Capitol Alert

The Milken Institute has become the latest authority to declare a crisis in financing pensions for California's nearly two million state and local government workers.

Capping a conference this week on California issues, the Santa Monica-based research organization released a report that says demography -- a rapidly aging public workforce competing with sharp increases in demands for education -- could be the greatest factor in creating deficits in state and local pension trust funds.

It provides support to Gov. Arnold Schwarzenegger and other critics of the pension status quo, who contend that state and local governments cannot finance promised benefits over the long run. As part of the recent state budget agreement, Schwarzenegger won a partial rollback of pension benefits that were expanded in 1999.

While much of the debate over pensions has revolved around benefits and pension fund investment losses, the Milken report, authored by Perry Wong and I-Ling Shen, says "the funding status of California state pension funds had been deteriorating over the last decade. It is not simply a phenomenon created by the financial crisis and the recession."

The report recommends a long-term approach to financing pensions, including the politically difficult steps of raising employees' share of costs and shifting away from defined-benefit plans to defined-contribution plans, similar to 401k plans in private employment.

"It is in the interest of California's government, state employees, and taxpayers to come together on this issue," the authors write. "We need to identify a politically feasible and fiscally attainable resolution to the huge and expanding funding gap of our state pension systems. Currently, the debate over pension reform has centered on immediate remedies to the present funding shortfall, which was magnified by the funds' investment losses in the 2008-2009 market meltdown.

"With this paper, however, we would like to apply a longer time horizon to the discussion. In order to formulate a long-term solution, we need to bear in mind the fact that the state pension gap was swelling even during the robust economic growth period of 2003-2007. Hence, the discussion has to be placed in a broader context of the state's economic and demographic trends.

"General demographic trends indicate that the demand for public services is not likely to decrease in the foreseeable future; meanwhile, the state budget crisis is expected to persist for many years to come. The state of California simply lacks the fiscal capacity to guarantee public pension payments, particularly given the wave of state employees set to retire in years to come. These structural shifts, coupled with the financial design and the accounting practices of state pension funds, all point to the fact that reform is imperative."

The full report can be accessed here.