Potemkin Pension Accounting In California

Accounting for state and local governments is determined by the Governmental Accounting Standards Board (GASB), which has a too-cozy relationship with the governments it is supposed to regulate. GASB doesn’t stop state and local governments from treating borrowings as revenues, avoiding cost recognition by simply not paying expenses, or claiming balanced budgets that often are nothing of the sort.

The most costly example takes place in pension accounting. When pension promises are made, GASB allows state and local governments to value those promises at a fraction of their real value. Today, state and local governments use GASB rules to value their unfunded pension liabilities at just one quarter of the $4 trillion the same unfunded liabilities are valued by the Federal Reserve Bank. Put another way, GASB’s rules are today enabling state and local governments to hide $3 trillion of unfunded liabilities.

I call it “Potemkin Pension Accounting” because GASB’s rules are rigged to make pension plans look better able to meet pension promises than they really are. That helps the beneficiaries of pension promises (government employees) to obtain richer pension packages. But like Potemkin’s villages, the deception is temporary. That’s because the discount automatically evaporates over time under a process known as “accretion.” Values that were initially suppressed spring back with vengeance. The bigger the discount, the bigger the vengeance. See for yourself:

Pension liabilities reported by California’s largest pension fund (CalPERS) rose nearly 5x in just 20 years, from $97 billion in 1997 to $465 billion in 2017. Those liabilities were neither announced by elected officials nor approved by voters. They simply showed up as discounts evaporated. As the discount evaporates, so does the masquerade of pension fund health.

As pension liabilities rise, so do pension costs. Pension spending per K-12 student in California doubled in just four years, diverting money that should’ve gone to teacher staffing and salaries. State pension spending has more than doubled this decade, diverting money from underfunded courts and more. Worse is on the way. This is why California’s practice of suppressing the true cost of pensions when they are created is so dangerous — and so jealously guarded by the beneficiaries of such a practice.

California’s pension funds could choose to report pension obligations honestly. But in 2006, when I told the California State Senate that California’s pension funds were hiding liabilities that would later crush school and other budgets unless change was made, the only change they made was to remove me from the board of one of those funds. Their unwillingness to do the right thing more than a decade ago is why schools today are laying off teachers despite a ten year bull market, 30 percent income tax increase, and record tax and school revenues.

If you’re hoping for a “tipping point” that forces the state legislature and governor to act, it won’t happen in the case of the state or its school districts. That’s because states can’t declare bankruptcy and California school districts are backed by the state. As a result, the consequences of rising pension costs are more like those faced by a frog in gradually warming water: gradually, public services are crowded out and taxes are raised.

On the other hand, tipping points can be reached by local governments, which can declare bankruptcy. In addition to crowded out services and higher taxes, local government employees are at risk to forfeiture of their pensions and other post-employment benefits. They should be particularly concerned about dishonest pension accounting. Unlike state and school district employees, local government employees are at risk.

State and local governments provide the lion’s share of domestic services in our federalist system of government, including public education, safety and infrastructure. States like California have harmed — and continue harming — the funding of those services by hiding the true costs of pension promises. They should tell the truth.

Originally appeared on Medium, 8/23/19.