San Diego's Tough-Love Pension Proposal

After San Diego voters rejected a budget-balancing half-cent sales tax increase last month, Mayor Jerry Sanders unveiled what he calls a radical idea: He'll ask voters to eliminate the city's traditional defined-benefit pension plans for new employees, offering them 401(k)-like savings accounts instead. "We saw the private sector go through this," the 60-year-old Republican says. "Government will have to relook at how we do stuff as well."

Falling tax revenue and poor pension fund investment returns have put a squeeze on cities from New York to San Jose. Many are cutting services and laying off employees to meet rising retiree costs. States are struggling, too; Illinois may even issue bonds so it can make pension fund contributions. The pressures may lead more mayors to explore the 401(k) option. "This approach will certainly receive some attention," says Christopher Hoene, research director for the National League of Cities.

There are already signs investors are growing weary of cities' weakening finances. Interest rates on top-rated, tax-exempt bonds have risen by nearly one-third since September. Cities may have more trouble borrowing under legislation proposed on Dec. 2 by Republican Representatives Devin Nunes (Calif.), Darrell Issa (Calif.), and Paul Ryan (Wis.). Their bill would bar cities and states from issuing tax-exempt bonds if they don't use more conservative return projections that could result in higher estimates of pension liabilities. "Lucrative pension promises are being made to public employees that taxpayers simply cannot afford," Nunes said in a Dec. 2 statement.

Defined-contribution plans such as 401(k)s, where employees bear the risk of poor investments, are a rarity in the public sector. Only 17 percent of government workers have such accounts, about one-third the number in the private sector. Says Chuck Reed, the mayor of San Jose, which is also considering cutting pension benefits to new employees: "San Diego is the leader, the bleeding edge."

America's ninth-largest city, with nearly 1.3 million people, San Diego earned the nickname "Enron by the Sea" in 2004 for a pension fund scandal that led to the resignation of its mayor and a half dozen city officials. Sanders, who had retired as the city's police chief, was elected in a special 2005 contest. The following year the city settled Securities and Exchange Commission charges that it had committed securities fraud by underreporting pension liabilities.

Even after closing a $179 million deficit this year, San Diego faces a $72 million budget gap for the fiscal year beginning July 1 and has a $2.1 billion unfunded pension liability. The city has trimmed costs by eliminating 1,400 of its 11,000 employee positions, closing some public restrooms at the beach and ending police horse patrols in scenic Balboa Park. Sanders says his proposal will save the city money, though he doesn't have an estimate yet.

Sanders is hardly a rebel, though he has surprised voters before. Three years ago, in a tearful news conference, he said he would no longer oppose gay marriage, revealing that his adult daughter, Lisa, is gay. "He's a bridge builder," says Brian Adams, a political science professor at San Diego State University. "He's trying to find some sort of consensus way out." Michael Aguirre, a Democrat and former city attorney, questions whether the mayor is going far enough. The city should declare bankruptcy and then renegotiate current employee contracts in court, he says.

Others criticize Sanders for excluding police and firefighters from the 401(k)-like plans on grounds that it'll hurt recruitment. After 26 years as a police officer, he collects a $90,000 city pension on top of his $94,000 mayoral salary. "He's the ultimate double-dipper," says Steven Kreisberg, director of collective bargaining at the American Federation of State, County, and Municipal Employees. The mayor notes that his current salary is not counted toward pension benefits. Michael Zucchet, general manager of the 4,000-member San Diego Municipal Employees Assn., says the measure, which could come up for a vote as early as 2011, is unnecessary. He says the city has already eliminated retiree health-care coverage, reduced its maximum pension payouts, and cut in half pension fund contributions for new employees. "We've been cutting for five years," Zucchet says.

The bottom line: With pension costs soaring in San Diego, Mayor Jerry Sanders wants voters to approve a 401(k)-like plan for city workers.

    Before it's here, it's on the Bloomberg Terminal.