The Perfect Fiscal Storm

My hometown is asking voters to approve a sales tax increase of 1.25% in November 2020. I know they need the money, but it is certainly a crapshoot whether they will get it. The plan is to frame the tax for infrastructure improvements but to ask for a general tax that can be used for anything. The reasoning goes that a general tax can be approved by a simple majority of the voters, but a special tax would require a two-thirds vote. City hall is betting that at least a majority of the voters will believe that the new tax will be used for infrastructure even if there is no guarantee.

As sure as God made little green apples, this won’t be the last time my hometown goes to the taxpayer trough. Covid-19 is acerbating the city’s financial picture; however, we have to look behind Covid-19 to see the real problems that have led us to this point. The California Public Employees Retirement System (CalPERS) contribution crisis is a significant element.  City after city is financing their unfunded CalPERS retirement liability with sales tax increases, utility user taxes, parcel taxes and/or long-term debt. If it uses debt, that will reduce the monies available for future city services even more.

On May 2, 2018, the League of California Cities held a general session at their annual conference on “PERS’ Path Forward.” The speakers identified three court cases that were winding their way through the courts at the time. The California Supreme Court has now opined on all three. The most recent decision was last week on July 30, 2020, when the Court held that the “California Rule” (that retirement benefits are contractual obligations that cannot be changed) has its limitations. However, to date, there has been no legislation that has effectively stopped and/or reversed the inexorable climb of CalPERS benefit costs to local governments and, consequently, no recent Court decision to uphold or reject it.

The following is my observations over the last forty years on what has happened:

1. It used to be that cities had many more employees. The additional staff was able to maintain parks, trim street trees and fill potholes. The employees earned a living wage and they were able to raise families on their salaries.

2. City employees were paid below their private-sector equivalents, but they were given a defined-benefit retirement that insured a comfortable living upon retirement.

3. Then, city employees clamored for wages equivalent to the private sector which, by itself, wasn’t a problem. The real problem was in granting comparable wages without creating a comparable retirement system. The comparable wages raised the retirement contributions necessary to provide the annual payouts upon retirement.

4. Cities used to be managed by professional city managers who would have an independent retirement plan (usually the International City Management Association’s [ICMA] plan). This meant that they were insulated from receiving benefits from a CalPERS benefit increase and wouldn’t let any personal benefit cloud their professional judgment.

5. City councils used to take direction from the professional city managers so there was less political pressure on them to approve salary increases. Today councils tend to micro-manage cities with city managers doing the council’s bidding. Unfortunately, that corresponded to the rise of aggressive public-sector labor unions which were able to elect councilmembers beholden to them.

6. The natural consequence of more powerful unions has been higher salaries and benefits. Since retirement costs are based on salaries while employed, the retirement contributions have significantly increased without any corresponding revenue increase.

Returning to the League meeting in 2018, the authors quoted the Little Hoover Commission report from 2011 which said, “California’s pension plans are dangerously underfunded, the result of overly generous benefit promises, wishful thinking and an unwillingness to plan prudently.” The report concluded that “…pension costs will crush government…(city) budgets are being cut while pension costs continue to rise and squeeze other government priorities.”

Some examples of the fiscal impact to California cities as reported in the Los Angeles Times:

1. City of Richmond in northern California cut about 200 jobs from 2008 to 2017. These were probably the parks maintenance, tree trimming, pothole employees—the first sacrificial lambs to CalPERS demand for more money. The City estimates that by 2021, its retirement expenses could exceed $70 million or 41% of the City’s general fund. (2/16/2017)

2. The retired city manager of El Monte, in southern California, collects more than $216,000 annually plus COLA and fully-funded health insurance. The City’s retirement costs totaled $16.5 million in 2016 or 28% of the City’s general fund. This retired manager was instrumental in getting the retirement benefit adopted. (12/30/2016)

Covid-19 is an unexpected challenge to local governments. The growth of retirement contributions is a long-term major challenge. Both issues have been made worse by a systemic problem with local government management. I would recommend the following changes:

1. Nobody should expect that CalPERS will go away. However, the appellate court in the Marin case held that there was a right to a “reasonable” pension. Taking that point one step further, we could suggest that unreasonable pensions, such as received by the former El Monte city manager, should be reduced. This adjustment would provide more monies to pay the “reasonable” pensions.

2. As a minimum, City managers should be excluded from CalPERS and maybe all executive staff should be excluded. To avoid doing this is to allow the fox to guard the hen house. I would further suggest that the former El Monte city manager violated Tenet 12 of the ICMA Code of Ethics: “A member shall not leverage his or her position for personal gain or benefit.”

3. The State Legislature should require that city councilmembers who receive public employee contributions for their campaigns should be excluded from voting on public employee salaries and benefits.

4. Cities should follow a “best practice” of negotiating salaries based on total cost of the employee to the agency. Once the total cost is established, the employees can bargain for how to receive it: current salary vs. future retirement benefit; current salary vs. current health benefit, etc. The “total cost of the employee” should be based on what the agency can afford, not what the employee wants. Remember, it is normal for an employee to want additional income – it is not their responsibility to determine if the agency can afford it. That’s the job of professional city management!

Covid-19 may be making my hometown’s financial picture worse. But, without systemic change, I’m convinced that my city council will return in a few years with the request for more taxes to pay their CalPERS obligations. Maybe next time it will be a parcel tax for public safety? Meanwhile, I may have to fix potholes myself!