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Jun 29, 2015, Vol. 20, No. 40 • By Stephen Eide, Weekly Standard—
Not all Californians believe that drought is the greatest threat to their state’s future. Early this month, a bipartisan group of current and former local officials filed the “Voter Empowerment Act of 2016,” a statewide ballot measure aimed at reforming the politics of public pensions. Its passage would forbid politicians in California from lavishing expensive retirement benefits on workers without explicit voter approval.

The effort is being led by Carl DeMaio, a Republican former member of the San Diego city council, and Chuck Reed, a Democrat and former mayor of San Jose. If they prevail, the effects will be felt nationwide. A yes vote in this deep blue labor stronghold will strengthen the hand of reformers in other pension-plagued states, such as Illinois and New Jersey.

California’s pension struggles first gained national notoriety between 2009 and 2012. The financial crisis sent pension funds into steep decline, and the broader economic slump hammered public revenues from income, property, and sales taxes. Thus, short on cash with which to backfill their rapidly expanding pension deficits, the state government and all manner of municipalities were forced to slash services and raise tax rates.

Today, the main pension plans for state workers and teachers in California are about $190 billion short of what workers have been promised in benefits, despite the Dow Jones Industrial Average having nearly tripled in value since its March 2009 nadir. Not coincidentally, state and local governments’ recovery continues to trail that of corporations. The number of private sector jobs in California surpassed its pre-recession high in November 2013 and has kept climbing since. Local government employment, by contrast, is still down by about 90,000. This reduction in municipal workforces should not be seen as “right-sizing.” The cost of government has not declined, nor have continuing budget imbalances made cities, counties, and school districts any more efficient. Rising pension expenditures have left taxpayers in the position of having to, in effect, pay more for past government services while getting less and less in the way of current services.

The problem is as much legal and political as it is fiscal. Fifty-five percent of government workers in California are union members, the sixth-highest share among the 50 states. Pensions have become a cornerstone of the “new Tammany Hall” arrangement, whereby elected officials boost workers’ pay and benefits in exchange for union assistance at the ballot box. No other special interest comes close to matching the resources possessed and deployed by labor in California, especially at the local level.

Even on the rare occasions when political support develops to challenge the unions on pensions, legal barriers thwart reform. The so-called California Rule is a state constitutional doctrine that prevents modifying current public employees’ pension benefits: Whereas private corporations routinely “freeze” their defined-benefit pension plans—workers keep everything they’ve earned so far, but future accruals come in the form of 401(k)-style defined-contribution plans—this is effectively prohibited for state and local workers in California.

The pension reform game is rigged. As DeMaio explains, “I’ve always likened this to a baseball game. Reformers are one team and the government-union bosses are another team. And the reformers are out there on the field, doing practices, building support amongst the public. The unions aren’t doing any of this, .  .  . they’re sitting behind the dugout writing the rule book with the umpires.”

In 2012, Reed and DeMaio led local pension initiatives that won with 69 percent and 66 percent of the vote, respectively. Their 2016 approach draws heavily on those experiences, as well as Reed’s abortive attempt to put a statewide proposition on the 2014 ballot. He was stymied by Kamala Harris, the state’s pro-labor attorney general, whose office is responsible for the language of all state ballot measures. Reed accused Harris of using “false and misleading words and phrases which advocate for the measure’s defeat .  .  . and create prejudice against the measure, rather than merely informing voters of its chief purposes and point.” This time around, Reed and DeMaio believe they have designed a measure that will prove legally viable, appealing to voters, and effective as policy, and they’ve launched their effort early in the election cycle to allow plenty of time for potential litigation over an unfavorable ruling on the language.

Most debates about pension reform center on benefits, but Reed and DeMaio’s proposal is focused on process. Should California municipalities continue to offer six-figure pensions to retired firefighters, they are free to do so, but the public must approve. Under the terms of the initiative, as of 2019, governments would be required to reauthorize their current defined-benefit system for new employees via a popular vote.

Marcia Fritz, a Democrat and the president of the California Foundation for Fiscal Responsibility, calls the voter approval requirement “profound, because it’s going to require elected officials to justify to their constituents why they feel their employees absolutely have to have these pension benefits in order to attract and retain qualified workers. .  .  .

[B]efore, they never had to do that.”

Defined-benefit and defined-contribution plans differ mainly in that the latter entail no debt commitment on the part of the employer. In California, public pensions are financed by a combination of government and employee contributions and investment return. But they are ultimately backed by the taxpayers, who guarantee retirees a certain fixed percentage of their final salary throughout their golden years, irrespective of the stock market’s vicissitudes.

California law requires voter approval for the issuance of government bonds, but not for retirement benefit debt. The consequences have been predictable. According to a 2013 study by the California Policy Center, when state and local retirement-benefit debt in California is calculated using conservative accounting assumptions, the sum exceeds what governments owe for bonds and other credit market obligations.

In the early 2000s, a wave of benefit enhancements swept California. Cities, counties, and public agencies sought to imitate SB 400, state legislation that boosted pensions for California’s Highway Patrol from 2 percent of salary for each year of employment at age 50 to 3 percent (i.e., a $75,000 annual pension, instead of $50,000, for a 50-year-old worker with 25 years of experience making $100,000). SB 400 was enacted in 1999, at the height of the dot-com bubble, when pension systems were flush. But by the time local politicians got around to their knock-off versions, the bubble had burst and systems had dropped into deficit. Undeterred, local politicians went around piling on new debt (their pension systems lacked adequate assets to fund the more generous benefits) without even the pretense of public approval.

From a fiscal management standpoint, what’s vexing about public pension debt is not simply its magnitude but the volatility of the cost of servicing it. Over the last decade, San Jose’s pension expenditures have grown at a rate approximately 14 times the rate at which local revenues have grown. “Crowding out” is the phrase Reed, DeMaio, and other reformers use to describe the effect on services when escalating pension costs consume ever-increasing portions of government budgets.

In 2012, President Obama won California with 60 percent of the vote. The fate of the Reed-DeMaio initiative is thus in the hands of former Obama voters, and the crowd-out message is targeted at them. Liberals believe that it’s appropriate for government to expand as the economy contracts. But crowd-out is most pronounced during downturns. Between 2008 and 2012, California local governments saw pension costs increase 17 percent, while spending on libraries and parks declined and public safety spending was flat.

Despite record-low borrowing rates and widespread calls to upgrade our nation’s infrastructure, levels of capital debt issuance by state and local governments have actually declined in recent years. If California cities could devote what they now spend on pension debt to basic street and sidewalk maintenance, some cities could eliminate all or most of their infrastructure liability within a few years.

Three California cities—Vallejo, Stockton, and San Bernardino—recently went bankrupt over pension debt. But local officials made practically no use of bankruptcy’s extraordinary debt-adjustment authority to restructure their pension obligations. The problem with the bankruptcy process, as former Vallejo vice mayor Stephanie Gomes learned firsthand, is that federal courts are no match for unions’ political influence. “When we had a chance, in the court, with the judge, to renegotiate, [the majority on the city council] chose instead to give raises and free health care.” A Democrat, Gomes supports the Reed and DeMaio approach of giving voters veto power over retirement benefits because “it’s been proven: We cannot trust local politicians to rein in these costs.”

Though more promising than bankruptcy and the union-dominated legislative process, pension reform via ballot measure is not ideal. It’s enormously expensive to campaign competitively in a state whose population will soon reach 40 million. The 2012 election cycle saw two high-profile initiatives: Proposition 30, an income tax hike for education, and Proposition 32, which sought to ban unions from using payroll-deducted dues for political purposes. In each case, opponents and proponents combined spent over $100 million. The only two reliable sources of major funding for ballot measures are wealthy individuals and unions. Thus far, no public-spirited patron has stepped forward to bankroll Reed and DeMaio, despite constant claims that pension reform is a plot of the 1 percent to drive teachers and cops into poverty in their old age. Reed and DeMaio assume unions will outspend them by at least 5:1.

They are nonetheless confident of victory, pointing to public opinion and to their record of hometown wins on the issue. A February poll by the Reason Foundation found evidence that, nationwide, only a minority supports the status quo on public pensions. Establishment Republicans fear that Reed and DeMaio will provoke heavy labor turnout in the 2016 cycle. Not that anyone expects California to go Republican in the presidential vote, but there will likely be state tax hikes on the ballot, which unions tend to support. However, a May poll showed that, for the most part, Californians “agree that pension reform should come before the consideration of any tax increases.”

Crises may create the political opportunity for reform, but it’s another question whether bad times or good times produce more effective policy-making. As documented by the National Conference of State Legislatures, virtually every state passed some sort of pension reform after the global financial market’s near-death experience in 2008. And yet, though we are now six years on from the Great Recession’s official end, crowd-out remains pervasive across the state and local landscape, and many continue to raise questions about the threat that pension debt poses to government finances. An April poll of municipal bond analysts by Janney Montgomery Scott ranked public pensions as “by far the most important issue facing the municipal bond market right now.” Last month, Moody’s Investor Serv-ice downgraded Chicago to junk over “expected growth in the city’s highly elevated unfunded pension liabilities,” and the credit quality of Illinois and New Jersey is similarly fragile.

California’s bond rating is currently on an upswing, and the ruling elite is highly complacent about the state’s fiscal condition. But lawmakers’ reluctance to improve on their past halfhearted pension reform efforts has created an opportunity for Reed and DeMaio to seize the issue and put forth a proposal that might yield a long-term solution to the pension dilemma.

DeMaio likens his proposal to Proposition 13, the 1978 landmark measure that, within 10 years of being overwhelmingly approved by Californians, had inspired over half the states to impose similar limits on property taxes. “Prop 13,” he says, “sent a national message. I believe we will see the same happen when we’re successful on pension reform.”

Stephen Eide is a senior fellow at the Manhattan Institute.