How Unions Can Save America

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

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/

Inflation, Population & Government

For several months I have been privileged to receive informational emails from Senator Jeff Denham, who represents California’s 12 Senate District, a verdant (if gerrymandered) expanse of land that includes vast swaths of the San Joaquin Valley, along with virtually all of the beautiful Salinas Valley to the west. Senator Denham has been resolute in his opposition to California’s economically disastrous, politically opportunistic Global Warming Act, which has earned him credibility here, and hopefully elsewhere.

Today Senator Denham’s email dealt with another topic, the size of California’s state government, another area where Denham’s stated preference for smaller state government earns him additional points. Today’s email included some comments from one of his constituents that bear analysis – here they are:

“…in 1970, California took in 28 percent of state revenues from personal income taxes. Fast forward to 2010 and you find the state now pulls in a whopping 52 percent of its revenue from personal income taxes. During this same time period, our state budget increased from $6 Billion to $120 billion, an increase of approximately 2,000 percent. All the while, our population has barely increased 100 percent. As such, you could say that for every 1 percent increase in population, our spending has increased 20 percent.”

These are dramatic numbers – but they are misleading. Unlike people, who cannot be devalued, currency is a fluid asset, whose value is only pegged relative to other currencies and the commodities we use currency to purchase. And by this measure, Denham’s constituent has made a point we must attenuate. A good online source for compiled CPI (consumer price index) measurements is the website US Inflation Calculator, where there is a chart entitled “Consumer Price Index Data from 1913 to 2010.”

If you review this CPI chart, which references a “base year” of mid-1983, and reports the estimated purchasing power of a dollar for years before and after 1983, you will see that the year 1970 had an index of 37.8, and 2010 has an index of 216.7. This means that what a dollar would have purchased in 1970 would cost $5.73 today. While the CPI index is itself subject to criticism and is certainly not 100% accurate, it is obvious there has been inflation since 1970. In 1973, for example, the Big Mac burger made its debut, priced at $.50. Today a single Big Mac sandwich costs about $3.00. Similarly, homes that cost $50K in 1970 cost about $300K today (or more; the rate of price increases for residential and commercial real estate have exceeded the rate of inflation over the past decade – hence the deflationary pressures we’re currently facing).

So while Senator Denham is on the right track when he compares – and deplores – per capita government spending today vs. forty years ago, he needs to normalize not only for population, but also for inflation. The operative assumption requiring modification is this:  “During this same time period, our state budget increased from $6 Billion to $120 billion, an increase of approximately 2,000 percent.” In reality, the $6 billion needs to be increased by a factor of 5.73, which means $6 billion, in today’s dollars, would be $35 billion. This represents a growth in spending of 340%, which means that for every 1.0% annual increase in population, California’s per year state government spending since 1973 has increased 3.4%, not 20.0%.

Should California’s state government spending increase at a rate of 3.4x the rate of population increase? Absolutely not. But Senator Denham and other sincere and courageous advocates for limited government will not as effectively advance their agenda using statistics that cannot bear the light of day. Economics is called “the dismal science” for good reasons, and Mark Twain’s old adage that there are “lies, damn lies, and statistics” has endured as a favored quote for good reasons. But this doesn’t absolve any of us from making ongoing and sincere attempts to extract the truth from the myriad sea of numbers – because the truth exists, even if it isn’t precisely knowable – and because with integrity, instinct, intuition and reason, we get closer to that truth. And if our clear intention is to find the truth, even if that truth appears disruptive and disturbing, then our findings may convince not only those who already agree with us, but those multitudes who are still searching.

As it is, Senator Denholm is right, and his point is valid – California’s government is big enough, and should not grow at a rate more than triple the rate of population growth – particularly since today most of California’s politicians don’t want to use taxpayer’s money to build anything, but would rather use government as a weapon to restrict infrastructure development in favor of bloated wages and benefits for unionized government bureaucrats.

Pensions: Giant 401K Plans

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

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?