Public pension debt took an unusual bite out of taxes in Sonoma County last year, playing a role in the rejection of a ¼-cent sales tax increase by 63 percent of voters.
A broad business-labor-environmental coalition said the tax increase was needed to repair deteriorating streets and roads, reduce traffic congestion, improve transit services, create safer pedestrian and bicycle routes, and allow faster emergency response.
But the opposition ballot argument said that instead of being a specific tax to fund roads, requiring approval of two-thirds of voters, Measure A was a “bait and switch” general tax, only requiring majority approval, that could be used for any lawful purpose.
“It is also well known the County has a generous employee pension plan that has a significant funding deficit,” said the argument. “Probably it is fair to say the drain the pensions have on the General Fund have a role in the County’s motivation to enact this new tax.”
After the vote in June last year, Dan Drummond, Sonoma County Taxpayers executive director, told the Santa Rosa Press-Democrat that voters had spoken loud and clear.
“This shows that there was a real concern about the county’s unsustainable pension costs, and it sends the message that the board of supervisors needs to continue its forward march toward pension control,” he said.
Among the 20 independent county pension systems operating under a 1937 act, Sonoma County has been one of the leaders in trying to control pension costs, pushed by key county supervisors and at least two grass-roots groups.
To get to full funding, many public pension systems rely on rate hikes, mainly from employers not employees, and the all-important but unpredictable pension fund investment earnings expected to pay about two-thirds of future pension costs.
Sonoma supervisors went further in 2011 by adopting a 10-year goal of cutting pension costs from 20 percent of total compensation to 10 percent. Annual pension costs soared from $20 million in 2000 to $113 million last year.
A seven-member citizens committee, including a retired actuary and others with financial expertise, was appointed by supervisors last September to review previous pension reforms and recommend more.
The 95-page committee report delivered to supervisors in July is not only a detailed analysis of a pension system by independent outsiders, but also a rare attempt to measure excess pension costs.
The report restates the county goal of 10 percent of total compensation as a percentage of the pensionable payroll, a more conventional measurement used by the county retirement system, which turns out to be 18 percent of pay.
So, if pensions costing 18 percent of the payroll is considered by the supervisors to be sustainable, said the committee report, then annual pension costs over 18 percent are excess.
“We calculated that cumulative excess costs between 2006 and 2015 were $269 million,” said the committee report. “If the projections of future costs hold true, an additional $741 million in excess costs would be accumulated between 2016 and 2030.”
What could the county do with the excess money spent on pensions? With an additional $10 million a year, said the report, the county could fund 44 additional deputy sheriffs or pay for 40 miles of road improvements each year.
Much of the initial Sonoma County pension funding gap was created by a large retroactive pension increase in the early 2000s, later widened by court decisions expanding pensionable pay and heavy investment losses in the 2008 market crash and recession.
Safety workers got the “3 at 50” formula (3 percent of final pay for each year served at age 50) given the Highway Patrol by landmark legislation for state workers, SB 400 in 1999, which became the standard for urban police and firefighters.
Others got the “3 at 60” formula, the most generous of three higher pensions for local government authorized by AB 616 in 2001. The California Public Employees Retirement System board, despite opposition from its chief actuary, offered to inflate the market value of investment funds to help pay for the higher pensions.
Sonoma County, not part of CalPERS, took a higher road and got workers to pay more for the higher pensions. The average Sonoma worker contributes 10 percent of pay, plus an additional 3 percent for the generous pension.
The employer contribution is 36 percent of pay, said the committee report, which includes 22.4 percent for pensions and 13.3 percent to pay off pension bonds. CalPERS has 135 local governments with safety plan rates over 40 percent of pay.
Sonoma County has issued an unusually large amount of pension bonds. The bonds can stabilize or “smooth” pension payments. But there can be gains or losses, depending on whether the invested bond money earns more or less than its borrowing cost.
The committee report said the Sonoma County bonds have been “beneficial” so far. A $97 million bond issued in 1993 has been paid off. The county issued a $231 million pension bond in 2003 and a $289 million pension bond in 2010.
Now the debt the county owes for pension bonds, $425 million, is larger than the county debt or “unfunded liability” for pensions, $406 million. The committee report said the total debt, $831 million, results in a pension funding ratio or level of 73 percent.
Among the Sonoma County attempts to reduce long-term pension costs are a 7.25 percent earnings forecast to discount future pension debt and no cost-of-living adjustments for retirees since 2008.
CalPERS has a 7.5 percent discount rate, like the California State Teachers Retirement System and UC Retirement, and this year gave more than half of its retirees a cost-of-living adjustment of 1.5 to 4 percent.
Sonoma County also bargained an end to some “spiking” pension boosts before more anti-spiking provisions were included in the statewide Public Employees Pension Reform Act, which gives new hires after Jan. 1, 2013, lower pensions.
The committee report said Sonoma County is on track to cut costs to the sustainable target of 18 percent of pay by about 2030. (see chart below) But that assumes investment earnings will average 7.25 percent, which pension critics say is unlikely.
Sonoma County is a “mature” retirement system, with active workers (4,071 last year) outnumbered by retirees (4,563) receiving pensions. As a result, a small decline in expected investment earnings causes a larger increase in pension debt.
The county’s actuary, Segal Company, estimates that dropping the discount rate from 7.25 percent to 6.25 percent would increase the pension unfunded liability from $406 million to $716 million, presumably triggering a rate increase for employers who, unlike employees, must cover the cost of unfunded liabilities.
The citizens committee recommended a number of changes, including extending the 3 percent supplemental payment beyond the expiration in 2024, if it is not covering the $200 million debt from the retroactive pension increase, as appears to be the case.
The committee urged a push to get employees to share more costs through higher contributions. But with 13 percent of pay for pensions and 6.2 percent for Social Security, workers already have about 20 percent deducted from their paychecks.
A big recommendation would give new hires a federal-style “hybrid” plan combining a smaller pension and a 401(k)-style investment plan. But that would require action by the Legislature, which rejected Gov. Brown’s proposal for a hybrid plan.
San Diego and San Jose voters approved broad cost cuts in city pension systems. But in Ventura County, a judge blocked a vote on a proposal to switch new hires to a 401(k) plan, ruling the 1937 act does not allow counties to terminate their pension plans.
A federal judge ruled bankrupt cities like Stockton and San Bernardino can cut CalPERS pension debt. But the two cities chose not to alter their pensions, saying they are needed to be competitive in the job market, particularly for police and firefighters.
Last month, a state appeals court ruled in a Marin County case that reasonable cuts can be made in the pensions current workers earn in the future, contrary to previous “California rule” decisions that pensions can’t be cut unless offset by a new benefit.
But the state Supreme Court may not agree with the appeals court ruling giving pension reformers a long-sought way to control pension costs. If the unions do not appeal, the appeals court ruling may at a minimum give employers leverage in bargaining with unions.
“We don’t doubt the obstacles that exist to implementing reforms,” said the Sonoma County citizens committee report, “but we are also mindful of the substantial cost to the community of reduced services and/or higher prices for government services due to the substantial costs of pensions.”