Class warfare, public employee unions in California, their pensions, and the Little Hoover Commission

As noted in many press reports, union membership in the private sector has dropped so low that the unions are nearly irrelevant.

During the period from 1973 to 2010 private sector union membership dropped by half and as a percentage of the total workforce dropped by three-quarters. The number of private sector pension plans has also dropped by over two-thirds.

During the same period, public sector union membership doubled and as a percentage of the total workforce has increased by half.

Not surprisingly, in 2010 many in the voting public views public sector employee pension programs with some envy and dismay while public employees are looking at the voting public with shock. As usual one should look at this situation in historical context.

Let's examine one messy subject first.

Class Warfare

According to the many right wing pundits, advocates for workers are engaging in "class warfare." Yeah....

What I am discussing here is the decline of the American Middle Class (American households with a ten year average annual net income plus annual net worth growth valued at less than $200,000, but more than $30,000) - be they workers, small business owners (people who file a Schedule C or a Schedule K-1 with their tax return which reports their primary source of income), and landlords. We are not discussing the poor (the under $30,000 group).

The "other" class we are discussing is the American Investor Class (the over $200,000 group).

To figure out which class you're in, first add up your net income for the past ten years. Then take your net worth (the market value of all your assets less all you owe) at the end of  2010 and subtract from it your net worth at the end of 2000. Add those two numbers together and divide the total by 10. If the resulting number is greater than $200,000, you're either in the Investor Class or somehow you squandered over $2,000,000 in the past ten years.

In previous posts, I've presented the figures for the nation, but recapping quickly, the 1960's a pattern of income distribution became noticeable, as indicated on this chart (click on the chart to see a larger version):

What this chart shows is that after WWII the Gross Domestic Product after adjusting for inflation and population growth grew 186% but the benefits were distributed as follows:

• Investor Class income growth is three times the actual economic growth rate;
• Worker-income is 20% less than the economic growth rate
• Small business owner (small business owners probably not in the Investor Class) income growth is 80% less than the economic growth rate; and
• Landlord (both residential and commercial, also probably not in the Investor Class) income ...well... it appears to have been a roller-coaster ride that ends at a point 50% less than the economic growth rate.

More to the point, for $1 of dividends and interest earned by investors, the wages and benefits paid to workers have dropped from nearly $10 to around $4 as indicated in this chart:

In California, the income shift has been similar to the nation. The California Franchise Tax Board reports that during the two decades between 1987 and 2008 the inflation-adjusted incomes of the top 10% of California taxpayers increased by 43%; the top 1% by 81%. Incomes of the lower 60% dropped by around 12%. The 2009 numbers are just being released, but the median income fell in 2009 by 5.1% to the lowest level since 2004.

This history also can be seen in the loss of the defined-benefit pension plan in the private sector as seen in the chart below:

Essentially, the number of defined-benefit pension plans in the private sector was on the rise until the mid-1980's. But by the mid-1990's two-thirds of those plans were eliminated. The process of replacing those plans with 401(k) plans was well under way.

The difference in the plans is critical to understanding the meaning of retirement security for the Middle Class worker versus the interests of the Investor Class.

The defined benefit plan provided for a guaranteed pension upon retirement. The employer was to provide from its capital the pension guarantee, directly through investments and/or purchased annuities.

The 401(k) is a tax-deferred pseudo savings account for the worker (advocated by the capitalist right to loosen up capital locked in conservative pension investments).

It is true that 401(k) monies can be invested in government bonds so that it is secure, but it may not grow enough to provide for an adequate retirement.

Or it can be invested in the stock market directly or through mutual funds, at high risk, providing working capital for the investment community with the chance of high returns and a great retirement (much like betting on the craps table at Las Vegas).

One theme is clear from these charts. Sometime after 1952 and before 1962, the American Investor Class literally and systematically began to increase its share of American economic growth to the detriment of the American Middle Class.

Now, according to the right-wing talking heads, any organized push-back by the American Middle Class must be viewed as "Class Warfare" but the actions of the Investor Class are just good clean fun.

Since before the beginning of the 20th Century, we had Class Warfare. We will always have Class Warfare. The issue is about what constitutes a fair return on investments versus a fair income for labor. To the extent that labor gains usually through collective action and political power, small businesses and small landlords gain and investment returns are limited. Large investors don't want those limits and will fight a war to eliminate those limits.

So yes, we have Class Warfare. So what?  Well, in 2011 having pretty much put the private sector Middle Class worker in an economic decline, the Investor Class is attacking the last bastion of unionism and defined-benefit pensions - government employees.

About Organized Labor in the Public Sector in California

In the past, for many government employees a psychological distance existed between their own self-view and unions such the United Steelworkers which is the largest industrial union the North America with 705,000 members, the Teamsters Union with its 1.4 million member or the Carpenters Union with about 520,000 members or the storied United Mineworkers.

Consider the California Teachers Association, a movement founded within a framework of a progressive social agenda, not necessarily militant unionism, which represents 340,000 educators. Consider this history of the CTA from its website:

Founded in 1863 during the Civil War as the California Educational Society, CTA won its first major legislative victory in 1866 with a law providing free public schools to California children. A year later, public funding was secured for schools that educated nonwhite students. More early victories established bans on using public school funding for sectarian religious purposes (1878-79); free textbooks for all students in grades 1-8 (1911); the first teacher tenure and due process law (1912); and a statewide pension, the California State Teachers’ Retirement System (1913).

CTA led efforts to outlaw child labor in the state and enact other protections for children (1915), and to strengthen the teacher due process law (1921). In the 1940s, the union was the only major organization in California to protest against the internment of Japanese-Americans during World War II.

...After a decade of school strikes and teacher organizing, California K-14 educators at last won the right to bargain collectively in 1975 when the CTA-sponsored Educational Employment Relations Act, also known as the Rodda Act, was signed into law by Gov. Jerry Brown. The pent-up frustrations led to a rare and historic burst of union certification work — within 18 months, 600 of 1,000 CTA/NEA locals statewide secured bargaining rights in their school districts.

In essence, beginning in 1866 the CTA was a professional organization dedicated to progressive political causes, mostly related to education and teachers but broader in scope. It was 100 years after its founding that activities associated more with unions than professional associations became the public image of the CTA.

The California State Employees Association began as an advocate for the creation of a retirement system. In 1923 some of the pre-CSEA leaders from Sacramento, Los Angeles and San Francisco visited Gov. F. W. Richardson. A soon as they mentioned creating a retirement system for state employees, the Governor threw them out of his office.

In 1927, with the economy of the state booming, they prevailed upon then Governor Clement Young who appointed a special commission to study the issue. The commission produced a favorable report. An implementation measure was put on the ballot as Proposition 5. In November 1930, in The Great Depression, the voters approved the Proposition.

In 1931 Governor James Rolph signed the legislation creating the California Public Employees Retirement System. Also in 1931 these early state employee leaders and several hundred others created CSEA. They immediately turned their attention to getting rid of the "spoils" system of patronage jobs by getting the voters to create in 1934 the State Personnel Board giving it broad regulatory powers in setting up and administering the recruiting, examination and selection process, and in establishing employment standards and employees’ conduct and disciplinary procedures.

In 1933 one of CSEA's achievements was the establishment of a state employee credit union.

Again, collective bargaining did not begin until 1975. Since then, CSEA has reorganized into a federation of four affiliated organizations, the Service Employees International Union Local 1000 representing 95,000 California state employees through nine bargaining units; the Association of California State Supervisors representing 7,000 state civil service managers, supervisors and confidential employees who are excluded from collective bargaining; the California State University Employees Union representing 16,000 employees of the California State University system; and the California State Employees Association Retirees.

These two "unions" were not formed to engage in collective bargaining, though they were focused on progressive agendas that affected their members. And in that background, there may be a disconnect from the rest of the populous.

One has to comment that perhaps public sector unions, many of which didn't call themselves a "union,"  may have let down the very people they now depend upon to understand their situation - the simple plight of workers. Americans simply don't know what they owe to unions.

The two national teachers' unions are large and influential. This makes one wonder why the union movement that essentially made the large American Middle Class possible is held with such disdain by so many of the teachers former students who themselves are workers. Nationwide, state and local government employee organization members interact with other Americans daily, but their IT employee friends apparently cannot relate to the benefits of unions. Apparently, communications have broken down.

That's a problem. The public employees had better start communicating about the benefits of unions to the middle class.

The California Public Employee Pension Systems

Before moving on to the details of California's public employee pension systems, we need to acknowledge one significant political factor - the threat pension funds represent to the free-wheeling international corporate community.

1. Iran, CalPERS, and the Council on Foreign Relations

The Center for State and Local Government Excellence, an independent non-profit organization, commissioned Center for Retirement Research at Boston College to undertake a comprehensive examination of state and local government retirement plans which has resulted in a series of papers that can tell you far more than you ever wanted to know about those plans. While no one can examine an issue as complex as this without some bias, these are pretty well done.

One of the papers is entitled Is CalPERS a Sovereign Wealth Fund? The concept of "Sovereign Wealth Funds" is a highly charged subject particularly for the political right wing in the United States. The study had to include a paper on CalPERS because it is perceived as a potential threat by the most rabid free market advocates. From this paper:

While these funds are hard to define in precise terms, all agree they are government-sponsored pools of financial assets. With roughly $3 trillion under management today and forecasts that suggest this number could approach $10 trillion in under a decade, many wonder what role these public investment funds will play in private markets. Due to SWFs’ government sponsorship, some fear that they will be used illegitimately to advance political, instead of commercial, agendas....

...While all seem to agree that the China Investment Corporation and the Abu Dhabi Investment Authority are SWFs, there is a lively debate as to whether public pension funds, such as the California Public Employees Retirement System (CalPERS), are also SWFs. While CalPERS itself is adamant that it is not, others disagree.

After reviewing the "lively debate," the Boston College study concurs with the International Monetary Fund that government pension funds are not SWFs.

However, I cannot ignore the fact that within the United States CalPERS using its share voting power has pressured some Boards of Directors to improve corporate ethics by appointing independent directors, overhauling audit committee procedures, and alter corporate policies. Further, it has also restricted its foreign investments. That has unsettled the international corporate world and the powers that be. Consider the controversial Council on Foreign Relations, the source of many conspiracy theories. Benn Steil, Senior Fellow and Director of International Economics for the Council, wrote an opinion piece in 2008 that appeared in the Wall Street Journal stating:

If California were a national economy, it would be the eighth largest in the world. And its Public Employees’ Retirement System, Calpers, with $259 billion in assets, would rank fifth among the world’s SWFs. Combine it with the $169 billion California State Teachers’ Retirement System (Calstrs), and California runs the second largest SWF in the world, just behind the United Arab Emirates.

Calpers is a political entity in every sense of the word. Its board is comprised of four members of the state political hierarchy, two appointees of the governor, one appointee of the legislature and six elected members -- all six of whom have long ties to organized labor, including the board president, Rob Feckner, who is also executive vice president of the California Labor Federation. Calpers’s investment policies are politically driven, often dictated by the legislature, and even involve foreign policy goals.

While it may be true that the attack on public employee pensions is only a side-effect of a Republican assault on the political power of public employee unions, it is also more likely it has been orchestrated by international corporate interests pushing back at retirement systems such as CalPERS that see part of the job as a shareholder is to press for corporate ethics and international human rights. The objections articulated by Steil even extend to a moderate Republican and corporate interests in countries our government defines as rogue:

Gov. Arnold Schwarzenegger tried to tame the behemoth in 2005 by forcing public employees to join a defined-contribution pension plan. But he was driven into retreat by strong union opposition, and last October he joined the effort to politicize investments by signing legislation to force Calpers and Calstrs to divest about $3.4 billion in stock of companies that do business in Iran.

Yes, we wouldn't want to stop government employee pension money from being invested in ways that help Iran, identified by the world community and our own government as a rogue nation. And the solution advocated to make certain we don't see these kinds of restrictions is to force public employees into defined-contribution benefit plans like private sector employees.

2. The California Little Hoover Commission Reform Proposals

On February 24, 2011, the Little Hoover Commission of the State of California issued a report entitled Public Pensions for Retirement Security which makes recommendations regarding pension plans for State and local government employees, including school employees.

This report arrived after proposals from politicians and citizens ranging from eliminating to overhauling the pension systems for public employees filled the news media. Even the non-partisan Legislative Analyst offered a comment that the "goal should be to preserve public retirement systems that more closely resemble those of other Californians." What other Californians and what does "closely resemble" mean? It's a statement reflects a problematic political attitude ignoring real life.

Yes, the State employs janitors and laborers, but it employs more people whose jobs are akin to support and accounting staff and various professionals. Perhaps that State should have been invested in Google in 1998 and distributing shares to employees as part of their compensation package. What makes a person think like this???

As posted here previously, the Business Insider recently announced:

Here's a shocker: The most immediate state pension crises aren't in New York or California. They're in Middle America.

The article generated from a study done by Joshua D. Rauh of the Kellogg School of Management of Northwestern University. His study, generally quoted by the right as the guy who skewered "pro union" studies, concluded that Califonia's state pension funds could be bankrupt by 2030 without changes.

Changes were already put in place last year. Additional changes are needed. But the State of California, its school systems, and many of its local governments rely upon the California Public Employee Retirement System (CalPERS) and the California State Teachers Retirement System (CalSTRS). Neither of those systems is in trouble today.

The only complaint today is that proper employer contribution levels for 2011-12 require too much money. But too much based on what? The "what" is we don't want to pay it because it will require reducing services or raising taxes. This attitude has been reflected in past budgets which is a cause of the somewhat higher rates today.

Look at the contribution levels of the State as a percentage of payroll over the past 40 years.  Democrats who controlled the Legislature kept their constituencies happy by not meeting the State's retirement contribution obligation rather than not increasing programs. So at the very moment when the state really doesn't have the funds to provide minimal services, we have to meet our obligations by reducing services further instead of skipping a retirement contribution or two because in good times the Legislature and Governor gave away the windfalls.

Some local governments are in worse shape. The fact is that some of California's local governments which (mis)manage their own employee pension plans have pension systems that are essentially bankrupt. Many others appear to have substantial unfunded liabilities which are causing significant financial problems for the governmental entities involved.

Stupid solutions abound in the halls of our State Capitol. But at the federal level, House member Devin Nunes of Visalia proposes that state and local governments provide more extensive information about assets and liabilities focusing particularly on the potential effects of their assumptions on future pension trust fund earnings. He wants more complex reporting using several different assumptions. Sure, more complex reports about actuarial calculations are the solution, yeah, right.

Nothing about that reporting would have saved the County of Orange or the City of San Diego from the mismanagement that has resulted in serious pension fund problems. What would have saved them would have been a bill 30 years ago requiring all local agencies to use CalPERS (or CalSTRS where educators are involved). But no one would suggest that, as all that local money is viewed as a trough for the local investment banker and politician hogs. The only thing better would be if the system had been a 401(k) so that they could tell the employees and retirees "so sorry, but it was the market crash."

It needs to be noted that both state funds have recovered from The Great Recession market crash. The Winter 2011 CalPERS newsletter states:

"Beating market benchmarks, CalPERS earned 13.3 percent on investment in the fiscal year that ended June 30, 2010.
"...The overall return was almost 6 percentage points higher than the assumed rate of return of 7.75 percent for adequate funding of retirements. It brought the 20-year return average through June 30, 2010 to 7.65 percent."

But we do have an extensive report from the State's Little Hoover Commission. The press has already extensively misrepresented the report. Some of the more militant unions that have not negotiated lower cost packages during The Great California Slump have asserted that the recommendations are illegal or immoral. It appears the Democrats in the Legislature have dismissed the report out of hand.

All this, of course, makes it likely that the report offers some intelligent analysis and suggestions.

So let's look at it.

Little Hoover Commission Recommendations

Recommendation 1: To reduce growing pension liabilities of current public workers, state and local governments must pursue aggressive strategies on multiple fronts.

• The Legislature should give state and local governments the authority to alter the future, unaccrued retirement benefits for current public employees.
• State and local governments must slow down pension costs by controlling payroll growth and staffing levels.

What's most interesting surrounding this first recommendation is how strongly it has been asserted by many politicians, unions, and legal experts that the first part of this recommendation cannot be done. Thus we have a statement like this:

"The Little Hoover Commission is recommending something that it admits the courts have already determined is illegal and would violate the promise that government made to its public servants when they were hired," said Bruce Blanning, Professional Engineers in California Government Executive Director.

It's amazing how many times I have read in the press a similar statement.That isn't what I understand the courts have said. The courts did say several times that the government cannot take away from its employees what has been earned in the past pursuant to a written or implied contract. What Commission's report refers to is unaccrued retirement benefits for current public employees, meaning that in the future the contract may change.

"The idea that the state would go back on a deal it made with existing public servants is ridiculous," California Association of Professional Scientists (CAPS) President Patty Velez said. "Most state scientists turned down bigger salaries in the private sector to join the state workforce with the promise of job security and retirement security. Pension changes, just like salary and other benefit changes, belong at the bargaining table."

That pension changes belong at the bargaining table simply means that any contract changes have to be made based upon the State's collective bargaining process. There is nothing incorrect about that. And the Little Hoover Commission didn't say otherwise.

If there is a problem with these two statements from union leaders, it is the rhetoric saying the recommendations "would violate the promise that government made to its public servants when they were hired" and who "join the state workforce with the promise of job security and retirement security." These are the educated members of our state workforce. Somewhere in their educations they must have heard about The Great Depression when public employees took wage and benefit cuts, at least those that kept their jobs. Perhaps they even heard about teachers being paid with school district "warrants" that were IOU's as they couldn't be cashed.

So let's don't game the system to much, here. Union leaders can protest, that's their job. Legislators and Governors on the other hand are the employers, management. They are not supposed to respond to this rhetoric. Not that they're supposed to be union busting capitalists. They are just supposed to not reject Hoover Commission reports out of hand.

Recommendation 2: To restore the financial health and security in California’s public pension systems, California should move to a “hybrid” retirement model.

• The Legislature must create pension options for state and local governments that would retain the defined-benefit formula – but at a lower level – combined with an employer-matched 401(k)-style defined-contribution plan.
• The 401(k)-style component must be risk-managed to provide retirement security and minimize investment volatility.

Recommendation 3: To build a sustainable pension model that the public can support, the state must take immediate action to realign pension benefits and expectations.

►To provide more uniform direction to state and local agencies, the Legislature must:

• Cap the salary that can be used to determine pension allowances, or cap the pension, at a level that is reasonable and fair. Once the employee exceeds the threshold, employees and employers could make additional retirement contributions into a riskmanaged, 401(k)-type defined-contribution plan.
• Set appropriate pension eligibility ages to discourage early retirement of productive and valuable employees.
• Set a tight definition of final compensation, computed on base pay only, over a five-year average to prevent and discourage pension “spiking.”
• Set uniform standards for the maximum hours that retirees can return to work and continue to receive public-sector pensions.
• Set uniform standards and definitions for disability benefits.
• Restrict pension allowances to exclude service in an elected office.
• Eliminate the purchase of “air time.”
• Strengthen standards for revoking or reducing pensions of public employees and elected officials convicted of certain crimes involving the public trust.

►To minimize risk to taxpayers, the responsibility for funding a sustainable pension system must be spread more equally among parties:

• The Legislature must prohibit employees and employers from taking contribution “holidays,” except under rare circumstances.
• The Legislature must prohibit retroactive pension increases.
• The Legislature must require employees and employers to annually adjust pension contributions based on an equal sharing of the normal costs of the plan.
• State and local governments must explore options for coordinating pension benefits with Social Security.

Some pretty solid recommendations are contained in Recommendations 2 and 3. Sure, there are some policy issues that may not be acceptable. But dismissing these proposals sends the wrong message.

I am leery of any proposal involving the addition of a 401(k)-type plan in order to reduce the defined benefit plan. Just because employees in the private sector have abandoned labor organizations and allowed employers to take away their defined-benefit pensions doesn't make it a good idea.

Most baby-boomers and older people with 401(k) type plans have discovered the down side in The Great Recession. One has to keep in mind that CalPERS can, and has, completely recovered from losses in The Great Recession. The same cannot be said for the millions of individual 401(k) accounts.

CalPERS does offer a 457 deferred compensation plan. It allows investment in a broad range of mutual funds like most such plans. The 5-year return in all of those funds is far less than CalPERS has earned, like most such plans.

If there is to be a defined-contribution element in the state pension funds, it should be simply mixed into the investment pool of CalPERS removing from the international corporate community any opportunity to interfere in investment of government pension funds.

Perhaps a combination including a defined benefit element based upon an earnings ceiling, a defined contribution element for earnings above that ceiling, and the 457 plan would offer enough security and benefits to attract good employees while reducing the risk carried by the public agencies.

But a better solution would be to require public agencies to pay sufficient contributions in the current system to cover future costs plus eliminate all the possibilities for last minute "improvements" to a retiree's benefits.

Recommendation 4: To improve transparency and accountability, more information about pension costs must be provided regularly to the public.

• The Legislature must require government retirement boards to restructure their boards to add a majority or a substantial minority of independent, public members to ensure greater representation of taxpayer interests.
• All proposed pension increases must be submitted to voters in their respective jurisdictions.

  ►The ballot measures must by accompanied by sound actuarial information, written in a clear and concise format.

• The Legislature must require all public pension systems to include in their annual financial reports:

  ►The present value of liabilities of individual pension funds, using a sensitivity analysis of high, medium and low discount rates.

  ►The government entity’s pension contributions as a portion of the general operating budget and as a portion of personnel costs, trended from the past and projected into the future.

• The State Controller must expand the Public Retirement Systems Annual Report to include the above information.
• Administrative fees to pension systems should be considered as a funding source to support actuarial expertise and the timely production of the report.
• The Legislature must require pension fund administrators to improve procedures for detecting and alerting the public about unusually high salary increases of government officials that will push pension costs upward.

Personally, I don't think any of these things will do any good. They are focused on local agencies, not the state. They assume that providing the public more information will make things better when in fact practically nobody bothers to read the currently available information. A better recommendation would be to fold all local retirement plans into CalPERS and CalSTRS.

In the end, we need to understand that the state public employee pension programs were initiated in good faith. Yes, there are abuses but they can be stopped with some pretty straightforward rules. The two statewide systems are not in any immediate trouble and with some modifications and proper contribution rules, we don't have to worry about them nor are they some huge burden on the state budget. Because these two systems are stable and generally well-managed, all local government retirement systems should be folded into them.

In summary:

• Americans need to understand that "Class Warfare" is a constant given in modern economic systems.
• For the past 60 years, the Investment Class has successfully diverted the lion's share of economic growth to themselves, away from members of the Middle Class whether labor, small business, and landlords.
• Right at the moment there is an orchestrated attack on public employee unions (which tend to support Democrat's running for office as the better of two evils?) with public pension systems as a significant target because the larger ones represent a potential threat to the freewheeling international corporate world.

If this sounds paranoid, rest assured it is but that doesn't mean they aren't out to get you, members of the American Middle Class. The facts and numbers are available. They should be worrying you, particularly because of what they will mean to your children and grandchildren.