California's new taxes are paying for pensions
WHAT if a corporation raised $500 million in a securities offering on the premise that the proceeds would go for operating expenses, then disclosed a few months later that $300 million of this amount would instead be used to service a debt that wasn't disclosed in the offering document? This would be false advertising, subject to sanction by the Securities and Exchange Commission. Unfortunately, the SEC doesn't have jurisdiction over state politicians engaging in the same behavior, and, in the case of California, involving sums that are 100 times bigger.
Last November, California politicians persuaded voters to support a proposed seven-year, $50 billion tax increase, largely on the vow that the money would go to public education. The first five words of the initiative's title were "Temporary Taxes to Fund Education."
Now, just four months after the election, the state's Legislative Analyst's Office has announced that the California State Teachers' Retirement System requires an extra $4.5 billion a year for 30 years -- $135 billion -- to cover its unfunded liability for teacher pensions and that the money will have to come from some combination of school districts and the state. To the extent that it comes from the school districts, $4.5 billion a year is 167 percent of the annual amount those districts expected from the tax increase. To the extent that it comes from the state, $4.5 billion is more than 100 percent of the annual amount it expected in new rev- enue. Either way, more than $30 billion over the next seven years will go to the service of a debt that wasn't disclosed before the voters were asked to approve the tax increase.
None of this is a surprise to longtime observers of many teacher pension funds and of Calstrs specifically. It's just as I predicted a year ago on Bloomberg View, as the Volcker-Ravitch report on California's budget outlined last year, and as Bill Gates explained in a 2011 TED talk. It's also no surprise to state officials. On the day the proposed tax increase was announced in early 2012, I raised the issue with the leaders of California's State Assembly and State Senate and later with Governor Jerry Brown, and surely all were aware of the Volcker-Ravitch report.
Worse, the $4.5 billion-a-year requirement is based on the teachers retirement fund's self-reported unfunded liability, which in turn is based on Calstrs's selfchosen and unrealistically high investment-return assumption that implicitly forecasts the stock market to double every 10 years. Anything less than that and the cost to service the unfunded liability will be higher (even that frothy assumption presumes bond yields will rise to levels exceeding their current levels and will do so without crushing the principal value of Calstrs's existing bond portfolio).
To put the far-fetched nature of this annual investment- return assumption in perspective, it's almost 15 percent higher than the investment return that Warren Buffett assumes for his pension funds, which not only are invested under Buffett's direction but also are, in size, a tiny fraction of Calstrs's portfolio and therefore much easier to compound at higher rates of return.
That's why financial economists working for the Volcker- Ravitch report said last year that, under a more reasonable earnings assumption, the cost to meet the retirement fund's unfunded liability is closer to $7 billion a year. Nondisclosure of Calstrs's liability before the tax vote continues a pattern of deception about California's pension obligations.