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What If Everyone Had a California State Pension?

eye on the news

What If Everyone Had a California State Pension?

A thought experiment on how much more bankrupt we could be May 5, 2011
Economy, finance, and budgets
California

As states and municipalities across the nation struggle with budget deficits, public-employee pension costs have become a major political issue. Most notably, the showdown in Wisconsin between Republican governor Scott Walker and Democrats in the legislature centered on the ongoing costs of government workers’ salaries and retirement benefits. Emotions tend to run high on both sides of this issue, but an objective look at the numbers can tell us a lot.

A realistic way to gauge the fairness and financial sustainability of retirement benefits for government workers is to estimate how much it would cost if everyone in the U.S. received the average pension granted a state or local worker in California. How much would each active worker need to pay to support these retirees?

First, we need to know how much a retired government worker can expect to draw in pension benefits. An accurate, conservative estimate would be $55,000 per year after 30 years of service, based on figures from the California Public Employee Retirement System. CalPERS is the largest public-employee pension fund in the United States, managing more than $231 billion in assets and serving more than 1.6 million active and retired state and local employees. According to the fund’s most recent annual report, the average pension for a new retiree with more than 30 years of service was $66,828 per year, with a pension award equal to 79 percent of his final salary. For a new retiree with between 25 and 30 years of service, the average pension was $53,184, with a pension award equal to 67 percent of his final salary.

CalPERS touts a much lower dollar amount—about $27,000 per year per retiree, on average. But that average is misleading. It includes thousands of pensioners who retired more than a decade ago, before state and local officials happily raised public-employee retirement benefits amid the Internet and housing bubbles. The lower average also includes retirees who spent only a few years in public service and barely vested their benefits. The reality is, for a career government employee retiring in California today, his pension would be more than double the “official” average.

Next, to determine how much these benefits would cost in aggregate if every American were lucky enough to receive them, we need to estimate the number of retirees and workers. Assume the average worker begins his career at 25 and would retire after 30 years, like many state employees. The latest U.S. Census Bureau data show 128 million Americans between the ages of 25 and 54, and 81 million Americans who are 55 or older—a ratio of 1.58 to one. If every American over the age of 55 received a pension of $55,000 per year, it would cost current workers $4.45 trillion per year, an amount equivalent to nearly one-third of America’s annual GDP. Put another way, it would cost every one of the 128 million Americans of working age $34,800 per year to support retirees.

Over the coming decades, the financial burden on U.S. workers to support retirees will worsen as life expectancy continues to improve and birthrates decline. America is fortunate compared with most nations, having the highest birthrate of any developed nation as well as significant immigration of young people. But by 2030, the Census Bureau projects the United States will have 139 million citizens between the ages of 25 and 55, and 112 million citizens 55 or older—a ratio of 1.24 to one. That works out to $44,300 per worker per year to support the retired population.

California’s generous public-employee pensions yield awards that are, on average, more than three times the standard Social Security benefit. And given the earlier retirement age, workers will necessarily pay into the system over a shorter period of time. Understood this way, the ratio of workers to retirees would change from roughly two to one (40 years working, 20 years retired), to a more perilous one to one (30 years working, 30 years retired).

Apologists for California’s current public-pension schemes insist that there is no crisis, and that despite the financial collapse and late recession, future investment returns should easily cover the costs. But it’s hard to imagine stock market dividends alone funding California’s unfunded liability of more than $500 billion, let alone the $5 trillion in pension payouts we’re imagining. When more than 100 million people are withdrawing funds on that scale each year to fund their retirements, the market has too many sellers to permit meaningful rates of return.

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