Entrepreneurial vs. Casino Capitalism

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This week’s New Yorker editorial “Puppetry” by Hendrik Hertzberg properly takes Fox Commentator Glenn Beck to task for distorting the life-story of financier George Soros. There are plenty of reasons to criticize George Soros, but how he survived the Holocaust as a pre-teen in wartime Hungary is not one of them. What bears mention is the fact that Glenn Beck may have overplayed the “holocaust” card, but Glenn Beck is one man, a frothy, overwrought pundit who offers a lot of useful insights to his viewers, but isn’t always right. Beck may be condoned by his network, but he hardly represents a movement.

It is indeed appropriate for the New Yorker to condemn Glenn Beck for demonizing George Soros, but the New Yorker is being hypocritical. New Yorker writers routinely participate in character assassination when they criticize climate change skeptics, and they too devalue the holocaust, every time they taint anyone who may disagree with the theory that anthropogenic CO2 is going to destroy our planet as a “denier.”

In last week’s New Yorker editorial, for example, entitled “Uncomfortable Climate,” author Elizabeth Kolbert leads off by calling attention to the behavior of Congressman Darryl Issa, who as a teenager was accused of car theft. This, along with the fact that Issa is “one of the richest men in Congress,” precedes Kolbert’s discussion of Issa’s intention to reopen investigations regarding whether or not it is justifiable to regulate CO2 emissions. In her editorial, Kolbert also makes sure to cherry-pick the most easily mocked quotes attributable to Republican members of Congress, ridiculing their Christianity, reminding us how wealthy they all are, deploring that “the recent election represents a new low.”

Kolbert also uses New Yorker as a forum for her to play the holocaust card, as in a March 2009 post entitled “Donating to the Deniers,” a piece where, again, she references a handful of political donations, that altogether amounted to less than $50,000, made by energy companies to politicians who were known global warming skeptics. Is this the best she could do? This scope-insensitivity is typical of alarmist journalists, who apparently either fail to grasp that the money is overwhelmingly pouring into the coffers of the alarmist lobby, or cynically provide these anecdotes to the contrary because they know most readers won’t notice the differences in magnitude.

It is interesting to note that later in the November 29th issue of the New Yorker, after defending financier George Soros in their lead editorial, the New Yorker offers a feature entitled “What Good is Wall Street?“, by John Cassidy. In this lengthy examination of Wall Street, Cassidy makes clear what pretty much everyone in America already knows, which is, as he puts it, “for years, the most profitable industry in America has been one that doesn’t design, build, or sell a single tangible thing.” Does anyone at the New Yorker see the irony – George Soros may as well be the patron saint of Wall Street! Glenn Beck got inappropriately personal regarding George Soros – that isn’t behavior exclusive to Glenn Back, or the right wing – but Beck’s more valid criticisms of big finance, and the larger-than-life individuals who play at big finance, are pretty much in agreement with John Cassidy’s.

As it stands today, Wall Street has sucked the life out of the United States of America, and the worst is likely yet to come. Big finance, along with their puppets in big government and big labor, have dismantled American manufacturing, and suckered us into national bankruptcy. Another of Glenn Beck’s primary insights has been that the notion of right-wing vs. left-wing, Republican vs. Democrats, is nothing but a smokescreen for financial elites to manipulate our government and act contrary to the interests of the American people. The New Yorker would do well to embrace this complexity, because the latest and greatest scam perpetrated by Wall Street on the world is their scheme to CO2 into a trading commodity. This scheme will further enrich big government, big labor, compliant businesses, and, most important to the big finance crowd, it will keep the lights on in lower Manhattan. But it will result in slower overall economic growth, undermine more useful innovation, transfer wealth away from addressing more compelling environmental challenges, depress development of cost-effective energy solutions, stifle the emergence of competitive new companies, empower monopolies, and deny upward mobility to aspiring individuals and emerging nations. It will do NOTHING to change whatever climate destiny nature may have in store for us.

The New Yorker remains my favorite magazine despite having become, over the past six years or so, the intellectual big brother of every left-wing alternative weekly newspaper in America. They are capable of far more nuanced editorial positions. The New Yorker editorial writers should ponder this: Capitalism as practiced by manufacturers and innovators who compete to build things that work better, faster, and cheaper, is the finest engine to uplift humanity ever conceived. Capitalism, on the other hand, as practiced by financiers who create fictitious currencies to gamble with other people’s money – currencies as diverse and fraudulent as derivatives or carbon credits – are another beast entirely. If this 2nd, more pernicious version of capitalism is a casino, and it is, then Wall Street is the house.

Fighting Bad Policy With Facts

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A couple of months ago in a post entitled “Inflation, Population & Government,” I criticized California Senator Denham for making the following assertion in a press release: “between 1970 and 2010, for every 1 percent increase in population, our [California’s state government] spending has increased 20 percent.” In reality, if you adjust for inflation, that statement should read as follows: “between 1970 and 2010, for every 1 percent increase in population, our [California’s state government] spending has increased 3.4 percent.”

This is still a shocking statistic. California’s state government grew over the past 30 years at 3.4x the rate of population growth. Why make an unbelievable comment – 20x – when the inflation-adjusted indisputable truth is so dramatic?

Here’s another one, just for the record. In today’s Wall Street Journal, one of my favorite writers, George Gilder, has a guest column entitled “California’s Destructive Green Jobs Lobby.” In this column he makes some fundamental points about California’s failure on Nov. 2nd to pass Prop. 23, which would have slowed down implementation of AB32, the “Global Warming Act” passed by their legislature in 2006, and set to take effect in 2012. To paraphrase Gilder:

  • CO2 is not pollution.
  • Fossil fuel is cheaper and in many respects far cleaner than “alternative energy,” and there is plenty of it available within the borders of the United States.
  • Economic growth depends on basic resources such as energy costing consumers and businesses LESS, not more.
  • “Green plutocrats” ponied up tens of millions and were prepared to spend Prop. 23’s backers into the ground to make sure it was defeated.
  • The reliance on government edict to grow venture-backed “green” companies is undermining and corrupting the most competitive, innovative sector in the U.S. economy, the venture capital industry, with potentially tragic consequences to our national security, technological leadership and economic future.

It is difficult to overstate how much I agree with Mr. Gilder on these points, as any reader of CIV FI knows. That the destroyers of Prop. 23 really believe CO2 is pollution is plausible, although they ought to do their homework because CO2 is not pollution, it is a benign trace gas that plants depend on in order to live and helps make our planet habitable. But how can they possibly think putting California through the hardship of AB32 will actually make a difference in atmospheric CO2 concentrations, or empower anything other than their own financial returns along with enhanced revenues to the public sector? These billionaires were able to persuade economists to release studies claiming that subsidized “green” jobs, producing inefficient, expensive energy solutions, and forcing consumers and businesses to buy these “solutions,” would actually create economic growth. The whole thing is ludicrous. It is laughable. The backers of Prop. 23 should have publicized the names of these plutocrats, challenged their motives, and ridiculed their premises.

Here’s where Gilder got careless, however:

“What is wrong with California’s plutocratic geniuses? They are simply out of their depth in a field they do not understand. Solar panels are not digital. They may be made of silicon but they benefit from no magic of miniaturization like the Moore’s Law multiplication of transistors on microchips. There is no reasonable way to change the wavelengths of sunlight to fit in drastically smaller photo receptors. Biofuels are even less promising. Even if all Americans stopped eating (saving about 100 thermal watts per capita on average) and devoted all of our current farmland to biofuels, the output could not fill much more than 2% of our energy needs.”

Biofuel is indeed inefficient, but it isn’t that inefficient. There are roughly 470 million acres of active farmland in the U.S. (ref. Carrying Capacity Network, “U.S. Food & Land Production“), and bioethanol from corn can yield roughly 500 gallons per acre per year (ref. EcoWorld, “Is Biofuel Water-Positive“). There are roughly 81,000 BTUs of energy within a gallon of bioethanol (ref. “Gasoline Gallon Equivalents“), which means that if you produced corn ethanol on every available acre of farmland in the U.S., you would produce about 19.2 quadrillion BTUs per year. Since we use about 100 quadrillion BTUs of energy per year in the U.S., growing ethanol on every acre of farmland would deliver us about 20% of our total energy needs, not 2%. Gilder dropped a decimal.

The reason to stop California’s global warming act isn’t that alternative energy shouldn’t be promoted. The point is alternative energy, in most cases, is still too expensive to replace conventional energy development. There are parts of the world, such as Brazil – where you can get over 1,000 gallons of ethanol per acre from sugar cane – where biofuel makes economic sense (although the environmental price paid for all that acreage of sugar cane for transportation fuel is another story). There are off-grid applications of solar electricity that also make economic sense. But these are the exceptions, not the rule, and will remain so for a few more decades. All of Gilder’s fundamental points are completely accurate. The idea that we are about to force California’s industry to trade “carbon emissions credits,” so “green” entrepreneurs can make billions, and Wall Street brokerages can rake commissions off of trillions – all on the backs of the people least able to afford this – is truly deplorable.

When the facts are on your side, there is no need to inadvertently exaggerate them. And those who want to impose bad policy onto the backs of honest working people should examine their own premises.

Public Sector Deficits & Global Warming “Mitigation”

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About the same time one might belatedly realize that reducing anthropogenic CO2 emissions will do absolutely nothing to alter or avert whatever climate “change” nature may have in store for us, might also be the time to realize the real reason we have chronic government deficits is because we not only have too many government employees, but we pay them too much. Connecting the dots, on July 2nd, 2008 in a post entitled “Breaking Down California’s AB32 Global Warming Act,” I wrote the following:

“Based on the potential of offset sales, carbon fees, and sales of emissions allowances, one may dismiss claims that AB32 will cost California’s government more than it will bring in revenues. AB32 will potentially cause tens of billions of dollars of net cash per year to flow into California’s public sector. Qualifying municipalities that enforce high density may earn carbon offset fees from polluters, based on how many vehicle miles they can calculate they eliminated through high density zoning. AB 2596 sets the stage for this. Redefining public sector jobs to address global warming mitigation may encompass a huge percentage of the public sector workforce, including construction, infrastructure, education, as well as explicitly environmentally focused agencies. Already California’s 400+ cities, 58 counties, and 32 air quality management districts are imposing new global warming related fees. Since global warming mitigation is a specific program – no vote is required to assess these fees. Auctions of emissions allowances to industry could pour additional hundreds of millions, if not billions, into the public sector each year.

…public sector agencies are salivating over cash flow potential associated with AB32. But why wouldn’t they? Nearly every public entity in California – and elsewhere in the USA – is at risk of bankruptcy, primarily because of grossly over-generous employee compensation, benefits and pensions. Other than carbon-related offset payments, fees and auctions – or massive tax increases – there is no new source of revenue even remotely capable of restoring solvency to public entities. Avoiding public sector reform in general, and avoiding public employee pension reform in particular, is the hidden issue that informs global warming alarm in the public sector.”

Now that California’s Proposition 23 – which would have suspended implementation of California’s Global Warming Act – has failed to pass at the same time as the looming insolvency of public sector employee pension funds is becoming common knowledge – the connection between public sector deficits and the potential revenues associated with global warming mitigation is coming more into focus. Here is more on how AB32 is going to try to rescue the finances of public entities, written in a post last week on CalWatchdog.com entitled “Expect More Population Flight,” by Wayne Lusvardi:

Utility user taxes provide a money lifeline for municipalities to raid water and power utility funds and shift them into their general operating and fiduciary retirement funds. When California’s Green Power law goes into effect in 2012 it is likely that municipal water and power funds will swell and the surplus siphoned into city and county general funds to meet pension obligations. Voters will not have a vote in determining whether existing pension obligations will be met or not. Instead lucrative union pension deals will be buried in increased water and power rates.

This may explain why expensive Green Power is being rolled out so aggressively and so fast over the voices of prominent scientists exposing global warming and C02 pollution as a fraud. Green Power may be a means to bail out broke municipalities before 2015 or 2020 rolls around whichever is the case. Green power could result in 40 percent to 60 percent higher electricity rates coupled with a 15 percent to 30 percent increase in water rates, not including the $44 billion water bond proposed for the 2012 ballot (including bond interest and matching funds).

Despite AB32 being nothing more than a mechanism to transfer wealth from lower and middle class private sector workers into the pockets of public sector workers and “green entrepreneurs” (they are neither), Prop. 23 which would have suspended its implementation was soundly defeated. The reason it was defeated was because its proponents were outspent 3 to 1. And who was it who opposed those evil oil companies? It was wealthy hedge fund oligarchs and “green tech” moguls, abetted by environmentalist “nonprofits” whose boards of directors are almost exclusively populated by trial lawyers, and, imagine this – other oil companies who have sold out. These special interests all know that implementing AB32 will pour more money into their own pockets. Take a look at how many of the super rich threw millions into defeating Prop. 23 in order to protect their financial turf: Ballotpedia Prop. 23

The failure of Prop. 23 is instructive, because it illustrates quite well the accusation by conservatives that the Democratic Party is actually the party of the “ruling class.” Because the incredibly wealthy individuals who stepped up to annihilate Prop. 23 – and they could have spent far more than the $20M+ that they donated without blinking – are nearly all Democrats. They are so wealthy that buying off the public sector workers, who in California make nearly twice as much on average as private sector workers, is more important to them than fostering an equitable society where hard work and merit can still allow people who aren’t spectacularly lucky or supremely intelligent to get ahead financially. As long as society’s administrators and enforcers – unionized public employees – can afford to pay 60% more for electricity and 30% more for water, who cares about all the other little people?

The failure of Prop. 23 is also instructive because it shows, yet again, nauseatingly, where the money really is in the debate regarding what causes climate change. Everything associated with climate change “mitigation” is regressive. It creates new – absolutely absurd, nonsensical “CO2 credits” – classes of assets for Wall Street brokerages to collect trading fees on, it creates new legal frontiers for attorneys, new carve-outs for insurance companies, new accounting rules for CPAs, heavily subsidized new “green” industries to attract entrepreneurs and investors who used to believe in competition, and it pours money into the public sector, alleviating the need for public sector union reform. Everyone wins except the ordinary Californian.

For more on AB32 and the real reason for public sector deficits, read “Implementing California’s Global Warming Act,” and “Public Employee Compensation.”

Bullet Train Boondoggles

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On November 4th California’s “High-Speed Rail Authority” released a press release entitled “Federal Funding for High-Speed Rail Dedicated to the Central Valley.” Apparently an additional $715 million in infrastructure investment is going to be directed to the development of California’s bullet train, bringing the total to $4.3 billion. All of these funds are to be spent on what will be the first segment of the high-speed rail system, running between Merced and Bakersfield.

A few years ago, when I worked as CFO for a short line railroad, I learned of a term familiar to railroad professionals, “foamer,” which is used to describe rail enthusiasts whose interest in everything having to do with locomotives, rolling stock and track, matched that of rock star groupies. But pleasing the foamers – and the foreign corporations who will gobble up most of the borrowed government loot that gets sunk into high-speed rail – is not reason enough to direct money at this project.

A commenter on a previous post here said something very insightful – “if we’re going to spend money we don’t have, let’s at least spend it on things we can see.” He was referring to the folly of using deficit stimulus money simply to continue to pay over-market compensation to government employees. But I would take that a step further. If you are going to spend money you don’t have, at least spend it on things you can see that will yield a return on investment. The bullet train boondoggle will never yield a return on investment – it will be a financial drain on our economy forever. It will never make money.

The reason high-speed rail makes sense in other parts of the world are because they are more densely populated, and because they are smaller geographically. There are nearly 100 million people living along the 250 mile corridor between Tokyo and Osaka. This is the industrial and urban heartland of Japan, a megapolis where the population density per square mile is often 50,000 people or more. In places like this, high speed rail makes sense. If you are traveling within this region, you can board a train and travel 200 miles in less time than you would require to board an airplane and travel 200 miles. And because there are nearly 100 million people living along the rail corridor, there is a large population of potential passengers.

California, by comparison, is contemplating an 800 mile system, with 24 stations, in a state with not quite 40 million people. How would high-speed rail transport compare with airplane transportation in California? Here is the “high-speed” route being contemplated to get someone from San Francisco to Los Angeles:
San Francisco to San Jose – 50 miles
San Jose to Fresno – approximately 150 miles, the Rail Authority doesn’t provide information for this leg
Fresno to Bakersfield – 130 miles
Bakersfield to Palmdale – 85 miles
Palmdale to Los Angeles – 58 miles

If you fly from San Francisco to Los Angeles, your experience isn’t that different from if you take a bullet train from San Francisco to Los Angeles, except for the actual transit time. You will still have to get to the airport or the station using a car or mass transit. You will still have to go through security. You will still have to wait to board the next available flight, or train. But the travel time from San Francisco to Los Angeles on a plane is about one hour. On a bullet train, this same journey would traverse at least 450 miles of track, and a non-stop trip at an average speed of 180 MPH would take 2.5 hours. The round trip would take five hours instead of two hours. And how many non-stop trips are they ever going to have on a bullet train per day from San Francisco to Los Angeles? There are literally dozens of non-stop flights each day from San Francisco to Los Angeles. It is not practical.

To estimate what this bullet train is really going to cost to build, consider the costs currently projected for the test track just funded. Apparently this first segment will comprise the “core of the system,” which is “either Merced-to-Fresno or Fresno-to-Bakersfield.” Since it’s 60 miles from Merced to Fresno, and 113 miles from Fresno to Bakersfield, if one divides the $4.3 billion in required funding by the average of those distances, which is 86 miles, you will get a cost of $50 million per mile! If you multiply this amount by the planned 800 miles of track, you get a cost of $40 billion. Is this accurate?

When the bullet train proposal was originally sold to voters, it was marketed as costing $9.5 billion. Simply by extrapolating the costs for the first stretch of track – in the most remote, sparsely populated area of the entire system, where the land is both far cheaper and also flat as a pancake, we get to a cost of $40 billion. And does this $50 million per mile cost include all the rolling stock, all the stations, all the corridor security fences? What about the costs for land where the high-speed rail right-of-way will be traversing the land between San Francisco and San Jose, or everywhere from just north of Los Angeles all the way to San Diego – arguably the most expensive acreage on earth? What about the cost to cut routes through the mountainous Pacheco Pass in Northern California, or the Grapevine in Southern California? It is difficult to imagine that the real cost, in today’s dollars, of the entire California high-speed rail system, as it is currently envisioned, costing less than $100 billion. If this gargantuan boondoggle is ever realized, it is probably going to cost a lot more than that.

If you read the website of the California High-Speed Rail Authority, you can get additional clues as to just how expensive this system is going to be. For example, the page showing projections for the San Francisco to San Jose corridor projects passenger counts of 31,600 per day. You have to assume this is not a low-ball estimate, since the purpose of this website is to present a supportive perspective on the project. This means that 31,600 people are going to make 100 mile round trips approximately 250 times per year. Since this is the Bay Area, and not Fresno County, it is safe to assume the cost per mile will be well in excess of $50 million, but even at $50 million per mile this is a $2.5 billion expenditure to move 31,600 people to work and back. This will not make a dent in Bay Area traffic. There are nearly 7.0 million people living in the San Francisco Bay Area, and probably at least 3.0 million of them have to transport themselves to work every day. The bullet train will move 31,600 people out of 3,000,000 commuters, alleviating traffic congestion by about 1.0%. And that’s the best case, in the most likely segment of the rail system to be maximally used. Nobody who can board an airplane is going to use the bullet train to go to Southern California from Northern California. Relatively few riders will use the train to travel between the smaller urban centers, such as from Bakersfield to Fresno.

So how much will this system cost per year to pay off the bonds, if the system costs $100 billion and 30 year bonds are issued at 5.0% interest? Using an online mortgage calculator, you will see that a 5.0%, 30 year fully amortized loan will require total payments per year equivalent to 6.4%. That is $6.4 billion per year that taxpayers will pay in principal plus interest to service the debt for California’s high-speed rail system. Readers who disagree with these assessments are invited to convincingly prove that this system is going to cost less than $100 billion. Don’t count on ridership revenue to pay for this – it is highly unlikely ridership will even cover operating costs.

The question is not whether or not we need high-speed rail – if you want a 200 MPH theme park ride scarring California’s beautiful landscape for 800 miles from north to south – that is a matter of taste. The real question is what could we do instead with all that money. And the answers are plentiful. We could spend $20 billion (that will probably inflate, too) and reenact the water bond, which would invest in upgrades to our aqueducts and dams, introduce new sources of water storage, construct a peripheral canal around California’s delta, and hopefully even fund upgrades to our wastewater treatment facilities. We could invest in public/private ventures to build 2-3 nuclear power stations; for $10 billion of public money we could probably leverage construction of another 10.0 gigawatts of electrical output, plenty to guarantee California cheap electricity. And we could upgrade and widen our roads, getting them ready for tantalizing new designs for surface transport – busses and cars that operate on auto-pilot in high-speed lanes – there is no transportation medium as versatile as a simple road. We might even upgrade intercity trains in the densely populated Bay Area and Los Angeles, using existing rail corridors.

There are 12 million households in California. If this boondoggle is actually realized, it is going to cost each of them over $500 per year. Since half of the households in California don’t pay any taxes, or pay minimal taxes, however, those Californian households who do pay taxes will each be more likely to pay $1,000 per year to pay for high-speed rail. Is that worth it? Particularly when that financial sacrifice could be used instead to invest in nuclear power, water storage, conveyances and treatment, and more roads – which would deliver cheap energy, cheap water, and cheap and convenient transportation.

A legitimate role for government spending is to make strategic investments that reduce the costs for basic necessities. That is what makes a nation prosperous. That is a proper use of public funds. Artificially inflating the costs for energy, water and transportation – which is the current policy of California’s government – is a crime against the people of California, and the “environmental” justification for all of this is a smokescreen and a fraud. California’s bullet train boondoggle is just one example of this travesty.

Pension Reform Options

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Not present on the ballot this year in California is an initiative to reformulate pension benefits for state and local government employees. The subject of dozens of posts, public employee pensions are financially unsustainable and grossly inequitable. The reasons for those assertions have been fully explored in previous posts, so the purpose of this post is not to reiterate those reasons, but to enumerate some of the key reforms that would, if they were all enacted, bring pension benefits for public sector employees down to a level that would be financially sustainable while still preserving the defined benefit option. In some cases, these reforms would have to be implemented not via an initiative amendment, but via municipal bankruptcy court – but if they were included in an initiative, it would provide a roadmap for bankruptcy courts to follow. Here goes:

(1) Lower annual pension accrual to 1999 levels for new hires:
The public sector pension formula for all new hires would be based, as before, on accruing a percentage of final salary for each year worked. For public safety employees this percent would be reduced from 3.0% per year to 2.0% per year. For all other employees, this percent would be reduced from 2.0% per year to 1.25% per year.

(2) Lower annual pension accrual to 1999 levels going forward for existing hires:
Current employees would, for all years remaining in their public sector career, accrue their retirement benefit at the new reduced percentage rate. Current employees would retain the higher percentage rate they have earned in prior years, subject to the conditions in (3).

(3) Reverse any retroactive pension accrual enhancement ever granted existing hires:
Current employees whose annual pension benefit accrual was increased retroactively from 2.0% to 3.0%, or from 1.25% to 2.0%, will retain this increase for the years subsequent to that change (subject to the conditions in item (2), but will revert to their original rate of pension benefit accrual for the years prior to that change.

(4) Retired public employees will see no change to their pension benefit.
Create a “pension review commission” to audit and adjust any existing pensions where evidence of “spiking” or other inappropriate enhancements are uncovered.

(5) Spread “final year” salary calculation over five years and eliminate “spiking”:
The final salary base for which the accrued percentage based on years worked shall be applied will be calculated as follows: The average of the final five years of each retiree’s annual compensation, adjusted for inflation, but not subject to any other adjustments. Annual compensation shall not include overtime, cashed in sick time or vacation time, bonuses, or any other form of compensation not considered base salary.

(6) Establish ceiling on maximum pension benefit:
A ceiling on eligible pension compensation shall be set at no more than 75% of the average final five years salary as calculated in item (5). Additionally, a ceiling on eligible pension compensation shall be set at no more than triple the maximum benefit awarded under social security. A floor on eligible pension compensation shall be set at no less than the benefit as calculated by social security.

(7) Raise eligible retirement age:
Public safety employees shall become eligible for pension benefits no earlier than age 55, and other employees shall become eligible for pension benefits no earlier than age 62.

(8) Reduce pension benefit by amount retiree earns in new job:
Public employees shall not be eligible to receive their full pension if they engage in work subsequent to their retirement. To the extent a public sector retiree works in any job, public or private, the gross amount they earn shall be deducted from the gross amount of their eligible pension payment.

(9) Eliminate tax-free or reduced tax pensions:
No portion of public employee pensions shall be awarded tax-free status, or subject to a reduced rate of taxation, for any reason.

(10) Aggregate multiple pensions under same ceiling:
Public employees who have earned two or more pensions by virtue of working in two or more public sector jobs for a period sufficient to vest these pensions shall have the sum of these pension benefits subject to the ceiling limitations as set forth in items (6) and (7), and these reductions to benefits shall be apportioned on a pro-rata basis to the applicable benefit plans.

(11) Require conservative pension fund investment strategy:
Public employee pension funds will be required to invest 80% of their assets in low-risk annuities.

(12) Require public employees to contribute a fair share to their pension fund:
All public employees shall contribute 50% of the amount necessary to fund their pension each year in the form of withholding from their gross earnings, with the employer contributing the other 50%.

While many of these items may violate existing collective bargaining agreements, they are worth considering either as an initiative amendment, legislation, or as the product of bankruptcy negotiation. Because these twelve items represent an equitable way to move forward with pension benefits for public employees that remain considerably better than social security, retain the security of being defined benefits, and would – if all of them were enacted today – almost certainly preserve the solvency of the public employee pension system.

Public Employee Compensation

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A recently released study sponsored by U.C. Berkeley’s “Institute for Research on Labor and Employment,” authored by Sylvia Allegretto and Jeffrey Keefe, entitled “The Truth about Public Employees in California: They are Neither Overpaid nor Overcompensated,” contains its conclusion in its title, but whether or not this study is presenting the “truth” or not is worthy of further discussion.

According to this study, “the wages received by California public employees are about 7% lower, on average, than wages received by comparable private sector workers; however, public employees do receive more generous benefits. An apples to apples comparison, or one that controls for education, experience, and other factors that may influence pay, reveals no significant difference in the level of employee compensation costs…”

While the study goes on to explain the variables they evaluate in order to arrive at an “apples to apples” comparison, it never actually estimates the actual amount of wage disparity between the average compensation packages for California’s public employees compared to California’s private sector employees, so here goes:

Using California’s Employment Development Department’s recent report “Labor Market Trends,” (ref. figure 1) it is evident there are 2.4 million Federal, State and Local employees in California, 12.2 million full-time private sector employees who work for an employer, and another 1.4 million “self-employed” private sector workers. Worker compensation as reported by the Bureau of Labor Statistics don’t include estimates for California’s 1.4 million self-employed workers, nor does the U.C. Berkeley study. If these estimates were included, they would almost certainly skew average private sector compensation downwards, since according to California’s Employment Development Dept., self-employment does not include anyone working for a Corporation or LLC, even their own, meaning that more highly-compensated professionals fall within the BLS statistics for California’s 12.2 million private sector employees, whereas the remaining self-employed include part-time workers, independent contractors; in aggregate, a marginally compensated multitude who have to cover 100% of their benefits  – a 2x payment for social security, and zero paid time off, or free insurance of any kind, or automatic pay for sick time and retirement.

Returning to the 14.6 million people in California who either work for the government or are employed by private sector firms, according to the Bureau of Labor Statistics report “May 2009 State Occupational Employment and Wage Estimates California,” their average annual compensation (not including employer funded benefits) in 2009 was $49,550. In order to extract from that average the compensation for the 2.4 million government workers in California, one may refer to Census Bureau data for 2009 as follows – for 394,000 state workers ref. State Government Employment Data, and for 1,451,619 local government workers ref. Local Government Employment Data. If you combine and average the compensation data for these two groups, you will arrive at an annual average pay – before any employer funded benefits – of $65,000 per year.

Making just one assumption, that California’s 500,000 federal workers not included in these statistics are earning the same average salary as the state and local workers, it is possible to subtract the figures for government workers from the pool of 14.6 million workers, who, according to the BLS earn an average of $49,500 per year, in order to calculate an average private sector (not including self-employed) compensation of $46,528 per year. This means that the Berkeley study has “normalized” for education, experience, and “other factors” to turn a 40% disparity between public and private sector compensation into a 7% disparity.

Before accepting the conclusion of this study, there are several assumptions it makes, both factual and subjective, that should be questioned; starting with this: “The average age of a typical worker in state and local government is 44 compared to 40 in the private sector.” The benefit of coming up with a “fact” like this, of course, is because by combining this fact with the assumption that compensation increases with seniority, the researchers are able to normalize downwards the average compensation of public employees significantly. For example, if one assumes an average career of 30 years, and that a worker’s inflation-adjusted salary will double between when their career begins and when they retire, than one might reasonably conclude a “normalized” compensation average for the public sector worker must be adjusted downwards by 13.3% in order to represent an “apples-to-apples” comparison with the younger private sector workers. Here again, it is serendipitous for the Berkeley study to exclude self-employed individuals, since according to California’s EDD, for workers over forty years of age, fully 50% of the civilian workforce is self-employed (ref. EDD’s California’s Self-Employed Workforce,” figure 6).

Another normalizing factor used by the researchers is gender, wherein they claim 55% of the state and local government workers are women, compared with 40% of the private sector. This is partially skewed, again, by the fact that 60% of self-employed people are men, but even adjusting for that, this fact, if accurate, represents another huge opportunity for the researchers to “normalize” compensation statistics in favor of reducing the disparity between private and public sector pay. Without having access to the work-papers used by the researchers, one can only speculate, but here’s the logic that could have been used: If women make 30% less than what men make for comparable work requiring comparable credentials, and if women represent 55% of the government workforce compared to 40% of the private sector workforce, this means an “apples-to-apples” comparison would require adjusting the public sector compensation upwards by  17% (55% x 30%) vs. an upwards adjustment of only 12% (40% x 30%) for the private sector workforce. Voila, another 5% of pay disparity is vaporized. The problem here is whether or not the “30%” pay differential rests on valid assumptions. When one normalizes for technical degrees vs. non-technical degrees, and the actual supply and demand parameters for jobs that might be deemed “comparable,” as well as for the significant percentage of women who opt out of full-time work in favor of being moms, much of this gender disparity may disappear. Whether or not there remains a gender bias in employee compensation is certainly open to debate, but the researchers should be transparent regarding how significant this factor was in their calculations.

The other major normalizing factor employed by the researchers is education, because the researchers have determined that 35% of the private sector workforce have earned at least a bachelors degree, compared with 55% of the public sector workforce. The researchers also claim the “return to education,” wherein people who have higher educational attainment should earn more, is skewed; that is, they claim private industry rewards education more than the public sector. What the study ignores here, however, is the fact that educational attainment yields qualitative dividends – what degrees are being compared? Is a sociology degree from Sonoma State the equivalent of a computer science degree from Stanford? Is it appropriate to pay more to employees with advanced degrees even if the job they do doesn’t require that level of education? The study doesn’t address this.

In any event, by excluding 1.4 million self-employed and part-time workers, and “normalizing” for seniority, gender and education, the Berkeley study has concluded that an average public sector salary in California is not 40% more than an average private sector salary – and without any normalizing adjustments, 40% higher wages for public sector vs. private sector workers appears to be a conservative estimate – but instead, that public sector wages are 7% less than private sector wages.

When turning to comparing benefits for public employees vs. private sector workers, it is important to understand that salary is the base on which the most significant benefits are calculated. In particular, the largest benefit category in the public sector is retirement pensions, which are calculated based on final salary earned. This means that even if public employee pension benefits were calculated in the same parsimonious manner as social security, they would apply to an average compensation base that is 40% larger for public employees. Moreover, public sector pensions are linear, meaning the benefit increases exactly proportionally to the amount of base salary without limit, whereas social security benefits increase at progressively lower rates, meaning that the more one makes, the lower percentage of their final salary will actually be realized in a social security benefit. These sound like nuances, but have enormous financial consequences. For more on this ref. “Pensions: Giant 401K Plans,” “Sustainable Retirement Finance,” and additional links therein.

Before independently estimating the disparity between public employee and private sector employee benefits, here is the Berkeley study’s specific conclusion: “public employers contribute on average 35.7% of employee compensation expenses to benefits, whereas private employers devote 30% of compensation to benefits.”

By far the biggest single cost for employee benefits in both the public and private sector is the cost of retirement security. The calculation in the private sector is relatively straightforward – the employer withholds 6.2% for social security and 1.45% for medicare from employee paychecks, and contributes an equivalent amount themselves as a benefit – 7.65%. Some private sector employers will match a 401K contribution up to 6.0%, but the percentage of private sector employers who do this, combined with the number of private sector employees who take full advantage of this, is probably under 25%, which means the average overall retirement benefit paid by private sector employers is probably 10% (or less) of total wages.

For the public sector in California, the cost of retirement security borne by the employer is something else entirely. The typical formula for non-safety employees (about 85% of the public sector workforce) is to multiply the number of years they work by 2.0%, and apply the resulting percentage to their earnings in their final year of active employment. For example, if a non-safety employee works for 30 years, then 60% of their final salary will be the amount of their retirement pension. For safety employees, the typical formula is the same, but based on a 3.0% per year accrual. In the public sector, unlike with social security, the money contributed each year to fund the future retirement benefit is invested by a pension fund, which means the value of this benefit – and the funding required each year to ensure the pension fund remains solvent – must be calculated based on the expected investment returns of the pension fund. This is a matter of great controversy.

In the post “Sustainable Pension Fund Returns,” a best-case and realistic-case set of scenarios are offered:

(1) At a real rate of return of 4.75% per year, a worker would need to set aside an additional 21% of their salary each year for 30 years, in order to enjoy a pension benefit during a 30 year retirement equivalent to 60% of their paycheck.

(2) At a real rate of return of 4.75% per year, a worker would need to set aside an additional 32% of their salary each year for 30 years, in order to enjoy a pension benefit during a 30 year retirement equivalent to 90% of their paycheck.

(3) At a real rate of return of 3.00% per year, a worker would need to set aside an additional 35% of their salary each year for 30 years, in order to enjoy a pension benefit during a 30 year retirement equivalent to 60% of their paycheck.

(4) At a real rate of return of 3.00% per year, a worker would need to set aside an additional 52% of their salary each year for 30 years, in order to enjoy a pension benefit during a 30 year retirement equivalent to 90% of their paycheck.

For this independent estimate of the value of public sector employee pension benefits, using an assumption that 15% of public employees receive the enhanced “safety” pension, and assuming that the real rate of pension fund returns going forward will be 3.0% per year (still quite optimistic), it is necessary to contribute an amount equivalent to 38% of the average public employee’s pay in order to keep their pension solvent. Since, on average, public employees contribute about 5% of this amount in the form of withholding, an additional 33% has to be contributed by the employer. Many public employees receive supplemental retirement health insurance, for which few of them contribute anything at all in the form of withholding. It is certainly accurate to value this additional benefit as at least twice the amount of medicare, which adds another 3.0% per year.

Adding this all up, using conservative assumptions, the employer contribution to retirement security in the private sector is at most 10% of average salary, whereas in the public sector the employer contribution is at least 36% of average salary.

When assessing the value of current benefits granted public employees, most reviews of public sector benefit schedules suggest the standard package is a comprehensive set of benefits – for example, if one refers to the State of California’s Dept. of Personnel Administration, some of the current benefits include health insurance, dental benefits, a vision program, long-term care insurance, and long-term disability insurance. While these benefits are partially funded through employee withholding, the amounts withheld almost never exceed 50% of the premium, even for dependent coverage. To suggest that current benefits for public employees are, on average, less generous than the average current benefit for private sector employees strains credulity. What about the millions of part-time workers and self-employed people, who have to pay 100% of whatever health insurance they can afford – at premium rates that aren’t discounted and guaranteed by the insurance companies the way they are for the huge state employee bargaining units? What about all the small companies out there, employing at least 50% of full-time private sector workers, who can barely afford to offer basic health insurance, much less dental, vision, long-term care and long-term disability? It would be conservative indeed to simply assume the cost of current health insurance and other current benefits paid for by the employer is the same for both public and private sector workers, at approximately 5.0% of payroll.

The other significant factor to assess when estimating the value of public sector benefits is the amount of paid time off enjoyed by public sector employees vs. private sector employees. On this matter the Berkeley study makes a claim that they simply must substantiate; they state: “public employees receive considerably less supplemental pay and vacation time.”

Perhaps to rebut this preposterous claim one must revert to anecdotes, but here at least are some quantitative considerations: there are 723,000 teachers in California who work for the government either in primary and secondary school or in higher education. Every one of these instructors and administrators works about 180 days per year, which when one considers there are 260 weekdays in a year (52 weeks x five days per week), indicates that teachers in California get 16 weeks of paid days off each year. What about college professors who only teach one class per week, yet enjoy total compensation packages worth $138K per year (ref. The Real Reason for College Tuition Increases). If you review compensation studies for safety employees in the city of Costa Mesa (ref. The Price of Public Safety), or firefighters in Sacramento (ref. California Firefighter Compensation), you can see, for example, that before overtime, full-time service for a veteran firefighter in Sacramento requires them to work, on average, two 24 hour shifts per week. Does the Berkeley study normalize for any of this? Compare vacation time in any public entity in California against private sector norms – the average vacation days awarded in the public sector allocate employees after about 10-15 years of service 20 days of vacation per year, and by the end of their careers, up to 30 days of vacation per year (ref. CA Dept. of Personnel Administration, Leave Benefits). This amount of paid vacation is rarely offered to employees in the private sector – with many small companies offering virtually no vacation to their employees, a generous assumption might be 10 days, half as much as public sector vacation benefits. With respect to paid holidays, the typical public sector benefit is at least 12 days, while small private companies often only award six (Christmas, New Year, Memorial Day, July 4th, Labor Day and Thanksgiving), if that. In addition to vacation and holidays, many local governments and various state units also offer paid “personal days,” something nearly unheard of in the private sector. It is also common for sick time to be accrued without limit in the public sector, also something nearly unheard of in the private sector. And self-employed workers, of course, get nothing.

In order to continue to make conservative assumptions, however, one may estimate the average number of paid days off in the private sector to be 20 per year (probably high) and the average number of paid days off in the public sector to be 30 per year (probably low). How does this all add up?

The average public sector worker makes $65,000 per year, with the employer contributing an additional 21,450 for their retirement pension, $1,950 for their retirement health insurance, $3,250 for their current health insurance and other benefits, and they earn vacation worth an additional $10,575 – making their average total compensation $102,225 per year. It is interesting to note that the benefits as a percent of total compensation in this analysis agree with the Berkeley study – 36.4% vs. 35.7%, because the Berkeley study has almost certainly understated the value of the required pension fund contribution, which is another reason why the assumptions made here to estimate the value of all the other public employee non-pension benefits are probably conservative.

The average private sector worker makes $46,500 per year, with the employer contributing an additional $4,650 for their social security, medicare, and 401K, $2,325 for their current health insurance and other benefits, and they earn vacation worth an additional $4,113 – making their average total compensation $57,558 per year. The average private sector worker’s benefits as a percent of total compensation in this analysis is 19%, not 30% as claimed in the Berkeley study. And again, the Berkeley study failed to consider any of California’s 1.4 million self-employed and part-time workers in the pool they evaluated .

It is left to the reader to decide which numbers are more accurate, the numbers put forward here, or the numbers put forward by the Berkeley research team. Similarly, it is left to the reader – and the voter – to decide whether or not the services provided by California’s state and local governments, and the skills required to render them, entitle California’s public servants to earn, on average, $102K per year, compared to average annual earnings of $57K by those of us whose taxes sustain them.

Local Government Public Employment Data – revised Dec. 2009

How Unions Can Save America

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In a previous post entitled “The Razor’s Edge, Inflation vs. Deflation,” the following assertion is made:

“When the financial history of early 21st century America is written, it is interesting to wonder how historians will characterize the behavior of public sector unions, who were indifferent to deficits, who were incestuous with Wall Street, who rode the waves of unsustainable debt and deficit-fueled phony booms to guarantee their members would enjoy magnificent benefits calibrated on bubble values, but contracted to endure even after the bubbles burst. Will the refusal of all-powerful public sector unions to embrace fiscal reform be seen by future historians as contributing to the collapse of the bond markets, the pension funds – and under the burden of new taxes instead of reform, property values, as the nation’s collateral imploded? At the least, it is fair to say that what today’s leadership of public sector unions decide – whether they embrace concessions for the sake of the nation, or not – is one of the biggest opportunities remaining to avert further financial calamities.”

The point of this is certainly not to hold public sector unions solely accountable for the financial predicament facing the United States. The root cause is a 40 year debt binge that enabled unsustainable economic growth and unrealistic consumer expectations. And everyone is to blame; consumers who borrowed more than they could afford, lenders who pounced on them, and politicians who – in a bipartisan failure of leadership – failed to regulate any of it. But public sector unions now occupy a unique position of economic leverage, because with deficit-fueled debt no longer an option, restoring the solvency of public institutions can only be purchased by raising taxes or by cutting spending. Raising taxes will place burdens on consumers and taxpayers who are already contending with reduced wages, high rates of unemployment, and crippling levels of debt. Cutting government spending is the only option.

In-turn, how government spending is reduced is crucial. By cutting future benefits, for example, such as future pension obligations to government employees, no money is removed from the economy today. Similarly, by freezing all government worker salaries, budgeted salary increases can be eliminated, saving jobs and reducing deficits instead. Public sector unions may have the opportunity, through dramatic concessions on wages and benefits for their members, to literally save the American economy from deflationary collapse.

Is this equitable? Should public sector employees forfeit their generous pensions, suspend their cost-of-living increases, and even take pay cuts? Public employee unions typically argue that government deficits can be closed simply by raising taxes only on wealthy individuals and profitable corporations. Whether or not this argument is valid, it completely misses the point. Government spending – no matter how the revenue is raised – needs to prioritize infrastructure investments, technological initiatives, and national security. Government spending should not be squandered to pay grossly over-market rates of compensation to public sector employees. Primarily using California as an example – since California is the poster-child for an American unionocracy – here are some economic points to back up this assertion:

(1)  COMPARING PAY – PUBLIC VS. PRIVATE
The average state or local government worker in California makes $59K in base pay and earns at least another $30K in benefits – $90K per year. California’s average private sector worker makes $41K in base pay and earns about another $10K in benefits – 51K per year. California’s government workers average pay is nearly twice that of the private sector (ref. California’s Personnel Costs, U.S. Census Data, and Reason Foundation Study).

(2) COMPARING RETIREMENT – PUBLIC VS. PRIVATE
The maximum social security benefit is $31K per year, paid to retirees with a final salary of $125K+ per year (17%). Again using California as an example, there is no maximum public sector pension benefit – no percentage or absolute ceiling. On a percentage basis, a public safety pension averages 5x-7x greater than social security. Similarly, a non-safety public pension averages 3-5x greater than social security. On the basis of the actual dollar payout, the disparity is even greater (ref. Social Security Benefits vs. Public Pensions and Social Security Benefit Estimator).

(3) COSTS OF BENEFITS ARE UNDERSTATED
Current year payment obligations for the future pension benefits of public employees assume an over-optimistic rate of investment fund return. If you cut the projected rate of fund return by 50%, you double the funding required. In addition, most government budgets don’t recognize costs for future retirement health insurance. The benefits overhead for public employees is understated on most government budgets by at least 50% (ref. Real Rates of Return, Pension Funding & Rates of Return, and Maintaining Pension Solvency).

(4) FUNDING SOCIAL SECURITY VS. PENSIONS
Social Security serves 80%+ of retirees with benefits averaging 1/3rd of final wages, and projects a 2 to 1 worker/retiree ratio. Public sector pensions serve 20% of retirees with benefits averaging 2/3rds of final wages, projects a 1 to 1 worker/retiree ratio, and retiree payouts begin 10+ years earlier than Social Security. Notwithstanding fund returns, social security requires 16% of salary withheld, pensions require 66% of salary withheld. Total pension payments to public sector retirees, representing 20% of the population, are on track to equal, in absolute dollars, total Social Security payments to the other 80% of retirees in America – four times as much money per recipient. Social Security can remain solvent with relatively minor adjustments, public sector pensions are grossly insolvent and cannot be salvaged without major benefit reductions (ref. Sustainable Retirement Finance and Funding Social Security vs. Public Pensions).

And how did it come to this?

UNION POLITICAL SPENDING
In California there are just over 1.0 million unionized public sector workers (this represents about 55% of California’s 1.85 million state and local workers, but nearly all of them enjoy union-negotiated pay and benefits). Average union dues are at least $750 per year per member. At least 33% of union dues are allocated to political activity – lobbying & election campaigns. This means public sector unions are spending $250 million per year on politics in California. There is no comparable source of political spending, and to the extent other special interests participate financially in politics, their agenda is diverse, and rarely if ever devoted to fighting the public sector union agenda of more government workers, and higher government worker compensation packages (ref. Public Sector Unions & Political Spending).

It is difficult to overstate the impact of public sector unions. For years, they have coerced politicians who they can make or break with massive political spending into granting unsustainable and unwarranted rates of pay and benefits for public employees. In California, their unfair advantage in political spending has given them effective control of most state and local politicians. The union work rules, ostensibly to protect worker’s rights, have lead to an unaccountable workforce, damaging the effectiveness and efficiency of all our public institutions – what public sector unions have done to public education is a tragic example. Public sector unions undermine democracy and have bankrupt our state and local governments.

Public sector unions hold the key today to saving the economy of the United States, because with their consent, we can freeze government worker wages, even reducing them in some cases, and we can reduce their defined retirement benefits to something moderately greater than social security instead of 3x-7x social security. Eventually, with reformed work rules, we can begin to downsize and improve the quality of our government workforce, and if we act soon, that may be even possible mostly via attrition. If all of this is done, government deficits will quickly disappear without decimating government programs and services, or precipitously lowering current worker pay. This would enable us to actually begin shrinking, year over year, government debt – which is the most persistent and alarming category of debt in the American economy. And as this occurs, we can begin to use government surpluses to make genuine investments in our future.

Dramatizing the Inequity

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This is a hilarious video that is accurate and nicely summarizes our challenge – our state and local governments are going broke in order to pay not only for pensions that are 3-5x more generous than social security, but for overall compensation and benefits to public employees.  To balance budgets, we don’t have to cut services or raise taxes, we just need to reduce the grossly over-market compensation paid to public employees. Warning – while clever and accurate, this video does contain foul language…

http://www.fullertonsfuture.org/2010/stop-the-madness-now/

By the way, I have personally verified the compensation parameters referenced in this video, as summarized in this post:

https://civicfinance.org/2010/08/27/the-cost-of-firefighters/

Pensions: Giant 401K Plans

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One of the biggest apparent misconceptions on the part of those who believe public sector pension benefits can remain unchanged is that somehow there is a difference between 401K plans and public sector pension funds. The only difference is one of scale. Individual citizens save money and invest the money in a 410K plan or other individual retirement account. Public sector pension funds take vast sums of money and invest it in the very same places – primarily Wall Street equities.

While it is true that an institutionally managed, massive and diversified pension fund may be less volatile than an individually managed retirement account, it is also true that massive pension funds are far less likely to enjoy returns that beat the market. They’re too big. So when the market value of stocks and other assets fall, it is impossible for large pension funds to not also see their values also fall.

If you recognize this – the fact that public sector pension funds are just as subject to economic ups and downs as individual 401K funds, and that they are invested in exactly the same things – then comments by defenders of keeping the public pension benefit system unchanged become inexplicable.

President Obama, in a speech last month where he lambasted the nonexistent Republican plan to privatize social security, said “I’ll fight with everything I’ve got to stop those who would gamble your Social Security on Wall Street.” But public sector employee pension funds are themselves gamblers on Wall Street.

SEIU Executive Vice President Eliseo Medina, in a Sept. 3rd commentary on the Huffington Post entitled “Wall Street is to Blame for Pension Shortfalls,” claims “For generations, Americans have counted on three sources of retirement income: social security, employment pensions, and personal savings. Wall Street is bent on undermining all three by pushing risky social security privatization schemes…” and further states, “Their goal is to strip away guaranteed pensions and force more workers into 401k-style plans that put all the risk onto workers while putting more money into the bankers’ own pockets.” But Wall Street returns are the only way pension funds can project solvency. Wall Street has already robbed the private sector taxpayer, and now those same taxpayers will have to also cover the losses of the pension funds, who gambled taxpayer’s money on Wall Street?

The President of the Los Angeles Police Protective League, Paul Weber, in an editorial published last month entitled “Public employee pension ‘reforms’ recipe for disaster” wrote “the 401K approach to retirement savings is, and will continue to be, an absolute disaster for this country.” In the same editorial, he goes on to say “while public pension plans have also taken severe hits, they have a long-term investment outlook, and their obligations aren’t due in full in the next five, 10 or even 20 years.” But all this means is that pensions are gigantic 401K plans, administered by professionals, managed over decades, but still reliant on Wall Street to survive.

What Obama, Medina, Weber and others don’t seem to fully recognize is that (a) massive public employee pension funds are themselves gambling with Wall Street just as much as any 401K plan participant, (b) the Wall Street crash was the result of a debt bubble that was built with the avid collusion of Wall Street, the government, and feckless consumers, and (c) long-term return on investment projections for large pension funds based on a 40 year expansion of unsustainable credit are too high for the era we now live in, where collateral continues to shrink and credit lines collapse apace.

Here are some additional thoughts:

(1) Social Security serves 80% of the retired population with benefits that on average are one-fourth what public sector pensioners receive, because they pay out 1/3rd vs. 2/3rd of recent salary, and because they begin payments 10 years later than public pensions.

(2) The absolute dollars necessary to pay Social Security to 80% of our retired population are therefore approximately the same amount as the absolute dollars necessary to pay public sector pensions to 20% of our retired population. The same size liability for one-fourth as many people!

(3) While in the past public sector employees made less than their counterparts in the private sector, in exchange for better benefits, that hasn’t been the case for over ten years. The average private sector worker in California earns less than $60,000 in total compensation (including all benefits). The average public sector worker in California earns about $100K in total compensation – nearly twice as much.

(4) Social Security is not in danger of going insolvent – it can be fixed with incremental changes; a higher ceiling on withholding, a higher percentage withholding, an older retirement age, and slightly lower benefits. Social Security is an appropriate taxpayer funded system of retirement security. In conjunction with personal savings, eliminating debt, and no new taxes, Social Security enables retired workers to live with dignity.

(5) Public sector pensions rely on the whims of Wall Street just as much as 401K plans. To demonize Wall Street at the same time as resisting calls to reduce public sector pension benefits is grotesquely hypocritical. Public sector pension funds are in bed with Wall Street, transferring over $250 billion dollars of taxpayer’s money through Wall Street brokers every year.

(6) If the inflation-adjusted projected rate of return for public sector pension funds were lowered from 4.75% to 2.375%, the contribution rates into these funds would rise from between 20-35% of salary (non-safety vs. safety) to between 40-70% of salary. This is not possible. This is why pension fund managers are making increasingly risky investments on Wall Street instead of admitting they will not be able to sustain 4.75% rates of return any longer.

(7) The solution to public sector pension plan insolvency – and they are all insolvent once you admit 4.75% returns will no longer accrue to trillion dollar funds in a debt-saturated, stagnant economy – is to move to a pay-as-you-go system, just like Social Security. Current tax receipts should be used to pay current retired workers.

Defenders of the status quo seem to embrace the seductive notion that Wall Street will solve all of our retirement security problems for public sector workers at the same time as they indulge the urge to demonize Wall Street for the failures of 401K plans. This contradiction escapes them, as they expect private sector taxpayers cover not only the downside of their individual retirement savings losses, but also whatever losses may accrue to the public employee’s pension funds.

Sustainable Retirement Finance

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When assessing the financial sustainability of any government administered plan to provide retirement security to their citizens, it is important to consider two factors, (1) the nation’s overall population demographics, and (2) the economic model of the plan. In-turn, when evaluating the economic model of the plan, it is important to consider the plan’s sustainability apart from reliance on returns from passive investments. It is important to assess how well a government-funded retirement benefit plan can be supported via a pay-as-you go system, where each year, tax assessments on current workers are used to pay retirement benefits for retired workers.

In the United States, there are two government operated financial systems that administer our collectively funded, i.e., taxpayer funded programs to pay retirees a certain amount each year that they may live comfortably. One may assume a great range of thresholds to define “comfortably” but in any event these two systems are very distinct, in ways that are fairly easily explained. They are social security, for which about 80% of the U.S. workforce participates, and public employee pensions, for which about 20% of the U.S. workforce participates.

Social security is based on the assumption that participants work, on average, from the age 25 to 65, then are retired from age 66 to 85, i.e., there are two participants in the work force for every one recipient who is retired. Social security, on average, also may assume that payments to retirees average one-third what earnings are by workers. On this basis, on-sixth of a worker’s wages, or about 16%, are required to be additionally assessed in order to fund payments to retirees on a pay-as-you-go basis. Social security clearly can remain sustainable, as long as it maintains the current two-to-one ratio of workers to retirees, and also pays on average one-third in retirement benefits compared to what current workers earn.

This relatively sanguine outlook for the future of social security is supported by that other key factor, demographics, particularly in the United States. For people born between the years of 1956 through the present, there about 20 million citizens for every five year age-group, from zero to 5, through 50 to 55. This means these projections will not be undermined by an aging population. The United States has a serendipitously even stream of people insofar as every age group is equally represented numerically, from today’s babies through baby-boomers born in the 1950s (ref. Funding Social Security vs. Public Pensions).  America’s social security system as it is currently formulated is financially sustainable, and unless it dramatically changes its benefit formulas, will be for at least the next 50 years based on existing age demographics; probably much longer. The formula of 16% withholding for one-third average earnings in Social Security payments is eminently sustainable, without reliance on investment earnings.

When one considers the average years retired vs. worked, and the average annual pension as a percent of average annual per worker earnings, and compares public sector pension benefit formulas with social security benefit formulas, a completely different picture emerges. Public sector pension benefits, when evaluated on a pay-as-you-go basis – wherein current workers support retirees via current assessments – require far more withholding from total compensation. Here’s why:

The average public sector workers enjoys a one-to-one ratio of working years to retired years, unlike the social security system, which only provides a benefit based on a two-to-one ratio of working years to retired years. Public sector workers on average work from age 25 to 55, then are retired from age 55 to 85 years, one-to-one. Private sector social security recipients work from age 25 to 65, then are retired from 65 to 85, a two-to-one ratio. But the disparity doesn’t end there.

The average public sector worker – averaged based not on formulas for safety vs. non-safety workers, but at a blended rate incorporating the collective reality of all government workers – enjoys a retirement pension that is not, on average, one-third of what the average worker earns, but is instead two-thirds of what the average worker earns, twice as much. So if public sector worker retirement systems were funded via pay-as-you-go assessments, with each worker being responsible for supporting one retiree, they would have to have the system allocate an amount equivalent to 66% of their salary, an additional two-thirds on top of what they make, to be paid out to a public sector pensioner.

The financial sustainability of public sector pensions depends on 66% of each worker’s earnings being simultaneously paid out to a public sector retiree, the financial sustainability of social security depends on 16% of each worker’s earnings being simultaneously paid out to a social security recipient, less than one-fourth as much. No wonder public sector pension funds have become a collection agency for Wall Street, as their aggregated 401K plans tumble and toss upon the speculative waves of global finance, and are chary to simply ask for twice as much or more to be collected, from the taxpayers, now and forever to sustain public employee retirement pension payouts. As it is, about $250 billion per year of new money pours into Wall Street via public sector pension fund collections from state and local government payrolls (ref. The Axis of Wall Street & Unions).

It is ironic at best how spokespersons for public sector employee unions (also known as “associations.”) and even spokespersons for public sector employee pension funds are fond of accusing taxpayer groups and others concerned about unsustainable public sector pensions of “throwing us to the same fate as those private sector workers and their underwater 401K retirement funds.” Don’t they realize these taxpayer-funded public sector pension funds are themselves still merely gigantic 401K plans? Don’t they see the irony of holding private sector taxpayers accountable not only for our own losses at the hands of those Wall Street sharks, but also holding private sector taxpayers accountable for public employee pension fund losses at the hands of those same Wall Street sharks? Are government workers and their associations, however well-intentioned, complicit in or at least condoning this sustainability disparity because they like to retire collecting twice as much money for ten extra years?