In this video interview, former Los Angeles Mayor Richard Riordan predicts that Los Angeles will be unable to meet its obligations to former and current employees within two to three years and will be forced to declare bankruptcy. He urges city leaders and employee representatives to make tough choices to reduce costs. And he calls on the city to attract business and spur employment.
In the brief interviews below, UCLA Anderson faculty offer suggestions for ways that Los Angeles can mitigate the problem. One point of agreement is that the city's future is closely tied to the recovery of the U.S. economy.
How Can Los Angeles Avoid Bankruptcy?
Dan Mitchell Notes Three Options for Cutting Labor Costs
"The crisis today in Los Angeles is that more was promised to employees than was contributed into the retirement and healthcare programs. You can't reduce benefits for those who have already retired. That's a legally binding obligation. But you can consider moving current and future employees to a less costly plan. It can still be a defined benefit plan, but with lower payments for years of service, age and so on.
"Or you can move to a defined contribution model going forward. These are basically tax-preferred savings plans. The employee usually has some say in how the money is invested. If you do well, the money grows enough to finance your retirement. If things don't go so well, then maybe you aren't going to do so well in retirement. The risk is on you. This is like 401k programs in the private sector.
"Another option is to raise the employee contribution to existing plans. Or you can have some combination of these solutions.
"How do you get there? Most organizations have collective bargaining contracts and there are various rules and procedures for how you go about negotiating. But you come to some agreement with the public sector labor unions about how this is going to be done. There have also been efforts to control spending at state and local levels through ballot measures. We could see some activity there -- but it might be best to quietly negotiate a settlement and keep it out of the political realm.
"In the 1990's, Orange County went bankrupt and it was a very costly process. It's full employment for lawyers. It also makes it very difficult if you ever need to go back to the credit market. You're going to pay a premium for credit. So both the direct costs and future costs discourage local governments from declaring bankruptcy. The City of Vallejo in the Bay Area declared bankruptcy during the recent downturn and people have noted how costly it was."
David Lewin Suggests User Fees
"Los Angeles will need to do some of the things that many other state and local governments are doing such as raising the retirement age, moving from defined benefit plans to defined contribution plans, increasing employee contributions to health care and changing the formulas for determining retirement benefits, including eliminating overtime pay from base earnings that are used for calculating benefits.
"A few months ago, several city unions representing some 40 percent of the city's employees, mostly people in low-paying occupations, formed a coalition and negotiated new agreements with the city that raised their contributions to pension and health care costs from about six percent to over 11 percent. These changes will affect the current workforce, not just new employees. This puts a stake in the ground for future labor-management negotiations.
"One other thing I would mention, but the city can't do this alone, is user fees. Other parts of the country have masses of toll roads and this has been the source of lots of revenue for lots of governments. Another option is to add a local surcharge of perhaps $.25 per gallon at the gas pump. Given the volume of traffic in Los Angeles, that initiative could have a substantial deficit reduction effect.
"You can also look at new local taxes, but user fees are preferable because they introduce the price system and people can make choices. That would be simple and straightforward, without changing tax codes or pension formulas.
"What we really need is more rapid economic growth and more employment. When you put people to work, they are earning and paying taxes. And if stock markets rise, things could look much brighter for the funds invested in retirement plans."
Romain Wacziarg Says Economic Growth is Needed
"There are two solutions to avoid bankruptcy. One is raising revenue and the other is cutting spending. Finding new sources of revenue is extremely difficult because L.A. is already losing its manufacturing base and it is losing people and businesses. So the only option is to cut services, a very painful option. L.A. has a huge budget and I think that's the only way it can sustain itself in the long run. Nobody likes to enact cuts to police and fire departments, libraries, welfare programs and things like that, but that may well be necessary to restore fiscal soundness.
"However it's not entirely clear that it is desirable to avoid bankruptcy. You need to understand what bankruptcy is. Bankruptcy is when you have a big stack of debt that you are no longer able to service. There's a bankruptcy judge who decides the priority level of the claims that are on a city and who will be repaid first or at all. Bankruptcy is not liquidation. It's not like there's not going to be a government or that public services will cease. Bankruptcy is like an orderly default. You might be better off going into bankruptcy rather than having to repay all this debt. However you still have to address the imbalance between expenditures and revenues going forward, which is not in itself affected by default.
"Santa Monica raised its sales tax by a half point. Los Angeles could do that but you would see businesses and people leave. It's tough.
"Ultimately the only thing that will really help is if we have an economic boom so the tax base rebounds, property values go back up and people start spending money again. You can undo really bad things quickly with a little bit of economic growth."
Jerry Nickelsburg Says the City Must Attract Business and Encourage Growth
"Most major cities in California have some long-term structural problems related to their pension and entitlement programs, and Los Angeles is no different. Pensions and entitlements definitely need to be re-examined to ensure they are sustainable, both for the benefit of the city and the benefit of their employees.. But a re-examination followed by a restructuring as required is very different than suggesting that bankruptcy is imminent. We are currently at the end of a deep recession and the beginning of a recovery and extrapolating from the current revenue shortfalls to future bankruptcy assumes that the economic recovery is going to leave Los Angeles behind. The evidence is to the contrary. The only question is how fast and how much revenue will that growth generate?
"Improvements in taxes, infrastructure and services are the essential ingredients in accelerating Los Angeles' economic growth. For example, the city needs to ensure its tax structure is competitive with neighboring cities. Differentials in taxes and tax rates may discourage growth because businesses can choose to locate in a lower tax jurisdiction and still retain the benefit of locating in greater Los Angeles.
"On the infrastructure front there is currently work going on to make the ports more competitive and enable them to increase traffic when demand dictates. There is also infrastructure development at the airport, including the substantial construction and expansion of the Tom Bradley West International Terminal. In addition, the mayor has proposed a new funding source for re-paving a third of the city's roads and the city is implementing an acceleration of public transit construction. So, there is extensive infrastructure work in process, which will contribute to making Los Angeles a more attractive location for economic activity and to alleviating some of the current fiscal stress.
"The ability of the city to reform pensions and the tax structure, to foster additional infrastructure construction and maintain an appropriate level of city services will be the key to fiscal strength in the future. While none of the current or required initiatives are certain to be successful, an overall strategy to foster growth will generate the revenue required. Thus, the notion that Los Angeles will be bankrupt is predicated on a prediction that the city will be unable to manage itself and its future growth, and the evidence that this is the case appears to be weak at best. Such a prediction does, however, present a warning as to what might happen were the very real challenges the City of Los Angeles faces to be ignored."
