Anthony P. Archie
Archie is a public policy fellow in Business and Economic Studies.
Prior to joining Pacific
Research Institute, Anthony earned his masters degree
in public policy from Pepperdine University, specializing in
economics and regional/local policy. As part of his graduate
work, he co-authored Crisis in California: Reforming Workers’ Compensation,
a proposal that drew praise from an esteemed panel of scholars
and policy advisors. Mr. Archie has held internships on Capitol
Hill and in the State Assembly. He received his B.A. in economics
and political science
from Pepperdine University. [Archie index]
Taxing Pension System
Unstable and underperforming...
[Anthony P. Archie] 2/23/05
As the pension
debate finally begins here this week, California’s
legislators should take note. California’s current pension
system is inherently unstable and its huge costs jeopardize the
CalPERS’s annual unfunded liability has grown substantially
in recent years. In 2000, taxpayers had to cover a $160 million
shortfall. In 2005, that number has climbed to $2.6 billion.
These figures represent the amount of General Fund dollars allocated
in a given year’s budget, all derived from taxpayer money.
While visibly generous benefits and instances of disability
fraud have impacted these costs, the problem lies within the
structure of the pension system itself.
current defined-benefit pension plan allows a retiree to obtain
a pension based upon a combination of peak
salary, age, and years of service. Pension amounts are guaranteed
under state law upon retirement.
This ensures that the employee will obtain a set amount no matter
how the funds are performing. This detachment from the success
of the investments reveals the inherent dilemma. The taxpayers
are liable for the pensions while the employees are entitled
to them automatically. Since the investment risk is borne by
the taxpayers, the government must fund the pension account regardless
of whether the system can allow for it. The crux of the issue
is that defined-benefit plans have unpredictable costs.
plan depends on the success of the collective investment portfolio.
If the investments are under-performing
and can’t meet the pension obligations, the taxpayers must
foot the bill. Under-performance can be a result of various factors,
primarily the overall success of the market.
During a recession, investment gains usually slow along with
the economy. Tax revenue tends to do the same. Therefore, state
and local governments that operate under defined-benefit pension
systems must deal with the problem of having to cover pension
deficits at a time when revenue does not provide for it. This
increases the incentive for cuts in services, borrowing, and
tax increases, all unpopular moves.
Conversely, with an
economic boom, investment returns and revenues are most likely
abundant. Rarely though is the windfall given
back to the taxpayers. In fact, in California it is illegal to
use CalPERS’s surpluses as General Fund allocations.
The volatility of
the pension costs makes it unpredictable to plan for pension
allocations out of a government’s budget.
This has occurred in local governments throughout the state.
In Contra Costa County, for example, retirement expenses have
ballooned from $37.8 million, or 5.6 percent of the budget in
1995, to an estimated $143.4 million, or 12.26 percent of the
budget in 2005.
As our elected officials take a good look at our current pension
structure, they should see the writing on the wall. California
deserves a stable, fully funded pension system.
proposed defined-contribution plan would save the state and
local governments from fluctuating pension
costs. By predetermining pension contributions, elected officials
can allocate accordingly in their budgets. This predictability
will allow for future revenue planning, delivering piece of mind
to taxpayers against sudden tax hikes or unpleasant cuts in services. CRO
2005 Pacific Research Institute