How to Reform Pensions at the Ballot Box

In my column last week on the landmark pension reforms approved by voters in San Diego and San Jose, I concluded with the thought that political leaders across the country can take heart that voters are able to see and are willing to back the kinds of reforms that can bring a city's finances back into balance. In an interview in the days after the remarkable success of San Jose's ballot measure known as Measure B, Mayor Chuck Reed discussed with me the ideas and principles that led to that success, as well as those that open the door to future reforms. Here's an edited transcript of our conversation:

Please explain the budget and service context that led you to pursue the recently enacted pension reforms in San Jose.

San Jose Mayor Chuck Reed

Leading up to the passage of Measure B earlier this month, the city had been forced to deal with quickly growing budget shortfalls for 10 years in a row. By 2011, the gap had reached $115 million, with much of the increase coming from increases in pension costs. For example, the city's annual pension contribution grew from $73 million in 2001 to $245 million this year. The reductions in basic services the city could provide were dramatic, and the consequences of corresponding cuts were falling on the backs of the very workers that pensions are intended to serve. In the years leading up to this month's ballot measure, for instance, we cut our workforce from 7,400 to 5,400 workers.

With independent analysis showing another 12 years of increases in pension costs, we feared we were driving the city toward essential-service insolvency. We knew we needed to take action both on behalf of taxpayers, as well as that of the city's public servants.

It is rare to rally the relatively diffuse interests of taxpayers and residents to overpower the vested interests. What themes and ideas were most effective to amplify the voice of the public over the vested interests?

First we polled our citizens to understand what information and messages would catch people's attention. We worked hard to build a case that plainly laid out the problem and the fact that it wasn't going to change without changing course.

Second, we made it clear that all reforms were aimed at increasing the fairness of the city's pension programs for all existing employees as well as new hires. Our central case was that reasonable reforms would help guarantee reasonable benefits and protect the benefits that workers have already earned.

What are the core changes to pension benefits that achieve these goals?

For new employees, we've maintained a lower-cost defined-benefit plan that accrues at a more manageable 2 percent per year with a maximum payout of 65 percent of final salary. For new hires, Measure B also raised the retirement age to 65 for civilian workers and to age 60 for fire and police. A key provision here is that employees and the city agree to pay half the cost of these new pensions to help ensure both the city and workers have a strong interest in making sure pensions don't go underfunded.

For existing workers, we were able to preserve the existing defined-benefit plan and ensure that they keep any benefits earned and accrued to date. But going forward, employees who stay in the current plan will be required to share with the city the cost of covering the funds' unfunded liability. Depending on a variety of factors, this could increase to as high at 16% of annual earnings for an employee who decides to stick with the current defined-benefit plan. We understand that increased cost won't work for everyone, so we've also created an optional lower-cost plan for existing workers that brings into better balance the costs and benefits of the city's pensions.

One of your early reforms in this area was to professionalize the membership of the pension funds' boards. What were those changes and how did they help?

In 2010, we were able to pass a critical shift in pension-fund governance that made sure that at least half of the funds' board members were individuals with financial expertise and without conflicts of interest. Now a majority of the board members see things a little bit differently than they used to. Now the city's two pension boards can look at the numbers in an unbiased way. We think this kind of impartial analysis has helped us see the fiscal condition of the funds more clearly. And it has equipped us to communicate to voters the need to make better policy.

Presumably Measure B has the potential to produce positive results for economic development and job growth in San Jose. How has the private sector reacted to your advocacy and the success of the ballot measure?

We have had tremendous support from the business community. Business leaders see a direct correlation between these skyrocketing costs and the consequences of declines in public services. They get it: Losing services makes San Jose a worse place to do business. Sometimes just seeing the numbers can have an impact. For example, when the business community understood that the city government pays more than half of payroll costs to retired city workers, they were shocked.

What's next for pension reform and government innovation in San Jose?

This has been a long process, starting with simple reforms like professionalizing the boards as I mentioned earlier. We've also made changes to health policy to ensure that the city and employees split 50-50 the increasing cost of retiree health care. What follows Measure B will start immediately. We'll be carving out the specifics of the new alternative retirement plan for new employees. We'll also be making moves to create a lower-cost health-care package. And we'll be building on other reforms to payroll policy; a year ago we reduced payroll costs by 24 percent to get us some cushion. But we still need to eliminate sick-leave payout [for retiring employees] and modify policy to reduce the high cost of overtime.

What advice do you have for other mayors wondering about how to collect and use political capital to move similar reforms?

If you get the facts of the case for reform clear and put the issue to the voters, you can win. Working with current employees is also critical. Even though we are not taking away any benefits that have already been accrued, we are making changes to their future expectations. The three basic options to fix these problems are to cut workers' pay, lay some employees off, or agree to pay more for services and benefits. We've done all three of those, but importantly we've worked to give employees a choice: Either maintain future expectations by paying more, or go to an alternative lower-cost package of benefits.

We think we have proven that this mix of changes proves there is a path to reform that is an alternative to bankruptcy.