Rising Pension Costs, Falling Revenues Lead to a $179 Million Budget Deficit in San Diego

The City of San Diego has released its 5-year forecast-and the future is not pretty. The city is facing a record $179 million deficit this year, followed by additional projected annual deficits of at least $150 million for several years.
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San Diego Mayor Jerry Sanders addressed the sobering news in a press release:

As we begin putting together a solution to close our budget gap, we will examine every responsible alternative to cutting services. But make no mistake about it, there will be cuts and the public will feel them.

As the San Diego Union-Tribune reported:

The city has generally closed recent budget gaps by eliminating vacant jobs, increasing fees and tapping reserves. Those decisions largely avoided controversial cuts such as laying off employees and closing libraries. That will no longer be possible, Sanders said.

A deficit this size is so significant that we can no longer shield the public from its impacts,” he said.

The city’s budget deficits have been exacerbated by the economic recession but began when past leaders chose to increase employee pension benefits without identifying a way to pay for them.

While governments at all levels are experiencing falling revenues due to the recession, San Diego’s outlook is particularly dire because of egregious missteps the city made regarding its pension system. San Diego’s pension problems stem from pension deals reached in 1996 and again in 2002 which led to the city underfunding the system by increasing pension benefits without setting aside enough money to cover the additional costs. The city is still paying for its mistakes today. In addition to an extra $57 million that the city will have to pay from its general fund to cover pension investment losses-an increase in the city’s pension contributions of approximately 34%-San Diego must pay $32 million as part of the McGuigan legal settlement to remedy its past pension underfunding.

If this picture is not bleak enough, consider that San Diego’s fiscal situation is actually even worse than the 5-year projections because, as Councilman Carl DeMaio notes, the city did not include the costs of its retiree health-care benefits or deferred maintenance, such as street, sidewalk, and storm drain repairs that must be made, in its budget forecasts. The city is planning to pay $43 million next year for retiree health care-barely one-third of the estimated $120 million needed to adequately pay for the benefits. The city is already running a $1.3 billion unfunded liability for retiree health care.

In a speech given to the San Diego County Taxpayers Association last month, Sanders said, “We will make our full pension payment, to the penny. The Mayor and City Council do not determine the amount of the payment, nor should we. Nor should we repeat the mistakes of our predecessors and shortchange the retirement system so we can avoid making tough decisions.” Yet, when it comes to San Diego’s retiree health-care obligations, it appears that the city is set to repeat the same mistakes that got it into so much trouble with the pension system.

San Diego has implemented some pension reforms in recent years, but they were likely “too little, too late.” In 2006, voters approved a measure to require voter approval of future city employee benefits increases. And beginning July 1, 2009, the city implemented a lower tier of benefits to new city employees. The new retirement plan is a hybrid plan that includes a 401(k)-style “defined-contribution” component to shift some of the risk of retirement investments from the city to the employees.

Nonetheless, lawsuits to undo the arguably illegal pension deals of 1996 and 2002 have proven unsuccessful, and the considerable debts that have already been racked up must be paid. The results will be severe negative impacts on city services, and only bold and significant reforms may prevent these service cuts from lingering for many years or keep the city from going bankrupt.

The city should switch to a pure defined-contribution retirement system for all new employees, with compensation levels comparable to those received in the private sector. Savings from this pension reform would be long-term, however, and the city needs some more immediate relief.

To that end, there are many government services that could be performed more cheaply and effectively by the private sector. Forcing the government to compete with the private sector to provide services could result in significant cost savings while maintaining or improving service quality. A 2007 study done by Reason Foundation and the San Diego Institute for Policy Research conservatively estimates that the city could save between $80 million and $200 million a year by implementing managed competition for services such as:

• Water and wastewater treatment,
• Trash and recycling collection,
• Vehicle fleet maintenance,
• Street maintenance,
• Parks and recreation (including city-owned golf courses),
• Library operations,
• Permitting,
• Facilities maintenance,
• Information technology, and
• Printing and copying.

Voters saw the wisdom in this “managed competition” approach, and overwhelmingly passed a measure in November 2006 to amend the city charter to allow the city to implement it. But city labor unions have tied up the process, and nearly three years after the voters passed Proposition C, the city is still without a managed competition program.

If labor unions continue to hold the city hostage, they will drive San Diego to the same fate as the City of Vallejo, California-into bankruptcy.

Other resources:

» Reason pension reform study: The Gathering Pension Storm: How Government Pension Plans Are Breaking the Bank and Strategies for Reform (see pages 33-40 for a case study on the City of San Diego)

» Reason-SDI study on managed competition in San Diego: Streamlining San Diego: Achieving Taxpayer Savings and Government Reforms Through Managed Competition

» Reason’s privatization research and commentary

Adam Summers is a policy analyst at Reason Foundation.