The problem of rising retirement benefit costs crowding out municipal services in California will worsen short-term, according to a report on Thursday by the New York-based Manhattan Institute for Policy Research.

"California localities are at a crossroads," Manhattan Institute senior fellow Stephen Eide wrote in the study, titled "California Crowd-Out."

During each of the three recessions since the early 1990s, said Eide, California cities and counties' tax revenue growth rate dropped below that of local governments' pension contributions.

The report said local governments should concentrate on scaling back retiree health care benefit commitments instead of, or as part of, funding arrangements, and state action on pension overhaul.

"The success of pension reform at the state level will, however, depend on local leadership," said Eide.

Former San Jose mayor Chuck Reed and former San Diego city councilman Carl DeMaio have revived an initiative to enable local California governments to negotiate defined-benefit contracts. They want to add the measure to the 2016 statewide ballot.

The effect of crowd-out on services varies by type of locality — large and small cities, transit systems, school districts — relative affluence and local district, the report said.

"Elevated retirement costs pose the most serious threat to budgets when coupled with declining revenues, a situation that led to bankruptcy in the cases of Stockton, San Bernardino and Vallejo," Eide wrote.

Since 2000, for example, Los Angeles' pension costs have risen to 18% of its general-fund budget from 2%, though the city remains determined to expand its police force. Long Beach is already contributing $27 in pension and health-care benefits for each $100 in salary it pays to uniformed employees.

San Jose two years ago had to lay off police officers to keep its libraries open.

In an interview this week in New York, Reed cited a police station built with bond money that had to remain closed because the city could not afford to operate it.

"We were doing cut, cut, cut, layoff, layoff," said Reed, who in 2012 championed a local law that reduced pension benefits and costs as part of an overall fiscal overhaul. A state appeals court is weighing a challenge by local unions.

Reed has been making a nationwide pitch for his initiative amid heightened concerns in the capital markets about pension debt. Excessive retirement debt has raised the cost of borrowing, according to Eide, and bond rating agencies are weighting pension and other post-employment benefit, or OPEB, measures more heavily in assessing overall credit quality.

Pension debt has been linked to negative rating actions against Illinois, New Jersey and Pennsylvania.

"Illinois and New Jersey are almost hopeless," Reed said in the interview at the Harvard Club of New York, where he spoke at a Manhattan Institute dinner. "Prospects are not good anywhere. Thirty percent of big cities are not fully funding their ARC [actuarially required contributions."

Some analysts say crowding out is restricting capital investment.

Eide said Federal Reserve data shows the total amount of outstanding credit market debt for state and local governments declining annually since 2010. Throughout this period, according to Eide, the average yield for The Bond Buyer's 20-bond general obligation municipal index was 4.2%, the lowest since the 1960s.

"You've got to find either new revenue or you've got to cut other services or other public investments, say, in infrastructure, to cover those costs," Daniel DiSalvo, a City College of New York professor and Manhattan Institute senior fellow, said in a recent Bond Buyer video.

DiSalvo is the author of the book "Government Against Itself: Public Union Power and Its Consequences."

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