Sunday, November 22, 2009

The California Debt Crisis, Sinking in Quicksand


As California seemingly sinks deeper and deeper into debt we have to ask the question, “How did we get here and can we fix it?” What follows is a discussion on the symbiotic relationship between elected government officials and public employee unions.

On May 23, 2008 the City of Vallejo filed a case seeking bankruptcy protection under Chapter 9 of the United States Bankruptcy Code.[1] In its filing it disclosed that the cost of public safety salaries represented 74% of its $80 million budget.[2] The average fireman in Vallejo takes home $170,000 while City Manager Joseph Tanner’s total annual compensation is more than $400,000.[3] And the response is to cut services not salaries.

Not far behind is the city of Bakersfield with its “3 at 50” retirement benefit. In 2001 Bakersfield’s city council voted to allow police officers and firefighters retirement pay equal to 3 percent of their best year’s salary for every year they worked, to a maximum of 90 percent. Their retirement eligibility begins at age 50.[4]

In 1999, in the transition between governors Pete Wilson and Gray Davis, California SB 400 was passed. Sponsored by the California Public Employees Retirement System and proposed by the Senate Public Employees and Retirement Committee it cleared that committee by a vote of 4-0. It cleared the Senate Appropriations Committee 11-0 and passed on the Senate floor 35-0. In the Assembly it garnered only 7 nays to pass and become law on September 10, 1999 by a vote of 70 ayes to 7 nays. This bill established a new level of survivor benefits for state and school employee participants comparable with Social Security and made significant increases to the benefits of state and school employees. Among others it provided for retirement at age 50 and cost of living adjustments. Benefits were increased even more for “safety” employees, that is state police and firefighters.[5] It became a mammoth unfunded liability and the model for municipalities around the state.

Hit by the twin financial downturns caused by the dot-com bust and 9/11, Governor Gray Davis struggled with mounting deficits and a dysfunctional budgetary system. Finally, blamed for the electricity crisis that hit California, Davis was recalled in 2003. He was replaced by Arnold Schwarzenegger who ran on a campaign of fiscal responsibility. When the state legislature rejected his spending limit proposal a compromise was struck and Proposition 58 requiring a balanced budget appeared on the March 2004 primary ballot and was approved by the voters. Still the deficits persisted and the pessimistic forecasts became reality.



Spurned by the state legislature but emboldened by his election victory Schwarzenegger turned to the voters. In 2005 he backed four initiatives designed to restrain some of the leverage public unions held under current law. Proposition 74 extended the probationary period for new teachers from 2 years to 5 and made it easier to dismiss teachers with unsatisfactory performance. Proposition 75 prohibited public employee unions from using union dues for political purposes without the consent of the union members. Proposition 76 limited the growth of state spending to the growth in revenues and gave the Governor certain veto powers. Proposition 77 changed the way California draws boundaries for congressional and legislative districts giving the power to a panel of retired judges approved by the voters. Opposed by the California State Teachers Union and aggressively financed, all four initiatives went down to defeat.[6]

Public employee unions hold a unique position in society. Unlike unions in the private sector where demands are constrained by the ability of a business to finance wage and benefits packages or go out of business, municipalities are monopolies. Public unions are well financed. Unlike private unions where dues collection is a cost, public union dues are deducted from pay and the cost of administration and collection is paid for by taxpayers. Because of the monopolistic nature of public services (if the local policeman doesn’t show up you can’t call a competing police station) unions hold a gun to the head of the public that pays them. With the potential for disruption in services from municipal transportation to schools, firefighting services to police protection, voters put enormous pressure on their elected representatives to settle public sector labor disputes.

But the root of the problem is the ability of public unions to influence the outcome of elections. As noted above the unions are highly organized and well financed. When legislation is proposed the union and union members are well versed on the effect, often involved in writing the legislation as in SB 400. Union leaders lobby on behalf of their constituency, and unions are well represented at the ballot box. Often, legislation is targeted and very specific in its desired effect and misses the scrutiny of the public. Set against this specialized and skilled lobbying machine is the typical voter. So far in 2009 there have been 1,589 bills introduced in the California Assembly and 833 bills introduced in the Senate.[7] The time and energy to simply understand and track a mere handful of legislation is daunting. The prospect of over 2,000 pieces of legislation each year leads to what is called “rational ignorance”, a condition that occurs when the cost of educating oneself on an issue exceeds the potential benefit that the knowledge would provide.[8] And with this power in place the unions are in a position to elect their bosses, the very individuals the public relies on to manage the finances of government and negotiate union contracts. It is pretty easy to see who wins and who loses in this proposition.

And unions now have the strong backing of the White House. When Governor Schwarzenegger attempted to reduce wages for unionized home care workers President Obama threatened to withhold billions of dollars in federal stimulus funds if the salaries weren’t reinstated[9] placing the federal government squarely in the middle of the fiscal problems of the State.

On January 30, 2009 the newly inaugurated president signed three executive orders,[10] 13494, 13495 and 13496 strengthening the union’s position in any projects funded under ARRA (the American Recovery and Reinvestment Act) and overriding state labor rules.[11] According to The Kansas City Star, “President Barack Obama …issued an executive order backing the use of union labor for large-scale federal construction projects.

“The order encourages federal agencies to have construction contractors and subcontractors enter project labor agreements. Those agreements require contractors to negotiate with union officials, recognize union wages and benefits and generally abide by collective-bargaining agreements…”[12]

And on the same day as those executive orders were signed a group of union leaders was welcomed to the White House. “I do not view the labor movement as part of the problem. To me, it’s part of the solution,” Mr. Obama told the group.[13]

On November 18, 2009 the California Legislative Analyst’s Office released its report on California’s fiscal outlook projecting a deficit $20.728 billion[14] for fiscal year 2010.



There is an unsettled debate over whether higher taxes and regulation are causing wealthy individuals and businesses to leave the state. What is not open for debate is that the cost of staying is rising while the quality of services provided by local and state government is declining. The poor are disproportionally impacted and that is the exact opposite of the goal of the so-called socially responsible. When a county employee recently told me about how tough it is to cut benefits for the poor, as the county has been doing repeatedly while grappling with their budget issues I suggested, “Why don’t the county employees take a pay or benefits cut and ease the burden for the poor?” The answer was immediate and unequivocal, “Are you kidding? We wouldn’t do that!” No doubt.

The best analysis I have seen of the power of public sector unionism was published by the Cato Institute on September 28, 2009.[15] It ends:

“As keepers of the public purse, legislators and local council members have an obligation to protect taxpayers’ interests. By granting monopoly power over their governments’ supply of labor to labor unions, elected officials undermine their duty to taxpayers, since this puts unions in a privileged position to extract political goods in the form of high pay and benefits that are way above anything comparable in the private sector. Under such an arrangement, government, being itself a monopoly, leaves the citizens whose money it squanders with no options.”
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[1] http://www.ci.vallejo.ca.us/GovSite/default.asp?serviceID1=712&Frame=L1
[2] http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/05/06/BACH10HUK6.DTL
[3] http://www.bondbuyer.com/issues/117_87/-288275-1.html
[4] http://www.kget.com/news/local/story/3-at-50-retirement-debate/msXwaOs5k0eCtPms3hnh6g.cspx
[5] http://info.sen.ca.gov/pub/99-00/bill/sen/sb_0351-0400/sb_400_cfa_19990928_142123_sen_floor.html
[6] http://en.wikipedia.org/wiki/California_special_election,_2005#Results_2
[7] http://www.sen.ca.gov/~newsen/senate.htm
[8] http://en.wikipedia.org/wiki/Rational_ignorance
[9] http://www.kget.com/news/local/story/President-Obama-threatens-to-withold-billions/6bQ0EuJLlkq3mzJ0_q3dOA.cspx
[10] http://www.archives.gov/federal-register/executive-orders/2009-obama.html
[11] http://www.flemploymentlawblog.com/articles/government-contracts/
[12] http://artfularticulations.blogspot.com/2009/02/president-obama-executive-order-favors.html
[13] http://www.telegraph.co.uk/news/worldnews/northamerica/usa/barackobama/4401782/Barack-Obama-welcomes-union-leaders-to-the-White-House.html
[14] http://www.lao.ca.gov/handouts/education/2009/California%E2%80%99s_Fiscal_Outlook_Proposition_98_Briefing_111809.pdf
[15] http://www.cato.org/pub_display.php?pub_id=10569

Monday, November 2, 2009

Health Care Part II; Would you Buy an Insurance Policy from this Man?[1]

On October 29, Speaker of the House Nancy Pelosi released the long-awaited House version of health care reform which was crafted partly in Congressman Rangal’s Committee on Ways and Means. Actually, she introduced two bills; H.R. 3961, the Medicare Physician Payment Reform Act[2] and H.R. 3962, the Affordable Health Care for America Act.[3]

Let’s look at H. R. 3961. In my last blog post I discussed the $285 billion budgeted in 2010 for overturning the impending 21% cut in Medicare payments to physicians scheduled to take place on January 1, 2010. That discussion pointed to a budget resolution from the House Finance Committee passed on March 29, 2009[4] which requires enacting legislation. H.R. 3961[5] is that legislation and it seeks to permanently change the way physician reimbursements are calculated through amendments to Section 1848 of the Social Security Act,[6] the section of the Act that sets physician reimbursement rates.

In an effort to be diligent and to supply you, the reader, with a clear picture of how physicians are currently compensated under Medicare, I read Section 1848. It is 40 pages long, contains 14,000 words and 86 footnotes including legislative changes. The complexities of the language make it impossible to do a simple calculation and we can only assume the Mandarins in Washington have it right. But the question is really about the cost of this legislative change. In most of my analysis I consult the Congressional Budget Office report of the fiscal impact of legislation. Unfortunately H. R. 3961 has not been scored by the CBO. I assume this is because it is in the aforementioned budget resolution, which was. I score it as they did then at a cost of $285 billion. There is a silver lining. That is Ms. Pelosi’s claim that this legislation will fall under the new Pay-go rules codified by the house, but that silver lining dims significantly when you consider the Senate has openly rejected that kind of budgetary restraint.[7] Nevertheless this represents somewhere in the neighborhood of a quarter of a trillion dollars that have to come from somewhere.

The other examination is of H. R. 3962, the “Affordable Health Care for America Act.”[8] It is nearly 2,000 pages of legislative language. I again deferred in my analysis to the CBO.[9] Table 2 from their report shows their estimate of the Net Cost at $894 billion. The first thing I noticed is the disparity between the Net Cost and the impact on the budget. In years 2010 through 2012 the cost is minimal. Yet the impact to budget is different with deficit increases of $6.8 billion in



2010 and $16.6 billion in 2011. In 2012 there is a decrease of $15.8 billion. What accounts for this? As part of the American Recovery and Reinvestment Act of 2009 (ARRA) there was a temporary increase in payments to states for Medicaid (FMAP) which apparently is not considered part of health care when it is stimulus.[10] That stimulus expires on December 31, 2010 so the House has included a one-time extension of these payments into 2011 at an estimated cost of $23.5 billion. Payments to Primary Care Practitioners account for the majority of the rest at an average of $5.7 billion per year over the ten-year estimate.[11] This of course is in addition to the $285 billion discussed above from H.R. 3961. The majority of the savings comes from discounts in Part D (Prescription Drug Benefit) and Phase-in of Payment Based on Fee-for-service Costs.
But the best way to analyze the bill is to put it against the Chairman’s Mark of the proposed Senate legislation, which I discussed in my last blog post. Several things stick out. First, the House bill is 30% more costly than the Senate proposal. Interestingly both bills assume half of



the cost will be paid for by savings in Medicare, Medicaid and other programs. Second, the House bill forgoes tax on high premium plans and makes only minimal changes in existing tax expenditures, leaving us with a $598 billion shortfall compared to the Senate plan’s $85 billion. And how does this become deficit negative? The House plan charges significantly higher penalties for non participation (to the tune of $167 billion) and raises taxes on the wealthy by $536 billion! And, if the House is successful in enforcing Pay-go for H. R. 3961 they will either have to raise taxes by an additional $285 billion or cut spending by that amount. If the savings are truly realized the plan will simply be deficit neutral at a cost of $800 billion in potential new taxes.

Once again I will pose the question, “With an unfunded liability of $107 trillion in the current Social Security and Medicare program[12] can we afford to just spin our wheels?” It appears to me the “Affordable Health Care for America Act” will be very unaffordable for someone, possibly everyone.


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[1] http://www.politico.com/news/stories/0609/24167.html
[2] http://www.ssa.gov/OP_Home/ssact/title18/1848.htm
[3] http://docs.house.gov/rules/health/111_ahcaa.pdf
[4] http://budget.house.gov/PRArticle.aspx?NewsID=1677
[5] http://docs.house.gov/rules/health/111_sgr1.pdf
[6] http://www.ssa.gov/OP_Home/ssact/title18/1848.htm
[7] http://thehill.com/homenews/house/63399-senate-move-on-medicare-payments-sets-up-pay-go-showdown-with-house
[8] http://docs.house.gov/rules/health/111_ahcaa.pdf
[9] http://www.cbo.gov/ftpdocs/106xx/doc10688/hr3962Rangel.pdf
[10] http://www.legis.state.ia.us/lsadocs/SC_MaterialsDist/2009/SDDLH031.PDF
[11] http://www.cbo.gov/ftpdocs/106xx/doc10688/hr3962Rangel.pdf, pg. 23, Table 3.
[12] http://www.freerepublic.com/focus/news/2269595/posts