Gov. Jerry Brown last week made a down payment on pension reform in the form of seven specific recommendations to slow the growth in pensions for public employees, including teachers. It’s the obvious steps to curb abuse, like banning retroactive pension increases, the purchase of additional pension credits, and the spiking of income in the final year to boost pension payouts.
But the release of CalSTRS’ annual report and the Legislative Analyst Office’s readable summary of it** last week shows why Brown is taking his time on dealing with the bigger issue: CalSTRS’ large unfunded liability. The remedy for straightening out the retirement system will be painful for taxpayers and for future teachers and administrators.
The reason, the LAO said, is unequivocal: “CalSTRS’ current fiscal model is unsustainable. … There is no realistic way for CalSTRS to ‘grow its way’ out of this problem through favorable investment returns over the long term, as the system’s own officials have acknowledged clearly.”
Though CalSTRS rebounded nicely with a 12 percent return in the past year, the loss of a quarter of its portfolio value in 2008 created too big a hole to count on the growth of investments to keep up with obligations to current teachers and administrators and those already retired. As a result, payments into the system must be raised.
The current yearly contribution to CalSTRS is $5.2 billion: $2.3 billion from educators who pay 8 percent of their pay into the retirement fund, plus a match of $2.3 billion from school districts and county offices, plus $688 million from the state. (The state also contributes about $700 million more into a cost-of-living account.) CalSTRS actuaries are saying it will take an additional $3.9 billion annually for a fully funded system over the next 30 years – an increase in the contribution level of 75 percent.
Given the state’s precarious financial condition, no one is predicting the state will raise contributions this year. They could be phased in gradually, starting in a few years. But the longer the delay and the slower the phase-in, the higher the contribution level ultimately will have to be. Pay now or pay more later.
Unlike other public pension systems in California, in which employees can negotiate contribution levels, only the Legislature can set contributions for CalSTRS. A long line of court decisions has held that lawmakers cannot raise the contribution level of current employees or cut their benefits.
Brown may still choose to challenge those rulings – and raise the retirement age or put a cap on the level of income on which retirement benefits are paid, as some are urging. But it’s a dicey strategy. So over the next decade, billions of dollars in retirement obligations may have first dibs on new revenue that could have gone toward restoring programs and teaching positions cut over the past three years.
The only other way to gradually cut into the state’s liability is to whack the pension benefits of new teachers. That’s unfortunate, since the state needs to make teaching a more attractive profession, but it’s also all but certain, in one form or another.
Beside raising new teachers’ contributions and lowering the state’s and districts’ share, one option is a hybrid plan that combines a smaller defined benefit with a 401(k)-type matching program – technically, 403(b) – in which the risk of investment decisions is shifted to teachers.
An alternative pushed by the bipartisan Little Hoover Commission is to require future teachers and principals to pay into Social Security (currently requiring workers and employers each to contribute 6.2 percent of pay). Teachers, along with some fire and safety workers, opted long ago not to enroll in Social Security – and, for the most part, for good reason: A teacher with 35 years of experience retiring at 65 will receive more than twice what a worker making the same pay will get from Social Security.
But most young teachers don’t think about pensions; they worry about pay. Especially if cutting retirement benefits of new teachers is coupled with a long-term commitment to raise the pay of new teachers, converting to Social Security does have some advantages:
- Social Security is portable, while CalSTRS is not. Teachers who don’t work five years in the profession – a huge percentage – aren’t vested and lose the districts’ and state’s contribution to their retirement. With Social Security, they’d get full credit for their work.
- An alternative to CalSTRS would reduce pressure on middle-aged teachers, especially the low performers, to stay in a profession they may have tired of. As Merrill Vargo, executive director of Pivot Learning Partners, noted in a recent column, “Most people aren’t gluttons for that much punishment … so what is the incentive that keeps teachers hanging on when an employee in the private sector would be polishing her resume and scouring Craigslist for the next opportunity? Once we ask the question, one part of the answer is pretty obvious: it’s the pension.”
- Participating in Social Security would eliminate a penalty that discourages people who have paid into Social Security from making a mid-career switch into teaching. They currently lose about $4,300 per year in retirement benefits under something called the windfall elimination provision, which deducts part of what they’re entitled to under Social Security. Congress shows no inclination to fix the problem.
CalSTRS’ challenges are real, and the unfunded liability to taxpayers is large. Those who dismiss the call for pension reform as merely another attack on teachers and the middle class should read the LAO summary.
** The LAO report was written by Jason Sisney, the LAO director of state finance.