Back in May, Riordan laid out a plan to keep Los Angeles out of bankruptcy, and much of his advice would also be sound for other municipalities (including Newark): Move new employees to 401(k) plans instead of defined-benefit pensions, raise pension contributions for existing employees, and raise retirement ages. Riordan also suggests staff cuts, which would be appropriate in some cases; in others, it would be better to freeze or cut salaries.
Officials all over California already know this is what they need to do. Vallejo tried to achieve similar savings before its bankruptcy filing but could not get union approval. While Riordan frames his proposal as a way to avoid bankruptcy, it reads more like a list of items to be included on a reorganization plan after declaring bankruptcy. Over the next several years, as costs rise and revenues most likely remain anemic, actions based on the Riordan plan — and the bankruptcy filings to make them possible — will look more and more appealing. Naturally, employee unions are fighting in Sacramento to subject municipal bankruptcies to approval by a union-influenced state board; so long as the state has a Republican governor, that, fortunately, is unlikely to happen.
Bankruptcy has its downsides. Municipal bondholders will lose money, and a lot of them are individual investors in California attracted by the tax benefits. Further, if more cities start defaulting on their bonds, interest costs will rise for municipalities across the state and perhaps the country.
The right solution isn’t to cut off the bankruptcy option and leave cities trapped with unsustainable costs they can’t discharge. Instead, California should implement structural reforms that help municipalities control costs. This has been a key focus for New Jersey governor Chris Christie, who has correctly noted that you can’t control local taxes without controlling local spending. Key options include tenure and civil-service reform, a requirement that public employees’ health benefits track the value of private-sector benefits, and even a prohibition on public-sector collective bargaining, which has helped Virginia municipalities maintain moderate cost growth.
Without such reforms, bankruptcy will be essential as cities’ last viable path to solvency — and as a credible threat to bring unions to the table. If those threats do not work, and if Sacramento does not bring structural reforms that strengthen municipal officials’ hands, then California’s local fiscal crises may lead to a series of municipal bankruptcies that would unsettle markets around the country. California has long been a national trendsetter — but this is one we’d do well not to follow.
– Mr. Barro is the Walter B. Wriston fellow at the Manhattan Institute.