The Real Pending Crisis: Public Pensions

The Real Pending Crisis: Public Pensions
Bruce Bialosky
Monday, November 02, 2009

President Obama often states that the federal budget cannot be balanced without health insurance reform. Even if that were true, the real crisis that exists already and will only worsen over time comes from the horrendous obligations taken on by state and local governments for public employee pension plans.

Keith Richman caught on to this problem while a California Assemblyman. He has formed the non-profit California Foundation for Fiscal Responsibility to educate elected officials and the public on the looming budget disaster. Fortunately, he is not the only one touting this pending mess. Ron Seeling, the Chief Actuary for CalPERS (the California public employees’ retirement program), has stated the plan is unsustainable. CalPERS represents state employees and 1,500 local governmental entities.

Some would say the pension problem starts with the unionization of public employees. In California, the major catalyst was SB400, signed by Gray Davis in his first year in office, 1999. The bill lowered retirement age for public safety employees to 50 years old and to non-public safety employees to 55 years old. We are in an era when people are living on average until around 80 years old.

The law gives the employee pension benefits of 3.0% of their final income for each year of service. It also made the 3.0% amount retroactive to the beginning of their employment period. That means if you work 20 years you receive a pension benefit equal to 60% of your final income. The problem was compounded by how they calculated the income on which to base the pension.

Everything including the kitchen sink adds to the final income level. Things such as auto allowance and bonuses boost the final number. If the employee did not use vacation pay or holiday pay for the prior 10 years that adds to the base salary to determine the income. Understanding that in most private sector jobs when you do not use your vacation, you lose your vacation, the ability to accumulate vacation time opens up the system for vast manipulation. Peter Nowicki, the Moraga Orinda fire chief, retired at age 50. His final salary was a whopping $185,000, but small compared to his annual pension benefit of $241,000. Making that matter worse, Nowicki was hired as a consultant to the fire department for an additional $176,000 per year -- on top of his retirement benefit.

This is not an isolated case. In Los Angeles County there are over 3,000 people receiving greater than $100,000 per year in pension benefits. In San Francisco, it was found that 25% of employees’ income spiked up over 10% in the final year of their work. The San Francisco grand jury found that amount cost the city $132 million.

Some would argue why not game the system? Let’s say you start working for the government when you are 30 years old and work for 25 years. Your final income with all the fancy calculations ends up at $120,000. That means you would receive $90,000 plus full health care benefits. You can either live on that very nice retirement or you are free to get another position. After all, being 55 years old, you are still in your prime earnings years. Where in the private sector are there comparative opportunities?

These kinds of retirement ages and benefits are why the estimated unfunded liability is soaring. California has estimated unfunded pension and health care liabilities ranging from $100 to $300 billion. The school systems operate under their separate pension program – CalSTRS. The Los Angeles Unified School System estimate for unfunded retiree benefits comes in at about $10 billion. That is one school system, be it the largest, in one state. Estimates show that the LAUSD will soon carve out 30% of its budget for combined retiree health and pension benefits.

California may be the worst example, but not the only example of deplorable financial planning by governmental entities. The original justification for rich benefits for public employees centered on lower salaries, but that no longer rings true. A recent analysis by the U.S. Bureau of Economics shows that federal employees receive compensation that is double the average of the private sector. Other studies have shown state and government employees to be receiving like levels of compensation.

The genesis of this pending disaster comes from the right of public employees to unionize. This was not always so. The first opportunity occurred in 1958 in New York City under Mayor Robert Wagner. President Kennedy instituted the right for federal employees to unionize in 1962. Since then the right for public employees to unionize has spread, but is not universal. States that have more restrictive laws have blocked public employee unions and thus have not suffered the consequences.

In states like California, the public employee unions fund huge political campaigns. To most observers, the unions have a stranglehold on the state legislature, Los Angeles and San Francisco city governments, and most if not all of the school districts in the state. When the employees control the employers, the results are uncontrollable obligations.

A recent report stated that children born today will live an average life span of 100 years. With public employees retiring at 50 or 55 years of age, it doesn’t take a deep thinker to extrapolate that these retirement benefit programs are unsustainable.

Private sector employees now receive less annual income than their public counterparts. Private sector employees will have to work well into their seventies to pay for these public sector employees’ retirement benefits which far exceed what the private sector offers. The public will, little by little, become aware of this upside-down arrangement. Heroes like Keith Richman are sacrificing to make the public aware of this coming debacle. Our elected officials need to heed his warnings.

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I wanted to compare or supplement this article with an old article about Social Security (all liberal-democrat ideas btw) and the trouble it is set to cause in the near future...

January 14, 2005
Social Security: Follow the Math
by Michael Tanner

Michael Tanner is director of the Project on Social Security Choice at the Cato Institute and author of Social Security and Its Discontents.

President Bush has made it clear that reforming Social Security is one of his top priorities for his second term. Battle lines are forming among supporters and opponents of his proposal to allow younger workers to invest privately a portion of their Social Security taxes through individual accounts. At times the debate can seem mind-numbingly complex, full of arcane actuarial terms and competing claims about insolvency and rates of return.

But underneath all the noise, there are only a few things that Americans need to know in order to understand the Social Security crisis.

First, the current Social Security system is what is known as a "pay-as-you-go" system. It is not a savings or investment system, but a simple transfer from workers to retirees. The payroll taxes from each generation of workers are not saved or invested for that generation's retirement, but are used to pay benefits for those already retired. The current generation of workers must then hope that when their retirement comes, the next generation of workers will pay the taxes to support their benefits, and so on.

Obviously, a pay-as-you-go system is very sensitive to the number of people paying in versus the number of people collecting benefits. In other words, the ratio of workers to retirees is crucial to the financing of the current system.

The current worker-to-retiree demographics in the United States spell trouble for Social Security and its ability to keep up with its promised benefits. People are having smaller families resulting in fewer new workers paying taxes into Social Security. And seniors are living longer and collecting benefits for many more years.
Add to this the fact that the Baby Boom generation is about to retire and you end up with far, far fewer workers than retirees than when Social Security started.

In 1950, there were 16 workers paying taxes into the system for every retiree who was taking benefits out of it. Today, there are a little more than three. By the time the baby boomers retire, there will be just two workers who will have to pay all the taxes to support every one retiree.

Fewer workers for more retirees mean each worker bears an increasing financial burden to pay the benefits that Social Security has promised. The original Social Security tax was just 2 percent on the first $3,000 that a worker earned, a maximum tax of $60 per year. By 1960, payroll taxes had risen to 6 percent. Today's workers pay a payroll tax of 12.4 percent.

It is going to get much worse. In order to continuing funding retiree benefits, the payroll tax will have to be raised to more than 18 percent. That's nearly a 50 percent increase.

Let's look at that financial burden another way. The Social Security payroll tax is already 12.4 percent of wages, or one eighth of a worker's total annual wages. It is the biggest tax the average household must pay. Roughly 80 percent of American families pay more in Social Security taxes than they do in federal income taxes.
Despite that already huge tax burden, the payroll tax will have to be increased by nearly half in order to continue paying Social Security benefits. That's a terrible burden to impose on our children and grandchildren.

The only way out of this problem is to change Social Security from a pay-as-you-go model to a system based on savings and investment. That is why President Bush wants to allow younger workers to begin saving some of their Social Security taxes. Those who disagree have an obligation to tell the rest of us how they would deal with the grim demographic reality.

And along the same lines - a recent article on demographics...

New Geographer

The Kid Issue
Joel Kotkin, 09.08.09, 12:00 AM ET

Japan's recent election, which overthrew the decades-long hegemony of the Liberal Democratic Party, was remarkable in its own right. But perhaps its most intriguing aspect was not the dawning of a new era but the emergence of the country's low birthrate as a major political concern.

Many Japanese recognize that their birth dearth contributes to the country's long-standing economic torpor. The kid issue was prominent in the campaign of newly elected Democratic Party Prime Minister Yukio Hatoyama, who promised to increase the current $100 a month subsidy per child to $280 and make public high school free. The Liberal Democrats also proposed their own pro-natalist program with a scheme for free child day care.

Japan's predicament seems obvious. Its fertility rate has dropped by a third since 1975. By 2015 a full quarter of the population will be over 65. Generally inhospitable to immigrants, Japan could see its population drop from a current 127 million to 95 million by 2050, with as much as 40% of the population over 65 years of age. By then, no matter how innovative the workforce, Dai Nippon will simply be too old to compete.

While Japan's demographic crisis is an extreme case, many countries throughout East Asia and Europe share a similar predicament. Even with its energy riches, Russia's low birth and high mortality rates suggest that its population will drop 30% by 2050 to less than one-third of that of the U.S. Even Prime Minister Vladimir Putin has spoken of "the serious threat of turning into a decaying nation."

Russia's de facto tsar has cause for concern. Throughout history low fertility and socioeconomic decline have been inextricably linked, creating a vicious cycle that affected once-vibrant civilizations such as as ancient Rome and 17th-century Venice.
Persistently low birthrates and sagging population growth inevitably undermine the growth capacity of an economy. Children provide a large consumer market and push their parents to work harder. By having children, parents also make a commitment to the future for themselves, their communities and their country.

In contrast, a largely childless society produces other attitudes. It tends to place greater emphasis on leisure activities over work. It also shifts political pressure away from future growth and toward paying pensions for the aging. An aging society is likely to resist risky innovation or infrastructure investments meant to serve future generations.

Of course, on a global level, lower birthrates should be seen as a positive. Population growth projections made around the time of The Population Bomb, Paul Ehrlich's widely acclaimed 1968 Malthusian tract, which predicted global mass starvation, have turned out to be well off the mark. Global population growth rates of 2% in the 1960s have dropped to less than half that rate, and projections of the number of earth's human residents in 2000 overshot the mark by over 200 million.

This pattern is likely to continue: growth rates will drop further largely due to an unanticipated drop in birthrates in developing countries such as Mexico and Iran. These declines are in part the result of increased urbanization, the education of women and higher property prices. The world's population, according to some estimates, could peak as early as 2050 and begin to fall by the end of the century.

Yet in some places, like Japan, declining birthrates may already be too much of a good thing. The same is true elsewhere in East Asia, particularly in China, where the one-child policy has set the stage for a rapidly aging population by mid-century. Fertility is particularly low in highly crowded Asian cities like Tokyo, Shanghai, Tainjin, Beijing and Seoul.

Over the past few decades a rapid workforce expansion fueled the rise of the so-called East Asian tigers, the great economic success story of the late 20th and early 21st centuries. But within the next four decades most of the developed countries in East Asia, as well as Europe, will become veritable old-age homes: A third or more of their populations will be over 65, compared with one in five in the U.S.

Not that the U.S. doesn't also have to cope with an aging population and lower population growth. But comparatively speaking it maintains a relatively youthful, dynamic demographic. Its fertility rate is about 50% higher than Russia's, Germany's or Japan's and well above those of China, Italy, Singapore, Korea and virtually every country in the former eastern Europe.

The reasons for this divergence with other advanced countries likely includes such things as continuing immigration, more land, larger houses, a strong aspirational culture and a higher degree of religious affiliation. Whatever the cause, a younger demography could lead to a relatively brighter future for America than is now commonly assumed.

Additionally, in the next decade the U.S. will benefit from a millennial baby boomlet, as the children of the original boomers start having offspring. This next surge in population may be delayed if tough economic times continue, but over time it will translate into a growing workforce, sustained consumer spending and will likely spur a rash of new creative inputs.

On the surface, these trends should help America to maintain a growing economy while its main competitors fade. By 2050 Europe's economy could be half that of the U.S. But this is not inevitable. As in Japan, some leaders in European countries understand they cannot sustain prosperity with a steadily declining workforce.

Many European countries are boosting benefits for families. In some, a pro-natalist policy is also being driven by concerns about the preservation of national cultures. In contrast to America, a country defined by immigration, most European countries--as well as Japan, China and Korea--have been far more resistant to outside influences.

The rise of immigration in recent decades has led to growing European nativist movements. Many Europeans, including liberal ones, are less than sanguine about the long-term consequences of Muslim birth rates now three times higher than those of indigenous Europeans. If current trends continue, according to the Brookings Institution, the Muslim population of Europe could double by 2015 while the non-Muslims shrink by 3.5%. Without a sustained boost in baby-making among native Europeans, much of the continent may soon confront the prospect of an essentially Islamic future.

But even so, attempts to foster a revival in European birthrates will face strong opposition from environmental activists who have amassed enormous influence. Some consider procreation of carbon-belching E.U. citizens as something close to anathema. In Great Britain, Jonathan Porritt, chair of the U.K.'s Sustainable Development Commission has advocates cutting the island's population in half as a way to reduce global greenhouse gases.

For their part, some America greens have expressed concern over our country's relative fecundity. The president's science adviser, John Holdren, a longtime protégé of Malthusian prophet Ehrlich, has in the past spoken about the need to limit families to two children. On the right, nativists also fear that too much of our new population will be of Asian or Hispanic descent.

These pressures could lead to curbs on immigration, which would slow population growth. Other steps being considered by administration planners, such as cramming Americans into smaller houses in urban centers, would clearly discourage family formation. A persistently weak economy would do the same.

Yet those favoring strong steps to curb population here first should think of the consequences. As the Japanese increasingly recognize, it's better to experience some population growth than to become a giant nursing home. A somewhat youthful, gradually growing population certainly may create considerable environmental and social challenges, but a scenario of persistent decline and rapid aging seems far worse.

Joel Kotkin is a presidential fellow in urban futures at Chapman University. He is executive editor of newgeography.com and writes the weekly New Geographer column for Forbes. He is working on a study on upward mobility in global cities for the London-based Legatum Institute. His next book, The Next Hundred Million: America in 2050, will be published by Penguin early next year.