Paying down its debt should be a priority for California

As California voters consider their options in the recall election, one factor to consider is the state’s long-term fiscal health. With California’s state government receiving $26 billion in COVID-19 relief and stimulus from federal taxpayers and a large state budget surplus this year, it is easy to forget the “wall of debt” that former Gov. Jerry Brown frequently warned us about. While the state’s finances have had plenty of good news in recent years, Gov. Gavin Newsom’s administration has thus far failed to build upon many of Gov. Brown’s fiscal reforms, leaving the state vulnerable to future economic storms.

California’s 2020 audited financial statements are over four months late, so according to the state’s 2019 audited financial statement, the state government and its component units (i.e., subsidiaries such as the University of California system and the California Housing Finance Agency) have a total of $359 billion in long-term obligations.

With a surprise $75 billion budget surplus this year, California’s flush financial situation was an opportunity to use the surplus to pay down some of the wall of debt but, instead, leaders in Sacramento have largely opted to spend that money on shorter-term priorities.

Most of California’s long-term liabilities making up the wall of debt arise not from bonds but from unfunded future obligations to provide retired state workers with the pensions and health care benefits they’ve been promised. Gov. Brown implemented reforms to contain the growth of these public pension liabilities, but Gov. Newsom’s administration has not followed up on them.

Brown enacted reforms intended to help the state’s two pension systems, the California Public Employees’ Retirement System (CalPERS) and California State Teachers’ Retirement System (CalSTRS), to begin digging out from their deep financial holes. These reforms included raising retirement ages for new hires and increasing pension contribution rates. But the two systems remain deeply underfunded, reporting ratios of assets-to-actuarial liabilities of about 71%, as of June 30, 2020.

While these funded ratios should improve substantially when updated for 2021, given the recent stock market performance, both pension systems remain well below fully funded at a time of record equity prices. As of 2020, CalPERS still had $163 billion in unfunded liabilities and CalSTRS had $106 billion in unfunded liabilities—debt for which state and local taxpayers are ultimately on the hook.

Reason Foundation’s Pension Integrity Project finds states often must make multiple rounds of legislative reforms to make the structural fixes necessary to straighten out their pension systems. Unfortunately, since Gov. Brown left office, there has been little enthusiasm in Sacramento for further pension reform.

Short of making fundamental reforms, California could simply make extra pension contributions (above and beyond those recommended by system actuaries) to pay down unfunded liabilities. Brown began this practice, and it continued at the beginning of the Newsom administration. But Newsom canceled a planned $2.4 billion extra payment to CalPERS in 2020-2021 amidst the emergence of COVD-19.

Fears of a prolonged economic downturn were understandable when COVID-19 first hit, but rather than a fiscal crisis, California and its tech sector experienced an economic boom that produced a $75 billion surplus for the state government. Unfortunately, even when it was clear the state wouldn’t have a deficit, Newsom didn’t go back and make the pension payment he canceled.

The state’s 2021-22 budget includes $2.3 billion in extra CalSTRS and CalPERS contributions—payments mandated by Proposition 2 (2014), another legacy of the Brown era, which requires the state to apply a portion of capital gains tax revenue to public pensions and other long-term obligations when the tax collections rise above a specified level.

But, rather than taking advantage of the state budget surplus and doing more than the statutory minimum to pay down this debt, Newsom and the state legislature prioritized spending on stimulus checks—in addition to checks provided by the federal government—and funding things like broadband infrastructure, which is also redundant since the federal government is also sending California money for broadband-related projects.

Financial reforms from the Brown era are still helping California tear down its wall of debt. Hopefully, whoever prevails in the recall election will prioritize and continue this essential work.

A version of this column first appeared in the Los Angeles Daily News.