Thursday, April 07, 2005

What a Wimp! 

Narcissus gives up on plan to privative state pensions

Friday, February 18, 2005

The Bear Will Hang His Head In Shame 

Dan Weintraub of the Sacramento Bee was the first to spot it:

The UCLA Faculty Assn. has filed a ballot measure with the AG's office that mirrors Schwarzenegger's pension reform proposal with one exception: it would leave in place the defined benefit pension plan for University of California employees. The UC plan is fully funded and in surplus. The faculty group is apparently hoping that when the time comes to start gathering signatures, the governor will choose their proposal rather than his original plan and thus avoid opposition from the university and its employees.”

Alas, it’s all too true. Anthropology professor and UCLA Faculty Association Chair Dwight Read has indeed submitted the “California Public Employee Pension Reform Act” to the Attorney General’s office as one step towards qualifying for the next state election ballot. Most of the text is copied word for word from a measure (ACAX1_1) that was introduced in the legislature back on January 6th to implement the Governor’s plan to strangle the state employee pension system and replace it with privatized accounts. (Background
here and here.)

“But Professor Tax! When we hand in term papers that we’ve copied from the Internet you mark an ‘F’grade on them and you get very upset about ‘plagiarism’ and ‘academic standards’. Isn’t the UCLA Faculty Association setting a really bad example? ”

True -- but the real problem isn’t the plagiarism (legal codes are in the public domain), but the part that’s original with Dr. Read’s Association. Let's look at what they added and changed. The Governor’s original plan in ACAX1_1 would prohibit “defined benefit” pension arrangements for any employee hired after July 1, 2007 by any “public agency” – a defined term that:

“includes, but is not limited to, the State of California, and any city, city and county, or county, including a charter city or charter county, district, school district, University of California, California State University or other political subdivision or public entity of, or organized under the laws of, this State, or any department, instrumentality, or agency thereof.”
Dr. Read seems to believe (n. 1), however, that defined benefit pensions are good as long as he and his colleagues at UC are the ones who benefit, but that such plans are bad when they benefit anyone else. In the version on file with the AG's office, the introductory pitch to the gullible public – the “Whereas” words -- repeat the party line about the budgetary evils of pension plans generally. However, the actual proposal now applies only to “public agencies as defined in subparagraph SEC. 4 (d) (3)” (n. 2), meaning all of them "except the University of California, its laboratories, and its affiliates, all of which are excluded from the California Public Employee Defined Contribution Plan.“ This means that UC would keep its own defined benefit retirement pension plan – a plan that
the University calls “one of the most generous benefits of UC employment”.

"But isn't the University of California a *public* state supported university? Don't our tax dollars pay Dr. Read's salary?"

You're right. State Budget Code: 6440 University of California. The
proposed general fund appropriation for 2005-06 is $ 2,835,841,000, and taxpayers are also on the hook for the billions in bonded debt that built all those lecture halls and cyclotrons. UC is public, except when the magic pencil of statutory drafting says it isn't. The initiative sponsors try to rationalize the magic pencil in Sec. 2(h), an unconvincing attempt to explain why the UC retirement plan should not be held to the same standard as everyone else. First, we learn, UC has Competitive Faculty Compensation. (fn 3.) The defined benefit plan helps the University attract good professors, because:

"The University of California's generous retirement savings and investment plan benefits are some of the most tangible rewards of University employment. The impressive array of plans and investment products can help you achieve future financial security."

But there’s no reason to believe that UC professors are the only people who want financial security, and if similar plans help other public agencies get good employees, then abolishing them is a bad idea. This is really an argument against the initiative, not for it.

The second reason to exempt UC, we learn, is the unique role of the Regents in managing the UC Retirement plan as a public trust. How unique? According to the
Spring 2004 Newsletter of the UCLA Faculty Association (the initiative's sponsor), very unique indeed:

“The transcripts of the Regents’ discussions conveyed pressure to turn around a faltering investment performance that had trailed the market by about one percentage point since 1984. In these closed sessions, UC Treasurer David Russ calculated that UC could have added $2.5B to its $26B portfolio of U.S. stocks from 1992-2002 had it simply pegged its investments to overall market indexes—or benchmarks based on S & P 500 and the Russell 3000. In addition, it could have added another $2.3B by following the advice of professionals about which indexes to invest in (SJ Mercury News, 1/14/2004). The Regents’ discussions were leading up to a major change of strategy: fire most of the internal investment staff and outsource to professional financial advisors. On Nov. 5, 2002, state election day, the Regents informed the UC staff about the firings. The next day, the announcement appeared in the SF Chronicle, but few people read it (transcripts from the closed sessions reveal that the Regents and others discussing these events knew that few people would notice anything during these days except election results).”
Or maybe secrecy, mediocre results and arbitrary firings aren’t unique to the UC Regents after all.

The other changes the UCLA folks made in der Governor's plan just compound the injury to everyone else. Not content with denying others the retirement benefits they continue to enjoy, they would add strict limits on "public agency" contributions to employee plans -- a maximum 6% of pay, with a 1:2 employee contribution match requirement. For
state employees, this would be about a 50% to 70% reduction in employer pension funding. In an attempt to placate voter sympathies with teachers, cops and firefighters, the UCLA folks allow, in Sec. 2 (e) "important adjustments for education and public safety employees". The adjustments would raise the maximum public agency share a full 3%, up to a 9% maximum, which is only a small benefits cut for teachers not covered by social security (currently 10%), but still a huge hit for State Highway Patrol officers. (currently at 33%).

We all can understand why some university professors would propose a ballot measure that preserves their own pension position by sacrificing others. They are scared, and want to curry favor with Governor Narcissus. Perhaps Finance Director Tom Campbell, lately Dean Campbell of the UC Berkeley Business School will take the hint and help bail out his erstwhile colleagues. Perhaps the Faculty Association folks even believe their own rationalizations about why their pensions are special. It’s understandable.

Understandable, but still inexcusable. Is there any English word that describes such behavior? The French call it “
collaboration”: not in the nice sense of “working for the common good”, but as in “helping an adversary injure friends in order to escape injury to one’s self.” Pronounce it in the manner of the corrupt and charming Captain Reynaud in Casablanca: "Collaboration”. It still doesn't sound very nice. Let's hope that the faculty at UCLA and the other UC campuses, in their better wisdom, sense the precarious nature of state support for all public college education. They may conclude, on reflection, that it's not in their interest to deepen the divide between UC and the CSU. If so, "This could be the start of a beautiful friendship."


fn. 1 In what may be a clever ploy or profound absent-mindedness, Dr. Read refers to the UCLA Faculty Association, rather than himself, as the “proponent” of the measure.

fn 2. Or maybe it applies to “all state and local government employees as defined in subparagraph SEC. 4 (d)(3)” -- § 2(c), or to "employers of public agencies as defined in subparagraph SEC. 4 (d) (3)" -- § 3(b). Legislative drafting is not the Faculty Association’s strong point, as evidenced by Sec. 5(d):

"Public Agency" as defined in subparagraph SEC. 4 (d) (3) and "Defined Contribution Plan" shall be as defined in Article XX, Section 8 of the Constitution.”

This word tangle is the result of trying to fit a constitutional amendment inside a statute while knowing nothing about the Federal tax and retirement security laws that shape pension plan design.

Fn 3. Strangely enough, the
January 2005 Newsletter of the UCLA Faculty Association complains that faculty pay needs to be boosted by 10.6% or maybe 17.5% so it will equal the pay at comparable institutions. It’s hard to know what the numbers mean, tho, since an earlier newsletter describes a “salary puzzle” at UC, with many professors getting pay supplements “off-scale”, through non-state funds. In 2001-02, UCLA full professors ranked 11th nationally with pay of $115,700.

Thursday, February 17, 2005

Narcissus Wimps Out 

Governor Schwarzenegger has abandoned his reorganization plan to eliminate 88 boards and commissions, conceeding that it "needs more work".

Thursday, February 03, 2005

Schwarzenegger's Monkey Finger Ouija Board Budget Plan 

Back on January 10th, Governor Narcissinator announced his plan to terminate California’s budget problems. He called for a constitutional amendment so that budget shortfalls would trigger “fiscal emergencies”, during which the state would automatically reduce payments to vendors and employees “across-the-board”, so they would only get a fraction of any money the state owed them. In effect, it’s a “doomsday machine” solution – a threat to create such a mess that every politician in the state would prefer to negotiate a new budget compromise instead.

But it’s not so easy to create the right kind of mess. On February 2nd, Arnold’s finance consigiliere Tom Campbell
publicly admitted that:

“…the administration is still trying to determine exactly what areas would be subject to the across-the-board cuts. For example, he said, it's unclear whether the state could cut payments to vendors or reduce paychecks for state employees because both are bound by contracts. ‘The possibility of litigation is clearly there,’ he said. ‘But I don't think that should intimidate us into not doing strict reform.’”

Translation: “Oops. It’s not even a *good* doomsday machine.”

The clever and canny Dr. Campbell clearly understands that his role as state Finance Director is to play the “bad cop”, and take the heat when his boss slips up. Governor Narcissus can’t admit that he made a mistake back on his first day in office when he chopped a $4 billion hole in the state budget by cutting the car tax. As a result, tax increases to help cover next year’s expected $8.1 billion gap between revenue and expenses are ganz verboten. In response to questions, der Governator just repeats his scripted mantra: “We don’t have a tax problem, we have a spending problem”, which the news hacks dutifully quote as tho it meant something.

This is the right approach as long as short-term popularity is seen as more important than trying for real solutions and risking failure. Taxes are not good – they are, at best, necessary evils – so it is easy to please the public with anti-tax rhetoric. What rare politician would willingly choose to annoy voters with tedious explanations of the need to fund the public services they expect? Der Governor’s stance also pleases his upper-income celebrity friends, his allies in California’s corporate establishment, and the tax-loathing troglodytes on the right wing of his own party.

The problem, tho, is that future state budgets still have a recurring yearly “structural imbalance” in the $6 to $10 billion range. The Legislative Analyst explains:

“The state has been plagued with a large structural budget shortfall since 2001-02, when revenues plunged following the recession and the steep decline in the stock market. The annual gap between projected revenues and expenditures has been massive, reaching as much as one-quarter of annual General Fund spending. While the state has addressed the annual shortfalls in each of the past three budgets, many of the solutions have involved borrowing, spending deferrals, accounting shifts, and other one-time actions. As the benefits of these onetime solutions fell away in subsequent years, the large underlying structural shortfall reemerged.”

The smart and ambitious advisers who surround der Governor know that general outcries against “waste, fraud and abuse” aren’t solutions – viewed close up, the potential savings from greater operating efficiencies usually seem smaller than they appear from a distance, while offsetting capital costs and transition expenses are inherent in any restructuring. Programs are rarely 100% wasteful, so funding reductions will inevitably harm someone, and demonizing teachers, nurses and public employee unions as “special interests” is a quick way to burn off charisma. So how can a Governor who loves public applause avoid blame? How to raise taxes, but avoid blame? Reduce spending and transfers but avoid blame?

Enter the Budget Doomsday Machine. The idea could well have emerged from a seminar in strategic game theory for graduate students, like those taught by Dean Campbell's colleagues at Stanford or Berkeley. “Strict reform” sets up automatic cuts that are so disruptive that the legislature will be forced to offer alternative solutions. A chorus of public doom will force the free-spending Democratic liberals and the tax-hating Republican troglodytes to make the concessions needed to get the 2/3rds supermajority to pass tax and budget legislation. Taxes up, spending down, and it’s all the fault of those @#$%^&* legislators. Score one for the Groepper.

That’s the theory, at any rate. Doomsday machines don't appear to be very popular in practice, and now that Der Governor’s hench-persons have introduced
legislative language (ACA1_4, 1/20/05) and dropped matching initiative petitions (6 different versions) into the hopper at the AG’s office, we can understand why. We're looking at a kludge, a multi-megaton device cobbled together by amateur bomb designers. Let's give Dr. Strangecamp some room while he struggles to define “across the board” cuts that aren’t across the board, and instead examine some other design flaws, like the “monkey finger” trigger mechanism and the use of a ouija board to drive the state’s spending plans.

Here’s the core of ACA1_4, as summarized by the Legislative Counsel's office:

“This measure would require, rather than authorize, the Governor to issue a proclamation declaring a fiscal emergency, and specify that the proclamation would be issued when the Governor determines either that General Fund revenues will decline below the estimate of General Fund revenues upon which the Budget Bill for that fiscal year was based, or that General Fund expenditures will increase above that estimate of General Fund revenues, or both, by at least $250,000,000, adjusted to reflect the rate of inflation shown in the consumer price index.

"The measure would also require, as an additional consequence if the Legislature fails to pass a bill or bills to address the fiscal emergency by the 45th day, that reductions be imposed, on a pro rata basis, on all General Fund appropriations enacted on or before the date of the proclamation, by a percentage estimated by the Director of Finance to cause total General Fund appropriations not to exceed General Fund revenues by the end of that fiscal year, with specified exceptions.

"It would additionally require the amount of certain payments calculated pursuant to state statute to be reduced as necessary to reflect the reduction in General Fund appropriations.”
Monkey Finger On the Trigger

ACA1_4 is set to fire on a hair trigger, so fiscal emergencies will become a chronic condition. $250 million sounds like a lot of money, until it is viewed in the context of the $80 billion annual general fund budget of a state with a $1.5 trillion ($1,500,000,000,000) economy -- the sixth largest economy in the world. The trigger goes off when the variance between actual and budget rises above 0.3% -- one part in three hundred -- which is less than the statistical noise in the numbers, and does not allow much margin of error before forcing a state of emergency. It’s like someone calling an ambulance every time their personal thermometer reading rises 1/10th of a degree above normal, or scheduling major weight-loss surgery every time the wiggling needle on the bathroom scale makes it look like they gained half a pound.

Suppose tax revenues are down by $300 million at some point during the year, but expenses also pencil out at $500 million below the budgeted amounts. Is this an “emergency”? Common sense says “no”, but ACA1_4 says the opposite. A revenue decline alone triggers the proclamation, not the net effect on the budget. It’s not clear if the law permits a Governor to exercise any judgment: while ACA1_4 doesn't say how a Governor will decide that a shortfall exists, Counsel's summary says the emergency proclamation is *required* as soon as that determination is made. Apparently, the only way to preserve common sense in the case where revenues and expenses both decline is to have the Governor keep both eyes closed and both ears covered whenever talking to the Finance Director. [Note a difference between ACA1_4 and the voter initiative filings at the AG’s office: the latter use the net spread between revenues and expenses to define the trigger point.]

Behind the Crystal 8-Ball

State budgets are like weather forecasts: they are good guesses by experienced people, but there still are times when it rains on those “fair and mild” outdoor picnic days. Yogi Berra was right: “It’s hard to make predictions, especially about the future.”* Consider the timing of the key dates in the state budget process:

  • January 10, year 1 - Governor proposes budget for next fiscal year, from July, year 1 to June, year 2
  • May 15, year 1 - Governor revises proposed budget
  • June 15, year 1 - Legislature supposed to pass a budget bill. 2/3rds majority of all members is required.
  • July / August, year 1 - Legislature, after much political posturing and increasingly serious delays in paying state employees and vendors, actually passes budget with appropriations for the year. Governor has line item veto power over specific items.
  • July 1, year 1 to June 30, year 2. - Legislature may enact additional appropriations, but only one purpose per bill, and may revise/reduce appropriations.
  • January, year 2 - Department of Finance updates current forecast – “Midyear Revise”
  • July, year 2 - The fiscal year is over, so the state can finally tally up what was actually spent. The official numbers are firmed up in January of year 3.

    The revenue laws are *not* re-enacted in each year’s budget process, but are “permanent” legislation, requiring a 2/3rds majority to amend.

    More details are

* Some scientists claim it was actually Quantum Nobel Laureate Niels Bohr who said this. Then again, as Yogi Berra said: “I didn’t really say everything I said”.

“So, Professor Tax – does this mean that the new budget Governor Narcissus just presented is really only a guess as to how much the state will collect in taxes six to eighteen months from now? And that the plan for allocating revenue among state operations is based on those revenue predictions?”

Right! The prediction could have been backed up with proposed changes in the tax laws, but Arnold is afraid that might hurt his fragile popular image. And even tho the budget is presented one year at a time, state agencies and programs can’t be turned off and on easily. You don't build an organization by flicking a switch. The largest parts of the budget are fixed by state law (like Prop 98 education funds for the state’s 982 school districts) or involve cost sharing with the Federal government, or are mandated by Federal law, or are required by court orders, or are multi-year software systems contracts, or are protected by the US Constitution (Alexander Hamilton was the bondholders’ friend). Most so-called “state spending” in California actually involves transfering money to cities and counties ($13.2 billion for Medi-Cal alone), to schools (Proposition 98 money represents 40% of the state budget and pays
61% of the cost of K-12 education) and to the 72 Community College Districts. More than 3/4ths of General Fund outlays are transfers to the local level($62.4 BB in FY 2004-05), and the bulk of the remaining $19.8 BB that is spent at the state level goes for salaries and benefits.

“Paying a bunch of useless bureaucratic drones, I suppose.”

Well … some would say that. Statistically, California has about 326,000 state employees (8.8 per 1,000 population, a ratio which has been fairly constant over the last 40 years, and is among the lowest in the nation even when local employees are added in.) Over half of them work in the 3 biggest agencies supported by the general fund:

EmployeesSalaries and Benefits
University of California71,000 $3.9 billion
Corrections56,000 $3.6 billion
California State University42,000 $2.2 billion

Transportation – CalTrans, etc. -- comes in fourth, with 40,000 employees, but a large part of its funding is outside the general fund.)

Not only does the prison system have more employees than the state university system, but a little arithmetic shows that average employee compensation is higher in Corrections than in either UC or the CSU. Sigh… Professor Tax has just realized that he would personally be better off financially if only he could be re-incarnated as Deputy Warden Tax the next time the Cosmic Cycle of Being winds its way through our patch of the Universe.

“Enough Theosophy, Professor. At least your students don’t riot during your exams. But getting back to the topic, how good are those forecasts of state revenues and expenses? Does ACA1_4 mean that lousy forecasts will produce fake fiscal emergencies, like false alarms for firefighters? And how do we know that the proposed fixes won’t flop if they are also based on shaky guesses about the future?”

It turns out that expenses are relatively predictable, just as there aren’t many snowstorms in LA during the month of August. Here’s link to a table covering the last 30 years that shows the various expense predictions(January yr 1, June year 1, and January yr 2) and what actually was spent from the general fund.

A little slice-and-dicing using the statistical Vegamatic™ tools in Excel™ shows that between FY ‘91-92 and FY’03-04, actual general fund spending grew an average 5.5% per year with a 6.8% standard deviation. Actual spending averaged slightly (1.95%) more than budget act levels (std deviation 3.1%), and was very close to midyear review projections (0.14% with std dev. 1.5%). While actual expenses appear to run an average 5.54% above the governors’ January year 1 proposals, the large (8.84%) standard deviation suggests this was distorted by that 20.3% drop between ’02-03 and ’03-04. The latter was not a serious budget plan, but was instead a lowball pitch from ex-Governor Davis that positively dripped with the budgetary equivalent of slippery elm juice.

Revenues are far less predictable. Take a look at these tables from The Legislative Analyst’s January 2005 report on Revenue Volatility.

The report shows that tax revenues have risen about as fast as spending -- an average 5.2% per year since FY’91-92 – but had significantly higher volatility – a standard deviation of 9.4% vs the 6.8% calculated above. The Personal Income Tax is the main culprit: average growth of 6.5% and standard deviation of 13.8% implies about a 1 in 6 chance of a 20% increase from one year to the next, and an equal likelihood of a 7% decrease. This factor alone makes budget planning resemble a roll of the dice at a craps table, because over half of all general fund revenue comes from PIT, which is to generate over $43 billion in the new budget.

The Analyst’s report refrains from comparing actual receipts with budget projections, but the cash receipt schedules maintained by the Controller’s Office do track revenue forecasts, by source, against actual receipts. Professor Tax recently armed a phalanx of graduate students with an array of statistical tools, and set them loose with orders to interrogate the data and extract such correlations and confessions as may be present. Detailed results should be available soon, but here's an indication of how much daylight separates the budget forecasts from the actual results:

California Personal Income Tax: per Funded Cash Receipts
YearBudget Act Est.Actual Receipts Difference Error
FY ‘98-99$28.76 $30.72$1.966.8%
FY ‘99-00$32.66 $39.27$6.6120.3%
FY ‘00-01$40.98 $44.77$3.799.3%
FY ‘01-02$41.99 $33.29$(8.70)-20.7%
FY ‘02-03$37.53 $32.46$(5.07)-13.5%
FY ‘03-04$33.64$36.75$3.119.2%
FY ‘-04 to 12/04$17.85$18.21$0.362.0%
all dollar amounts in billions

The average difference between the budget act estimates and actual receipts for this small data set is only 1.9%, but the standard deviation is six times as large (13.2%). That suggests there's only a 2/3rds chance that actuals will be somewhere within 13% of the budget estimates. Professor Tax suspects that a ouija board would make equally accurate predictions. It’s like watching a baseball pitcher first throw the ball towards first base and then towards third base and then having the manager argue that the average was right over the home plate strike zone. But if the state can’t predict revenue amounts with any claim to precision, then there’s no way to tell real fiscal emergencies from false alarms, and no way to know whether measures taken in response to a proclamation are either necessary or sufficient.

The reason state income tax receipts are so unstable is that most of the tax is paid by relatively few high-income taxpayers, and their prosperity is tied to the business cycle. Take a look at Tables B-2 and B-3 in the most recent
Franchise Tax Board annual report with data for year 2002 (i.e. returns filed in 2003). 11% of all returns reported income above $100,000, but these taxpayers accounted for 46% of all income in the state, and they paid 73.3% of the tax. Almost half of the returns reported incomes under $30,000, but they accounted for only 1.5% of total collections. Indeed, the 24,939 income millionaires of year 2002 comprise less than 0.2% of the taxpaying public (1 in every 500), but they got over 10% of all the income and paid 21.6% of the tax. They paid over $6 billion dollars, an average of $250,000 each. (The hand bleeds at the prospect of writing such a check.)

The IRS also reports statistics of income on a state by state basis, and here's what their
latest Bulletin shows: Californians reported $773 billion of year 2002 income on 15 million Federal income tax returns. Only 2.5% of these returns had income above $200,000, but these hi-bracket folks received 1/4 of all the income in the state and paid almost half (45%) of the tax. Income from capital is concentrated in the upper brackets. Wages and salaries represent 75% of all income in California, but only half the income of the top 2.5%, who also got 36% of all interest income, 44% of all dividends and 85% of all capital gains. Almost half ($15 billion) of the total deduction that the Feds allow for state income taxes shows up on these top tier returns.

When the business cycle turns down and the stock market catches cold, these high bracket folks feel the chill. Their capital gains turn into losses and their stock options vanish underwater. Table B-2 in that FTB report shows that total year 2002 income was about the same as year 2000 income for Californians making under $100,000. However, the aggregate income shown on the 1.4 million returns with over $100K fell from $445 billion to $336 billion, and their total state income tax liability shrank from $32 billion to $21 billion. The taxes paid by Californians at the top of the income ladder are the unpredictable swing factor in California’s fiscal system.

The problem has become much worse over time, as income and wealth have become increasingly concentrated. According to a
year 2000 report by the Legislative Analyst, in 1975 the top 1% of all state taxpayers reported 7.0% of all the income, but by 1998 the share of the top 1% had jumped to 19.6% of all income. The 1% below them, (98th to 99th percentile) saw their share rise from 3.4% to 4.5%, the folks in the 95th to 98th percentiles went from 7.2% to 8.8%, and the bottom 95% of Californians all saw their shares decline.

“So, Professor Tax. Are you saying that we should solve the state budget problem by raising taxes on the rich?”

Haven't you been listening? Unfortunately, the way California taxes the rich is a *cause* of the problem. Making investors and entrepreneurs pay more may gratify the rest of us, but it will also make the state’s fiscal situation even less stable and more leveraged to the fortunes of the favored few.

“So what do you recommend? What would you do, Professor Tax, if you were in Tom Campbell’s position?”

You mean: aside from submitting my resignation because: "We don’t have a spending problem, we have a Governor problem....”


Sorry. That’s the bell. Class over. See you next time.

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