Christmas Cards 2012

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Martini
19.75″ x 27.5″, 2005

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Pinwheels
19″ x 24″, 2006

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Mandala
18″ x 18″, 2007

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Octopus
12″ x 12″, 2008

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Backgammon
16″ x 18.5″, 2009

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Yin Yang
18″ x 18″, 2010

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Andromeda
20″ x 34″, 2011

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Chromaticism
10.75″ x 13.5″, 2012

 

Defending Defined Benefits

Among pension reformers there is a spirited ongoing debate regarding what might constitute a financially sustainable yet equitable solution. On one side there is a call to do away with defined benefits entirely, replacing them with defined contribution plans. The argument is compelling; with defined contribution plans, when the participant retires, they survive on the assets they have invested, and the employer has no contingent liability whatsoever. This is an appealing scenario to anyone who fully appreciates just how close our public sector pension funds are to financial collapse. But some of the ways defined benefits are characterized by their detractors are inaccurate.

For example, defined benefit plans are often referred to as “Ponzi schemes,” based on the premise that pension funds depend on new participants making contributions in order to fund the distributions being made to retirees. But the scam used by Ponzi (and Madoff) was to let new investors fund interest payments to existing investors, while all the while making the promise that existing investors had a claim on their original principal investment and could have it back at any time. Defined benefits do not offer a return of principal. If incoming contributions, plus interest earned on assets under management, offer sufficient extra capital to fund distributions, a pension fund is sustainable. A Ponzi scheme by definition is not sustainable.

Slightly more apt, but still inaccurate, is to characterize defined benefit plans as “Pyramid schemes,” based on the same premise – that their solvency depends on new participants making contributions in order to fund the distributions being made to retirees. But Pyramid schemes only work when an expanding number of new entrants buy into the scam. As soon as the number of new entrants in a given year is not, for example, twice as plentiful as the number of existing participants, a Pyramid scheme collapses, and the last ones in lose everything. Properly managed pension funds do not require an increasing number of entrants.

It doesn’t take a lot of imagination to see the problem with putting everyone onto an individual matching 401K plan, i.e., convert everyone to a defined contribution plan. Every participant is on their own. No matter how generous the employer matching may have been, and no matter how much money they may have put away during their working years, if any retiree’s investments lose their value, they will be financially ruined. And even if their investments perform to expectations during their retirement, they will continuously have to worry about how much they can spend, because should they be fortunate enough to live longer than average, they may still find themselves penniless.

Hence there are two distinct virtues to defined benefit plans, both based on the fact that these plans allow large numbers of participants to pool their risk. This means that even though some participants may live longer than average, their income is secure their entire life, because by definition whoever collected more from the plan by living longer than average had their higher than average withdrawals offset by those whose lifespans were shorter than average. And because risk in a defined benefit fund is shared across generations of workers, during eras when investment returns are low, existing workers guarantee extra cash coming into the plan to keep it solvent, and during eras when investment returns are high, surpluses are fed into the pension fund that can also be used to make up the shortfall during lean years.

The only way defined benefits as they are currently structured for California’s public employees can remain solvent is if annual investment returns go into the double digits and stay there for the next 20 years. Even if that happens, contribution rates may have to go up. And if that doesn’t happen, the likelyhood that anyone is going to be willing to pay the required higher contributions is virtually nil – whether it is the participants themselves who are (at least according to Gov. Brown’s AB 340 pension reform that was signed into law on Sept. 12, 2012) going to eventually have to pay 50% of the required contributions through withholding from their paychecks, or taxpayers. So how can defined benefits be saved? A question that big defies concise answers, but it is unlikely that any financially viable, equitable solution can be found that will not affect existing workers and existing retirees. Here are some options:

  • For all pensions to existing retirees over $50,000 per year, whenever necessary, reduce the pension payout by an amount proportional to the amount the existing pension assets are underfunded. Restore them – but not retroactively – whenever and to the extent the funds move back towards being 100% funded. This can be accomplished by declaring a fiscal emergency.
  • For all participants still working who are unable or unwilling to afford to pay 50% of the required pension contribution – should it skyrocket in the face of persistent low returns to the fund – offer them an opportunity to accept a smaller defined benefit that they can afford. This can be done pursuant to AB 340.
  • Impose a ceiling on pension benefits to retirees, based on the principle that pensions are supposed to ensure retirement security, not lavish affluence. Similarly, establish a floor for pension benefits to retirees, based on the principle that employees at the low end of the pay scale are nonetheless entitled to retire with an income sufficient to live with dignity. Assuming the pension ceiling is realistic, the savings from establishing a ceiling for benefits will greatly offset the costs of establishing a floor on benefits.

If the annual rate of return currently projected by most pension funds, 7.5%, is lowered, for example, to 5.5%, it will probably be necessary to consider all of these options in order to save defined benefits.

Preserving defined benefits will require hard choices. But defined contribution plans should supplement pensions or social security, not replace them. And comparing defined benefits – or social security, for that matter – to Ponzi schemes or Pyramid schemes are specious arguments that do not belong in serious debate.

Solutions for California

When Governor Jerry Brown, back in the 1970’s, suggested that California should have its own aerospace program, he was dubbed “Governor Moonbeam,” and the moniker has stuck to this day. That’s too bad, because at the time Gov. Brown made that statement, California had the most robust aerospace infrastructure in the U.S. The nexus of companies in Los Angeles – Northrop, Hughes, Rockwell, TRW, plus the branches of dozens of others – the launch complex at Vandenberg, the vast resources of land in the Mojave including Edwards AFB – made California a natural location to further America’s space efforts.

Today half of the companies noted above have been driven out of California by over-regulation, and instead of talking about mining the asteroids, Jerry Brown is talking about a bullet train to nowhere. Before you laugh at the Gov. Moonbeam’s original idea, consider California-based entrepreneur Elon Musk, founder of SpaceX. This private aerospace company, which is already supplying launch vehicles to NASA, has just announced that their “Falcon Heavy,” the largest launch vehicle since the Saturn V moon rocket, will be tested later this year.

The asteroids will be explored and mined by robotic spacecraft within a few decades. And much of the ingenuity and entrepreneurship, risk capital, and high technology will be coming from California. Imagine if California’s dawning recapture of the lead in aerospace technology, following her existing lead in biotech and info-tech, were encouraged by California’s laws and regulations instead of occurring in spite of them?

There are two steps towards putting California back on track. Both relate to public policy: One, reform California’s government and make it more business friendly, two, set a government project agenda that emphasizes infrastructure over pay and benefits for government workers. These steps will lower the cost of living for all California residents.

It is an ironic blessing that California’s bloated, dysfunctional state and local governments will financially implode sooner than anywhere else in the U.S., because it means we’ll be the first to come out recovered on the other side. It will be a painful transition, but manageable if projects to lower the cost of living are invested in at the same time as austerity measures are imposed on government workers and recipients of government entitlements. Here are solutions for California:

(1) Balance State and Local Government Budgets:

(a) Lower the wages of all state and local government workers by 20% of whatever amount they make in excess of $50,000 per year. Lower the wages of all state and local government workers by 50% of whatever amount they make in excess of $100,000 per year. Include in “wages” ALL forms of compensation.

(b) Impose special tax assessments on state and local government pensions in the amount of 50% of all pension payments in excess of $50,000 per year and 75% of all pension payments in excess of $100,000 per year.

(c) Require 75% of all school employees to be teachers in a classroom. Raise average class size to 30 students per classroom by abandoning the failed policy of “mainstreaming” disruptive students, and by separating students into classes based on their academic performance.

(d) Return to welfare and entitlement policies adopted by most other states under the Clinton administration.

(e) Reduce the size of the state and local full time government workforce by 20%.

(2) Change the Rules in Sacramento:

(a) Implement fundamental curbs on the rights of public sector unions, including:  Grant all public sector workers the right to opt-out of union membership and payment of any union dues including agency fees. Prohibit government payroll departments from collecting union dues. Allow all public sector employees to negotiate their own wages and benefits and not be bound by collective bargaining terms if they wish. Prohibit public sector unions from negotiating over long term benefits, and require all current wage and benefit agreements to expire at the end of the term for the elected officials who approved the agreements. Prohibit public sector unions from engaging in political activity of any kind.

(b) Discontinue the planned “CO2 auctions,” which are nothing more than a way to redistribute money to bankers, phony green entrepreneurs, and public sector payroll departments. Repeal AB32. Crucially, lift the crippling burden of land use regulations that keep the prices of homes and commercial property ridiculously high in California.

(c) Revisit all business-friendly recommendations made by business associations such as the bi-partisan California Chamber of Commerce. This would not include compromise positions in support of public sector unions and crony capitalist environmental regulations. This would include banning project labor agreements or requiring union only contractors on government funded projects.

(3) Use government surpluses to engage in public works, and streamline permitting for private works, that LOWER the cost of living for everyone:

(a) Rebuild the aqueducts – build the peripheral canal underground – develop aquifer storage for runoff harvesting. Build desalination plants on the southern California coast. Upgrade existing dams and pumping stations. Create water abundance and make water cheap.

(b) Build new power stations. Whether this is a joint project with Nevada to establish nuclear power stations in the vicinity of Yucca Mountain, or building new natural gas fired power plants, the immediate establishment of an additional 20%+ of generating capacity in California would allow a lowering of utility rates.

(c) Enable development of offshore oil and gas using slant drilling from land. It is no longer necessary to develop offshore drilling rigs to extract energy reserves. There are cost-effective ways to bring this energy onshore without the risk of an oil spill from an offshore platform.

(d) Enable development of natural gas reserves in California.

(e) Enable development of mines and quarries in California.

(f) Build additional pipeline capacity into California to import natural gas from elsewhere in North America.

(g) Enable development of a liquid natural gas terminal at least 10 miles off the California coast. Get California onto the global LNG grid to further diversify sources of energy. Create energy abundance and make energy cheap.

(h) Upgrade existing roads, bridges, and freeways. Begin working on “smart lanes” that will facilitate cars driving on autopilot.

(i) Instead of developing a bullet train – something that might be worth experimenting with once everything else on this list is done and Californians have money to burn – upgrade California’s existing freight and passenger rail infrastructure. When practical, integrate passenger and freight rail in large cities where high population densities make passenger rail economically viable. Complete a passenger rail link from Bakersfield to Los Angeles. Increase the speed of intercity passenger rail to 100+ MPH, which can be done on upgraded but already existing track.

Implementing policies designed to lower the cost of living is a perilous undertaking. Because it involves increasing the supply of all basic commodities and services including taxes, housing, energy, water and transportation, it lowers profits and can contribute to a deflationary economy. But the deflationary forces at work globally are likely to impose this austerity on Californians anyway. By lowering the cost of living, despite the fewer dollars earned by our public sector workers, or by our private sector workers employed by corporations competing in the global economy, the overall standard of living may actually improve.

The solution for California is to develop infrastructure to lower the cost of living at the same time as deregulation is encouraging economic growth. Because California enjoys so many gifts – natural resources of staggering abundance and diversity, and an economy that is the technological leader in the world – the solutions described here, though painful, will ensure California survives and thrives during what are sure to be challenging years ahead.

During the 21st century there are two competing models of economic growth. The path we’re on involves artificially inflating the prices of all basic commodities. Staying on this path will reduce global competition, empower entrenched global elites, and consolidate the power of public sector unions, monopolistic corporations, and the global bankers. Economic growth will be slow, political turmoil will be appalling and barely contained – if contained at all – and the economic focus will be – to use two representative examples – on expensive solar panels and (by definition) unproductive virtual games and infotainment. In terms of genuine productivity, it will be an anti-competitive age of control by the few over the many, and a sad utilization of the great technological advances we have seen in recent decades.

The solution for California is an alternative economic model, and by extension, is a preferable alternative for the world. And California is a place uniquely equipped to offer this solution by example. If the costs for basic commodities are lowered instead of raised, capital is released to finance completely new industries, from space commercialization and development to life-extension and other fundamental advances in medicine. This will cause rapid and sustainable economic growth, unprecedented per-capita prosperity, even faster technological advancement, and a new golden age.

What Unions Should Be in 21st Century America

The role of unions in the United States has historically been to pool the collective power of workers to negotiate an end to exploitative work conditions and elevate rates of compensation. During the late 19th and early 20th century, unions fought courageously and successfully to raise the standard of living for workers and to push for systemic legislative reforms. While union spokespersons today may overstate their role in the creation of a middle class in America, their legacy is one of undeniable heroism and accomplishment.

In the aftermath of WWII, when the United States had an economy that was larger than the rest of the world combined, and a uniquely intact industrial base, unions flourished as never before. As America’s manufacturers enjoyed a near monopolistic position on world markets, and exported products to the recovering and developing nations, record profits amid minimal foreign competition enabled management to grant request after request to union negotiators, and a middle class was established that enjoyed an unprecedented level of broad prosperity.

Today the status of unions, and workers, is very different. The recovery of Europe and Japan, followed by the rise of great manufacturing nations throughout the world, has disrupted if not destroyed entire industries in the U.S. The American consumer can purchase a dazzling array of products at incredibly low cost, but the price for this has been the decimation of private sector unions. And into this void, public sector unions have emerged as the new voice of labor in the United States.

With public sector union members now comprising more than half of all union membership in America, and probably more than two-thirds of all union revenue, organized labor is no longer a voice for exploited workers – that battle was fought, and won, nearly 100 years ago. Today organized labor is predominantly representing white collar professionals who work for the government. The agenda of these unions is to increase their membership, and increase the pay and benefits for their members. They negotiate not with managers representing the owners of capital – where there is a common interest in preserving the ability of the company to survive in the competitive free market – but with elected officials who rely on taxation for their funds. When a government program fails, rather than cancel it, the union agenda would more naturally favor extending and increasing it.

Here then are some principles and reform ideas that might inform any realistic program to redefine and revitalize unions in 21st century America:

(1) The greater the extent to which unions operate in a monopoly environment, the more restrictive the regulations should be governing their conduct and the scope of their permitted activities. Public sector unions operate in a total monopoly. Public utility worker unions operate in a near-monopoly. These unions should not have the same rights as unions operating in a totally competitive environment where there are natural checks on their agenda. For example:

(a) Public sector unions should not be able to negotiate for long term benefits such as retirement pensions or retirement health care. These benefits should be offered or withdrawn based on policy decisions made by elected officials who are accountable to taxpayers. To the extent public sector unions can collectively bargain for current pay and benefits, these contracts cannot extend beyond the term of office of whatever elected officials may approve these packages.

(b) Public sector unions should not be able to require any employee to join their unions, nor to pay the “agency fee,” nor to be required to participate in the terms of the collective bargaining agreement. Public sector union participation by individuals, at all levels of participation, should be strictly opt-in.

(c) Public sector unions should not be permitted to use their funds for any political activity whatsoever. If public employees wish to form voluntary associations to lobby for political issues or support political candidates, they should do it entirely outside the union organization.

(d) No government agency should be used as a collection agent for union dues. Public sector unions should be required to bill their members using their own resources, not rely on the government payroll department to collect these dues for them.

(2) In general, the principle that should apply to the bargaining agenda of public sector unions, if not all unions, should be to push for benefit enhancements for ALL workers, not just the members of a particular union. Public sector pensions for state and local workers in California, for example, now offer newly retiring workers with 30+ years of service, on average, a pension that is literally four times bigger than the average social security benefit. We are on track to pay more in pensions to our retired population of government workers than we will be paying in social security to everyone else. This is totally unsustainable. Unions, especially public sector unions, should be working with other activists to develop one financially sustainable formula of withholding, investment and disbursement that applies to ALL workers in the United States.

(3) Unions, especially public sector unions, need to acknowledge their partnership with America’s overbuilt financial sector, instead of pretending Wall Street is to blame for the economic challenges facing America. Whenever governments spend more than they receive in tax revenue – in order to pay for union negotiated, over-market wages and benefits, along with union supported programs that increase the numbers of unionized government workers – it is the bankers who loan the money and collect the fees and interest. And public sector pension funds are pouring more cash into Wall Street brokerages than any other source in the world. There are many thoughtful solutions to America’s challenges relating to government deficits, debt (all sources), and demographics (aging population). But they cannot be seriously addressed until public sector union members – and the taxpaying voters – connect the dots. The agenda of government unions is symbiotic – to put it mildly – with the agenda of global bankers.

(4) Unions need to prioritize infrastructure over compensation structure. Instead of elevating the wages of union workers to the point where the average government employee now enjoys total compensation that is literally twice that of the average American worker, unions should push for projects that rebuild our roads, railroads, bridges, aqueducts, water storage, power stations, energy grid, communications grid, and energy development. Here the axis of public sector unions and global bankers is particularly apparent, as is the looming schism between public and private sector unions. Because public sector unions benefit when infrastructure development is stopped in the name of environmental concerns. It frees more money up for their compensation packages. And when “carbon emission auctions” extract hundreds of billions of dollars from rate paying utility consumers, Wall Street brokers the deals, collecting commissions and fees, and for public sector workers who have assessed the “CO2 mitigation” value of their jobs (think bus drivers and code inspectors, to name just a few), those CO2 auction proceeds go straight to government payroll departments.

There is a win-win that it is important to emphasize when discussing how unions may be reformed and redefined in 21st century America. Because unions today operate under an economic model that exchanges social costs for private gain. That is, taxpayers pay a little more, and government workers make a lot more. How do you convince unionized government workers to accept making less?

The solution is to embrace a new economic model, that supports investment in infrastructure to LOWER the cost of living for EVERYONE. With cost-effective development of energy and water resources, investment in practical transportation improvements, and an end to restrictive land use regulations, the costs to ALL consumers will go down. This requires confronting the alliance of government unions, global bankers, and monopolistic corporations. Government workers need to make less, the financial sector needs to shrink, and corporations need to compete. If this can be accomplished, retirees can afford to live on a defined benefit that is barely better than what social security offers, because everything, from taxes to the cost of basic utilities to the cost of housing, energy and transportation, will go down more than wages.

This solution – that in exchange for lower wages and benefits, the cost of living will go down even more – is what must accompany any calls for union reform.

China’s Economy is Going to Crash

Close attention has been paid to the fragmenting Eurozone, where social benefits funded by debt accumulation are bankrupting the entire aging continent. Less attention has been paid to China, where debt accumulation has financed not social benefits, but massive construction projects.

Financial strength is always ultimately found on the balance sheet of a nation, not the income statement. A nation with high GDP, i.e., strong revenues, may be funding that growth through massive borrowing. As the income statement racks up a string of impressive performances, the balance sheet may be steadily worsening.

Nearly two years ago, in “The China Bubble,” I pointed out numerous examples of asset inflation, primarily in real estate, that had already been going on for over a decade in China. Just like in the United States, these over-valued assets have been used as collateral to fund economic expansion. And just like in the United States, eventually people in China will stop buying over-valued assets and their price plummets. This is happening now in China.

One of the best economics blogs out there is “Global Economic Analysis” by Mike Shedlock. His recent post entitled “Real Estate Crash in China Underway: Foreign Funding Down 80%, Land Sales Down 57%, Starts Down 27%; Expect Chinese GDP to Plunge,” says it all. In his post, Shedlock references a report entitled “China Real Estate Unravels” by Patrick Chovanec, a professor at Tsinghua University’s School of Economics and Management in Beijing, China. Chovanic writes:

“Property investment accounts for roughly a quarter of gross Fixed Asset Investment (FAI), and net FAI accounts for over half of China’s GDP growth. As I noted in January, in a back-of-the-envelope thought exercise, if property investment plateaus (growth falls to zero), it could shave as much as 2.6 percentage points off of real GDP growth. If it fell 10% (in real, not nominal terms) it could bring GDP growth down to 5.3%.”

And Shedlock responds:

“Chovanec notes if real estate investment drops by 10%, GDP will come in at 5.3%. What if real estate investment falls by 20% or 25%? Moreover, why shouldn’t it?”

I agree completely. There is no market left for Chinese real estate. They have entire cities they’ve built that are empty. With no more buyers, there will be no more investment. China’s economy ran on construction and exports. Their export market has not only matured, but declined. Now their construction market is collapsing. They are losing their two primary engines of GDP growth. China now joins Europe, desperately confronting an era of prolonged deflation.

There are several take-aways here:

(1) The US Dollar will remain the global transaction currency and will hold its value in spite of a monetary policy that enables massive deficit spending.

(2) The global prices for conventional energy will drop; the price impact of future middle-eastern turmoil will be mitigated by the reality of depressed energy demand.

(3) China will shift her economic priorities to militarization and become more aggressive in the South China Sea.

(4) The United States, while challenged by the economic disasters unfolding in the Eurozone and China, will not necessarily share their fate. For much more on why the U.S. economy can remain dominant despite mounting levels of debt, read “National Debt and Rates of Return.”

(5) While the relatively better financial condition of the U.S. economy buys time, if the U.S. doesn’t resolve its structural deficits and reform its banking system, it will eventually experience the problems already starting in Europe and China. If this occurs, instead of being the locomotive that pulls the world economy out of a prolonged deflationary depression, the U.S. will be the locomotive that drags the entire global economy into the abyss.

(6) One of the biggest economic challenges facing the United States is providing equitable and sustainable retirement security to an aging population. But America’s population, while aging, is demographically sustainable, unlike that of any other developed nation. Here is one way to restructure America’s retirement entitlements: “Merge Social Security and Public Sector Pensions.”

As I wrote in June 2010 in “The China Bubble,”

“The biggest risk of America reemerging economically amid relatively worse economic problems in the rest of the world is that their good fortune will be squandered, as structural reforms to America’s economy are deferred or abandoned in the face of a deceptively positive economic performance. America will still be able to print currency at will, borrowing additional trillions because even as a nation dealing with unprecedented debt, she still has the most diverse and secure economy on earth. Most crucially, America may delay reforming her public sector, using her ability to persist in massive federal deficit spending only to indulge in overpaying public sector bureaucrats – a hideous waste of deficit spending, which is properly used on infrastructure projects and technology initiatives that yield long-term strategic returns on investment.”

California’s Government Worker Pensions Are Bankrupt

As reported today in Capitol Weekly, in a post entitled “CalPERS ignores Brown, delays pension payment” by Ed Mendel, the amount taxpayers will have to fork over to CalPERS next year will rise by $213 million, to a total of $3.7 billion. Governor Brown, quite rightly, believes the full amount of the necessary increase should have been assessed, another $149 million, instead of being “smoothed” over the next twenty years.

But CalPERS – the largest of over 30 major government worker pension funds in California, only manages about a third of the the state and local public sector pensions. And CalPERS is basing their increase on a lowering of their projected rate of return for their invested funds by one quarter of one percent, from 7.75% down to 7.5%.

People may debate endlessly over whether or not government worker pension funds in America, now managing over $4.0 trillion in assets, can actually earn 7.5% per year, every year, for decades on end. We have argued repeatedly that this rate of return is impossible to achieve any longer, because (1) high returns in the past depended on debt accumulation, which poured cash into the economy, which stimulated consumer spending, investing, and asset appreciation – enabling more borrowing – all of which caused investment returns to grow at levels that cannot continue now that borrowing has reached its practical limit, (2) our aging population means more people will be selling their investments to finance their retirements – including the pension funds whose participants themselves are aging and are retiring with higher benefits than previous retirees – and this puts more sellers in the market, lowering asset values and returns on invested assets, and (3) pension funds are much larger as a percent of GDP than they were in previous decades, and they are now too big to consistently beat the market.

This debate will not go away. But it is at least worth examining just how much it will cost Californians if the rates of return on state and local government worker pension funds drops by 1.0%, 2.0%, or 3.0%. The fact is, they might drop by even more than that. Go to a commercial bank and try to buy a U.S. Treasury bill or certificate of deposit that pays 4.75%. Or examine the returns on the major stock exchanges over the past 10+ years. Yields are well under 4.75%, yet CalPERS has lowered their rate of return by only one-quarter of one percent to 7.5?

What are they scared of? Why not pick a risk-free, much lower rate of return?

The table below shows how much the annual pension contribution as a percent of payroll increases when the rate of return drops. Column one shows the contributions required under the original 7.75% long-term rate of return projection, which has just been lowered to 7.5%. Columns two, three and four show the contributions required under lower rates of return, 6.75%, 5.75%, and 4.75%. The rows show just how much these contributions need to be under various pension formulas. These formulas govern most government worker pensions – the percentage noted, “1.25% per year,” for example, means that if a government worker retires after 30 years, their pension will be calculated as follows: 1.25% x 30 x final salary, or in this case, 37.5% of final salary. The amounts selected for these rows are representative of the following pension formulas:

  • 1.25% per year  –  for typical non-safety employees up until around 2000.
  • 1.6% per year  –  the average of non-safety and safety employees up until around 2000.
  • 2.0% per year  –  for typical safety employees up until around 2000; for typical non-safety employees since then.
  • 2.5% per year  –  the average of non-safety and safety employees since around 2000.
  • 3.0% per year  –  for typical safety employees since around 2000.

On the table below, row four of the pension formulas, outlined, shows how lowered rates of return will impact the contributions necessary to fund a 2.5% per year formula. Since 2.5% per year is the blended average that would represent all current state and local government employees in California, the results in this row should be of great interest to taxpayers and public employees alike. As can be seen in this case, the annual pension contribution as a percent of payroll must increase from 16.3% at the rosy rate of return of 7.75% to 21.4% (at 6.75% return), to 28% (at 5.75% return), to 36.6% (at a still impressive 4.75% rate of return).

The table above concludes by taking these pension contributions and applying them to the total payroll of California’s state and local governments, which is (using conservative estimates) 1,500,000 employees times an average annual salary of $70,000 per year (ref. U.S. Census, 2010 CA State Gov. Payroll, and 2010 CA Local Gov. Payroll). As can be seen, if the rate of return for California’s state and local government employee pension funds drops from 7.75% to 6.75%, this will cost taxpayers another $5.4 billion per year. If the return projection drops to 5.75%, it will cost taxpayers another $12.3 billion per year. And if the return projection drops to 4.75% per year, it will cost taxpayers an additional $21.3 billion per year. But wait, because the above analysis still understates the problem.

There’s one more big gotcha.

The first table is entitled “Impact of Lowered Return Projections if we could Retroactively Increase Contributions.” But we can’t do that. Contributions that are in the funds currently were made under the assumption that the 7.75% rate of return would last forever. If we lower that assumption, we still have to fund our pension obligations by investing the money we’ve already got, plus whatever additional monies we can collect from now on. This severely compounds the problem.

The next table, below, calculates how much lowered return projections will cause pension contributions to increase, if half of the contributions are already made. This assumes that in aggregate, the participants in California’s government worker pensions are at mid-career. This is an extremely conservative assumption, because there are millions of government workers who are already retired, whose pension payments are equally dependent on investment returns from the pension funds. This next table therefore understates the impact of lower investment returns on the required contributions to the fund from existing workers.

As can be seen in this more realistic, but still very much a best case scenario, if the rate of return for California’s state and local government employee pension funds drops from 7.75% to 6.75%, this will cost taxpayers another $11.3 billion per year. If the return projection drops to 5.75%, it will cost taxpayers another $24.9 billion per year. And if the return projection drops to a still quite aggressive 4.75% per year, it will cost taxpayers an additional $40.8 billion per year.

This is what the pension funds are up against. These are the scenarios the pension bankers exchange in closed meetings, where the press and even their own PR people don’t attend. Imagine if CalPERS admitted, as they should, that their funds cannot reliably expect to earn more than 4.75% per year. It would mean that – assuming all 10 million of California’s households pay taxes, which obviously is not the case – that every household in the state would have to fork over another $4,000 per year in increased taxes.

Critics of pensions and critics of pension reform alike are invited to verify for themselves the calculations made here. To imply, as CalPERS has, that about another $1.0 billion per year, spread among the 30 California government worker pension funds and “smoothed” over the next 20 years, is all it will take to shore up their solvency, is irresponsible. The additional amount necessary to save California’s government worker pensions is probably closer to $40 billion per year, from now until these pension formulas are reduced.

How Construction Worker Unions Can Save California

The California Labor Federation has a membership of more than 1,200 unions, representing over two million workers. And the first of seven key issues they list on their legislative agenda for 2012 is supporting high speed rail. As they put it, “Building high speed rail will grow our economy and create long-term jobs. An estimated 450,000 jobs in operations, maintenance, ticketing, and services will be needed to keep HSR up and running.”

It is difficult to imagine economic thinking more well intentioned yet fundamentally flawed. What private sector unions want, ideally, is to work cooperatively with government and industry to help create well paying jobs. But high speed rail will incur far more economic costs than economic benefits. Massive construction projects, using public/private financing mechanisms, have to benefit the economy. Otherwise they are examples of private gain – high paying jobs for workers who happen to belong to unions involved in the construction and maintenance of the project – in exchange for socialized loss – higher taxes that lower the disposable income of everyone else.

Policy activists who are critical of unions must understand that there are two crucial debates they are engaged in with unions. The first one is an economic argument – convincing union leadership that encouraging free market competition will lower the cost of living for everyone, and that when this happens all workers benefit. This is a tough sell, despite being entirely accurate. But the second debate, which regards what projects unions should be putting at the top of their legislative agenda, is much easier, because all projects create jobs.

During the great depression, massive infrastructure projects were completed that delivered millions of jobs, but they also delivered amenities to society at large that yielded long-term economic dividends. Hydroelectric dams increased the availability of water for irrigation and the supply of electricity. Rural electrification delivered cheap and clean power to homes and businesses across the country. New roads and bridges resulted in cheaper and faster movement of people and goods. From new school buildings to new civic stadiums, the public/private projects of the 1930′s helped make affordable education and entertainment more accessible to millions. These infrastructure investments put millions of people to work, but they also fundamentally transformed America’s economy, enabling everyone less expensive access to water, power, transportation, education and entertainment.

There is no possibility whatsoever that high-speed rail can compete in California with existing air travel services. It will lose money forever.

The legislative agenda of unions in California should indeed prioritize public/private partnerships to create high-paying jobs, but they should promote projects that will lower the cost of living in California. This is the win-win formula that results in accelerated economic growth and a higher standard of living for all workers, in addition to delivering construction jobs today. Here are examples of such projects – and none of these would cost anywhere near the $100 billion that is the new minimum estimate for high-speed rail:

(1) Build desalination plants off the Southern California coast:
Desalination technology has advanced to the point where it is now possible to desalinate a cubic meter of seawater using less than 2.0 kilowatt-hours of electricity. Put another way, the energy necessary to desalinate seawater is now less than the energy currently required to pump an equivalent unit of seawater over the mountains from the California aqueduct into the Los Angeles basin. Because the California current is one of the biggest ocean currents in the world, the brine that would be discharged as several gigatons of fresh water were recovered each year from seawater would have an insignificant environmental impact. The brine could be discharged through pipes that would run atop the seabed with the outfall 10+ miles offshore where the California current would disperse it immediately. Desalination is a key element towards delivering cheap water again in California, and like nuclear power, claims that desalination is prohibitively expensive are based more on the cost to overcome regulatory hurdles and lawsuits, not the actual construction costs, and certainly not the operating costs.

(2) Develop new surface storage and aquifer storage for storm runoff:
California’s system of reservoirs provide ample fresh water to agriculture, industry and residential/commercial users in years with normal rainfall, but inevitably there are cycles of drought when the existing water storage infrastructure is inadequate. It is probably possible to add another 5 million acre feet of storage without resorting to high dams by identifying areas within the Central Valley where runoff can be collected in great bulk and kept there until spring irrigation draw-downs begin, or systematically transferred to underground aquifers. The capacity of underground aquifers to store water in California is still poorly understood, but California’s water commission estimates there could be 10 million acre feet or more of underground water storage capacity in California. There is plenty of runoff, even in drought years, that isn’t being harvested. To allow California’s agricultural industry access to cheap, abundant water (agriculture consumes well over 80% of the fresh water diverted in California), better storage of storm runoff is essential.

(3) Widen and upgrade interstate freeways:
Along with interstate freeway upgrades, widen and upgrade all major freeways, highways and boulevards in California. Widen and retrofit bridges and tunnels. California needs smart lanes on upgraded roads, not the “bullet train.” As energy becomes abundant and cheap – and technology guarantees this will occur – the most convenient personal transportation appliance ever conceived, the automobile, will become even more indispensable. Cars of the future will be not only clean operating and fuel efficient, but will go faster than ever and be capable of operating on autopilot. To participate in this revolution in transportation, Californians need to upgrade their roads, not attempt to discourage people from using them by neglecting their maintenance, upgrades, and expansion.

(4) Upgrade existing rail corridors:
It is not necessary to develop bullet trains for passenger transportation in a state that will never have more than 50 million people living along an 800 mile corridor. But fast intercity rail, using existing track that is upgraded to tolerate speeds of 120 MPH is a viable proposition, particularly if these upgraded rail lines are also still utilized for faster freight transportation, which will always be more efficient via rail. Diverting public funds into bullet trains is folly, when immediate returns would accrue to investments in better roads and better existing rail.

(5) Streamline permitting process to allow more oil and gas drilling, and more mines and quarries:
California has abundant energy and mineral resources, but nothing can be developed without years of permit applications and legal battles. As a result, basic raw materials have to be imported at far greater cost than necessary. Making development of mineral resources in California more expensive than virtually anywhere else on earth robs Californians of jobs, and constitutes a drain on every facet of California’s economy that relies on these resources.

(6) Build nuclear power plants:
The latest generation of nuclear power technologies are safer than ever, and there is an abundant supply of nuclear fuel within North America. Adding a few nuclear power stations in California would have a dramatic impact on the price of electricity. Claims that nuclear power is more expensive than alternative energy are based more on the cost to overcome regulatory hurdles and lawsuits, not the actual construction costs, and certainly not the fuel costs. Nuclear power development is a key element towards delivering cheap energy again in California.

(7) Build an LNG terminal off the California coast:
Along with new North American sources of natural gas from shale, there is abundant natural gas around the world, and a global market exists for liquified natural gas that is transported by tanker. A few years ago an LNG terminal was proposed to be built fourteen miles off the coast in Ventura County, but was nixed by California’s legislature. By receiving LNG tankers several miles offshore, and piping in the less hazardous gaseous fuel, this terminal would not pose any threat, however remote, to onshore communities, and would allow California to further diversify their sources of this abundant and clean fossil fuel.

By pushing for high-speed rail which will never come close to ever operating at a profit, the current agenda of California’s union leadership is to create more jobs that are essentially parasitic. They will impose new costs to society to benefit a relatively small number of workers, but make everyone else poorer. It doesn’t have to be this way.

California’s union leadership should recognize that by successfully pushing for infrastructure projects that pay for themselves, they can not only create new jobs, but foster long-term economic growth. This, in turn, will enable perpetual job creation. But if they do this, they would have to take on the powerful environmentalist lobby, for whom high-speed rail is virtually the only project they seem to favor.

Union leadership should also recognize that as long as they are unwilling to take on the environmentalists, and push for projects that lower the costs for water, power, transportation – the basic necessities for all consumers – they are doing the bidding of the corporate special interests. These quasi-monopolies benefit from environmentalism run amok, because it means they avoid competition as long as new projects remain on the drawing board. It means they can charge exorbitant prices for commodities that ought to get cheaper every year.

For private sector unions – who value jobs in construction – to remain relevant and forge new partnerships, they will have to divorce themselves from the environmentalist lobby, which has become extreme, and from the public sector union agenda, which prefers to allocate resources to inflated pay and pensions for government workers over investing taxpayer’s money in public/private infrastructure projects.

Related Posts:

Is Union Reform Partisan?, March 30, 2011

Unions and the American Worker, March 25, 2011

Redefining Environmentalism, March 4, 2011

State Politics and Right-to-Work, January 22, 2011

How to Revive California’s Economy, January 18, 2011

California’s Green Godfathers, January 4, 2011

Investigating Climate Alarmism, November 28, 2010

Bullet Train Boondoggles, November 10, 2010

How Unions Can Save America, September 30, 2010

An Environmentalist Agenda for Earth Day, April 22, 2010

Implementing California’s Global Warming Act, April 13, 2010

The Footprints of Rail Traffic, June 23, 2009

Social Security Isn’t Insolvent, Public Pensions Are

In the March 19th, 2012 issue of the New Yorker magazine, as part of a full-page advertisement for MSNBC, there is a quote from Rachel Maddow that I couldn’t agree with more. She says:

“Social security isn’t a Ponzi scheme. It’s not bankrupting us. It’s not an outrage. It is working.”

Rachel Maddow is absolutely right. In one of several attempts to compare the costs, benefits, and solvency of social security to public sector pensions, in the post from November 2011 entitled “Merge Social Security and Public Sector Pensions,” I concluded the following:

“If one strips away the reliance on investment returns and compares social security to public sector pensions based on payroll withholding from current worker’s providing 100% of the funds required to make current payments to retirees, it quickly becomes obvious that public sector pensions are completely unsustainable, whereas social security can be rendered permanently solvent with relatively minor tinkering.”

The reason for this is simple enough: Social security, on average, collects about 12.5% of someone’s annual earnings for about 40 years, then when that someone retires in their mid-sixties, it pays back about 33% of those earnings for about 15 years. Public sector pensions, by contrast, on average collect not quite 20% of a government worker’s annual earnings for about 30 years, then when that government worker retires in their mid-fifties, it pays back about 75% of those earnings for about 25 years. Do the math.

Compared to public sector pensions, along with having far more proportional funding inputs vs. outgoing payments, Social security is progressive, meaning that the percentage of earnings that are delivered as payments in retirement are less if someone made more money. The social security benefit is also capped at around $32,000 per year, unlike government worker pensions.

For these reasons, to keep social security solvent as America’s population ages, a few minor adjustments are all that is necessary – increase the amount of the contribution by a few percentage points, implement means testing, and raise the ceiling on withholding from the current $108,000 per year to $250,000 per year or more. Is Rachael Maddow as incensed as I am that instead of maintaining the current required contribution at 12.5% of payroll, it has been recently lowered to 10.5%? Why are our policymakers trying to destroy one of the most financially stable systems of retirement security in the world?

When it comes to retirement security, where Rachel Maddow might shine some of her famous indignation ought to be on what is, if not a Ponzi scheme, one of the most egregious transfers of wealth from the disenfranchised to the privileged in the history of America – the public employee pension scam. Because this is a story of everything Maddow ought to hate – privilege, corruption, Wall Street wealth, and government collusion with corporate monopolies. Across the United States, cities and counties and states are going bankrupt to pay tithe to Wall Street Brokerages to fund government worker pensions.

Here is a simple equation that anyone opining on sustainable retirement security in America ought to study and memorize:

(public sector pensions)   1.5S x 67% x 30%  >  S x 33% x 70%   (social security)

In this equation, “S” refers to annual salary, which on average is 50% higher for government workers than private sector workers. The middle variable, 67% for public sector pensions, and 33% for social security, refers to the percent of salary that is recovered as a retirement payment. Government workers typically retire with two-thirds of their salary paid in the form of a pension, private sector workers typically get about one-third of their salary paid in retirement by social security. The final variable, 30% for public sector pensions, and 70% for social security, represents the percentage of America’s retired population receiving a public sector pension, 30%, vs. receiving social security, 70%. It is important to point out that actually government workers only comprise 20% of our workforce, but they comprise 30% of our retired population because they retire, on average, ten years earlier than private sector workers.

If you run these numbers, this equation proves that as a nation, we are already spending more in payments to retired public sector workers each year than we pay in social security to the entire remaining retired population. This is an absurd injustice to taxpayers and a crippling drain on government budgets.

What Rachel Maddow and other liberals might consider, along with every fiscal conservative who stops short of being a full blown libertarian, is that there is a centrist perspective to the challenge of providing retirement security. This perspective indicts not only Wall Street, who is by far the biggest beneficiary of the wealth accumulation represented by public sector pension funds, but also the public sector unions, who have put their government worker’s agenda  in front of their financial better judgement or the broader interests of the private sector working class. The idea that over $4.0 trillion in invested public sector pension funds will earn over 7.0% per year, long-term, to fund public sector pensions – when the federal reserve is lending money at essentially zero percent interest – is an absurd lie. Public sector pensions are bankrupt. Period.

The solution to providing retirement security in America is to retain the taxpayer funded safety net called social security, but provide that benefit to ALL workers, public and private. If public sector workers desire and deserve more compensation for their work, it can take the form of higher base pay. They can then eliminate debt and wisely save for their retirements, a process that will join them in empathy and experience with the rest of us.

What do you say, Rachel?

*  *  *

Inquiring readers are invited to review the calculations and data offered in these related posts:

Senator DeLeon’s Universal Retirement Security Act – March 3, 2012

Government Workers vs. Self-Employed: A Financial Comparison – February 24, 2012

Pricing A Taxpayer Bailout of California’s Pensions
– February 24, 2012

Preserving America’s Middle Class – February 8, 2012

America’s Forgotten 33% – January 8, 2012

How Wall Street Bought the Public Employee Unions – December 12, 2011

Merge Social Security and Public Pensions – November 29, 2011

Government Pensions Increasing Hedge Fund Investing – November 1, 2011

Public Safety Compensation Trends, 2000-2010 – October 14, 2011

The Impact of Tax Exempt Pensions – September 23, 2011

CalPERS Projected Returns vs. Reality
– August 13, 2011

How Interest Rates Affect the Federal Budget – August 4, 2011

The Impact of Pension Spiking – July 24, 2011

What Percent of Payroll Will Keep Pensions Solvent? – July 23, 2011

Why Pensions Are Grossly Underfunded – June 27, 2011

Preserving America’s Retirement Security – June 4, 2011

Why Real Rates of Return Must Fall – May 16, 2011

How Rates of Return Affect Pension Contribution Rates
– April 27, 2011

How Rates of Return Affect Required Pension Assets – April 7, 2011

The Cost of Government Pensions – March 11, 2011

California’s State AND Local Government Personnel Costs – February 17, 2011

When is Debt Unsustainable, February 4, 2011

What Percent of Payroll Will Keep Pensions Solvent?,” July 23, 2011

Why Pensions Are Grossly Underfunded –  June 27, 2011

Preserving America’s Retirement Security –  June 4, 2011

Government Worker Understates Average Pension –  May 31, 2011

Why Real Rates of Return Must Fall –  May 5, 2011

How Rates of Return Affect Pension Contribution Rates –  April 27, 2011

Require CalPERS to Invest 100% in California? –  April 14, 2011

How Rates of Return Affect Required Pension Assets –  April 7, 2011

The Cost of Government Pensions –  March 11, 2011

When is Debt Unsustainable? –  February 4, 2011

China’s Economic Challenges –  December 28, 2010

The Cost of Retirement Security in America –  December 23, 2010

National Debt and Rates of Return –  December 18, 2010

Teacher Pension Solvency –  December 12, 2010

Entrepreneurial vs. Casino Capitalism –  November 11, 2010

Pension Reform Options –  November 1, 2010

Pensions: Giant 401K Plans –  September 14, 2010

Sustainable Retirement Finance –  September 11, 2010

Avoiding Global Deflation –  July 18, 2010

The Axis of Wall Street & Unions –  July 8, 2010

The China Bubble –  June 8, 2010

Funding Social Security vs. Public Pensions –  May 22, 2010

Social Security Benefits vs. Public Pensions –  May 8, 2010

The Razor’s Edge – Inflation vs. Deflation –  March 15, 2010

Senator DeLeon’s Universal Retirement Security Act

The challenge of providing retirement security to all citizens is the broader issue behind the debate over what level of public sector pension benefits are both equitable and financially sustainable. California Senator Kevin De Leon’s proposed legislation, SB 1234, will hopefully further this debate.

As reported in the Sacramento Bee by Jon Ortiz on February 24th “California Democrats push pension plan for nongovernment workers,” and in the Los Angeles Times by Mark Lifsher on February 23rd, “Private-sector retirement savings plan proposed for California,” DeLeon’s bill will require every employer in the state with five or more employees to participate in the plan. If employers already offer a pension plan or 401K plan, they would be exempt.

Plenty of commentators have already weighed in with sobering missives on the many problems with DeLeon’s bill. You can read them in the San Bernardino Press Enterprise, the Pleasanton Weekly, CalWatchdog, CalWhine, and elsewhere. But when DeLeon says his bill “is designed to supplement Social Security retirement benefits,” he is on to something bigger than he may realize.

The goal of taxpayer funded retirement security, whether it is for a retired government worker or a retired private sector worker living on social security, is not to support an affluent lifestyle. A taxpayer funded retirement pension should be a modest amount, better than social security – but not some huge amount that enables an affluent lifestyle. To have an affluent lifestyle in retirement, people should expect to save money and eliminate debt, not just show up at a government job for 20 or 30 years then collect far more than a social security recipient could ever hope to collect. Why not eliminate public sector pensions, and provide everyone social security, supplemented by the plan DeLeon is proposing?

When estimating just how much DeLeon’s pension plan for private sector workers is going to actually be able to pay out, it will highlight a fundamental principle that still seems to be lost on the public sector apologists: Not all of us are libertarians, nor are all of us against improved retirement security for all citizens. But whatever it is that taxpayers are asked to support has to be equally accessible to ALL workers according to the same merit-based and need-based formulas. We can disagree on the formulas. We can disagree on what we believe is financially sustainable. But however our government may enable better retirement security – it should be the SAME DEAL for all taxpayers. The disgrace is that public sector unions have used their political muscle to offer deals to their members in the government workforce that could never, ever be financially feasible to all workers.

As DeLeon’s bill is debated, hopefully it will not only highlight the truly grotesque disparity between government worker pensions and social security for the rest of us, but it will shed light on the biggest single variable affecting the affordability of public sector pensions: The long-term annual rate of return for the pension fund.

As quoted in the Los Angeles Times, DeLeon said “The board would be required to invest only in conservative instruments, such as U.S. government Treasury bonds.”

Does Senator DeLeon understand what sort of can of worms he is opening here? A ten-year U.S. treasury bond pays around 3.0% per year. Yet CalPERS still claims they can earn 7.75% per year. How much money will this “supplemental pension,” expressed as a percent of final salary, deliver to someone who contributes 3% of their salary for 40 years, invested at 3% per year?

As the chart following this post proves, taking 3.0% from a paycheck – assuming normal inflation and minimal merit increases (which increases ultimate fund earnings by concentrating more investment in the early career years) – will buy a person who retires after 40 years of full time work at a final annual salary of $50,000 with a whopping $2,010 pension per year; that’s an extra $168 per month. Anyone who dismisses this decidedly math-centric, wonkish claim as “right-wing spin” is invited to verify these calculations for themselves.

What Senator DeLeon is going to learn, along with many other worthy liberals in the State Legislature who are grappling with the pension crisis, is the extreme sensitivity of pension fund solvency to the achievable rates of return for these funds. And if Senator DeLeon wants to impose a “risk free” rate of return on a pension fund for private workers, he may wish to impose the same restrictions on public sector pension funds. Or stop having taxpayers make up the difference when those more aggressive investments fail to meet expectations.

There is nothing wrong with our legislators trying to address the issue of retirement security. But while doing so, they might question why we are now on track to pay more money each year, in absolute dollars, to our retired public sector workers in the form of pensions, than we will pay in social security to the other 80% of our workforce when they retire. They might also question why they have gone into partnership with the very Wall Street wizards they rhetorically condemn, by allowing them to promise absurdly high rates of pension fund returns to public sector employee negotiators, then together turn on taxpayers to cover the inevitable shortfall (for more, read “Merge Social Security & Public Pensions“).

*  *  *

Government Workers vs. Self-Employed: A Financial Comparison

When discussing what level of compensation is appropriate and affordable for government workers, it is helpful to make apples-to-apples comparisons between public and private sector workers. In this analysis, the ultimate private sector taxpayer, the self-employed worker, is compared to the typical state or local government employee in California. In both cases, the annual compensation used for comparison is $70,000, which is the average base salary paid to state and local government employees in California (ref. U.S. Census data for California: State, and Local). But the impact of benefits paid by the government employer, combined with the impact of mandatory employee contributions (taxes, retirement set-asides, and healthcare costs), yield dramatically different end results in terms of total net compensation. Both the self-employed worker and the government worker make $70,000 per year. But to say they make the same amount of money is grossly misleading.

The table below, “Total Compensation – Gov’t vs. Self-Employed Worker,” begins to illustrate this disparity. The difference between total compensation and gross earnings in the case of the self-employed worker is zero. There is nobody paying for benefits beyond what the self-employed person earns. Whatever amenities they need to purchase, they have to pay for out of their gross earnings.

In the case of the government worker, there are a host of employer funded benefits; only the basic ones are covered here, using conservative assumptions. If it is assumed the average household health insurance coverage is $500 per month, and the employer pays 50% of that, this adds $3,000 per year to the total compensation of a government worker. In reality, factoring in employer coverages of medical, dental and vision plans, it is very unlikely the average government worker doesn’t get well in excess of $3,000 per year in employer health care benefits.

Current expenses for health care, however, are not the only health expenses that governments pay for their workers. Typically there are provisions for retirement health care coverage that are taken on as obligations by the government for their workers. For example, there are “medigap” plans, with all or part of the premiums paid for by the government. In some cases, such as with most safety employees and management employees, the government pays 100% of the premiums for lifetime premium health insurance plans. These future obligations must be funded during current employment. To estimate another $2,000 per year for this cost, or, more generally, to estimate $5,000 per year per employee for the average government contribution to current and retirement health care, is definitely conservative.

In addition to healthcare costs, state and local government employers cover pension benefits for which much of the costs – and in many cases 100% of the costs – are paid by the government, not the employee. If one assumes a contribution by the government employer of only 12% of gross salary per year – clearly lower than reality – this adds another $8,400 to the total compensation of a government worker.

A simmering question regarding pensions for government workers – how much can these pension funds really earn each year in interest – generates the next estimate. In our analysis “The Taxpayer Cost to Bailout California’s Pensions,” along with “What Percent of Payroll Will Keep Pensions Solvent,” we have explored the underlying calculations in depth. The reader is invited to review those calculations and assumptions. But the bottom line is this: If pension funds have to lower their long-term expected rate of return by 2.0%, and they will, this will add at least $11,200 per year to the cost of funding the average pension. These obligations may be scaled back, but until they are, this amount must be included when adding up the total compensation of the average government employee in California.

Taking all of this into account, a self-employed person making $70,000 per year makes $70,000 per year. A government worker making $70,000 per year in base pay is actually making $94,600 per year in total compensation, 35% more. But it doesn’t end there.

The next table, below, examines the impact of what might best be described as “mandatory employee contributions,” taking the form of the employee share of health insurance coverage, retirement pensions and social security, along with state and local taxes. Once these mandatory contributions are deducted from the income (before tax in the case of health care and retirement contributions) of both the self-employed and the government worker, and the employer provided benefits – which are tax-free – are added back to the income of the government worker, the disparity between their actual net total compensation becomes even more dramatic.

If one assumes that the self-employed person is going to purchase health insurance for their household, they will pay 100% of the premium. Using the same assumptions, this means they will spend $6,000 per year for these benefits, whereas the government worker, paying 50% of the premium, will only spend $3,000 per year.

By participating in social security and medicare as a self-employed person, they are obligated to pay both the employee and the employer share of those assessments, which at a gross annual income of $70,000 will cost them $10,500 per year. By contrast, even if the government worker pays 10% of their salary into their pension – a level that is still fairly unusual to see among government workers – this will only cost them $7,000 per year.

In the above table, “Net Total Compensation – Gov’t vs. Self-Employed Worker,” these before tax deductions are subtracted from their base annual salary to arrive at their taxable annual salary. This taxable amount then has deducted from it what a California household in 2011 would have to pay in state and federal taxes. Finally, the non-taxable employer contributions are added back to the actual take-home pay to yield the net total compensation after mandatory contributions.

This is the apples-to-apples result: A self-employed person making $70,000 per year, once they’ve paid their taxes. social security and insurance premiums, will enjoy compensation of $45,021 per year. A government worker making $70,000 per year, once they’ve paid their taxes, pension contribution and insurance premiums, with the value of their current and deferred benefits added back, will enjoy compensation of $74,781 per year, 66% more.

It doesn’t end there. As shown on the next table, “Retirement Security – Gov’t vs. Self-Employed Worker,” the self-employed worker, who must pay $10,500 per year for social security and medicare, can expect to retire at the age of 66 with a social security benefit of $20,144 per year. The government worker, who must pay $7,000 per year for their pension, can expect to retire at the age of 60 with a pension of $46,666 per year. The total value of these respective retirement benefits, based on a life-span of 80, is $282,016 for the self-employed worker, and $933,324 for the government worker.

It is important to emphasize how conservative these numbers are. While the average pay of a government worker in California is only about $70,000 per year, the average pension for state and local government workers in California is not $46K per year, but nearly $70K per year. For state and local government workers who retire at age 66 and spend their careers in government service, the average pension is nearly $100K per year (ref. CalPERS Annual Report FYE 6-30-11, page 153, and CalSTRS Annual Report FYE 6-30-11, page 149). This means the assumptions used to calculate pension contributions at various rates of return, which assumed pensions equivalent to 66% of average salary, are obviously inadequate. This is because pensions aren’t calculated on average salary, they’re calculated on final salary. The assumptions underlying our pension contribution estimates also don’t take into account the current state of underfunding for pensions.

For a self-employed person to enjoy a net total compensation equivalent to the average government employee who makes “only” $70,000 per year, they would have to earn well in excess of $100,000 per year, particularly since as they climb in gross income, they encounter higher and higher tax brackets. A self employed person who makes less than $108,000 per year and more than $74,000 per year, because their income is still under the social security withholding ceiling, actually pays taxes at the margin of over 50%. But that is a topic for another post.