When something important happens, it often happens first in California. It is therefore unsurprising that the Golden State is where a national age of reckoning may hit its stride.
I call it the Era of Broken Promises.
In California, as in Detroit, the immediate focus is on retirement and health care benefits for public employees. Three of the state’s cities filed for bankruptcy even before Detroit’s filing this summer. California’s second-largest municipality, San Diego, and its third-largest, San Jose, have both moved to cut benefits for new hires and, if voters and courts permit, for existing workers as well. Public employee labor unions are resisting these moves.
Across the state, municipal services are being slashed. Swimming pools are closing, parks are unkempt, library hours are shorter, and police and firefighter staffs are being cut. All of this is happening in order to free up cash to pay for current benefits and to fund future benefits for those employees who remain on the payroll.
Yet even though the public’s attention currently focuses on local government finances, which are indeed in generally the worst shape, there are problems everywhere you look. Illinois’ state government is saddled with an unsustainable pension system, though the state’s Legislature has thus far been unwilling to pass a plan to deal with it. On the federal level, we are not even discussing Social Security’s disability program, which is on track to run out of reserves in just a couple of years, let alone the bigger and longer-term funding shortfalls for Medicare and Social Security retirement benefits. In the private sector, many multi-employer benefit plans are in seriously bad shape, and the federal Pension Benefit Guaranty Corp. may have its own funding issues down the road.
The cause of these problems is the habit we developed in the 20th century of paying employees and satisfying voters with promises of future goodies, rather than with compensation and benefits up front. The epitome of the trend may have been the dot-com bubble year of 1999. That year, California lawmakers decreed that public employees could retire at age 50, with 90 percent of their final year’s salary – including salary “spikes” resulting from overtime and accrued vacation.
Yesterday’s citizens benefited from the work; tomorrow’s must pay the bills. In every situation where the money was not fully set aside from the outset – which is to say nearly every situation – these promises acted like a Ponzi scheme.
Now, as the baby boomers age and a relatively small working age population must bear the costs for a growing cohort of retirees, the Ponzi scheme is running out of new players. The inevitable result: Somebody is not going to get what was promised. More accurately, a lot of somebodies.
Public officials from both major parties are finally facing reality, although not everywhere and not fast enough. Still, it is a hopeful sign. For years, public employee unions took shelter behind the Democratic lawmakers who benefited from labor’s campaign contributions and get-out-the-vote efforts. They painted Republicans who called for lower benefits and lower taxes – in large part to attract business and residents to expand the tax base and share government’s financial burdens – as the working person’s enemies.
In deep-blue California, Republicans are almost irrelevant. The state’s only hope is for Democrats to deal with the problems. Some, including Gov. Jerry Brown, are beginning to try.
But the state and local government shortfall alone is estimated nationally at anywhere from $1 trillion to nearly $3 trillion. Unless we expect the next generation to make do with minimal government services, the gap may simply be unbridgeable. The best we can do is allocate and share the pain, and restructure our entire approach to old age planning so that a multi-decade problem does not turn into a chronic failing that lasts the entire century.
Personally, I would abolish traditional defined-benefit pension plans on the grounds of being intrinsically fraudulent. Mathematically they can work, but practically speaking, they don’t. We have evidence going back all the way to the first years of Social Security. I would pay people today for the work they do today and let them save for their own retirements. Retirement should start later in any event, given changes in life and health expectancy.
Welcome to the Era of Broken Promises. And congratulations, if any are in order, to California, for showing us how it’s going to be.
For more articles, please visit the Palisades Hudson Financial Group LLC newsletter or subscribe to the blog.