California Governor Jerry Brown (D) yesterday announced a pension reform agreement, which if approved by the legislature, likely will help narrow the Golden State’s huge public pension gap. Brown’s proposed reforms take several steps in the right direction, but they do not address the fundamental problem that could lead to renewed pension shortfalls in the future: the structure of defined benefit pensions.
Defined benefit pensions operate on a pay-as-you-go basis. Under such a system, a defined benefit pension plan’s liabilities can continue to grow regardless of its ability to pay. Thus, an increase in benefits when times seem flush can lead to significant shortfalls in later years, when the boom times end. That is exactly what happened in California under former Governor Gray Davis (who was recalled by voters in 2003).
And therein lies the danger in not moving away from a defined benefit pension system to a defined contribution one. At the slightest sign of economic recovery, labor-friendly politicians find it hard to resist the temptation to reward their union allies with ever more generous compensation — a real likelihood in a blue state like California.
Unfortunately, Governor Brown backed away from a proposal to create a hybrid pension plan that includes a 401(k)-style defined contribution component.
Still, Brown’s pension reform agreement includes some sound and significant reforms. Among its provisions, it:
- Requires all state employees — both new and current — to pay 50 percent toward their pensions;
- Raises retirement age by two years or more for all new employees;
- Caps the amount of salary to be considered for pension purposes ($100,000 for employees who participate in Social Security and $130,000 for those who do not, such as public safety personnel);
- Seeks to end pension spiking by requiring annual pension payouts to be calculated based on a final three-year average;
- Eliminates state-imposed barriers that have prevented local governments from increasing employee contributions;
- Limits retirees to working a maximum of 960 hours per year.
- Bans retroactive pension increases;
- Bars felons from collecting pensions.
These reforms are all welcome, but a long-term solution requires moving away from a pay-as-you-go defined benefit system. Otherwise, a spendthrift future governor and legislature could undo the above reforms when state revenues spike up again.
For more on public pensions, see here.
For more on Democratic politicians taking on public sector unions, see here.