MOORLACH UPDATE — Governor’s Budget — January 16, 2011

Cathy Taylor, the OC Register’s Editorial Page Director invited me to opine on Governor Brown’s budget proposals released this past Monday.  It is expected to be in Sunday’s OC Register Commentary section, but it is already up on their website, so you get an early peek.

Trying to provide a response within 850 words is very difficult.  So many of the main themes I’ve hit are also being addressed by other pundits.  The thoughts I wanted to convey are:

1.       The pain is not being shared equally;

2.       Realignment works if the expenses pushed down to the local level are equally matched with revenues (which, consequently, doesn’t really solve Sacramento’s systemic problems);

3.       To get Republican buy-in, propose tax rate reductions instead of maintaining the historically high current tax rates; and

4.       Address the pension plan unfunded liability problem.

Yesterday I attended the swearing in ceremony of Sheriff Sandra Hutchens.  The OC Register had a photographer there.  I have been extremely pleased with her job performance since her appointment and enjoyed the event.  I did bump into an old friend from my C.P.A. practice days, Andy Pitchess.  I believe that’s who I was talking to before the start of the proceedings when the photo below was taken.  When Andy and I were assisting a mutual client, I did not put it together that he was the son of former Los Angeles County Sheriff Peter Pitchess.  Since getting involved in this career change, Andy, and his brother John, introduced me to their wonderful father and we enjoyed a number of fun get-togethers.  As history would have it, Sheriff Hutchens would mention in her remarks that Sheriff Peter Pitchess swore her in as a new officer at the beginning of her public safety career.  A small world, indeed.   

The second photo below shows the family in the first row.  I sat behind Sandra’s mother.  It’s a bonus photo to help you.  If you’re ever looking for me in a crowd, it shouldn’t be too difficult to find me.

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Orange County Supervisor John M. W. Moorlach is seen before Orange County Sheriff Sandra Hutchens is sworn in for her first four-year term at the Orange County Sheriff’s Training Academy in Tustin on Friday, January 14, 2011.

ANA P. GUTIERREZ, FOR THE ORANGE COUNTY REGISTER

John Moorlach: Budget pain overlooks schools, pensions

By JOHN M.W. MOORLACH

Orange County supervisor, 2nd District

The day after his inauguration, Gov. Jerry Brown walked over from the Capitol to the California State Association of Counties office. He reached out to county leaders and said one of his solutions to the state budget crisis would be to move more of the government services to the local level. The governor made it very clear that he would work with those actually delivering the state’s services. One week later he released his budget proposal. As a county supervisor, I applaud the governor for including us in his effort to reform and restore our state.

The big pills he wants the voters to swallow are the continuance of recent temporary tax increases for the next five years and major cuts to services to the poor and underprivileged. While proposing to realign more services to counties, he pays lip service to dramatically underfunded government employee pension plans.

"Government will be closer to the people," Brown said Monday. With realignment, Sacramento gives the counties the work (mandate) and a revenue source to fund the costs. Usually this has been sales taxes, as with Proposition 172 in 1993 to fund local public safety, or vehicle license fees (or backfills of same) to fund services like segments of Probation Department budgets.

Realignment is good, but volatile variable income sources are difficult with ever-increasing fixed costs. Recently the county of Orange had to reduce its welfare eligibility workforce because of a drop in sales tax revenue but still had to maintain a minimum response level of 90-plus percent for new applications within a specific timeframe – a difficult assignment when the welfare rolls are expanding. Orange County was within the range, but recently lost a lawsuit (Blackstar v. Orange County) because the judge felt the county should have been closer to 97 percent. Consequently, the county had to pay for the additional legal costs.

If the governor wants to give us more work, the county will do it, but the governor must provide the necessary financial resources.

Increasing tax revenue is best done, in this conservative’s opinion, by reducing tax rates and, thereby, increasing volume. Raising or maintaining a historically high sales-tax rate is counterproductive.

The governor instead should be counterintuitive; reducing the sales tax rate from 8.75 percent to 7.75 percent may generate an additional 5 percent in revenue. This would give the state an additional $1.2 billion. As our economy is expanding, potential revenue may even increase by 10 percent, or $2.4 billion.

If reducing the state’s income tax rates by 11 percent did the same, look for another $5 billion in revenue. This phenomenon, known as the Laffer Curve, works – even more so at the inception of an economic recovery in a high-tax state – providing stimulation that may also slow down the migration of Californians to Texas.

Reducing expenses is a no-brainer, but very difficult. Counties and cities have been making layoffs, but the state has not. Leaving K-12 education alone in his budget plan smacks of undue influence on the governor by certain unions. A pay cut can be a great variable-expense solution, but altering fixed expenses is needed at this time.

Addressing fixed expenses can be done by renegotiating the fiscal mess created by Senate Bill 400, which authorized a 50 percent increase in public employee pension benefits and made them, supposedly, retroactive to the date of hire. This created a $50 billion loan with a 7.75 percent interest rate for taxpayers to pay off.

Gov. Brown should negotiate pension rollbacks. Government in-house attorneys will tell you that pension formulas can be increased but not decreased, I understand their bias, but I believe they are wrong. Pension formulas are a two-way street, and this should be explored, and quickly. What goes up can, and must, come down.

A fully funded defined-benefit pension plan will become two-thirds funded once the benefits are increased by 50 percent. If the benefit formulas are reduced by one-third, a good portion of the unfunded liability is eliminated. The fly in the soup is the egregious granting of the retroactive component. The Second District Court of Appeal will look at this money grab this month when it hears the county’s lawsuit on the matter.

With the annual contribution requirement to the California Public Employees Retirement System at nearly $4 billion – and climbing – a one-third cut would replace one-twelfth of the spending cuts our new governor is looking for. If you add the California State Teachers Retirement System and the UC Board of Regents’ pension plans, we would be closer to one-sixth of the goal. If Gov. Brown is trying to sell continued higher taxes, he should provide balance by showing that public employees are also interested in their employer’s survival.

Continued high tax rates, cuts to the poor, realignment and no pension reform are ingredients that will not make the stew turn out as well as it should. But, if you want everyone to share the pain, that should include K-12 education and public employee pensions.

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Hutchens’ family members are seen as elected Orange County Sheriff Sandra Hutchens is sworn in for her first four-year term at the Orange County Sheriff’s Training Academy in Tustin on Friday, January 14, 2011.

ANA P. GUTIERREZ, FOR THE ORANGE COUNTY REGISTER

FIVE-YEAR LOOK BACKS

January 16

2001

The 16th of January, 2001, was the Tuesday after Martin Luther King Day.  It would also be the beginning of a wild ride for me, as the County’s Treasurer, dealing with the energy crisis facing the state’s utilities.  At that point in time, the utilities were paying very high spot market prices for natural gas to power their generating facilities.  The County owned two pieces of parent company Edison International short-term paper.  David Evans of Bloomberg News, got that fact correct in his article, “Orange County Says California Must Help Utilities.”  Fitch incorrectly told the world that the County owned Southern California Edison, a subsidiary, and downgraded the County’s Investment Pool rating.  Standard & Poor’s and Moody’s, the two other rating agencies, did not lower the ratings of investment pools holding Edison International.  Fitch overreacted and made severe technical errors.  When you hear the name “Edison,” it would be smart to ask if it is the parent or a subsidiary. 

This particular Tuesday would be an interesting ride in real world crisis management.  It can be quiet interesting when you are the victim of several layers of human errors.  Let me jump to the conclusion:  The County did not lose one red cent on its Southern California Edison holdings.  In between this particular Tuesday in January and the date the second piece was paid off, I enjoyed an amazing education.  You’ll get a taste from the Look Backs during the first seven months of this year.

                John Moorlach, treasurer of Orange County, California – the site of the biggest municipal bankruptcy in U.S. history – said the state should help its power companies, Southern California Edison and Pacific Gas & Electric, avoid a similar fate.

                “There should be some social responsibility by the state to ensure a solution to this crisis,” said Moorlach, who was elected treasurer after the bankruptcy.  Moorlach had warned that his predecessor made risky investments.

                Moorlach also has money at stake.  The $1.126 billion educational investment pool he manages for 31 school districts in the county owns $40 million in debt issued by Edison International, the parent of Southern California Edison, which totally defaulted on $230 million of notes.

The debt Orange County bought matures on Jan. 31 and July 18.  It is part of billions of dollars of bonds, notes, commercial paper and bank loans the two companies have outstanding.  PG&E has $11.3 billion of short- and long-term debt, according to a Sept. 30 filing.  Edison International has $15.8 billion of short- and long-term debt, according to its third-quarter filing.

Moorlach said the investment in Edison, which amounts to 3 percent of the fund’s total, prompted Fitch to lower its credit rating on Orange County’s educational investment pool to “AA” from “AAA.”  Earlier today Fitch lowered its ratings on the power companies’ commercial paper debt.

“We bought these when they were top grade investments,” Moorlach told Bloomberg News.

Standard & Poor’s Corp. (sic) today its ratings on Edison and Pacific Gas to junk levels.  Thirty six days ago, both companies enjoyed “A” credit ratings.

The utility units of Edison and PG&E Corp. have said they will run out of money by Feb. 2 and may file for bankruptcy.  The have run up $11.5 billion in debt buying electric power for more than they are allowed to sell it to consumers under California’s deregulation law.  Lawmakers are considering legislation that would allow the state to buy power for the utilities.

Moorlach said the situation reminded him of the Orange County bankruptcy in December, 1994.  The county filed for bankruptcy after losing $1.69 billion in an investment pool managed by former treasurer Robert Citron.

Moorlach said California utilities are victims of a flawed deregulation plan.  “They were forced into selling power at a fixed price even as their power costs shot up,” said Moorlach.  “Their only mistake was not lobbying thoroughly enough” for a better deregulation plan.”

The result has left the state facing the threat of blackouts.  The state Independent System Operator, which runs the transmission system that delivers 75 percent of California’s electricity, said it may have to rotate outages among power users to avoid a shutdown.

The Orange County Treasurer said he hopes the utility companies can avoid bankruptcy.

“With no leadership, bankruptcy court was the only place for us to go,” he said.

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