California Crowd-Out How Rising Retirement Benefit Costs Threaten Municipal Services

In recent years, California municipalities have seen retirement benefit costs grow at a rate above that of taxes, fees, and charges. “Crowd-out” is the term given to this condition by some public officials forced to deal with the resulting fiscal strain. Balanced budget requirements mandate that when costs grow more rapidly than revenues, something must give. All too often, this has meant reductions in core government services, most of which—police, fire, libraries, parks, and street and sidewalk maintenance—are delivered at the local level in California.

Retirement benefit costs have caused California localities to underfund basic infrastructure maintenance needs, even in affluent areas such as Sonoma County. Teachers in Los Angeles are threatening to strike over stalemated contract negotiations, as the school district has found itself unable to satisfy union demands for increased personnel and salaries, as well as its long-term benefit commitments.

This paper takes a broad look at California crowd-out, documenting the phenomenon across the local government sector. It will compare rates of growth between revenues and retirement costs and examine workforce levels, salary trends, infrastructure spending, and other service indicators. Major findings include:

Cause

• Crowd-out is a structural problem that asserts itself mainly during economic downturns and recoveries. In each of the last three recessions since the early 1990s, California local governments have seen annual pension contributions grow at a rate above tax revenues.
• A survey of cost trends in own-source revenues and retirement benefits across 25 municipalities, including San Diego, San Jose, and San Francisco, found that all experienced crowd-out over the last decade.
• Examples of crowd-out may be found in every variety of California municipality: city, county, transit agency, school district, high income, low income, and throughout all regions.
• The portions of local pension costs that have risen most rapidly have been those associated with systems’ unfunded liabilities.
• Active employee health care benefit costs have also grown rapidly over the last decade, though in more recent years, the pressure has weakened. A survey of 14 localities’ active employee health care spending found that the median increase during FY05–09 was 40 percent, but only 20 percent during FY09–14.
• Crowd-out will continue because of pressure to increase payments on retiree health care and mandated pension expense increases by CalPERS and CalSTRS, the state retirement systems in which many local governments participate.

Effect

• Census Bureau data show that, between 2004 and 2012, growth in pension costs for California local governments outpaced spending on core services, such as police and fire, and quality-of-life services, such as parks and libraries.
• Crowd-out’s most tangible effect has been on personnel. In December 2014, local government staffing levels in California remained eight percent below where they were in December 2007. Private-sector job levels in California, by contrast, were 2.4 percent higher.
• Job cuts have not been across the board. Local staffing data suggest that reductions in public-safety personnel have been less steep in recent years than for non-public-safety personnel. Bureau of Labor Statistics data show that local government education jobs have been reduced more than noneducation jobs.
• In California over the last 15 years, local government salaries have increased 5 percentage points more slowly than private-sector salaries, and 3.4 points over the last five years.
• Whether governments should increase their workforces must be evaluated on a case-by-case basis. But by restricting municipalities’ staffing possibilities, crowd-out also restricts municipalities’ policy possibilities.
• Crowd-out has had a more significant effect on the ability to perform basic maintenance than on major capital investments. Were localities to devote what they currently spend on pension debt service to basic maintenance instead, some could reduce all or most of their infrastructure backlog within a few years.

California’s fiscal position has improved since 2010. No longer does it have the lowest credit rating among American states; its unemployment rate is down; and it has not faced a multibillion-dollar budget deficit since the FY12 budget cycle. But local services are not improving at a rate proportionate to economic growth. When the next recession hits, more municipal bankruptcies will come. For the moment, the greatest threat is mediocrity, not insolvency.

Recommendations

1. Local governments should focus on scaling back retiree health care benefit commitments instead of, or as part of, funding arrangements.

2. Pension reform will require state action, likely through a ballot initiative. The success of pension reform at the state level will, however, depend on local leadership.

About the Author

Stephen D. Eide is a senior fellow at the Manhattan Institute’s Center for State and Local Leadership. His work focuses on public administration, public finance, political theory, and urban policy. His writings have been published in Politico, Bloomberg View, New York Post, New York Daily News, Academic Questions, and City Journal. He was previously a senior research associate at the Worcester Regional Research Bureau, and holds a bachelor’s degree from St. John’s College in Santa Fe, N.M., and a Ph.D. in political philosophy from Boston College.

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