Many Orange County cities are struggling to maintain budgets that keep, or minimally cut services and employees, while trying to keep up with growing law enforcement and fire pension spending.
Police officer and firefighter pension payments often take the biggest share of retirement benefits, especially in cities that have their own police departments, fire departments or both.
“See the problem is the great majority of public cost is in public safety and that’s very resistant to cuts. It’s politically powerful and the public wants public safety as well, so the public doesn’t like to see cuts there either,” said Fullerton City Councilman Bruce Whitaker.
But unions have to negotiate higher pay and benefits in order to stay competitive with other agencies to keep employees, while also trying to address the pension issue, said Garden Grove Police Officers Association President Brian Dalton.
“Moving forward, we’re obviously concerned about the pension issue. I think we all understand the gravity of the situation and I think we would be remiss in our ability to address the issue. It’s definitely something that we all have to look at,” Dalton said.
He said other police agencies, like Anaheim and Santa Ana have been able to pull some veteran officers away from Garden Grove.
“If you have other agencies that are more competitive than us, then you end up losing officers, real experienced officers, to other agencies that are paying more. We have to strike that balance to being competitive,” Dalton said. “It is a challenge, it really is … We’re working through it. We’re, at least from the association’s side, we’re open to looking at all angles.”
While Fullerton was able to adopt a balanced budget this fiscal year, some cities, like Santa Ana and Garden Grove, asked voters to increase the sales tax in order to keep police staffing levels the same, while meeting pension obligations.
Costa Mesa Councilman Jim Righeimer, who’s been critical of the increasing police and firefighter pensions, said he expects nearly every city to increase their sales tax within five years.
“I expect most every city in the next five years will raise a one cent sales tax in their cities. I think it’s wrong, I think it’s completely wrong to the public, but the public sector unions have figured out how to scare the public into ‘we can either get rid of your firefighters and police, or you pass a one-cent sales tax’ … you scare the public enough and you’ll get what you want,” Righeimer said.
He said the Legislature should come up with a statewide pension cap to reign in the rising costs.
Fullerton City Manager Ken Domer said it’s tough to pay pensions when the costs are rising at a faster rate than city revenues.
“It’s extremely difficult when your pensions costs are escalating at a pace that is much higher than your other expenditures and far higher than your revenues and if we have a recession in two years, we’re going to see our revenues decrease and our pension expenditures increase. And that’s where just about every city is going to struggle with,” Domer said.
The California Public Employees Retirement System (CalPERS) is asking cities to pay more toward unfunded pensions and pay them off sooner. CalPERS is a statewide agency that manages the pension funds of public employees and gives pension payment projections to cities.
The average retirement age is 62 years old, according to a CalPERS December 2017 staff report.
The California League of Cities released a report last January which outlines the pension hardships cities face and estimates pension costs will increase roughly 50 percent by 2024.
Balancing Cuts During Budget Process
According to CalPERS projections for Fullerton, the city will have to pay roughly $20.5 million total in pensions for the 2018-2019 fiscal year. The majority of that, $14.3 million, is for safety employees’ pensions.
Whitaker said Fullerton has had to put infrastructure projects, like road repair, on hold while the city figures out how to deal with the rising pension costs. At nearly every Fullerton City Council meeting, the city’s poor road conditions are brought up by residents during public comment.
“Actually what you’ve seen there has been threefold. One is postponing necessary infrastructure improvements, like in Fullerton, the streets have gotten worse because we need to take up the growing pension costs,” Whitaker said. “We’ve had to curtail a lot of the bottom-level employees when it comes to landscape maintenance, arborists … public works … it seems like that’s the choice area where cities start cutting back and we’ve seen some of that.”
“And the third consequence of this has been increased taxes and fees. Most cities have been working on driving up structural taxes and fees and we’ve seen this election,” Whitaker said, referring to sales tax measures and fee increases throughout cities.
Many cities will have to either raise taxes or cut services, said nonprofit pension watchdog California Policy Center President Will Swaim.
“The overview is we’re seeing — it’s not a left/right thing so much at the local level — is public officials have to balance their budgets year in and year out and faced with two possibilities, none of them appetizing,” Swaim said.
The California Policy Center’s members include some local Republican names like former San Diego City Councilman Carl DeMaio, who largely organized and funded the effort to repeal the 12-cent state gas tax this past election. The board also includes former Tustin City Councilman Jim Palmer and newly elected Santa Ana City Councilwoman Ceci Iglesias.
Righeimer said other city employees face cuts because they don’t have the political strength and organization of the safety unions.
“The reality of it is, in the end, except for police and fire, you continue to hit at everything else because they don’t have the political power that police and fire have,” Righeimer said. “I just call them your regular, everyday employees — they’re getting the short end of the stick.”
Santa Ana and Garden Grove Sales Tax Increases
The Santa Ana City Council, facing a financial crisis maintaining current personnel and city service levels, put a sales tax increase to voters in November. They voted to increase the city sales tax — from 7.75 percent to 9.25 percent — by a margin of 15 percentage points, which gave the city the highest sales tax in the county.
The city is facing a $10 million shortfall this fiscal year and it is expected to hit roughly $40 million by the 2021 fiscal year. The tax increase is expected to generate about $63 million annually.
Given the $40 million-plus funding gap in future years, it appears most of the $63-million tax increase would go toward maintaining existing services and the pension cost increases for the existing workforce and retirees, with the remainder supporting expansions.
According to CalPERS projections, Santa Ana has to pay $27.7 million in pension contributions for its safety employees for the 2018-2019 fiscal year. Of that, $19.3 million is going to pay unfunded liabilities — retirees’ benefits. The other $8.4 million is going to pay for “normal costs,” which is money paid to CalPERS to invest to pay for future pensions of employees currently working for the city. Employees also help shoulder some of the normal costs.
Current safety employees pay $3.5 million of the $11.9 million normal cost, leaving the rest — $8.4 million — for Santa Ana to pay.
“Santa Ana Police Officers have worked with the city to address pension costs. Officers are now paying 12% of their salaries towards PERS (Public Employees’ Retirement System). In addition, officers now have to work seven additional years before retiring and receiving said benefit. The economy is doing great and in fact PERS reported an 11.2% rate of return in 2017. The 11.2% rate of return will have a positive impact on what cities pay in the upcoming years,” said Santa Ana Police Officers Association President Gerry Serrano in an email.
The city also has a separate $24.5 million pension payment for all of its other employees, including $18.3 million in unfunded liabilities and nearly $6.2 million in normal costs — employees contribute nearly $4.9 million in normal costs. In total, Santa Ana has to pay over $52 million to pensions in the current fiscal year.
Serrano said Santa Ana has a high amount of vacancies in the police force and the positions have already been budgeted for.
“As far as retention and recruitment, the Santa Ana Police Department is the only Orange County agency with astronomical funded vacancies. The city of Santa Ana has 51 funded police officer vacancies, which makes providing public safety very challenging,” Serrano said.
According to the projections, Santa Ana’s contributions to unfunded liabilities for safety employees will increase from nearly $23.5 million in the 2019-2020 fiscal year to $35.1 million in the 2024-2025 fiscal year. During that same time frame, its pensions for the other city employees will rise from nearly $21.4 million to over $30.5 million.
“Pension contributions are already squeezing our cities and counties … so that has to be funded through pension contributions bonds, which is really kicking the can down the road, or they have to cut services or raise taxes. Period. That’s just really simple algebra — you push down the balloon in one spot and it goes up in another place,” said Ed Ring, CA Policy Center co-founder and financial analyst.
In Garden Grove, the city is trying to reduce a projected $8 million deficit for the 2018-19 fiscal year by instituting an early retirement program, a 5 percent budget cut to every department but public safety and other adjustments. Even after the cuts, the city is left with a $3.6 million shortfall, according to a budget presentation.
Like Santa Ana, the Garden Grove City Council put a sales tax question to voters in November. Voters overwhelmingly approved the sales tax measure by a nearly 30 percent margin, raising the sales tax by one percent, meaning Garden Grove will now have an 8.75 percent sales tax. Placentia voters also did the same this November.
“These are regressive taxes hitting people that are least able to pay. And they are shouldering some of the costs related to pensions and benefits — that really is the impact,” Whitaker said.
For the 18-19 fiscal year, Garden Grove has to pay a total of $25.6 million in pensions, with the majority — $16.2 million — going to safety employee pensions. The city owes $9.4 million to its other employees.
Dalton said the Garden Grove police union is currently negotiating its new contract with the city and both sides will address the pension issue.
“There are remedies to that, there are [pensionable] benefits, there are non [pensionable] benefits that address both sides of the fence. We want to stay competitive in the workplace, because we don’t want to lose experienced officers to other agencies,” Dalton said.
“Up until recently, we’ve maybe lost a couple officers to Anaheim, maybe one or two to Santa Ana, but we’re starting to lose more and more — going over to Anaheim. We’re talking 10, 12-year officers — we’re trying to avoid that.”
Dalton said in previous contract negotiations the union agreed to increase its contribution to pensions from 9 to 12 percent starting in 2015, three years earlier than the Public Employees Reform Act called for.
“It wasn’t an automatic increase, it was something that had to be negotiated between the union and the city … and that’s what we ended up negotiating to do in our contract,” he said.
At a July 24 meeting, when the City Council decided to put the sales tax question to voters, Mayor Steve Jones said the increase to pension payments from CalPERS hit the city hard.
“CalPERS lowered the discount rate (investment return rate) … they also shortened the amortization period (payment schedule) for the repayment unfunded liabilities,” Jones said. “It was unanticipated and directly out of our control … it exponentially increases next year and the years after in a very scary way. I don’t know how that’s going to be sustainable. I don’t know how cities across the state are going to survive that cost increase just from CalPERS alone.”
According to the CalPERS report, Garden Grove’s payments for its safety employees’ unfunded liabilities are expected to go from $12.1 million in the 19-20 fiscal year to nearly $17.8 million in 2024-2025 fiscal year. Payments for the other city employees’ unfunded liabilities are expected to grow from $7.4 million to nearly $10.4 million during the same time frame.
Although Garden Grove police department has one of the lowest officers per capita in Orange County, Dalton said, the city is in the top five safest cities.
“While we’re struggling in one area with our manpower … we’re also doing a great job on the other side with the manpower we have to keep the residents safe. My concern, as the association president, is maintaining that safe city status,” Dalton said. “Be patient with us, we’re working through it, we want to keep our experienced officers here and provide the best service for the residents of Garden Grove.”
Facing the Increased Pension Payments Ahead
Some cities, like Newport Beach, aren’t facing the financial hardships of Garden Grove or Santa Ana and are able to pay more than the minimum pension contribution in order to help save money on the backend.
Newport Beach City Councilman Will O’Neill, who also heads the city finance committee, said the city will pay anywhere from $3.7 million to $8.5 million on top of their required annual pension payments in order to bring down the unfunded liability amount.
“Let’s say you have a 30 year mortgage and you decide you’re going to pay it off in 15 years making discretionary payments. You will not have to pay any additional interest you would have had in the last 15 years. The same is true for unfunded pension liability,” O’Neill said. “We’re cutting our interest payment on the backend and in our case that’s about $45 million.”
O’Neill said the money used to pay down pensions faster could be used on other things in the city, but it’s fiscally responsible to shrink the unfunded liability as much as possible.
“It’s still a hard choice for public officials to take $8 million and use it for pension liability when there are plenty of short term things that would be fun … but this is the responsible thing for the long haul.”
Ring said the increase in unfunded pension liabilities is largely due to retired employees living longer than projected and CalPERS investments not making adequate returns.
“For example, when you look at in a pension fund — who’s participating in the fund? And you estimate for this participant population. How long are they going to live and how much money will they collect in the future?” Ring said. “Well, how much do you have to invest right now so over time that amount of money earns interest (returns) and that money’s sufficient to pay the pensions?”
Righeimer said the State Legislature could fix the increasing pension problem by adjusting the benefit amount going forward, but still keeping the accrued pension employees earned.
“The only way to fix anything is to change the plan with the employee. All you would talk about is changing the plan going forward. So you wouldn’t take away from anything they’ve already earned,” Righeimer said. “So far, we’ve never had a legislature willing to do that. The unions won’t allow that. That’s called the ‘California Rule,’ basically.”
In February, the Sacramento Bee reported CalPERS no longer expects to run deficits into the middle of the century — previous financial forecasts expected the agency to spend more money than it makes through 2040.
CalPERS’ anticipated investment return rate could also be off.
CalMatters, a nonprofit newsroom, published in-depth reporting in February about the statewide pension system and found CalPERS’ average 20-year investment return is 6.4 percent. The assumed rate is currently 7 percent until 2020.
“When you change your expected rate of return, all of a sudden that amount of liability, that amount of money you need goes way up,” Ring said.
Over the years, CalPERS return rate has varied — sometimes it is significantly high and sometimes it’s very low. For example, in 2014 there was an 18.4 percent return rate, but it dropped to 2.4 in 2015 and dipped to 0.6 percent in 2016. In 2017, the return rate was 11.2 percent. CalPERS lowered its expected return rate from 7.5 to 7.25 last year and is expected to lower it to 7 percent the next fiscal year.
The Sacramento Bee reported CalPERS enjoyed an 8.6 investment return rate for the 2017-2018 fiscal year, raising its total funding percentage by three percent for a total of 71 percent funded.
Economic downturns, like the Great Recession, often take a financial toll on cities. The downturns also hit CalPERS investments hard. In 2008 CalPERS had a negative 5.1 investment return and a negative 24 percent return in 2009, before going up to a 13.3 percent return in 2010.
“CalPERS projects about a seven percent return per year on investments and we are overdue for a recession and we are already seeing some weaknesses in the stock market. So if we get an economic downturn, that’s going to reduce the investment returns … taxpayers are always the backstop — so if investments underperform, the taxpayers get to throw in the difference,” Whitaker said.
Domer said the market trend affecting the pension system shows how difficult paying pensions can be.
“It’s been reflecting how easy it is to take a hit and how hard it is to climb back up,” Domer said. “I think everybody should be worried and we should be looking at ways to control our costs, reduce our pension load — we have to get through it.”
Ring said CalPERS projected return rate of 7 percent is a high amount.
“7 percent — a long-term rate of return — that’s tough. That’s hard to hit,” he said.
CalPERS investment return projections have been off and if the projections were accurate, cities and counties across the state wouldn’t be in the situation they’re in now.
“If that’s so true, how come they’re so far behind now?” he said.