Most Californians would be
surprised to learn that 100 percent of education’s share of
the tax increase proposed by Governor Jerry Brown will go to
pensions instead of classrooms. But that would be no surprise
to longtime observers of the California State Teachers’
Retirement System, which administers teacher pensions.
Here’s why: After retirement, teachers are
unconditionally guaranteed lifetime pensions by their school
districts. Everything works out fine if Calstrs, as the
retirement system is known, earns the investment returns it
forecasts and from which upfront contributions are derived.
But if they fall short, school districts must make up the
difference. Because of compounding, the failure to earn
forecasted earnings translates into huge deficiencies down the
road.
Unfortunately, “down the road” is where school districts
are now. Because Calstrs has earned only 60 percent of its
forecasted investment return since 1999, it needs school
districts to boost contributions by more than $100 billion.
Worse, Calstrs waited so long to seek more contributions that
its request is now for an extra $4.5 billion a year, almost
double the $5 billion a year it already receives in
contributions.
School districts can’t come up with such a large amount
of money without harming classrooms. And while they could
defer the request (Calstrs has enough cash to meet current
pension obligations for now), doing so would be very expensive
because every year that a contribution is deferred increases
the required contribution amount by 7.5 percent, compounded.
For example, for every $4.5 billion not contributed now, more
than $9 billion would be required 10 years from now. Thus it’s
much cheaper, and much fairer to future generations, to
increase contributions now.
Ignoring Warren Buffett
That’s where the tax increase comes in. Under California
law, schools get the first 40 cents of every dollar of state
revenue. With the state forecasting new revenue of $7 billion
from the tax increase, that means almost $3 billion a year for
the schools to use for pensions, or two-thirds of the Calstrs
$4.5 billion request. A good start to meeting pension costs,
but none of the tax increase will benefit students.
How did the teachers’ retirement system get here?
In short, it failed to take Warren Buffett’s advice. In
1999, Buffett said that long-term investors, such as pension
funds, should assume investment returns of roughly 6 percent a
year, not far from the actual return earned since then. Had
Calstrs used his figure for its projections of the fund’s
growth, it would have required larger contributions from
school districts, employees and the state, and Calstrs would
be healthier now.
But the retirement fund’s board — made up of the state’s
chief financial officials and others — chose to forecast much
higher investment returns that, as Buffett later pointed out,
implicitly predicted the stock market portion of the Calstrs
portfolio to perform 10 times better than stocks did in the
20th century.
Even when presented with a chance to help fix the
problem, the board declined. When I joined the Calstrs board
in 2005, I pleaded with my fellow board members to forecast
more reasonable returns and to seek higher contributions. But,
seduced by rising home and stock prices and not unlike the
boards of many Wall Street firms at that time, they turned a
blind eye to investment history and kept forecasts high and
contributions low.
To compound the problem, during the real-estate bubble
the Calstrs board bet more on ever-rising home prices, even
purchasing land for prospective development. Since then, it
has earned less than zero on its substantial real-estate
portfolio and, more important for the school districts on the
hook for shortfalls, suffered a loss of more than 10 percent a
year as compared with the return the fund must earn to meet
its forecasts.
Increase Masks Problem
Calstrs is now so far behind its forecast that the stock
market would have to be almost 2.5 times higher than it is
today in order for the system to meet that forecast, and from
that point would have to double every nine years to keep pace.
As a result, 6 million schoolchildren will get no benefit from
the proposed tax increase. Worse, unless accompanied by a
systemic solution, the tax increase will simply mask the
problem and enable it to grow.
The problem wasn’t caused by teachers, students,
taxpayers or California (BSTICA) residents. It was caused by
politicians who made — and are still making — promises
without contributing sufficient amounts to meet those
promises.
It would be nice if we could just collect the shortfall
from those politicians. But that isn’t possible. Solving the
problem requires sacrifices from all Californians, which means
some combination of the steps taken by courageous leaders in
states such as Rhode Island and Colorado to address the source
of their pension problems. Those steps include higher taxes,
lower benefits for newer and current teachers with respect to
years not yet worked, higher employee contributions and lower
cost-of-living adjustments for retirees.
No pension problem is in greater immediate need of
attention than the one at Calstrs. Unless addressed, more and
more tax dollars will go to pension costs instead of to the
classroom. In fact, not only would the proposed tax increase
provide just two-thirds of the Calstrs request but a recent
study from Stanford University says the system actually needs
to triple, not just to double, its current contributions. That
means even less money will make it to the classroom.
If children are to succeed in this very competitive
world, they must receive a world-class education. In
California, that won’t be possible so long as politicians
continue to steal from them by refusing to address the single
most important issue affecting school funding. Money from tax
increases should make it to the classroom, and for that to
happen, politicians must address pensions.
(David Crane, a former financial-services executive and a
Democrat, is a lecturer at Stanford University and president
of Govern for California, a nonpartisan government-reform
group. He was an economic adviser to California Governor
Arnold Schwarzenegger from 2004 to 2011. The opinions
expressed are his own.)
Read more opinion online from Bloomberg View.
Today’s highlights: the View editors on European austerity and
antibiotics in farm animals; Edward Glaeser on Mitt Romney’s
plan to shut the Department of Housing and Urban Development;
Jeffrey Goldberg on the space shuttle; Ramesh Ponnuru on the
Buffett rule; Enrique Krauze on Peru’s economic revival.
To contact the writer of this article:
David Crane in San Francisco at davidgcrane@gmail.com.
To contact the editor responsible for this article:
Katy Roberts at kroberts29@bloomberg.net.
Article source: http://www.bloomberg.com/news/2012-04-23/new-california-taxes-pay-for-pensions-not-schools.html
Tags: tax-news