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In the heartland of America, our once mighty U.S. auto industry is close to collapse. The reasons are many. But few things have contributed to Detroit’s death spiral as much as management’s failure to control runaway labor costs. Generous pensions and retiree health care benefits have been especially crippling. We can see clearly now that such “defined benefit” costs are simply not sustainable. Closer to home, the burden of “defined benefit” costs is weighing heavily on California’s cities, counties, and school districts. Last year, a financial death spiral caught up with the city of Vallejo. No longer able to find the funds to pay for the ever-more-generous salary and benefit contracts that had been negotiated by past city managers, the city was forced to declare bankruptcy. Right in our own backyard, Palo Alto is facing the same kind of financial bind. The city’s labor costs are ever-increasing, according to the terms of the “defined benefit” contracts that were negotiated by city management years ago. Does this mean that Palo Alto is on a one-way road to bankruptcy, like Vallejo? Maybe not. The Palo Alto City Government thinks it can find the money to meet its ever-increasing labor costs. It is proposing a business tax. This tax would be levied on the gross income (before expenses) of businesses in Palo Alto. How big is Palo Alto’s burden of ever-growing labor costs? It’s back-breakingly huge. The following example can illustrate. 30-Year Base Cost of A Police Officer-About $6.5M. Salaries and benefits comprise about 80%-85% of Palo Alto’s city budget. Labor costs are growing faster than the cost of non-labor costs. Importantly, they are also growing faster than the city’s revenue. These runaway labor costs are putting the city on a collision course with insolvency. The following graph shows the salary of a Palo Alto police officer, hired in 2008 at $100,000, who receives a 5.5% raise for each of the 30 years of his/her employment, and the pension payout for thirty years of retirement:
$700,000 $600,000 Yearly Salary $500,000 $400,000 $300,000 $200,000 $100,000
Yearly Salary And Pension Of Palo Alto Police Officer (30 Years Salary + 30 Years Pension)
30-Year Salary 30-Year Pension
With a yearly 5.5% pay increase, the minimum total base salary for the officer comes to about $6.6M, for a 30-year working life. 30-Year Pension Payouts—Almost $16M. Our public safety employees receive retirement pensions equal to 90% of their high salary. So, since this officer will exit the Palo Alto Police force making $411,000— his/her pension payout will start at $370,500 per year. As the graph shows, the retired officer will be receiving more in his/her retirement payouts than in his/her working pay. At age 81, the officer’s payout will be around $670,000 yearly. Total Lifetime Compensation—Over $22M. The minimum lifetime compensation for this officer is:
Minimum Lifetime Salary Lifetime Pension Minimum Lifetime Compensation
$6,643,885 $15,699,557 $22,343,442
The lifetime minimum salary, and pension (or deferred-salary), comes to about $22.5M. With overtime and salary increases due to promotions, the lifetime total will become much higher still. Total Cost of Employment—Upwards of $30M. Operational overhead, a new police building, new vehicle/equipment costs, payouts for police misconduct and retirement health care and pension costs all add to the total cost of employment. It would not be difficult to estimate that this hypothetical officer will cost over $9M to employ, and could draw well over $16M in retirement payouts/benefits for thirty years of service. All-in-all, it would appear that society is on the hook for anywhere from $26M-$30M for total cost-of-services for each such officer in the future. CalPERS Melt-down Payment of public employees’ retirement benefits is officially the responsibility of CalPERS (the California Public Employees' Retirement System). Yet our current financial crisis has reduced the value of CalPERS’ pension fund by almost one-third of its previous high value of only two years ago. If CalPERS is unable to generate sufficient money to pay for the pensions of Palo Alto’s public service employees, then the responsibility for making those payments passes to the ultimate “employer of record”, That would be the city of Palo Alto. CalPERS’ poor investment returns have recently required local governments, including Palo Alto, to make sizeable contributions to fund retiree payouts. Recently, CalPERS has warned state and local governments that their annual pension contribution could increase by nearly a third — starting July 1, 2010, for the state and schools and July 1, 2011, for local government agencies With the Pension payouts growing at the rate shown in the graph above, it would seem that CalPERS is racing toward an unavoidable financial train wreck. Situation Not Sustainable These public service labor costs are driving Palo Alto Government into ever deeper red ink, which can only be turned black by cutting service levels and/or by finding new sources of funds, such as the proposed Business Tax. But if the city’s salary and benefits costs continue to be ever-increasing, then the new business tax revenue would need to be ever-increasing, as well. Clearly, such a “solution” is not sustainable.
A Real Solution: Salary/Pension Reform The only way out of this quagmire is to terminate the system of uncapped salaries. The City must view its labor force just like the private sector, determining what a job is worth, and paying only for performance. There is no excuse for doubling the base salary of any employee every 10-12 years—with no productivity gains to justify increased salary. The current compensation scheme, which is seemingly based on “how much money the City has in its coffers”, needs to be changed to align with the “salary cap” models of the private sector—if not, then living in Palo Alto will be very difficult for people who are not doctors, lawyers, company CEOs or public safety offices in the future. The State must also tackle the issue of pension reform—given how out-of-control this system has become. The Palo Alto Business Community needs to take an active role in defeating this new Tax, and to begin to demand more fiscal restraint on the part of the City in the future.
Wayne Martin is a long time resident of Palo Alto, who is keenly interested in limited, common-sense, cost-effective government. Wayne Martin Palo Alto, CA Email: firstname.lastname@example.org Youtube: www.youtube.com/wmartin46 Twitter:www.twitter.com/wmartin46 On-line Source: www.geocities.com/wmartin46/msw_pa_business_tax_2.pdf www.geocities.com/wmartin46/msw_ca_future_calpers_payouts.pdf
On-the-NET: Pension Tsunami WEB-site: http://www.PensionTsunami.com How California Became France:
CalPERS: http://en.wikipedia.org/wiki/CalPERS Gilt-edged Pensions:
When City Hall Goes Bust: http://www.forbes.com/forbes/2009/0216/078a.html
CalPERS 2008: Down $60 Billion. http://sacrealstats.blogspot.com/2009/01/calpers-2008-down-60-billion.html CalPERS warns of rate hike http://calpensions.com/2009/01/12/calpers-warns-of-rate-hike/ On-the-NET (Con’t): CalPERS Took Huge Gamble At The Worst Time: http://www.sacbee.com/business/story/1515220.html Center For Retirement Research: http://crr.bc.edu/ The McCauley Public-Employee Pension Reform Act (08-0018): http://ag.ca.gov/cms_attachments/initiatives/pdfs/i793_08-0018_a1s_initiative.pdf email@example.com San Diego's city pension fund loses $789 million: http://legalnewsline.com/news/216856-san-diegos-city-pension-fund-loses-789-million Daniel Borenstein: Guide to bad pension policy http://www.contracostatimes.com/danielborenstein/ci_12265599?nclick_check=1
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