Jerry Brown’s pension pay-down plan isn’t a gamble

Albert Einstein purportedly called the compounding interest earned on investments the “eighth wonder of the world.”

Whether this is fact or legend, you do not need to be a financial genius to figure out it makes sense to pay down the state’s high cost pension liabilities with idle funds that earn very little interest.

The same reasoning that says it is smart to pay off a high-interest personal credit card with a low-interest one applies to government.

That is why the governor’s budget proposal presents a prudent opportunity to reduce the state’s unfunded pension liability by more than $11 billion over the next 20 years.

Shrinking the unfunded liability, now at $59 billion, frees up money down the road that can be used to invest in public safety, environmental protection, health care and other vital, public programs.

All this can be accomplished without reaching deeper into the pockets of taxpayers or the public workforce that serves them.

This plan works by having the state make an extra $6 billion payment to the California Public Employees’ Retirement System using monies not immediately needed for state operations.

These idle funds currently earn less than 1 percent. Given that pension debt costs the state 7 percent, this proposal is just as fiscally prudent as a family deciding to use some of its discretionary cash to pay off an expensive credit card or make an extra mortgage payment.

These idle funds will be paid back in 12 years — and hopefully sooner — at an interest rate based on two-year U.S. Treasuries.

Money to repay the $6 billion comes from a portion of the rainy-day fund created by voters in 2014 when they passed Proposition 2.

One of the two intended purposes of the ballot measure was to pay down certain debts, such as this proposed $6 billion internal loan of surplus funds.

It is important to emphasize that the proposal is a world away from being, as some claim, a “pension obligation bond,” which is money borrowed from Wall Street to use for investment purposes. With this proposal, the state is borrowing from itself.

The upshot is a classic win-win situation. CalPERS’ staggering unfunded pension liabilities are reduced, saving the state billions of dollars. And, the state’s surplus money fund earns higher rates of return than it receives on its typical short-term investments.

So, if there is a steep downturn in the economy, will this plan pencil out?

The fact is that the state must deal with an existing $59 billion unfunded pension liability regardless of whether this pension pay-down plan happens or not. The taxpayers of California are already on the hook to pay this bill.

If the interest rate gap between CalPERS’ investment returns and the $6 billion cash loan narrows, the savings may be less, but the scale of savings should still be significant. Based on 30 years of historic data, it is highly unlikely that the state would lose money.

What is more, nothing in this pension stabilization plan limits the state’s ability to exit the strategy early if required by changing circumstances.

Bottom line, this is an opportunity to make real progress toward reducing pension obligations. This prudent plan gives Californians a path toward easing the burden on future generations.