Briefing Report: Increases All Around! Taxes, Contributions and Teachers' Unfunded Pension Liabilities

Wednesday, March 26, 2014

The California State Teachers’ Retirement System (CalSTRS) will be bankrupt in less than 30 years.  The most recent assessment of contributions by the state, school districts, and teachers is $5.7 billion per year, and yet the system will still be broke in 30 years unless an additional $4.5 to $5 billion is provided annually to the woefully underfunded system.

As an aside, the Legislative Analyst’s Office (LAO) points out that the combined general fund spending on the University of California and the California State University in 2014-15 is roughly the same amount of the proposed additional state contribution to CalSTRS.1

The retirement system is in the red by an estimated $71 billion.  Numerous discussions and meetings, called for by Democrats, on the why, how, and the what of CalSTRS unfunded liability have been held in the Legislature and continue to be held.  CalSTRS has asked the Legislature for at least $4.5 billion per year for the next 30 years to cover their unfunded liabilities of retirement costs for all current and retired teachers.  Action has not been part of any Democrat solutions, only discussions.  Republicans have offered solutions and action,2 but experience in the capitol shows that the majority party votes for their union/labor benefactors and kills fiscally responsible Republican bills.

What are the possible solutions and how will the Legislature and local governments respond?

One of the most talked about solutions is for the state to appropriate an additional $4.5 to $5 billion per year concurrently with the school districts and teachers increasing their contributions. The LAO has suggested that school districts increase their contributions from 8.25 percent to about 16 to 17 percent, and teachers increase their contributions from 8 percent to about 12 percent.  There are a few problems with that though.  First, state law dictates that unionized employees who are subject to a cut in benefits are required to receive an equal or offsetting benefit.  That benefit will most likely be an annual guaranteed cost of living adjustment (COLA) to their retirement (current and future retirees). That state law curtails any proactive savings. Second, school districts are already pressed hard on their budgets and this increase will have reverberations on local governments who provide almost a third of school district budgets and would require tax, bond, or other new revenue streams to meet those increases (more on that later). Finally, there is a legal debate on whether an increase in funding for schools will affect Prop 98 minimum guarantee, thus providing an even larger share of the state general fund to school districts in the future and crowding out other state budgetary needs.3

With ever-increasing public employee pension and salary costs, all levels of government are, and have, looked at new revenue streams.  Jacksonville, Florida recently heard from their retirement task force that tax increases were the only viable solution.  Now they must choose to propose a property tax hike or a dedicated sales tax.  Philadelphia recently entered into an agreement to sell a city-owned utility and dedicate proceeds to underfunded public employee pensions.  The Pennsylvania Auditor General told the state Legislature in February “raising revenue is really the only option, but that comes with a steep price for taxpayers…without changes, municipalities may be forced to follow Detroit into bankruptcy to relieve some of the pension burden.”4

Chicago Mayor Rahm Emanuel is asking public sector unions to allow him to scale back their benefits while he continues to scale back other necessary public services, and the unions are telling him “no deal.”  The state of Illinois passed a temporary statewide tax increase in 2011 to pay for unfunded pension liabilities, and will sunset in 2015.  According to the Senate President John Cullerton (D) “The purpose of this bill is [was] to raise enough money so that we can continue to pay our pensions without borrowing the money, to pay off our debt, to have enough money to pay the interest on that debt.”  The Illinois Policy Institute had this to say about the 2011 Illinois statewide tax increase in late 2013: “The state’s official unfunded pension liabilities will grow to more than $100 billion during the current fiscal year (2013-14), up from $83 billion in 2011. That’s because the problem isn’t a lack of revenue; rather it’s that defined benefit pension plans are inherently unmanageable…The fact is Illinois doesn’t have a revenue problem; the state has a spending problem.”  The Illinois Legislature is already seeking ways to continue the temporary tax increase that will sunset in 2015.5  [One must wonder if there are any other temporary statewide tax increases that will sunset in the near future, say 2018, as approved by voters….]

In December of 2011, when discussing the public sector pension problem and potential benefits of a temporary tax increase, Governor Brown presented a pension reform plan to the Legislature.   He made the argument for a temporary tax increase in what would become Prop 30. “We’ve got to win the confidence of the people to achieve some of the other things we want to achieve…without pension reform I don’t think we will have the credibility to ask the people to do other things that are very much needed.’’6

Governor Brown promoted a good pension reform plan, but only some of the pension reform plan’s “low hanging fruit” provisions were eventually passed by the Legislature – and then the voters of California passed the Prop 30 “temporary” tax increases. It is ironic that the annual $6 billion in new Prop 30 revenue that was sold to the voters as “for the kids” may now be dedicated to the underfunded retirement systems while most poor and middle class citizens, who are struggling to build their own retirement plans, are paying higher taxes so public employees can retire in decent comfort.

Nearly everyone is aware that Detroit’s bankruptcy was primarily caused by generous public employee salaries and pensions, and many are aware of the severely unstable budgets and detrimental pension costs of California cities such as Stockton, San Bernardino, Compton, Desert Hot Springs, Vallejo, Mammoth, and Pacific Grove.  Those are the most talked about cities, but so many more California cities, which provide up to a third of the revenues for school districts, are in serious talks to raise taxes or seek dedicated special taxes for public employee and teacher pension costs.  According to a recent report, Los Angeles city council members are considering a $400 million Pension Tax for the 2016 ballot.7 A former economic advisor to the state has proposed California consider a severance tax on fossil fuel production that could dedicate $2 billion per year toward CalSTRS unfunded liability.  The same advisor mentioned taxing marijuana and dedicating that tax revenue to CalSTRS.8

The Legislature and teachers may be able to help their own cause.  Most public/private sector employees contribute 6.2 percent to the Supplemental Security Income - Social Security (SSI) and their employers provide a matching 6.2 percent.  Teachers do not contribute anything toward SSI and their employers do not contribute a matching portion.  As mentioned earlier, California teachers contribute 8 percent of their salary and their employers contribute 8.25 percent to CalSTRS.  CalSTRS recently compared contribution rates between teachers and public sector employees and an interesting idea came to mind: California’s miscellaneous public sector employees contribute about 8 percent of salary to their public retirement system and contribute an additional 6.2 percent of their salary to SSI.  The employers of public sector employees (on average) contribute about 21 percent of an employees’ salary and an additional 6.2 percent of each employees’ salary for SSI.  That’s a combined employee/employer contribution of almost 42 percent of salary for pensions and an almost broke SSI.9  (Teachers receive the better deal on that lack of investing with SSI since SSI earns less than 2 percent in returns and will be broke around 2033, according to SSI.)  Here’s where the interesting idea comes into play: The most recent US Census data has public school teachers in California earning an average salary of $70,000.  Perhaps the Legislature will consider requiring teachers and school districts to each contribute 4 to 5 percent of their salary to CalSTRS, instead of the federally mandated 6.2 percent to SSI.  CalSTRS typically has a better return on investment than SSI.  In addition, the Legislature may choose not to provide an equal or offsetting benefit, if their pension contribution levels are increased.  This would build their retirement funds, and show that teachers/school districts are willing to pitch in to save their own retirement fund. That may be a worthy starting point before the state considers any new annual state general fund mass contributions of $4.5 to 5 billion, in addition to local governments seeking new tax increases to pay for woefully underfunded public employee pensions.

Unfunded pension liability deficits spiraling out of control, potential tax increases to pay for public employee pensions, and the present public sector labor unions saying we “need” more teachers, so let’s raise taxes…Governor Brown summed it up best: “Well, that tells you you’ve got a Ponzi scheme, because you have to keep bringing in new members and the current system itself is not in a sustainable position.’’10

1 “Funding CalSTRS” February 19, 2014. Legislative Analyst’s Office.
2 Senator Mimi Walter (R-Irvine) introduced SB 984 that appropriates $1 billion in 2014, up to $2 billion if specified conditions are met, from the state general fund directly to the CalSTRS teachers’ retirement fund. As of the publish date of this report, this measure has not been voted down.
3 “CalSTRS and Proposition 98” March 19, 2014. Legislative Analyst’s Office.
4 “Pension crisis: PA auditor general warns of tax increases, bankruptcy.” February 27, 2014. Pennsylvania Independent
5 Illinois’ Temporary Tax Hike: $18 billion Later. Benjamin VanMetre, Illinois Policy Institute. September 17, 2013. 
6 “Gov. Jerry Brown defends plan to reduce pension costs.” December 2, 2011.  Los Angeles Times.
7 “Will LA Have a Pension Tax?” Jack Humphreville, February 27, 2014, PublicCEO.com.
8 “Finding $240 Billion for CalSTRS.” David Crane, Monday March 17, 2014. FoxandHoundsDaily.com.
9 CalSTRS Funding Needs. http://www.calstrs.com/calstrs-2014-funding-plan
10 Ibid, “Gov. Jerry Brown defends plan to reduce pension costs.”

For more information on this report or other Public Employment & Retirement  issues, contact Gary Link, Senate Republican Office of Policy at 916/651-1501.