Milken's Proposed Solutions

The Milken report recommends raising the retirement age and increasing employee contributions.

It also wants as shift from defined benefit plans to a hybrid plan with partial guarantees and a partial 401K type coverage.

I agree with the first set of proposals on retirement age and employee contributions. However, I strongly disagree with any guarantees.

The private sector has no guarantees. Pray tell why should taxpayers guarantee any benefit levels for public bureaucrats, most of whom are grossly overpaid in the first place.

Moreover, we need to get rid of public unions, privatizing every needed service, and killing all of the unneeded ones. The study fails to mention that as part of the solution.

Finally, I believe states should explore the legality of taxing all public sector pension benefits above some set amount, say $75K annual, at a very high penalty rate, say 90%. If legal, that would take care of the mess in one easy step.

Here is the Milken Slide Show on Addressing California’s Pension Shortfalls.

It's worth a look to understand the magnitude of the crisis even if the proposed solutions are lacking.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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