California's Tipping Point

by: Matthew Rafat

Investors should be worried. California's unemployment rate just skyrocketed, and Bay Area employers are laying off thousands of employees. As the eighth largest economy in the world, California and its consumers have the power to affect economies worldwide. Unfortunately, it doesn't look like things are going to get better anytime soon. Shannon Love writes about California taxpayers and California's tax consumers here. Ms. Love talks about a tipping point, which is reached when a state achieves enough power and money to dictate to the people. Once this tipping point is reached, she says, "it is only a matter of time before civil servants become civil masters."

Former Presidential nominee Barry Goldwater said it even better: "A government that is big enough to give you all you want is big enough to take it all away." I've echoed similar concerns here and here. Despite the danger of overweening government, nothing seems to jolt the average American citizen and voter into action. This is particularly distressing, because informed citizens seem to have become apathetic to the government's siphoning of taxpayer dollars.

Take this SJ Mercury news article, for example. The writers chastise Councilmember Pete Constant for trying to rein in profligate spending and public sector union demands. However, in promoting more government benefits, the writers reveal just how stunningly fat government employees have become.

Mr. Bruce De Mers and John Diquisto write: "[M]ost police and fire retirees left public service well before the advent of 90 percent retirements." [Emphasis added.] There's no way to escape the reasonable inference from this statement. We are being told that at least some current police and fire retirees will receive around 90% of their salary after retirement. This isn't an uninformed slip--Mr. De Mers is president of the Association of Retired San Jose Police Officers and Fire Fighters, so he knows his numbers. Of course, the writers forget to mention the lifetime medical benefits also given to police and firefighter retirees, but after getting 90% of your salary in retirement, why add insult to injury? I can't find a non-executive private sector worker in San Jose who gets 90% of his salary at retirement and lifetime medical benefits--and I'm an employment attorney, so I've met almost every kind of San Jose employee.

Let's get back to the article. It contains the usual platitudes, such as, "Panic is not productive. Promoting panic is a disservice to the public." Informed people should read between the lines. Our government officials want us to remain calm--while they dig deeper into our pockets. Unsurprisingly, the writers resort to the public safety argument: "Attacking retirees who risked their safety to make San Jose one of the safest big cities in America may feel good. [T]hat doesn't make it right."

Newsflash--if more police kept cities safe, or if police were even a substantial catalyst for safety, then New York City, Oakland, and Baltimore would be crime-free. (Last time I checked, they had plenty of police officers.) In reality, police and firefighters are only two components in the public safety analysis. The determinative factor in public safety is the composition of the residents themselves--more specifically, their education levels. For example, imagine a city with 1,000 cops and 1,000 gang members. Will there be more crime in that city, or in a city with 50 cops and 50,000 college-educated accountants? And yes, that's a rhetorical question.

San Jose isn't safe because of cops and firefighters--we're safe because of our high levels of education and and the high cost of living. First, most Santa Clara residents have a college degree--61%, to be exact. College-educated adults tend to be less interested in drugs and dangerous behavior, and somewhat more likely to be married. These traits generally lead to law-abiding behavior.

Also, it is very expensive to live in Santa Clara County. If you're a criminal, you need to make a profit (for more on this topic, read Freakonomics and the chapter on why most drug dealers live with their mothers). Given that most criminal enterprises make their money from drugs and counterfeit goods, having a citizenry less interested in these illegal products leads to less crime. Criminals quickly realize they're better off doing business in areas with lower rents and less educated residents, where they can sell more drugs, more counterfeit goods, steal more personal info (ID theft), and engage in more extortion. In short, criminals are not exempt from the laws of business. Like everyone else, they tend to go where they can make the most money.

Ultimately, the police and firefighters' unions do Santa Clara County residents a disservice when they claim to be a primary cause of our safety. After all, that's their main argument for overly generous benefits--pay us off, and you'll be safe. Don't pay us off, and, well...who knows? Combine that arrogance and ignorance with Tasers and enough political power to dump a diligent independent auditor (Barbara Attard), and you've got a ready-made recipe for oppression, or at least government-sanctioned extortion.

Investors must realize that public sector retirement benefits are a stock market issue, not just a political issue. Continuing generous government benefits will affect stock market gains in several ways. First, public sector retirement plans aren't necessarily linked to the stock market--CalPERS, for example, can invest in hard assets, like timber and land, as well as other investments unavailable to ordinary people. (CalPERS controls around 239 billion dollars, and its investment decisions move markets.) Thus, having a separate, two-track retirement system allows government to invest taxpayer money with little regard for the retirement prospects of ordinary citizens. Consequently, while non-government investors must rely on an ever-increasing stock market to retire, public sector unions and their employees are not so inhibited. Not being similarly situated, they may take actions to inhibit corporate profits and, in turn, stock market gains.

In fact, there is no question that allowing government's generous retirement benefits will drain taxpayers, providing them with less discretionary income. General Motors (NYSE:GM) and Ford (NYSE:F) are cases in point. Like the United States, they have deficits and are losing money. Just like government unions, the UAW lavished their employees with generous retiree benefits during flush times. As a result, until 2007, a Ford employee's average hourly wage was $71.00/hour--but with only $29/hr going to actual wages. Around forty percent (40%) of the total hourly wage went to retiree benefits and health insurance programs. (See WSJ, 1/22/09, A12.) Meanwhile, foreign automakers pay around $49/hr to their employees and still manage to create better products and have better service. Basically, GM and Ford were made uncompetitive by their own unions.

Think about that: if the private sector--with its self-interested, sophisticated shareholders--couldn't restrict union health and retirement benefits to a manageable level, what chance does California have? After all, California's legislature is majority Democrat, and the Democratic Party tends to listen to unions because of their generous donations. If GM and Ford are any indication, California's state budget could end up allocating 40% of our taxes to government retiree/health benefits and still not produce a balanced budget or better service. Like Ford and GM, if the status quo continues, California will be made uncompetitive by its own unions and more efficient competitors. This status quo story won't have a happy ending--Ford and GM recently considered bankruptcy but were bailed out by the White House at the last minute. Although some California cities have filed for bankruptcy because of overly generous public sector benefits, an entire state has never declared bankruptcy before. Who's going to bail out a state if it goes bankrupt? Will we see the day when California has to offer a 25% interest rate on its bonds to attract investors?

Finally, generous government benefits create major misalignments of interest. For example, having two separate retirement systems--one for Joe the Plumber and another for Sally the Cop--allows the government potentially dangerous leverage against ordinary citizens. The day may come when CalPERS says, "If you don't give us what we want, we'll pull all our money out of the stock market, invest it someplace else, and you can kiss your 401(k)s goodbye." Sound implausible? Until recently, so was the idea that our federal government would give $700 billion to financial institutions without strict oversight. Also, don't forget that just ten years ago, banks like Citigroup (NYSE:C) looked ready to take over the world. Now, of course, Citigroup (C) sells for around $3/share and is looking for a bailout.

Citizens should develop an eye for non-violent oppression. An oppressive government doesn't need to lock you up or arrest you to control you--it just needs to take enough money from you to buy off politicians and pass laws favoring them over regular folks. Investors, both foreign and domestic, need to stop being calm about overly generous government benefits and take action.