How do you solve a problem so vast that it's practically immeasurable?
That's the question the Palo Alto City Council continues to struggle with when it comes to the city's pension liabilities, a fluctuating burden that by most estimates ranges somewhere between $300 million and $800 million. During budget discussions in May, members of the City Council characterized it as the city's most massive budget issue, with Greg Tanaka saying the total owed to future retirees "dwarfs everything else by a lot."
The current city budget pegs the pension liability to be at about $330.1 million, though many expect it to rise steeply in the coming years. The California Public Employees' Retirement System (CalPERS), the massive public fund that manages the city's pension and health benefits, has recently decreased the expected rate of return from its investment portfolio from 7.5 percent to 7 percent, a change that will be phased in over three years starting in fiscal year 2019 and that will further accelerate the city's already rising pension costs.
To brace for the looming pension storm, the council has been pursuing two strategies: having employees pick up a greater share of pension contributions and creating what's known as an IRS Section 115 Pension Trust Fund to offset major fluctuations down the road.
On Monday, the council will address the former when it amends its contract with CalPERS. The new agreement calls for all bargaining units in the public-safety departments (which includes the Palo Alto Police Officers Association, the Palo Alto Police Managers Association, the International Association of Fire Fighters and the Palo Alto Fire Chiefs Association) to pick up 3 percent of the employer pension contribution as of fiscal year 2018.
For the roughly 600 workers represented by the Service Employees International Union, Local 521, the share of employer contribution they would have to pay would start retroactively at 0.5 percent as of Dec. 1, 2016, and then increase to 1 percent as of Dec. 1, 2017. The "management and professionals group" of about 200 employees is expected to adopt a similar arrangement after the SEIU deal is approved by CalPERS this fall.
The approach is a reversal from Palo Alto's traditional practice in which the city covered both its own and employees' CalPERS contributions. The burden began to slowly shift during the 2009 economic downturn, when a shrinking budget and growing expenses prompted the council to pursue new agreements with its labor groups so that employees would pay their own share of the costs and, ultimately, a small portion of the city's. The contracts included tiered pension plans, with new and recently hired employees belonging to a tier with less generous benefits.
In June, the council approved a budget that calls increases to employee contributions "an important tool to help the City contain pension costs." But even so, no one expects the Monday action to change the underlying problem. Collectively, the higher employee contributions are expected to lower the city's annual pension costs by about $1 million (from about $24.6 million to $23.6 million) -- hardly a panacea for a problem that continues to grow thanks to CalPERS' revisions.
For the council, shrinking the pension liability is among the most pressing and challenging priorities. And for Councilman Eric Filseth, chair of the council's Finance Committee, it is a problem that is gradually becoming less abstract and more tangible, with real impact to residents.
Just before the council adopted its budget on June 27, Filseth observed that the city's public pension and health liabilities are both growing much faster than revenues. The budget included an additional contribution to the Section 115 fund, raising its balance to $3.5 million.
"We've known for some time that eventually those liabilities would start to impact our regular operations, competing for dollars with aquatics, safety, tree trimming and all other things we spend time on," Filseth said. "That time has arrived. Just like with credit cards, as our overall liability grows, the minimal payment also grows."
In addition to creating the pension trust and reaching new agreements with labor, the city is also pre-paying the entire annual employer-contribution amount -- a practice that the city expects to save $813,000 in the current fiscal year (which began on July 1).
While these steps have had some impact, overall pension costs continue to rise. This year's budgeted $23.6 million is an increase of 11.4 percent (or $2.43 million) over 2017. This contributed to the broader trend of rising employee costs: In the General Fund, salary and benefit costs have gone up by 8.1 percent or $9.4 million, between the 2017 budget and the newly adopted one.
Tanaka believes the city should go even further in addressing the liability problem. As a member of the Finance Committee, he has repeatedly advocated for reducing employee costs and during the budget adoption, he voted against both the new public-information officer position (the only new position in the General Fund) and against a plan to retain a position in the Office of Sustainability. Both proposals sailed through despite his objections.
He also argued that the city should be more explicit in both articulating the pension problem in its budget documents and coming up with solutions.
"We're chipping away at $3.5 million a year, but it's such a small amount and such a big debt," Tanaka said at the June 27 meeting. "We are putting in such a relatively small, minimal payment that I don't think we're doing justice to our constituents or retirees.
"It's important that we realize that there is a part of our budget that's not accounted for -- the unfunded liability."