| SAN FRANCISCO, June 2
SAN FRANCISCO, June 2 A radical plan to slash
public employee pension benefits gets voted on by the residents
of Silicon Valley's San Jose on Tuesday - a decision that could
set an important precedent for many other cities, not only in
California but across the nation.
The nation's 10th-largest city is also one of the
wealthiest, but over the past several years it has cut its
municipal workforce by a quarter, laying off cops and
firefighters, shuttering libraries and letting street repairs
fall by the wayside.
The problem? Mayor Chuck Reed says it's simple: Retiree
benefit costs eat up more than a quarter of the city budget -
and are growing at a double-digit rate. The solution he is
pushing at the ballot box, after city council approval, would
slash benefits for workers, increase employee contributions -
and almost certainly prompt a precedent-setting legal challenge
from the public employee unions.
"The best metaphor is cancer," said Reed, a Democrat known
as more of a technocrat than a firebrand, who is now cast as
public enemy No. 1 by public employee unions. "It started a long
time ago, it goes for a long time, and then it becomes
It's a challenge other cities in California will soon face.
"Our problem is nearly universal in the state," he added. "It's
just a question of timing."
Public finance woes are nothing new in California. The state
budget deficit stands at an estimated $15.7 billion for next
year, requiring further cuts in state services and, if Governor
Jerry Brown has his way, higher income and sales taxes. Local
governments and school districts have struggled for years to
make ends meet.
The pension problem, though, may be the mother of all budget
issues - for California, for its cities and counties, and for
other states and municipalities across the nation. The main
California state retirement systems have a total shortfall in
pension-plan funding of close to half a trillion dollars, a
Stanford University study estimated. The bill is not due at
once, but payments on it grow steadily and can eventually
squeeze out even basic services. Public officials like Reed, and
academics who have studied the issue, say the day of reckoning
San Jose is not the only city making tough choices. In San
Diego, voters will also be asked to approve a pension-cutting
ballot initiative on Tuesday. In Stockton, city officials,
unions and creditors are engaged in a mediation process aimed at
avoiding a municipal bankruptcy - and public employee pensions
are an achingly large part of the problem.
San Jose, San Diego and the counties of Kern, San Mateo and
Santa Barbara are among the worst-off of municipalities with
their own retirement systems, based on calculations in the
Stanford study; all pay double-digit percentages of their annual
budgets to pensions and all face double-digit rates of increase,
among other issues. The city of Los Angeles was only marginally
healthier than the bottom of the pack.
Meanwhile, the giant California Public Employees' Retirement
System (CalPERS), the largest public pension fund in the
country, has been engaged in a tortured debate about whether its
rate-of-return assumptions are too optimistic.
The CalPERS plan covers state workers and dozens of cities
that voluntarily joined its system.
It recently cut its annual return assumption to 7.5 percent
from 7.75 percent, which would raise the shortfall it previously
had estimated at $85 billion to $90 billion. CalPERS says it has
easily met its return target for 20 years, but Stanford's Joe
Nation and other economists say a lower rate would better
reflect the uncertain outlook for markets and a century-long
record of market returns. On Friday the Dow Jones industrial
average fell to its lowest level in 2012 - dropping into
That explains why Nation calculates the collective shortfall
at CalPERS, the smaller California State Teachers Retirement
System and a state university plan at half a trillion dollars -
he assumes lower returns than do systems run by the state and
cities like San Jose.
It's some consolation for California, perhaps, that the bill
mounts slowly - and other states are in even worse shape.
"The pension situation in California is by no means the
worst," said Douglas Offerman, an analyst at Fitch Ratings. "We
rate California lower than we rate any other state. We do not
rate it at that level because of its employee obligations."
GOOD TIMES, BAD TIMES
The roots of the pension crisis can be traced to the 1990s,
when CalPERS, flush with cash from the stock market boom,
pushed state legislation to raise retiree benefits, including a
retroactive bump for state employees.
The 1999 law, adopted overwhelmingly by legislators on both
sides of the aisle, knocked five years off the retirement age
for many workers, bumped up payments - or both. Every career
government worker could quit at 50 or 55 with a solid, and
sometimes lavish, pension.
Because CalPERS also manages pensions for so many local
governments, the law set off a bidding war across the state,
with employees and their unions insisting on parity, or better,
with neighboring jurisdictions.
"That eventually washed its way down into local government,
and by 2006 our public-safety employees had 90 percent
retirement benefits at age 50," Reed recalled. Half a century
earlier a San Jose policeman had to work until age 55 to retire
with half his pay.
Stanford's Nation did a rough calculation to figure out how
much it would cost to get comparable retirement benefits in the
private sector. "You'd have to start putting away half your
salary, starting at 25," he said.
California, the most populous state, also has some of the
most generous benefits in the country, says Alicia Mannell,
director of the Center for Retirement Research at Boston
She is more optimistic than Nation about California's next
few years - she says the shortfall may shrink - but she agrees
the state has blundered.
"These plans get so expensive - California has the most
expensive plan - that people are going to have to realize that
if those commitments are fulfilled, then other things are not
going to get done," she said.
Critics say a big part of the problem is a fundamental
conflict of interest in the way the pension plans are governed.
Pension fund boards are dominated by beneficiaries - workers
A six-member minority of the 13-member CalPERS board
represents workers and retirees. But the minority also holds the
chairmanship, and the entire current board are CalPERS members,
due to their state service.
The directors of the nation's largest public pension fund
are not required to have financial backgrounds, either, although
the fund says it gives training to the board.
Beneficiaries have an incentive to keep the plans solvent,
but with a state constitutional guarantee they can rest assured
that their retirement benefits will get paid. Meantime, the
board members, themselves beneficiaries, also have an incentive
to make the benefits as rich as possible - and the CalPERS board
has focused substantial energy on raising benefits and enforcing
the state guarantee of payment.
"The way pension systems have been run, to a certain extent,
is legal corruption," said Nation, explaining the conflict of
interest inherent in systems run by beneficiaries rather than
those who pay the bills.
Brad Pacheco, a CalPERS spokesman, pointed out that
directors elected by members were a minority and that the entire
board had a fiduciary duty. "When they make a decision, it is
not in self-interest but through the lens of how the decision
will benefit or impact our members, employers and taxpayers,"
San Jose faced what it saw as a conflict of interest in
2010. That year it expanded and reformed its pension boards,
giving independent citizens with financial backgrounds, approved
by the city council, majorities on both.
Scores of city and state unions already have bargained to
cut the pension load, generally by creating lower-benefit plans
for new hires, Pacheco said. But that's not going to ease the
problem soon, economists say.
The state and cities need to be able to cut benefits for
current employees, concluded the state's Little Hoover
Commission, which is charged with creating realistic solutions
for tough problems in the state.
The commission recommended that state lawmakers point the
way with legislation allowing contract changes that gave
midcareer workers the benefits they had accrued but cut the
level of benefits they would earn in the future - which unions
say is not fair play.
CalPERS has drawn a line in the sand, saying it will defend
benefits, and there's been no major challenge yet. The city of
Vallejo went bankrupt in 2008 but agreed to pay its pension
obligations in full.
Proposals by financially hobbled cities to cut costs "may
lead only to additional litigation and administrative costs,"
CalPERS warned in a policy paper last year.
San Diego is focusing on future employees, who will go on a
401(k)-style plan, which is common in the private sector, if
voters approve the measure on Tuesday. That would transfer the
risks and gains of rising and falling markets to workers.
But San Diego is not aiming to change plans for police
officers, who generally get the highest benefits and can retire
earliest, and the change doesn't affect current employees.
San Diego's plan represents the biggest fundamental change,
while San Jose's would be the highest-profile effort to get
employees to pay more. It would change the rules for all current
employees. It wants to let city employees choose between
switching to a lower-benefit plan or paying substantially more
to keep current benefits.
San Jose's retirement costs rose to $244 million, or a
quarter of its general fund budget in the fiscal year ending in
June, and even with relatively optimistic investment return
assumptions, the city expects retirement costs to hit $325
million four years from now, unless voters pass Mayor Reed's
reform plan, known as Measure B.
The stakes are high for employees: The police union
calculates that the ballot measure and previous changes could
leave an officer paying more than 40 percent of his salary for
retirement, a figure the city describes as a worst-case scenario
but does not dispute.
San Jose Police Officers' Association President Jim Unland
thinks Mayor Reed is exaggerating the problem and is misleading
voters about the legality of the plan. That said, Unland expects
voters will trust their mayor and approve his plan.
If that happens, the battle is sure to move to the courts,
where Unland expects it to remain for years. "In the end, we'll
probably be right back where we are today," the police union