Beneath The Business Tax

Palo Alto’s Real Problem—

Growing City Salaries and Benefits
In the heartland of America, our once mighty U.S. auto industry is close to collapse. The
reasons are many. But few things have contributed to Detroit’s death spiral as much as
management’s failure to control runaway labor costs. Generous pensions and retiree
health care benefits have been especially crippling. We can see clearly now that such
“defined benefit” costs are simply not sustainable.

Closer to home, the burden of “defined benefit” costs is weighing heavily on California’s
cities, counties, and school districts. Last year, a financial death spiral caught up with the
city of Vallejo. No longer able to find the funds to pay for the ever-more-generous salary
and benefit contracts that had been negotiated by past city managers, the city was forced
to declare bankruptcy.

Right in our own backyard, Palo Alto is facing the same kind of financial bind. The
city’s labor costs are ever-increasing, according to the terms of the “defined benefit”
contracts that were negotiated by city management years ago. Does this mean that Palo
Alto is on a one-way road to bankruptcy, like Vallejo?

Maybe not. The Palo Alto City Government thinks it can find the money to meet its
ever-increasing labor costs. It is proposing a business tax. This tax would be levied on
the gross income (before expenses) of businesses in Palo Alto.

How big is Palo Alto’s burden of ever-growing labor costs? It’s back-breakingly huge.
The following example can illustrate.

30-Year Base Cost of A Police Officer-About $6.5M.

Salaries and benefits comprise about 80%-85% of Palo Alto’s city budget. Labor costs
are growing faster than the cost of non-labor costs. Importantly, they are also growing
faster than the city’s revenue. These runaway labor costs are putting the city on a
collision course with insolvency.

The following graph shows the salary of a Palo Alto police officer, hired in 2008 at
$100,000, who receives a 5.5% raise for each of the 30 years of his/her employment, and
the pension payout for thirty years of retirement:
 Yearly Salary And Pension Of
Palo Alto Police Officer (30 Years Salary
+ 30 Years Pension)
$700,000

$600,000

$500,000
Yearly Salary

$400,000 30-Year Salary

30-Year Pension
$300,000

$200,000

$100,000

$0
08

18

28

37

43

53

63

73
20

20

20

20

20

20

20

20

With a yearly 5.5% pay increase, the minimum total base salary for the officer comes to
about $6.6M, for a 30-year working life.

30-Year Pension Payouts—Almost $16M.

Our public safety employees receive retirement pensions equal to 90% of their high
salary. So, since this officer will exit the Palo Alto Police force making $411,000—
his/her pension payout will start at $370,500 per year.

As the graph shows, the retired officer will be receiving more in his/her retirement
payouts than in his/her working pay. At age 81, the officer’s payout will be around
$670,000 yearly.

Total Lifetime Compensation—Over $22M.

The minimum lifetime compensation for this officer is:

Minimum Lifetime
Salary $6,643,885
Lifetime Pension $15,699,557
Minimum Lifetime
Compensation $22,343,442
The lifetime minimum salary, and pension (or deferred-salary), comes to about $22.5M.
With overtime and salary increases due to promotions, the lifetime total will become
much higher still.

Total Cost of Employment—Upwards of $30M.

Operational overhead, a new police building, new vehicle/equipment costs, payouts for
police misconduct and retirement health care and pension costs all add to the total cost of
employment. It would not be difficult to estimate that this hypothetical officer will cost
over $9M to employ, and could draw well over $16M in retirement payouts/benefits for
thirty years of service. All-in-all, it would appear that society is on the hook for
anywhere from $26M-$30M for total cost-of-services for each such officer in the future.

CalPERS Melt-down

Payment of public employees’ retirement benefits is officially the responsibility of

CalPERS (the California Public Employees' Retirement System). Yet our current
financial crisis has reduced the value of CalPERS’ pension fund by almost one-third of
its previous high value of only two years ago.

If CalPERS is unable to generate sufficient money to pay for the pensions of Palo Alto’s
public service employees, then the responsibility for making those payments passes to the
ultimate “employer of record”, That would be the city of Palo Alto.

CalPERS’ poor investment returns have recently required local governments, including
Palo Alto, to make sizeable contributions to fund retiree payouts. Recently, CalPERS has
warned state and local governments that their annual pension contribution could increase
by nearly a third — starting July 1, 2010, for the state and schools and July 1, 2011, for
local government agencies

With the Pension payouts growing at the rate shown in the graph above, it would seem
that CalPERS is racing toward an unavoidable financial train wreck.

Situation Not Sustainable

These public service labor costs are driving Palo Alto Government into ever deeper red
ink, which can only be turned black by cutting service levels and/or by finding new
sources of funds, such as the proposed Business Tax.

But if the city’s salary and benefits costs continue to be ever-increasing, then the new
business tax revenue would need to be ever-increasing, as well. Clearly, such a
“solution” is not sustainable.
A Real Solution: Salary/Pension Reform

The only way out of this quagmire is to terminate the system of uncapped salaries. The
City must view its labor force just like the private sector, determining what a job is worth,
and paying only for performance. There is no excuse for doubling the base salary of any
employee every 10-12 years—with no productivity gains to justify increased salary. The
current compensation scheme, which is seemingly based on “how much money the City
has in its coffers”, needs to be changed to align with the “salary cap” models of the
private sector—if not, then living in Palo Alto will be very difficult for people who are
not doctors, lawyers, company CEOs or public safety offices in the future. The State
must also tackle the issue of pension reform—given how out-of-control this system has
become.

The Palo Alto Business Community needs to take an active role in defeating this new
Tax, and to begin to demand more fiscal restraint on the part of the City in the future.

Wayne Martin is a long time resident of Palo Alto, who is keenly interested in limited,
common-sense, cost-effective government.

Wayne Martin
Palo Alto, CA
Email: wmartin46@yahoo.com
Youtube: www.youtube.com/wmartin46
Twitter:www.twitter.com/wmartin46

On-line Source:
www.geocities.com/wmartin46/msw_pa_business_tax_2.pdf
www.geocities.com/wmartin46/msw_ca_future_calpers_payouts.pdf

On-the-NET:

Pension Tsunami WEB-site:

http://www.PensionTsunami.com

How California Became France:

http://digg.com/d1khOs

CalPERS:
http://en.wikipedia.org/wiki/CalPERS

Gilt-edged Pensions:
http://www.forbes.com/forbes/2009/0216/078.html

When City Hall Goes Bust:

http://www.forbes.com/forbes/2009/0216/078a.html
CalPERS 2008: Down $60 Billion.
http://sacrealstats.blogspot.com/2009/01/calpers-2008-down-60-billion.html

CalPERS warns of rate hike

http://calpensions.com/2009/01/12/calpers-warns-of-rate-hike/
On-the-NET (Con’t):

CalPERS Took Huge Gamble At The Worst Time:

http://www.sacbee.com/business/story/1515220.html

Center For Retirement Research:

http://crr.bc.edu/

The McCauley Public-Employee Pension Reform Act (08-0018):

http://ag.ca.gov/cms_attachments/initiatives/pdfs/i793_08-0018_a1s_initiative.pdf
pmcca28169@aol.com

San Diego's city pension fund loses $789 million:

http://legalnewsline.com/news/216856-san-diegos-city-pension-fund-loses-789-million

Daniel Borenstein: Guide to bad pension policy

http://www.contracostatimes.com/danielborenstein/ci_12265599?nclick_check=1