California Throws Down the Gauntlet for Pension Reform

California Gov. Jerry Brown finally announced a specific 12-point pension-reform proposal last week. Several of its provisions had been telegraphed last spring in a press release that lacked detail, but some of the features are more expansive than his critics and even his supporters expected. Here are some of the key points, which I will categorize as "anti-abuse provisions" and "fundamental fiscal reforms":

Basic anti-abuse provisions:

• No more retroactive benefits increases
• Control spiking with three-year final compensation and limitations on pensionable pay
• No pensions for convicted felons for compensation earned in related public service
• Double-dipper controls to limit post-retirement employment income
• No more "airtime" options to purchase additional service credit
• No more pension holidays for employers
• Governance reforms for the state pension board, CalPERS.

Fundamental fiscal reforms:

• Employees will eventually pay one half of pension contributions (phased in). It is not entirely clear whether this is limited to the normal cost or the full actuarial cost; one sentence in the media release says the former, and another paragraph leaves open the possibility of the latter.
• Full retirement benefits age for new civilian employees jumps to 67 (now typically 55).
• New hires will join a hybrid DB-DC plan with target replacement income of 75 percent including Social Security.
• Retiree medical benefits for new hires become vested after 15 years and require 25 years for full benefits

First, I want to congratulate the governor and his staff for a valiant effort to put forth a credible plan. Most of the reforms in these proposals have been recommended in my previous columns, so I support these efforts whole-heartedly. Hopefully the state legislature will finally move quickly to implement the provisions that can be adopted immediately by statute and put the remainder on the ballot for a constitutional referendum. Having been the nation's first industry commentator to call for mandatory equal employee contributions for retirement plans, hybrid plan structures and an age-67 civilian retirement provision, I am delighted to see these concepts finally get traction in a gubernatorial proposal.

Further, I'd like to suggest that the governor's proposals be the launching point — not the finish line — for the legislature's work on retirement plan reform. The new laws should also require equal contributions for retiree medical benefits, for both current and future employees. Also, in California's unique legal system, the total cost to taxpayers for any defined benefit features for new hires would best be limited by constitutional amendment so that future public officials do not simply repeat the mistakes of the past. What the legislature does today can be repealed tomorrow. Most of these reforms must be codified in a referendum even if a statute is used to expedite implementation before voters get a chance in November 2012.

Even more importantly, a state constitutional amendment is sorely needed to give pubic employers the indisputable right to change benefits prospectively for new employees. We must get rid of this California judicial nonsense that such benefits can only go up and never down, as an inalienable right. Even dumber is the La-La-Land notion that current employees' insufficient contribution rates are a lifelong entitlement as well. And there really must be a formal emergency mechanism to eliminate severe unfunded liabilities on a systematic basis before today's employees retire. Younger taxpayers should not be burdened with the deadweight costs of providing benefits to retirees who never served them.

Now one of the pension-reform groups circling the establishment wagons in Sacramento has filed two ballot proposals to the political right of the governor's plan. There are already reports of a possible union backlash in the capitol. Some would say that moderate Democrats need to feel the heat from conservatives so that they push union loyalists in the legislature to enact the governor's proposals and put something substantive on the 2012 ballot — for fear that something far more restrictive will qualify by petition and then pass on election night. The real question now is whether a grand compromise can be achieved that actually fixes the fiscal problem, or if we'll just see more symbolism, Band-Aids, political posturing and gridlock in Sacramento. Either way, Californians are increasingly likely to be voting on a public pension reform measure a year from now.

The governor may also have a tax-increase proposal up his sleeve, which could be tie-barred with the pension reform plan to help secure the votes to clear the legislature — and to seek voter approval of a Faustian trade-off: public pension reform as consolation for higher taxes.

My hunch is that California may once again become the national bellwether for change in public finance, especially if this all leads to a statewide referendum. Stay tuned, as the opening act has just begun.