California Dreaming: Lessons on How to Resolve America's Public Pension Crisis Kindle Edition
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Easy, just tax the rich. What, the upper 20% already pay 90% of the state taxes, well tax them more! Sounds like a great solution, but there is just one itty bitty problem, the wealthy can move. What! Why isn't there a law against that? Plus there are a lot of hidden California taxes that these people no longer pay. Auto reg renewal in Florida is $46 versus $500+ in CA for an expensive car. FL Electricity is $0.10/KWH versus $0.40 in CA once you go over the minimum, etc., etc., etc. Everything in Florida works just fine. The roads are better; the FL DMV person was pleasant, etc. Don't like Florida, try Nevada, Washington, or Texas.
So, what did McQuillian miss? First, when taxes get too high, the wealthy move. Second, once the wealthy move, they no longer support the California economy. Spending on home services, on restaurants, on entertainment, etc. etc. etc. also leaves. So, the tax base shrinks not only from their move, but also from the loss of their spending contribution that supports other California residents. Trust me, a lot of upper income Californians are leaving the state.
Should the wealthy feel guilty about leaving? First, if pensions were done correctly, there would be no unfunded liability, so there would be no basis for guilt. Second, California pensions are far, far in excess of what the average taxpayer gets from his or her employer. Once California public pension recipients face the same retirement benefits that the rest of us face, then those leaving should feel guilty.
McQuillan does a great job of explaining how a pension crisis is generated in California or anywhere else at any level of government (city, county, State). Politicians have used irresponsible pension enhancements as an easy way to buy votes to get in office while leaving staggering fiscal problems that will last way beyond their tenure in public service and even affect the fiscal solvency of future generations.
His recommendations make perfect sense. The main one is to disband defined benefit plans (associated with guaranteed income to pensioners resulting in unsustainable liabilities for public employers) and replacing them with defined contribution plans (401K, 403K structures). The private sector has made that shift (from db to dc plans decades ago). It is irresponsible that the public sector has not made that shift yet.
What is depressing is that this problem is not new, neither are the author’s recommendations to reform pensions and resolve the nationwide pension crisis (it is not just California; the pension problems nationwide are very much the same… it is plain math, those db plans just do not pencil out anymore). As McQuillan indicated, Arnold Schwarzenegger made the same recommendations and proposals back in 2005 when he was Governor of California. A decade later, Jerry Brown, as Governor of California, repeated very similar proposals. Yet, both Governors went just about nowhere. Pension reforms have been minuscule and inadequate to resolve this massive fiscal problem. And, if formidable politicians like Schwarzenegger and Brown couldn’t make any progress on such an issue who can?
Overall the book is excellent and really informative. I will keep it for a long time as a reference on an issue I do care about; and, I know it will remain a crucial one for decades to come. Along the same line, I think this issue should raise concerns among any muni bond investors nationwide.
I will mention one aspect of the issue that is rather confusing if not downright frustrating and that is the lack of established consensus on what is the appropriate discount rate of pension liabilities. As shown, throughout the book what seems like fairly small changes in discount rate make mathematically a huge difference in the net present value of pension liabilities. There is nothing fraudulent about this. This is how the math works. However, a good deal of the figures quoted by McQuillan come from Joe Nation who has a long history of coming up with the lowest discount rates that in turn translate into multiplying the size of the public pension fund liabilities. I personally do not find his “risk-free” discount rates credible (using those would render all of our 401Ks and IRAs grossly inadequate to fund our respective retirements even when that is not the case at all). I have debated this issue with him personally years ago. And, I was less than impressed by his knowledge in investment theory. Nevertheless, the questionable work of Joe Nation in his “Pension Math” does not affect much if at all the quality of McQuillan’s book. Fortunately, the latter also uses other sources that are much more credible and realistic including Warren Buffet.
My personal belief is that the system is too far gone to fix. The best solution is to allow the pension system to implode, and then start over. The U.S. Supreme Court has already laid the foundation with the JANUS decision that allows public employees to withdraw from union membership. Public employees should have some type of 401(k) plan, just like people in the private sector.