Concession Bargaining

This is our analysis of the Governor’s May Revision proposal to (1) not fund scheduled pay increases to state employees established in ratified labor agreements and (2) authorize the Department of Finance (DOF) to impose reductions to employee compensation if collective bargaining agreements to achieve savings are not in place by July 1, 2025. Before discussing the specifics of the Governor’s proposal in this analysis, we provide background information on the major components of state employee compensation, past strategies the state has used to reduce employee compensation costs in both the short and long term, and the collective bargaining process. We provide comments on the Governor’s proposal and ultimately recommend that the Legislature reject the Governor’s proposed control section language. Further, we recommend that the Legislature ask questions to better understand the administration’s proposal and to determine how—or whether—reductions in employee compensation meet legislative priorities. If the Legislature concludes that reductions in employee compensation are necessary, we make recommendations about how to structure budget bill language authorizing such a reduction in a way that would preserve legislative priorities.

Background

Elements of State Employee Compensation

The compensation earned by a state employee varies as the result of a number of factors, including the type of job that they do for the state, where they work, the date they were hired, special skills they possess, and the bargaining unit that represents them in the collective bargaining process. Despite these differences, there are three consistent, major elements of compensation that we discuss below—salary, salary-driven benefits, and non-salary-driven benefits.

Salary. State jobs are categorized into more than 4,500 specific classifications. Each classification establishes the minimum qualifications necessary for the job and the salary ranges available to employees in the classification. The salary range has a minimum step and a maximum step (also referred to as a top step) with intermediary steps in-between. Employees who are not at the top step of their job classification’s salary range may be eligible for a merit salary adjustment (typically 5 percent) in each year that they meet certain expectations, until they are at the top step of the range. For rank-and-file employees, salary increases (on top of merit salary adjustments) typically are negotiated at the bargaining table. The administration also has authority—subject to appropriation—to provide pay increases to employees excluded from the collective bargaining process (generally, managers and supervisors). In 2022-23, the state paid $25.5 billion (all funds) towards employee salaries.

Salary-Driven Benefits. A salary-driven benefit is a benefit whose value is, at least in part, dependent on an employee’s salary. We discuss the major salary-driven benefits below.

Pension. Most state employees earn a pension. The pension that an employee receives in retirement depends on the pension formula they earned during their career. The specific pension formula that an employee earns depends on their job and when they were hired. Although pension benefits earned by state employees vary significantly, each pension formula is similar in that the pension received by a state employee in retirement depends on (1) their final salary level, (2) their age upon retirement, and (3) the number of years of service they have earned before retirement. The California Public Employees’ Retirement System (CalPERS) determines how much money must be contributed each year to fund the pension benefit. There are two components of the total contribution to CalPERS. The first is payment towards the “normal cost,” which is the amount of money that actuaries determine (based on actuarial assumptions like expected investment returns on assets) must be contributed to prefund the benefit earned by employees today. The second is payments towards the “unfunded liability.” An unfunded liability exists when actuaries determine that there are insufficient assets to fully fund the benefit earned by employees in the past. Unfunded liabilities typically occur either because experience fell short of actuarial assumptions (for example, investment returns were lower than assumed) or changes in assumptions. The share of normal cost and unfunded liability paid by the state and employees is determined in statute and collective bargaining agreements. It is set as a percentage of pay. While payments towards normal cost are shared by employees, the state generally is responsible for any payments towards the unfunded liability. In 2022-23, the state contributed $7.2 billion (all funds) towards employee pension benefits.
Social Security and Medicare. Not all state employees earn Social Security benefits. Notably, peace officers and firefighters do not earn these benefits. Most state employees earn Medicare. The benefit levels and employer and employee contributions towards Social Security and Medicare are determined by the federal government. In 2022-23, the state contributed $782 million (all funds) towards Social Security and $323 million (all funds) towards Medicare. These payments also are set as a percentage of pay.

Non-Salary-Driven Benefits. Unlike salary-driven benefits, salary plays no role in determining the value of non-salary-driven benefits earned by employees. The most common type of benefits in this category, like those described below, are insurance plans.

Health Insurance. CalPERS administers the state’s health plans and negotiates with providers to establish plan premiums each year. The share of these premiums paid by the state varies by bargaining unit and is established in collective bargaining agreements and statute. The most common arrangement is called the “80/80 formula” where the state pays a dollar amount up to 80 percent of an average premium for the employee and 80 percent of an average for any additional premiums for dependents. There are three tiers of health premiums—individual, two-party, and family coverage. In 2022-23, the state contributed about $2 billion (all funds) towards employee health premiums.
Dental and Vision Insurance. The state pays the full premium cost for basic dental and vision benefits. The cost depends on whether the state pays for single, two-party, or family coverage. In 2022-23, providing dental and vision benefits to state employees cost the state $98 million (all funds).
Retiree Health Benefits. The state pays a portion of CalPERS health premium costs for eligible retired state employees. The state’s cost depends on (1) when the employee was hired, (2) the employee’s number of years of service, and (3) whether or not the employee is eligible to enroll in Medicare. In 2022-23, the state paid about $2 billion (all funds) towards retiree health premiums

Past Policies to Provide Immediate Budgetary Relief

Employee compensation is a significant cost, constituting more than one-half of General Fund state operations costs. To address past budget problems or anticipated budget problems, the state has used a number of strategies to reduce employee compensation in a way that provides immediate budgetary relief to the state. We describe some of these past strategies below.

Reducing Salary Costs. The below policies were implemented in the past to reduce state salary costs to help address an existing or anticipated budget problem.

Furloughs. Furloughs (also known as Personal Leave Programs or PLP) are possibly the tool most often used by the state to reduce state employee salaries to address a budget problem. Since 1992-93, furloughs have been used in nine fiscal years (1992-93, 1993-94, 2003-04, 2008-09 through 2012-13, and 2020-21). Furloughs typically reduce state employee pay by roughly 5 percent for every day-per-month of furlough. In addition to reducing salary costs, the state also realizes other (mostly short term) savings from furloughs because the lower salary also decreases state contributions towards benefits funded as a percentage of pay. Though furloughs provide immediate savings, they increase long-term state liabilities in the form of higher leave balances and by systematically underfunding pension benefits because, though the pension earned by state employees continues to be based on the full salary, the state’s contribution to the pension is based on the reduced pay level.
Delay Scheduled Pay Increases. There are four major types of pay increases: General Salary Increases (pay increases that apply to everyone in a bargaining unit), Special Salary Adjustments (pay increases that apply to select members of a bargaining unit, typically applying to specific classifications), top step increases (pay increases only for employees at the tops step of their salary range), and pay differentials (pay increases for specific circumstances, like work site location, language skills, or education attainment). For rank-and-file employees, labor agreements establish the effective date and types of pay increases received by employees over the term of the agreement. The administration most often extends pay increases agreed to at the bargaining table to excluded employees affiliated with the bargaining unit. One strategy the state has used in the past, most recently in 2020-21, is to delay or suspend these scheduled pay increases.

Increasing Pension Costs to Employees. The state’s contributions to Social Security and Medicare are established under federal law. Accordingly, of the major types of salary-driven benefits, the state only can change its contributions towards pensions. That being said, because CalPERS determines the total contributions that must be made to the pension system, the state cannot reduce its contributions towards pensions without increasing the contributions made by state employees. Typically, when the state has shifted pension contribution costs to employees, it has been done at the bargaining table—and codified in law—following a statewide policy direction. There have been two recent efforts of the state to shift a larger share of normal cost onto employees. In 2010-11, the state made changes to pension formulas for future hires and increased contribution rates for existing employees. For example, see the 2010 agreement with Service Employees International Union, Local 1000 (Local 10000), which increased employee contributions from 5 percent of pay to 8 percent of pay and reduced pension benefits for future hires. In 2013, under the Public Employees’ Pension Reform Act (PEPRA), the state established a standard that state employees would contribute one-half of the normal cost of pension benefits and adopted a new (lower) pension benefit for new state employees. These provisions of PEPRA were ratified in labor agreements and codified in law.

Shifting Health Premium Costs to Employees. To reduce state costs in the past, the state periodically has reduced the share of CalPERS health premiums that it will pay. This effectively shifts a larger portion of health premium costs onto employees. An example of the state doing this was in 2006 when the state and California Statewide Law Enforcement Association agreed that the state would reduce its contribution towards health premiums of employees represented by Bargaining Unit 7 from the “85/80 formula” to the less generous 80/80 formula.

Past Policies to Reduce State’s Long-Term Costs

Reduced Pension Benefits for Future Employees. Reducing pension benefits for future hires, as was done in 2010-11 and under PEPRA, creates a significant long-term fiscal benefit to the state but has little short-term benefit. (However, increasing employees contributions towards those benefits does provide immediate state savings.)

Matching Employer and Employee Contributions to Prefund Retiree Health Benefits. Prior to 2015-16, the state made no regular contributions to prefund retiree health benefits. Beginning in 2015-16, the state began implementing through the collective bargaining process a statewide change in its retiree health benefit that (1) required the state and employees each to contribute one-half of the normal cost of retiree health benefits and (2) reduced the value of the benefit for future hires. Although retiree health benefits are not a salary-driven benefit, the state and employee contributions to prefund the benefit were established in collective bargaining agreements and codified in law as a percentage of pay. The employee contribution ranges from 1.4 percent of pay to 4 percent of pay. In the short term, initiating a retiree health prefunding arrangement increased state costs; however, over the next several decades, this policy should result in significant savings to the state as the prefunding contributions are invested and compound interest that can be used to offset future state payments towards retiree health premiums. (Although employees began to pay a share of the costs, the state provided salary increases to offset the reduction in take home pay. As such, the state did not realize immediate savings.)

Collective Bargaining

Ralph C. Dills Act. Collective bargaining between the Governor and the state’s rank-and-file employees (organized into 21 bargaining units) is governed by the Ralph C. Dills Act (Dills Act). The product of negotiations at the bargaining table is a labor agreement referred to as a memorandum of understanding (MOU). The MOU establishes the terms and conditions of employment for employees represented by a particular bargaining unit. As part of the MOU, the parties agree to the duration of the agreement. Under the Dills Act, the provisions of an expired MOU generally remain in effect until a successor agreement is reached between the parties. Under the Dills Act, an MOU does not go into effect unless it is ratified by both the Legislature and the members of the union representing the affected bargaining unit. In addition to MOUs, the parties might agree to other types of labor agreements—including side letters and MOU addenda—that address specific issues. The legislative review process for these other types of labor agreements is established in budget bill language under Item 9800.

Item 9800. The economic provisions of a ratified MOU—meaning provisions related to compensation—must be funded in the annual budget act in order to go into effect. As such, the Legislature can choose in any year not to fund elements of compensation established in ratified MOUs. Under the Dills Act, if the Legislature does not fully fund the economic provisions of an MOU two things occur: (1) the unfunded provision does not go into effect and (2) either party—the administration or the bargaining unit—may reopen negotiations on all or a part of the MOU. In the budget act, the Legislature approves augmentations to employee compensation—including funding economic terms of ratified MOUs—under Item 9800. Item 9800 declares that it is legislative intent to “reject any proposed augmentations that are not included in [Item 9800].” If the Legislature does not include funding for an economic provision of a ratified MOU under Item 9800, the Legislature’s action prevents that provision from going into effect and reopens the agreement.

Most Bargaining Units Have Agreements in Effect. Of the state’s 21 bargaining units, 14 have agreements that will be in effect through 2025-26. These bargaining units include the nine units represented by Local 1000 (Units 1 [administrative, financial, and staff services], 3 [professional educators and librarians], 4 [office and allied], 11 [engineering and scientific technicians], 14 [printing and allied trades], 15 [allied services], 17 [registered nurses], 20 [medical and social services], and 21 [educational consultants and library]) as well as Units 5 (highway patrol), 7 (public safety), 8 (firefighters), and 10 (professional scientists). The provisions of the MOUs with these bargaining units would provide employees in each of the units some form of salary increase in 2025-26.

Seven Bargaining Units Have Agreements Expiring in 2025-26. The MOUs with seven of the state’s bargaining units are scheduled to expire by July 2, 2025, meaning that they will be expired for the duration of 2025-26. The seven units are Unit 2 (attorneys and hearing officers), 6 (corrections), 9 (professional engineers), 13 (stationary engineers), 16 (physicians, dentists, and podiatrists) 18 (psychiatric technicians), and 19 (health and social services/professional).

Governor’s May Revision Proposal

Control Section 3.91 and Item 9800: Suspend Increased Salaries and Wages Scheduled Under Ratified Agreements. As part of the May Revision, the administration proposes new control section language under Control Section 3.91 to suspend the economic provisions of the 14 bargaining units with active MOUs in 2025-26. In tandem with the control section, the administration proposes removing the funding for the schedule pay increase from Item 9800. Pursuant to the Dills Act, if the Legislature were to adopt the proposal, the MOUs with the 14 bargaining units would be reopened. Compared with the January Governor’s budget, the May Revision assumes that this action would reduce state costs by $766.6 million ($283.3 million General Fund). The May Revision assumes that these savings are achieved in two fiscal years: 2025-26 and 2026-27.

Control Section 3.90: Reduce Employee Compensation Across All Bargaining Units by Unspecified Amount Through Bargaining or Imposed Administrative Action. As part of the May Revision, the administration proposes new control section language under Control Section 3.90 to (1) authorize the Director of Finance to reduce as appropriate each item of appropriation in the budget to reflect “a reduction in employee compensation to be achieved through collective bargaining agreements” and the administration extending reductions to employees excluded from the collective bargaining process and (2) authorize the Director of Finance to “reduce the employee compensation for members of all bargaining units without such a collective bargaining agreement” by July 1, 2025. The control section language does not specify a level of savings that would be achieved through the Director’s action or the types of policies that would be used to achieve those savings. Based on our understanding of the proposal, this control section could be used to reduce employee compensation for all 21 bargaining units (in addition to the reductions achieved through Control Section 3.91 for the 14 bargaining units with active MOUs).

LAO Comments

Proposal Gives Administration Significant Authority to Determine Reduction Targets. The proposed language for Control Section 3.90 delegates significant authority to the administration to determine what elements of compensation should be reduced and at what level. The proposed control section would authorize the administration to impose reductions of any amount through any policy if reductions are not established under a collective bargaining agreement by July 1, 2025. Part of the collective bargaining process is the requirement that MOUs be ratified by the Legislature and union members before they go into effect. This means that one reason a bargaining unit might not have a collective bargaining agreement in place by July 1, 2025 could be because the Legislature rejected a proposed agreement. In such a scenario, under the proposed language, the administration would be able to override the Legislature’s action to reject the MOU and impose terms to achieve savings after July 1, 2025. The language would allow the administration to determine how to reduce employee compensation pursuant to its priorities and not necessarily the Legislature’s priorities.

Language Authorizing the Reduction of Employee Compensation Should Be Specific, Look to 2020-21 for Example. The proposed language is very broad and vague by establishing no limit on the reductions or the policies that the administration may impose. In contrast, when the Legislature approved reductions as part of the 2020-21 budget, it laid out clear guidelines for how savings in employee compensation should be achieved. In 2020-21, the Legislature used Control Section 3.90 to reduce each item of appropriation as appropriate to reflect reductions in employee compensation by a specified dollar amount listed in the control section. The 2020-21 budget specified that the noted savings could be achieved through any combination of (1) MOUs, side letters, or other labor agreements; (2) furloughs; and (3) other reductions of excluded employees’ compensation. In the end, all 21 bargaining units agreed to reductions in employee compensation through furloughs—under PLP 2020. The compensation reductions established under these agreements were in effect through 2020-21 and were restored through agreements in 2021-22.

Bargaining Concessions Lead to Offsetting Costs Down the Road. In the past, reductions established at the bargaining table have been coupled with increases in compensation at a later date. For example, the state agreed to offsetting pay increases for state employees when it negotiated for employees to contribute to prefund retiree health benefits and to contribute a larger percentage of pay towards their pensions. In addition to these direct costs, there can be indirect costs resulting from concession agreements—like furloughs increasing state leave balance liabilities.

Imposing Compensation Reductions on Bargaining Units With Active MOUs Weakens Labor Relations. The Legislature has the authority to not fund provisions of a ratified MOU and to impose reductions on bargaining units with active MOUs. It is within the Legislature’s prerogative to determine that such actions are necessary to address a budget problem. That being said, the Legislature must weigh such action against the damage that the action can bring to the state’s relationship with its employees.

Proposal Illustrates Importance of MOUs With Short Durations to Preserve Both Budgetary Flexibility and Harmonious Labor Relations. We long have recommended that the Legislature reject any proposed MOU that has a term of more than two years. The basis of this recommendation is to preserve legislative flexibility to respond to changing economic and budgetary conditions without the need to impose compensation reductions on employees with active agreements.

LAO Recommendations

Reject Proposed Control Sections. We recommend that the Legislature reject the proposed control sections.

Ask Administration Questions. We recommend that the Legislature ask the administration questions to better understand the administration’s proposal and also to help the Legislature determine its priorities when it comes to state employee compensation. Below, we raise specific questions that we recommend the Legislature ask the administration in hearings.

At What Level of Budget Problem Does the Administration View Reductions in Employee Compensation Necessary?
What Principles Would Guide the Administration at the Bargaining Table to Seek Concessions From Bargaining Units?
How Would the Administration Determine What Terms to Impose on Bargaining Units That Do Not Come to an Agreement?
Would the Administration Approach Bargaining With Bargaining Units With Documented Lags in Compensation or Recruitment and Retention Challenges Differently Than Other Units?

Adopt New Control Section Giving Administration Direction Based on Legislative Priorities. If the Legislature concludes that reductions in employee compensation are consistent with its priorities, we recommend that the Legislature adopt new control section language that provides specific guardrails to ensure that whatever actions the administration takes to reduce compensation respect those legislative priorities. We discuss the components that we think are necessary in such a control section below.

Specify Reduction Target. We recommend that any control section authorizing reductions in employee compensation identify specific targets for the administration to achieve. There are several options for how to establish such a target. For example, a target could be established as a dollar amount or a percentage of pay; and the target could be one state-wide target or be bargaining unit specific.
Identify What Policy Will Be Used to Achieve Any Imposed Reductions. If the Legislature chooses to allow the administration to impose reductions on employees, we recommend that the Legislature explicitly identify what policy the administration can apply to affected bargaining units—for example, the control section language in 2020-21 that specified furloughs as an allowable policy to achieve savings.
Require Legislative Review Before Reductions Are Implemented. If the Legislature authorizes the administration to impose reductions, we recommend that the Legislature require that the administration report to the Joint Legislative Budget Committee 30 days prior to the policy being implemented (1) the level of expected savings from imposing terms for each affected bargaining unit and (2) the specific policies to be adopted for each bargaining unit to achieve the identified savings.