California's Tipping Point?

[Note: this post has been revised since its original publication.]

Investors should be worried. California's unemployment rate just skyrocketed, and Bay Area employers are laying off thousands of employees. As the eighth largest economy in the world, California and its consumers move worldwide markets. Shannon Love writes about California taxpayers and tax consumers here. Ms. Love talks about a tipping point, which is reached when state employees achieve enough power and money to dictate to the people. Once this tipping point is reached, she says, "it is only a matter of time before civil servants become civil masters."

Former Presidential nominee Barry Goldwater said it even better: "A government that is big enough to give you all you want is big enough to take it all away." I've echoed similar concerns here and here. Despite the danger of overweening government, nothing seems to jolt the average American citizen and voter into action. This is particularly distressing, because informed citizens seem to have become apathetic to the government's siphoning of taxpayer dollars.

Take this 1/22/09 SJ Mercury news op-ed, for example. The writers chastise a San Jose City Councilmember for trying to rein in profligate spending and public sector union demands. However, in promoting more government benefits, they reveal just how stunningly fat government employees have become.

Mr. Bruce De Mers and John Diquisto write: "[M]ost police and fire retirees left public service well before the advent of 90 percent retirements." [Emphasis added.] There's no way to escape the reasonable inference from this statement. We are being told that at least some current police and fire retirees will receive around 90% of their salary after retirement. This isn't an uninformed slip--Mr. De Mers is president of the Association of Retired San Jose Police Officers and Fire Fighters, so he knows his numbers. The writers forget to mention the lifetime medical benefits also given to police and firefighter retirees, but after getting 90% of your salary in retirement, why add fiscal insult to fiscal injury? I can't find a non-executive private sector worker in San Jose who gets 90% of his salary at retirement and lifetime medical benefits--and I'm an employment attorney, so I've met my share of San Jose workers. (As I explain below, I am not against paying police officers and firefighters high salaries--I am against paying any public employee hard-to-calculate and unpredictable benefits.)

But let's get back to the article. It contains the usual platitudes, such as, "Panic is not productive. Promoting panic is a disservice to the public." Informed people should read between the lines. Our government officials want us to remain calm--while they dig deeper into our pockets. Unsurprisingly, the writers resort to the public safety argument: "Attacking retirees who risked their safety to make San Jose one of the safest big cities in America may feel good. [T]hat doesn't make it right."

Newsflash: if more police kept cities safe, or if police were even a substantial catalyst for safety, then New York City, Oakland, and Baltimore would be almost crime-free. (Last time I checked, they had plenty of police officers.) In reality, police and firefighters are just two components in the public safety analysis. The determinative factor in public safety is the composition of the residents themselves--especially their education levels. For example, imagine a city with 1,000 cops and 1,000 gang members, most of whom lack a college degree. Will there be more violent crime in that city, or in a city with 50 cops and 50,000 accountants, doctors, and engineers? And yes, that's a rhetorical question.

Most Santa Clara County residents have a college degree--61%, by some accounts. College-educated adults tend to be less interested in drugs and dangerous behavior, and somewhat more likely to be married. These traits generally lead to law-abiding behavior.

Ultimately, the police and firefighters' unions do Santa Clara County residents a disservice when they claim to be the primary cause of our safety. It's almost as if they are saying, "Pay us off, and you'll be safe. Don't pay us off, and, well...who knows?" Combine financial self-interest with political power, and you have a ready-made recipe for oppression, or at least government-sanctioned extortion.

Investors must realize that public sector retirement benefits are a stock market issue, not just a political issue. Continuing generous government benefits will affect stock market gains in several ways. First, public sector retirement plans aren't necessarily linked to the stock market--CalPERS, for example, can invest in hard assets, like timber and land, as well as other investments unavailable to ordinary people. (CalPERS controls around 239 billion dollars, and its investment decisions move markets.) Having a separate, two-track retirement system allows government to invest taxpayer money with little regard for the retirement prospects of ordinary citizens. Consequently, while non-government investors must rely on an ever-increasing stock market to retire, public sector unions and their employees are not so inhibited. Not being similarly situated, they may take actions to inhibit corporate profits and, in turn, stock market gains.

In fact, there is no question that continuing government's generous retirement benefits will drain taxpayers, providing them with less discretionary income. General Motors (GM) and Ford (F) are two analogous examples. Like the United States, they have deficits and are losing money. Just like government unions, the UAW lavished their employees with generous retiree benefits during flush times. As a result, until 2007, a Ford (F) employee's average hourly wage was $71.00/hour--but with only $29/hr going to actual wages. Around forty percent (40%) of the total hourly wage went to retiree benefits and health insurance programs. (See WSJ, 1/22/09, A12.) Meanwhile, foreign automakers pay around $49/hr to their employees and still manage to create better products and have better service.

Basically, GM and Ford became non-competitive (at least until declaring bankruptcy and/or gaining union concessions) because they offered generous retirement and medical benefits based on overly optimistic actuarial projections. The costs of their programs--like America's public sector pensions--are linked to the life expectancies of retirees and future profits/tax revenue; therefore, without a crystal ball, true costs are difficult to predict.

Since it's difficult to ascertain the exact costs of benefit programs--which, like construction projects, often take longer and usually go over budget--prudent persons would favor cutting hard-to-measure benefits and then increasing present-day salaries.  If the private sector--with its self-interested, sophisticated shareholders--couldn't restrict union health and retirement benefits to a manageable level, what chance does California have? After all, unions in California have heavy influence over a majority of California legislators. To be clear, I am not anti-union--I am against unpredictable and hard-to-calculate government costs, especially costs that are passed off to future generations. We simply cannot expect the government to consistently and accurately predict the lifespan of all government workers, the number of its retirees in any given year, or the future health and medical conditions of all of its retirees. Yet, in order to accurately predict future costs in any system that provides pensions and lifetime medical benefits to millions of people, the government would have to act as a financial soothsayer, which it has been unable to do.

Unions, both private and public, were originally great ideas (See the film, Harlan County, U.S.A.). However, like most entities with billions of dollars of influence and political involvement, many of the largest unions have become corrupt and unwilling to look at the big picture. If GM and Ford are any indication, California's state budget could end up allocating 40% of our taxes to government retiree/health benefits and still not produce a balanced budget or better service. Like Ford and GM, if the status quo continues, California will become non-competitive. But that's not all. Ford and GM recently considered bankruptcy but were bailed out by the White House at the last minute. Although some California cities have filed for bankruptcy because of overly generous public sector benefits, an entire state has never gone bankrupt. Who's going to bail out California if it goes bankrupt? Will we see the day when California has to offer a 25% interest rate on its bonds to attract investors?

Finally, generous government benefits create major mis-alignments of interest. Having two separate retirement systems--one for Joe the Plumber and another for Sally the Cop--allows the government dangerous leverage against ordinary citizens. The day may come when CalPERS says, "If you don't give us what we want, we'll pull all our money out of the stock market, invest it someplace else, and you can kiss your 401(k)s goodbye." Sound implausible? Until recently, so was the idea that our federal government would give $700 billion to financial institutions without strict oversight. Also, don't forget that just ten years ago, banks like Citigroup (C) looked ready to take over the world. Now, of course, Citigroup (C) sells for around $3/share and is looking for a bailout.

Citizens should develop an eye for non-violent oppression. An oppressive government doesn't need to lock you up or arrest you to control you--it just needs to take enough money from you to buy off politicians and pass laws favoring them over regular folks. Investors, both foreign and domestic, need to stop being calm about overly generous government benefits and take action. Future generations of taxpayers--namely, our children--deserve nothing less.

Bonus: more on California's government unions HERE:

Approximately 85% of the state’s 235,000 employees (not including higher education employees) are unionized. As the governor noted during his $83 billion budget roll-out, over the past decade pension costs for public employees increased 2,000%. State revenues increased only 24% over the same period. A Schwarzenegger adviser [Pat Dando] wrote in the San Jose Mercury News in the past few days that, “This year alone, $3 billion was diverted to pension costs from other programs.” There are now more than 15,000 government retirees statewide who receive pensions that exceed $100,000 a year, according to the California Foundation for Fiscal Responsibility.

Many of these retirees are former police officers, firefighters, and prison guards who can retire at age 50 with a pension that equals 90% of their final year’s pay. The pensions for these (and all other retirees) increase each year with inflation and are guaranteed by taxpayers forever—-regardless of what happens in the economy or whether the state’s pensions funds have been fully funded (which they haven’t been).[Steven Greenhut, WSJ, 1/22/10]