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The Economic Madness Of Cutting Pension Benefits

by: Robert Cruickshank

Sun Jun 20, 2010 at 12:00:00 PM PDT


As pension reform heats up, both here in California and in Congress, it's important to understand the underlying economic context - and why slashing benefits would be a stunning act of madness, likely to prolong our recession and budget problems instead of solving either one, at the expense of our basic standard of living.

We live in an economic era characterized by too much debt, itself a symptom of low wages and high costs of living. Although much of our media discussion of economic policy is still locked in the 1970s, obsessed with an obsolete worry about inflation, the reality is that households are not making enough money to pay the costs of living in 21st century California.

High taxes aren't the problem - how could they when taxes are at their lowest point in 60 years? No, the problems come from elsewhere. As Dave Johnson showed in charts, wage stagnation that began with Ronald Reagan has led to a decline in the savings rate and a massive concentration of wealth at the higher end of the income scale.

Meanwhile, the cost of living has soared. Gas prices are now permanently at a level unimaginable at any time after 1981, and are likely to rise for the foreseeable future. Health care costs are still rising at an unaffordable rate. Even with the market crash, housing is still unaffordable to most Californians unless they're willing to move to the urban fringe, savings which are canceled out by the cost of the commute.

Overall the economic situation is that of what Richard Koo called a balance sheet recession - where the private sector is scaling back on spending to purge debt, creating a long-term recessionary environment. The only solution is to increase wages and create more jobs. The absolute last thing you want to do is to slash wages - or pensions, for that matter.

Cutting pensions would be like taking a shotgun, aiming it at our feet, and pulling the trigger. It would cause a cascade of economic problems that would dramatically worsen our economic crisis.

But that's exactly what some people are now arguing needs to be done. Last week Governor Arnold Schwarzenegger announced a pension reform deal with several state employee unions, including AFSCME. The deal preserves current pension payments, and creates a two-tier system whereby new hires pay more of their wages into the system. It's not an ideal solution, but it's better than the alternative.

In assessing the pension deals, California political commentator and friend Joe Mathews argues that the deals don't go far enough, and that what's needed is to slash the benefits of current workers.

Below the flip is my explanation of why this is a very reckless approach, and if implemented, would produce long-term recession.

Robert Cruickshank :: The Economic Madness Of Cutting Pension Benefits
Here's Joe Mathews' response to the pension deals:

Current workers, particularly baby boomers, are virtually certain to get so much more out of the system than they pay into it that they ought to be arrested for generational theft. They need to take more of the hit for this. That's a difficult position to take, politically and legally, but it's also the right one.

I could not disagree with this more strongly if I tried. There are many things wrong with this assessment, and I'll take them in turn.

First, the "generational theft" argument. Generational theft is a very real problem. Young folks, those of us under 35, have been systematically robbed for the last 30 years. Our K-12 education was weakened through budget cuts. We were made to take on unaffordable student loans to get the same university education that our elders received for a fraction of the price. Older generations use Prop 13 to subsidize their own wealth while making it almost impossible for younger Californians to purchase a home of their own. When teabaggers in their 50's complain about debt because of the burden it will leave to the young, they are shedding crocodile tears, because they are systematically destroying the future of those same young people they misleadingly claim to care about.

But that does not mean the answer is to engage in our own generational warfare by slashing their pensions. Already many retired Californians struggle to make ends meet. Too many have to choose between pills and other costs, including housing costs. Cutting the pensions of those already retired would merely redistribute those costs onto everyone else, working people already struggling with low wages and high costs of living.

Mathews didn't appear to be calling for slashing pensions to those already retired, but for those currently working. But the outcome would be the same anyway. I'm 30, and my parents are in their mid-50s. One is fully vested in CalSTRS, the other has lost most of their 401k retirement to the market downturn. I cannot possibly imagine how my economic future would be improved if they had less money at retirement. I'd have to make up the difference if they had medical costs, housing costs, or other costs that they might struggle to afford of their state pensions and their Social Security benefits are slashed.

In fact, it would be yet another form of generational warfare against my generation if the pensions of my parents and their generation are slashed.

The better solution is to go after the massive wealth possessed by the top end of the income scale. California is still an extremely wealthy state. We just don't tax most of that wealth, and we should. Yet Mathews argues we shouldn't do it. Nowhere in his column does he indicate higher taxes should be on the table. Mathews suggests that the wealthy and corporations should "give back," but frames it as a general call for sacrifice, when in fact we need a fundamentally different approach to taxation that seeks new revenues from the rich without slashing benefits for others.

Instead he makes this sound like we have no alternative but to cut pension benefits. Remember what he said in the section I quoted above:

They need to take more of the hit for this. That's a difficult position to take, politically and legally, but it's also the right one.

It's neither necessary nor right that current workers see their benefits cut. We have choices, and one of those options is to raise taxes on the wealthy to bring in the revenue we need to sustain current pensions.

Of course, we also have to remember that the current bill for pensions is artificially inflated because of the recession. If we have economic recovery and growth, then state pension funds will be in a much stronger position. But if we give in to the desire to have widespread austerity, recovery will collapse, the state budget deficit will grow and persist, and the pension funds will continue to struggle.

California's unions understand this basic reality. Mathews argues they don't:

But these unions are one important part of the problem. While they don't always seem to recognize it, they have a strong interest in being part of solutions to make state government fiscally solvent.

And yet the solution being proposed - slashing benefits - will do absolutely nothing to make state government fiscally solvent. It will mean there's less money available to spend, meaning less sales tax revenue. Less consumer activity means there'll be less jobs available, meaning less income tax revenue. With fewer jobs available, and wage stagnation, and now the added financial burden of paying the costs of retired family members that used to be borne by the pensions and other state services that have been cut, younger folks won't be able to sustain the economy. Retirees and baby boomers will have to sell their homes for the cash, and in a recessionary environment where the young aren't able to afford the present market value, home values will spiral downward, causing further economic ripple effects as well as reducing property tax revenues.

It is a senseless outcome. California's unions are absolutely right to fight it. While they are framed as solely defending the wages and benefits of their members - as if there was anything wrong with that - these unions are also defending the economic prosperity and fiscal viability of the state of California. Their unwillingness to embrace deflation and depression should be lauded, not chided.

Mathews concludes by reasserting his claim that slashing benefits is necessary to our state's future:

But savings on pension obligations can't be the only money that elected officials and voters grab to balance the budget and put the state on a better long-term footing. Everyone needs to give back -- from those who rely on public services to the wealthy and corporations, who have seen their taxes cut even as Californians experience government service cuts and income and sales tax increases.

Of course, those income and sales tax increases have not damaged the state's economy. Since they went into effect in April 2009, the state has experienced a very halting and slow recovery - but it has not slid deeper into the recession. Had those tax increases not been accompanied by Hooverism - including but not limited to the loss of nearly 30,000 teaching jobs - California might be starting a more robust economic recovery.

More importantly, the notion that "everyone needs to give back" just doesn't make sense given our economic distress. We've already given back too much. We gave back our wages. We gave back our ability to afford health care and housing and transportation. We gave back the robust public sector services that created widespread prosperity in the 1950s and 1960s. We gave back affordable, quality education. And too many of us have given back our future.

No, it's time for someone else to give back. It's time for the wealthiest Californians, and the large corporations, to give back. For 30 years now they have benefited from economic policy designed to take money and benefits from the rest of us and give it to those who already have wealth and power. Mathews agrees the wealthy and corporations should give back - but that ought to be the centerpiece of the solution, instead of being linked to a downward spiral in living standards and economic prosperity.

We are now experiencing the predictable outcome of such policies - the worst recession in 60 years, an intractable downturn. The way out isn't to worsen the crisis by slashing pensions. The way out is to return to the sensible tax rates of the 1950s and 1960s and make the rich pay.

It's the right choice for California. Let's hope that's the choice we wind up making.

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You are making exactly the wrong argument (5.00 / 1)
Every dollar paid to a government worker in the form of a pension is one less dollar we have to lower tuition at public colleges and universities, to provide additional feet on the street for fire and police protection, and to help poorer state residents deal with the high cost of health care.  To continue to push for lavish pensions (90% of final salary is indeed lavish) for government workers is contradictory to a progressive outlook.  Such mandated payments increase current unemployment and continue to devote excess resources to a group that isn't as likely to create an immediate multiplier effect on the economy.  In point of fact, pensions payouts to retired CA gov't workers may go to people not even currently living in California -- thus further draining revenue from the state.

Your argument that pension reduction will prolong our economic stagnation is one that I strongly disagree with.  For starters, pension obligations are a debt.  They are money owed to a privleged group to be repaid in the future.  The primary cause of the current recession is excessive debt:  individual, private, and public.  Slashing pensions is one of the quickest ways to reduce public-sector debt.  With a reduced debt burden, the public sector would be able to retain more positions (fewer teachers fired, fewer DMV employees on furlough, etc).  This would immediately boost employment and do more to bring the economy out of recession than continuing to pay full pensions to retired government workers.

You argue that:  "High taxes aren't the problem - how could they when taxes are at their lowest point in 60 years?"  

At best this is a distortion of the CA situation by including Federal and State taxes.  The fact is that before Prop 13, CA consumed approx. 11.5%-12.0% of income in state and local taxes.  After Prop 13, this number plummeted to 9-9.5%.  However, since 1980, it has risen steadily and is now back up to 11.5%.  The fact is that we are a high-tax state, with the highest sales tax rate and the one of the highest top income tax rates in the country.  To argue that taxes are "at their lowest point in 60 years" is clearly not true in California.  The fact is that we are paying more and more for less efficient state and local government.  The root cause of that reduction in efficiency is having to pay more and more in non-salary (pensions!) to current government workers.

The good news is that general public opinion has now turned sharply against continued lavish public-sector pension payouts.  I predict a move to defined-contribution plans for new hires (at a minimum) and a reduction in payouts to existing retirees (at a maximum).  

Since this appears to be a bit of a philosophical difference, only time will tell who wins.  I'd bet 80/20 that the unions are about to endure a string of defeats, with punctuated wins only due to a bought-and-paid-for CA legislature.


Idiodicy (0.00 / 0)
The fact is that before Prop 13, CA consumed approx. 11.5%-12.0% of income in state and local taxes.  After Prop 13, this number plummeted to 9-9.5%.  However, since 1980, it has risen steadily and is now back up to 11.5%

 Every study indicates that it is only at this level for
the low-income population.  The top 1% has a burden of
a little over 7%.  Even a flat tax on income in California
would be better than our current situation.

  As for this latest episode in race to the bottom, I always tell Republicans that it is class warfare to stir up envy against government workers for their pensions, and
I ask--instead of taking for the government workers, why don't we bring the private sector workers up to their level?


[ Parent ]
Not all debt is alike (0.00 / 0)
The problem is that debt is owed to wealthy banks and wealthy creditors.

Pensions, however, go to people who actually need the money and who make productive use of it. It's a form of deficit spending, whereas the debt owed to the banks and creditors is little more than paying the local lord of the manor.

Further, you seem to believe that there is a finite amount of tax revenue available. I reject that nonsensical view. California is a very wealthy state with plenty of money for both pensions and public schools, for universal health care for all, and for job creation.

Only if you rule out taxing the wealthy does there somehow become a limited pool of revenue available. But since I don't rule it out - instead I argue such taxes are essential - then I'm not bound by the artificial construct you created.

You can check out any time you like but you can never leave


[ Parent ]
Pensions (4.00 / 1)
In all this bantering about pensions, I rarely see people acknowledge that public employees do not participate in social security, that public employees generally pay a higher percentage of their pay into PERS than private employees pay into Social Security, that there is no upper salary limit on PERS contributions while there is one on SS contributions, or that public agency contributions vary up OR DOWN based on investment performance.

The problems with PERS seem to me to be related to people gaming the system, spiking their salaries in their final years, cashing out vacation or sick leave artificially raising their salary.  Those things need to be fixed.

We ought to base pensions on real salary, based over the three highest years average rather than single highest year.  Public safety pensions ought to go to people actually doing the stressful, dangerous work rather than to chiefs and managers.  I don't want 55 or 60 year old cops trying to run down a 19 year old meth addict and I don't want a 55 or 60 year old firefighter trying to carry me out of a burning building.  Just think of the public liability from that!

People need to understand the system and the obligations to the employees before they complain about it.


Like the Social Security Crisis (5.00 / 1)
The pension "crisis" is vastly overstated and poorly understood, much like the Social Security crisis, which isn't a crisis at all.

In general, modest changes in contribution levels by the employees and the employers and some common-sense approaches to eliminate pension spiking solve most of the problem.

Having said that, there are some very large problems with some plans, with some classes of employees, particularly public safety employees, that need to be resolved.

And there are some very large actuarial problems with retiree medical benefits that can only be resolved by large-scale reform to our medical insurance and payment system.

What's really the problem is a fundamental assault on the very idea of public employee unions and their right to bargain. The right wing would vastly prefer to outsource much of government - not to save costs, but to provide opportunities for profits by crony capitalists.


OC Progressive is Gus Ayer, former Fountain Valley Council member.  


Pissed off Public Sector Employee (0.00 / 0)
As I young (under 30) public sector employee I have seen both the benefits and pitfalls of being in my field. A case has to be made more forth-rightly that public sector employees do eschew payments into Social Security to get involved in Calpers, Calstrs,ect. and that we get a fixed pension calculated on our last year of wages/salary. However, abuses must be pointed out and corrected. The abuse as I see it kicks in when both Union members and Management cash out their pay sick/vacation pay to inflate their wages/salary to get a bigger payout during thier last year of employment. We had a big contract fight earlier this year when Managment was asking for cuts and our CEO cashed out his sick leave at 100% to inflate his retirement income. And I know some retiring union members who work this system to benefit themselves as well. The pension system incentivicizes abuse.

Secondly, unions have been to lax by only unionizing government workers. There is a private sector to be unionized and why not try and unionize them. I feel that the unions have been lazy in their attempts to try and articulate why a union is needed in the 21st Century. I have pondered this question and my coworkers, some older than myself have asked me the same thing. What has the union done to market itself to private sector employees?

Lastly, us who are members of these pension funds have been too lax in not keeping a vigilant eye on what our penions are being invested in. Calpers invested heavily in the housing boom thinking that this would go on forever. Now they are weighing in on asking the state for 700 million dollars to cover their losses and maintain pensions. When will we hold this organization accountable?

As Progressives we must hold government to a higher standard of efficiency, transparency, and accountablity if we ever want to stave off attacks from Regressive forces who see the state as evil incarnate and will do anything to attempt to dismantle it.  


Also: low salaries vs good benefits trade-off (0.00 / 0)
Not only are there all the differences mentioned between PERS and SS which already make PERS more expensive for participants.  The unions also traded wage hikes -- many times and over many years -- for those benefits.  (In case anyone wonders why public employee wages are not currently that much lower than private sector, well, there's your answer for what happens when unions are squeezed out.)

If those who now want to reduce benefits were really worried about a fair deal, they'd be figuring out how to return all those lost wages.


local governments are in a very bad spot with pensions (0.00 / 0)
The state is raiding local treasuries, and the stock market returns are down, health care is through the roof, and local governments don't have a lot of options to work with.  

Fry, don't be a hero! It's not covered by our health plan!

Editor's note to Steve from Sacto (0.00 / 0)
I had to delete your post on George Skelton's op-ed - please don't post whole articles here. You can post a link and some excerpts, but not the entire thing. Thanks for drawing our attention to it!

You can check out any time you like but you can never leave

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