Collision Course between Private sector and Government Employee Pensions

Collision Course between Private Sector and Government Employee Pensions

Thirty years after the passage of Prop 13, state, local government, and school employee pensions, (Calpers and Calstrs), cover some 3,476,650 people, the vast majority of public employees.  The cost of these plans appears to be on a collision course with the private sector’s ability to pay.  In the year 2003-2004, the average annual salary paid to Calpers members was $46,124.  The private sector was $35,219.  Benefits paid statewide to retirees from these plans were $20.1 Billion.  Total state tax revenue was $37.7 Billion. While the funding sources are different, the comparative magnitudes are alarming.  Pensions can amount to 100% of their highest salary at age 55 after 30 years of service for life.  The payouts are so high early, they become an incentive to terminate and move on leaving the city basically with one employee for the cost of two.  The private sector cannot afford defined benefit plans for life.  The Vallejo proposed bankruptcy is the first of many if the public employees don’t reduce their demands. 

Former State Assemblyman Keith Richman filed a ballot proposition in 2007 that would maintain the benefits for non-public safety employees from age 55 to 65: Estimated savings over 30 years … $500 Billion.  The USA Today dated 2/29/08 reported a shortage of close to $49 Billion in retirement reserves benefits for Calpers and Calstrs retirement plans with combined assets of $330 Billion.

Looking at it from state-level Estate Tax planning perspective, the reality is that pension benefits paid to government employees are directly at odds with the private sector’s ability to pay.  Pensions have become actuarially unsound on both sides.  Pension costs must be controlled by change from defined benefit to defined contribution or other plans. Revenue improvements are also needed to meet actuarial demands already incurred, and this paper suggests one such revenue source.

Property taxes are a main source of revenue for public education and other local government services.  Governments generally have no earned income, just passive.  On the opposing side is the private sector that depends on earned and passive incomes if they are able to accumulate such assets.  The state wants taxes from those earnings whether they are earned or passive.  The private sector doesn’t have the personal bargaining power of 3,476,650* government employees, nor the ability to tax when monies get short.  Parcel taxes are a tough sell needing a two-thirds vote.

Prop 13 – Capital gains – ‘Step-Up-at-First-Death’: Restricts sales of Homes

As soon as Proposition 13 was passed in 1978 and was backdated to 1975, it became a powerful incentive to keep people in their homes.  Over the last 25 years due to limited inventories, inflation has grown beyond any experts expectations.  The state needs more money and the private sector says no.  But, homes have been appreciating at a rate far in excess of the general inflation rate in most middle to upper class neighborhoods for the last 15 years.

In addition to Proposition 13 keeping people in their homes, there is the California 9.3% and Federal 15% Capital Gains tax from the first dollar on all assets except homes with a $250,000 per person exemption.  There remain a large number of very early Proposition 13 beneficiaries whose homes have appreciated $600,000 to several million dollars.  The state needs the Capital Gains but seniors won’t sell because of Capital Gains and Prop 13, leaving a no win situation.  It’s been reported in the Wall Street Journal there is $18 Trillion of home equity in the USA.  With little doubt, a disproportionate amount is owned by seniors in California who could sell and benefit, but won’t because of Prop 13 and Capital Gains.

Finally, there is the Federal legislation that allows current surviving spouses to sell all their assets free of State and Federal Capital Gains taxes.  It’s called the –Step-Up-at-First-Death’ provision of the pre-World War I Federal Estate Tax law and does just that.  It was modified in 1981.  Federal Estate taxes were changed to the second death, but the ‘Step-Up’ remained on both halves of this community property state.  This is a big tax loophole for the rich and super rich since huge capital gains taxes are avoided by waiting to sell until after the first spouse’s death.

Summary

The state is looking for revenue.  The private sector is looking for more revenue and capital appreciation for retirement.  The State has a very rich retirement plan.  The three State and Federal tax laws “lock-up’ dead assets for the private sector waiting for a death to take place.  It makes no financial sense for the state nor the private sector.  Freeing up assets to put their equity to work for seniors over 65, and at the same time having a new owner for the residence who pays property tax based on current value, is the right thing to do.

Commercial property, when owned by a business entity, generally does not change ownership on death, and may continue to receive the benefit of Prop 13 almost indefinitely.  It’s a free lunch for Commercial real estate owners at the expense of education.

California schools have close to the largest class size in the nation and high dropout rates.  We are starving our schools.  The governor announced cutting their budget over $4 Billion.  The Jarvis Prop 13 organization under attack should seek parity and fairness which will increase revenues without a frontal attack on Prop 13.

Partial Long-Term Revenue Solution Mainly for Education

Allow all seniors age 65 entering Medicare to sell their homes when they choose, free of Capital Gains taxes similar to current surviving spouses at any age.  Currently, they are underperforming assets for the State educational system.  Secondly, under Proposition 13, allow senior couples to move from the large home they no longer need to a smaller home anywhere in California without receiving a property tax penalty.  Only seven counties have chosen to accept.  It’s fair and makes economic sense for seniors, the State of California and market investments.  This is personal and state Estate Planning.  Let’s all be winners.

*Numbers provided by Howard Jarvis save Prop 13 organization have not been updated since 2004

James U. Hall, CLU Former President Santa Clara County CLU Society, General Agents and Managers Association. Monte Sereno, CA (juhclu@yahoo.com)

John E. Upton, El Dorado County Board of Supervisors, 1990-1998.  Former president (1998), California State Association of Counties.  (rkupton@sbcglobal.net)

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