Court to rule on whether California cities can issue bonds without voter approval

The California Supreme Court has granted review on a pair of cases regarding the question of whether or not cities can issue bonds to cover unfunded pension liabilities without voter approval.

Voters argue the California Constitution requires a ⅔ vote to issue debt — bonds which would require interest payments — to cover the gap between city revenues and spending, while cities argue the vote is not required because the original liability — the pension promise — already occurred.

Article XVI, Section 18, subdivision (a) of the California Constitution requires that municipalities cannot incur “any indebtedness or liability in any manner or for any purpose exceeding in any year the income and revenue provided for such year, without the assent of two-thirds of the voters,” with exceptions only for repairing public school buildings deemed structurally unsafe, in which case a majority vote can suffice.

On August 15, the California Supreme Court granted review to City of San José v. Howard Jarvis Taxpayers Association, in which the California Sixth District Court of Appeals agreed with an earlier trial court’s ruling that the city was right to move ahead with the bond without a two-thirds vote.

While the trial court said the city can issue the bonds because state law and court cases require that it pay unfunded pension liabilities, the California District Court said the “actions that incurred the city’s existing liability—enacting the pension plans and employing the individuals covered by them—have already occurred” and that “A bond is not an indebtedness or liability.” San Jose, with a population of 971,000, has an approximately $4 billion unfunded pension liability, or about $41,000 in city employee pension debt per resident.

The court also noted the city’s resolution did not call for the immediate issuance of bonds, but for when market conditions allow the bonds to create a cost savings for the city — when interest rates on the bonds are below the 6.625% anticipated rate of return on pension investments, and said that converting the unfunded pension liability into another form of debt is allowed under Government Code section 53583(a), which allows governments to bypass the vote requirement.

On September 12, the California Supreme Court granted appeals review to City of Escondido v. Fawcett, in which a California District Court judge cited the San Jose case in unpublished ruling siding with Escondido when it sought to issue bonds when appropriate as a similarly presented cost-savings measure for dealing with its unfunded pension liability of $267 million. With a population of approximately 150,000 residents, the unfunded pension liability for city employees for each man, woman, and child in the city is over $100,000.

The California Supreme Court has extensively ruled that already established pensions cannot be cut, as they are deferred payment for services at the time of their completion, and that municipalities and the state have a duty to ensure that these untouchable benefits remain funded. As a matter of practicality it is thus likely the court will rule with the trial and lower appellate courts that the cities do have the power to issue bonds to cover unfunded pension liabilities.

According to a September 2023 report from the nonpartisan American Legislative Exchange Council, California has the worst unfunded pension obligation in the nation at $1.4 trillion. At 39 million residents, there is approximately $36,000 in unfunded pension debt per California resident. On a per capita basis, that puts California 47th, ahead of Hawaii, Illinois, and Alaska but still one of the worst in the nation. On a total funding ratio — that is how much money there is compared to how much money is owed — California is below average but not among the worst, coming in at 34th, with 34.7% of its pension obligations funded. Given that Wisconsin, which has 61.67% of its pension obligations actually funded, is number one in the nation, California’s position could be considered as less optimal than the low average.