Analysis of the 2007-08 Budget Bill: Perspectives and Issues

Legislative Oversight of State Employee Compensation

What Is the Process for Setting Compensation Levels for State Employees? What Are the Roles of the Legislature and the Administration in This Process? How Can the Legislature Use Its Powers to Improve State Employee Compensation Policies?

Summary

The delivery of state government services to the public ultimately depends on state employees. Pay and benefit levels for state employees play a major role in recruiting and retaining a talented workforce, but also in determining whether departments are successful in meeting their responsibilities. Employee compensation also drives a significant portion of the state’s operating costs. The Legislature plays the central role in setting employee compensation levels, but certain provisions in the state’s labor contracts—as well as administration actions—sometimes undermine the Legislature’s ability to oversee employee compensation policies.

In this piece, we focus on the process for setting compensation and recommend the Legislature improve the state’s employee compensation policies. Our recommendations are geared toward the Legislature focusing state employee compensation expenditures within the context of a balanced budget. Among our recommendations are for the Legislature to (1) limit the authority of arbitrators to order large payments under their interpretation of future labor agreements and (2) end the use of automatic pay raise formulas tied to actions by other governmental employers.

Pay and benefit levels for state employees often play a central role in determining whether departments are successful in meeting their responsibilities. Employee compensation also drives a significant part of the state’s operating costs. Accordingly, the Legislature has a significant interest in state employee pay and benefits.

In this piece, we discuss the processes for setting compensation levels for state executive branch employees. The Legislature possesses broad powers—through budget appropriations, oversight, and legislation—to determine salary levels and benefits for these employees and to review the application of these policies. Nevertheless, some labor agreements negotiated by the current administration and prior administrations contain provisions that make it difficult for lawmakers to use these powers effectively. In addition, the executive branch has taken actions that have undermined the Legislature’s central role in setting employee compensation. We recommend the Legislature use its powers to improve the state’s employee compensation policies so that employee pay and benefits can be managed within the context of a balanced budget. While this piece focuses on the processes for legislative approval and oversight of employee compensation policy, we acknowledge that there are other significant issues confronting the state’s personnel system including: (1) inefficiencies associated with the civil service hiring and promotion process and (2) the competitiveness of pay offered to some groups of employees with that offered by similar employers in the public and private sector. These other issues have likely contributed to some of the process issues we have identified.

The Processes for Setting Employee Pay and Benefits

In this section, we discuss the historical and current processes for setting employee compensation. First, we discuss how pay and benefit levels were set prior to the 1982 implementation of collective bargaining for most state employees. Then, we discuss the current processes of setting employee compensation for two broad groups: (1) unionized civil service employees and (2) civil service employees who are excluded from collective bargaining (excluded employees) or those who are exempt from civil service laws under the State Constitution (exempt employees). These three groups of employees are further defined in the nearby box.

The Employee Compensation Process Prior to 1982

The Legislature significantly changed public employment laws in the 1960s and 1970s, culminating at the state level with the passage of the state’s collective bargaining law (now known as the Ralph C. Dills Act) in 1977. Collective bargaining began for state employees in 1982 after the California Supreme Court rejected a claim that the Dills Act was unconstitutional. (University employee labor relations are governed by a separate law.) Prior to 1982, the State Personnel Board (SPB)—a five-member board created by the State Constitution to administer the civil service system—played a significant role in setting employee pay and benefits. The method for setting compensation levels during this period was different for civil service employees (including managers and supervisors) and exempt employees.

Definitions of Employee Groups Following are descriptions of the employee groups discussed in this piece. Civil service employees are part of the civil service system, which is administered principally by the State Personnel Board. Under the State Constitution, all state employees are part of the civil service system, unless explicitly exempted. Appointments and promotions in the civil service are made “under a general system based on merit ascertained by competitive examination.” In 1934, the voters approved the civil service system to prevent political motivations from influencing appointments and promotions. There are about 200,000 state civil service employees, of which about 83 percent are rank-and-file employees (nonsupervisory and nonmanagerial personnel). Excluded employees are those civil service personnel that do not have collective bargaining rights. They include managers and supervisors, as well as employees involved with certain budgetary and labor management functions of state government. There are about 35,000 excluded employees. Exempt employees include state officials appointed by the Governor—with or without confirmation by the Senate—and members of boards and commissions. Under the Constitution, these employees are not in the civil service. There are about 600 of this type of exempt state employees. Legislative, judicial, and university system employees are also exempt under the Constitution.

Civil Service Employees. The process for civil service pay setting evolved over time. By the mid-1970s, SPB staff conducted semiannual surveys of salaries and benefits paid by other public and private employers in the state. The SPB annually presented a report to the Legislature and the Governor in December containing its salary and benefit increase recommendations. This report described the prevailing salaries among other employers and estimated the “state salary lag,” the percentage amount by which state employees’ pay was lower than that of comparable employees elsewhere in the public and private sectors. Typically, civil service classifications across state government were recommended to receive the same percentage increase. The Governor’s budget in January included proposals for salary and benefit increases in light of SPB’s recommendations. After considering the proposals and SPB’s update of its survey results each spring, the Legislature then appropriated funds for salary adjustments in the budget act (and, if necessary, approved accompanying legislation for benefit increases). Of the 24 budget acts passed between 1955 and 1978, only 12 of them incorporated all of SPB’s salary recommendations without amendments. In many instances when the Legislature deviated from SPB recommendations, it included funds in the budget act for larger pay increases than had been recommended by SPB for some groups of employees.

Exempt Employees. The Department of Finance (DOF) generally set pay levels for exempt employees prior to the Dills Act. Departments paid for exempt employee salaries from their appropriations approved by the Legislature in the annual budget act.

Current Process for Unionized State Employees

State Employee Bargaining Units. About 83 percent of the executive branch’s employees are members of one of the state’s 21 employee bargaining units. Each unit is represented in the collective bargaining process by a union chosen by employees. The current list of bargaining units is shown in Figure 1. Members of the unit either are dues-paying members of the union or, as provided in the unit’s agreement with the state, have “fair share fees” deducted from their paychecks to cover the union’s costs for representing them.

Collective Bargaining Under the Dills Act. Under the Dills Act, the Department of Personnel Administration (DPA) represents the Governor in negotiations with unions concerning state employee labor contracts. After DPA and unions reach a tentative agreement—known formally as a memorandum of understanding (MOU)—the administration presents the MOU to the Legislature for ratification. The Dills Act was crafted to be consistent with the Legislature’s constitutional “power of the purse.” Specifically, the act provides that any provision of an MOU requiring the expenditure of funds may not become effective unless approved by the Legislature in the annual budget act. (Over time, this provision has been interpreted to allow other statutes—including those that amend the annual budget act—to represent the Legislature’s approval of MOU provisions that require expenditures.) In addition, if any provision of the MOU requires a statutory amendment—related to pension benefits, for example—those provisions generally do not take effect unless approved by the Legislature.

The Legislative Process for Proposed MOUs. In the past, some MOUs were presented to the Legislature very late during its annual sessions, and occasionally, they were passed with little debate or opportunity for legislators to obtain information about the fiscal and policy ramifications of compensation increases included in the MOU. In recent years, legislative actions have given Members and staff some additional time to consider the potential effects of proposed MOUs. In 2003, the Senate approved SR 29 (Burton), which amended Senate rules to prohibit passage of a bill approving an MOU until the final version of the proposed agreement has been available for Members to review for at least seven legislative days. Chapter 499, Statutes of 2005 (SB 621, Speier), clarifies the requirements for DPA to disclose side letters, appendices, or addenda to MOUs to the Legislature, as well as to the public on its Web site. Chapter 499 also provides that MOUs shall not be subject to legislative ratification until either (1) the Legislative Analyst’s Office (LAO) has presented a fiscal analysis of the proposed MOU or (2) ten calendar days have elapsed since the proposed MOU was received by LAO. (We began preparing MOU fiscal analyses for the Legislature in 2006 pursuant to the provisions of Chapter 499.) Typically during the legislative process, a bill is sponsored by DPA to ratify the MOU, make any needed statutory changes to implement the agreement, and appropriate additional funds needed to implement its provisions in the budget year. The Legislature may approve or reject the bill. When the Legislature approves a MOU bill, the MOU takes effect after the bill has been signed by the Governor and the agreement has been approved by the bargaining unit’s membership.

What if the Legislature Rejects the MOU? If the Legislature does not approve funds needed to implement any provision of an MOU, that provision may not take effect. The Dills Act provides that, in this scenario, either DPA or the union “may reopen negotiations on all or part” of the MOU. The DPA and the union, however, may agree to implement provisions of the MOU that do not require the expenditure of funds. (The MOUs contain many provisions not tied to pay or benefit levels directly, such as procedures for employees to request vacation time.) If, however, the parties do not implement any provisions of the proposed MOU and the unit’s prior MOU has expired, then another section of the Dills Act takes effect.

This section provides that when an MOU has expired, the provisions of the prior agreement (including “no strike” and arbitration provisions) remain in effect until an impasse is reached in negotiations. At impasse, the state may implement its “last, best, and final offer” to the bargaining unit if the Legislature approves expenditures and statutory changes associated with this offer.

Current Process for Excluded and Exempt Employees

Within Available Appropriations, Administration Has Some Flexibility. In statute and in practice, the Legislature has granted DPA the general authority to establish salary and benefit schedules for essentially all excluded and exempt employees. (The main exception is for certain exempt appointees—principally departmental directors—whose salaries are governed by statute, as described later.) Departments’ expenditures—including personnel costs for excluded, exempt, and other employees—are limited by the amounts, terms, and conditions of their appropriations in the annual budget act.

Pay Differential for Supervisors and Managers. Typically, when DPA extends pay raises to a broad range of excluded and exempt employees, it requests funding for this purpose in the budget bill or in a separate bill containing an appropriation. (Chapter 240, Statutes of 2006 [AB 2936, Ridley-Thomas], for example, ratified a new MOU for California Highway Patrol [CHP] officers and also included funds for pay raises for most excluded state employees.) The DPA’s current policy establishes a guideline for a minimum pay differential—now 5 percent—between the top pay available for senior rank-and-file employees and the top pay available for excluded managerial and supervisory classes.

Broad New Administration Authority for Certain Exempt Appointees. Chapter 240 also grants the administration broad new authority to increase the pay of 53 specified exempt appointees—principally agency secretaries and departmental directors. State law specifies that these employees will receive the same general salary increase as provided for state employees in any fiscal year. Chapter 240 gives DPA the power to “set and adjust, as needed,” the annual compensation of these employees. The law requires DPA to consider the size of the agency or department that the employee heads, the scope of responsibility of the position, and “other factors appropriate to the determination of compensation necessary to recruit and retain qualified employees in leadership positions for the state.” Chapter 240 limits these appointees’ compensation to no more than 125 percent of compensation that the California Citizens Compensation Commission sets for the Governor. Currently, the Governor is eligible for an annual salary of $206,500. Therefore, these appointees may not receive an annual salary of more than $258,125. The law requires DPA to notify the Legislature of increased compensation levels after the adjustments have been made.

Some MOUs Make It Difficult for Legislature to Oversee Employee Pay

As described above, the Legislature must approve any expenditure provided for by an MOU. Nevertheless, some MOUs negotiated by the current administration and prior administrations contain provisions that make it difficult for lawmakers to assess their long-term fiscal implications and provide effective oversight for the state’s employee compensation policies. In this section, we discuss several examples of these problems.

Automatic Pay Raise Formulas Compromise Legislature’s Power of the Purse

Several MOUs tie the pay of groups of state employees to that received by groups of comparable employees of other public agencies in the state. These formulas make the Legislature’s job more difficult because they provide significant pay raises that are beyond the state’s control. Examples of such agreements follow.

CHP Pay Raise Formula. Chapter 723, Statutes of 1974 (AB 3801, Brown), implemented the first CHP pay formula, which required SPB to survey pay levels for officers in specified urban police departments in making its recommendations for CHP salaries. Currently, the law specifies that DPA will survey the “total compensation” (including both base salaries and some other categories of compensation) provided to officers employed by Los Angeles County and the Cities of Los Angeles, San Diego, San Francisco, and Oakland annually.

In applying this formula, Chapter 1, Statutes of 2002 (SB 65, Burton), amended the law to provide that failure of DPA and the CHP officers’ union to agree to an MOU “shall not relieve the state of the duty” to provide the average compensation levels indicated in the annual survey for the five urban police departments. Absent an explicit agreement of the CHP officers’ union to the contrary, this means that CHP officers receive a raise virtually every year regardless of whether their MOU is current or has expired. The CHP officers are the only group of state rank-and-file employees with this type of statutory pay raise formula.

Correctional Officers Pay Raise Formula. Chapter 290, Statutes of 1986 (SB 1373, Keene), states legislative intent that, in order to address recruitment and retention difficulties in the state’s prison system, “salaries must be improved and maintained” for correctional officers and requires DPA to “take into consideration the salary and benefits of other large employers of peace officers in California.” The DPA noted in its responses to a State Auditor’s report that one purpose of the correctional officer labor agreement it presented to the Legislature in 2001 was to bring the state into compliance with Chapter 290. The 2001 correctional officer MOU, which was ratified by the Legislature in January 2002 and remained in effect (with subsequent amendments) until July 2006, increased correctional officer compensation each year between 2003 and 2006. Under the 2001 MOU, the officers’ pay and specified benefits were to be raised to a level of $666 per month less than CHP officers by the end of the contract. (The $666 monthly amount has been described as the “historic salary relationship” between CHP and correctional officers.) In June 2004, the correctional officers’ union agreed with the administration to defer portions of raises scheduled under the 2001 MOU for one to two years—giving the state the benefit of short-term budget savings in exchange for other changes in the MOU. In ratifying the renegotiated MOU, the Legislature continuously appropriated funds to bring correctional officers’ salaries up to the originally agreed $666 differential by July 1, 2006.

Engineers’ Pay Raise Formula. Chapter 616, Statutes of 2003 (AB 977, Diaz), ratifies a five-year agreement reached between DPA and the state’s professional engineer union. This MOU provides several consecutive annual raises based on the results of an annual salary survey comparing pay of state engineers with those employed by other public agencies in the state. Under the MOU, engineers will receive a pay raise on July 1, 2008 (one day before expiration of the agreement). This raise will eliminate any pay lag between state engineers and the weighted average salaries of the various public agencies surveyed.

Formulas Drive Significant Expenditures and Are Difficult to Predict. Personnel costs drive a significant percentage of the state’s operating expenditures. Under MOUs and statutes described above, a significant portion of these costs is governed by annual pay raise formulas. This is particularly true for the General Fund. Figure 2 shows that in 2005-06, 42 percent of General Fund salary and related expenses—$3.4 billion in total—was for employees (including supervisors and managers) whose compensation was covered by one of the pay raise formulas. The vast majority of these expenses relate to correctional officers, the costs for which are paid from the General Fund. All CHP salaries and most professional engineer salaries are paid from various special funds, although, in some cases, particularly for CHP officers, agencies with General Fund expenditures reimburse CHP for services provided (such as security). Moreover, the amount of the formula pay raises included in the agreements with these three groups of employees cannot be predicted in advance. Generally, the amount of the raise is not known until the May Revision or later due to when the local government salary surveys for peace officers and engineers are completed. Accordingly, these formula pay raises make it more difficult for the Legislature to plan, establish priorities, and balance the budget during the annual budget process.

Other Automatic Pay Raise Formulas Have Been Proposed. On several occasions, lawmakers have considered other proposals to institute automatic pay increase formulas for employee groups. Chapter 926, Statutes of 1999 (AB 1639, Committee on Public Employees, Retirement, and Social Security), states that the “policy of the state” is to consider prevailing salaries and benefits of local fire departments when considering compensation provided to the state’s wildland firefighters. Recently, legislative committees have discussed requiring the administration to tie salaries of Fish and Game wardens to those of CHP officers and tie salaries of state firefighters to local firefighters.

Formulas Difficult to Change. Under the Dills Act, the Legislature must approve expenditures for any provision of an MOU. This means that, while MOUs often have effective dates spanning two years or more, the Legislature must appropriate the funds necessary for agreed-upon pay raises each year (during the budget process). If, in any given year, the Legislature does not approve the funds necessary to implement any provision of an MOU, the union has a right to reopen negotiations on all or part of the agreement. In practice—due to the expectations of state employees that they will receive scheduled raises—the Legislature has not opted to disapprove funds for an MOU even when the state faced significant revenue shortfalls. Instead, in these years the Legislature sometimes has approved amended MOUs—negotiated between DPA and unions—that modify terms of bargaining units’ original agreements. Historically, these MOU amendments have allowed the state to forego paying a planned pay raise in a fiscal year in exchange for something else—enhanced health benefits, for example—that may have less of a cost in the near term but more of a cost over the longer term.

Formulas Not Tied to Actual Recruitment and Retention Trends. Historically, the Legislature has approved compensation increase formulas for employee groups because of concerns about employee recruitment and retention. (Chapter 290 specifically mentions recruitment and retention issues among correctional officers, and the current version of the CHP pay formula statute mentions similar issues among CHP officers.) Despite this legislative intent, the current employee pay formulas do not contain any factor that adjusts pay increases based on the success or failure of departments in actually recruiting and retaining employees. The CHP officer compensation increase under the pay formula, for example, remains the same each year even if officer vacancies or recruitment problems decline.

Long-Term Agreements Lock in Spending

Several Units Have Had Long-Term Agreements Recently. The now-expired correctional officers’ labor agreement took effect in 2001 and expired in 2006, as did the prior agreement between the state and the CHP officers’ union. The current CHP officers’ MOU took effect in 2006 and expires in 2010. The professional engineers’ contract was approved in 2003 and expires in 2008. By contrast, most other state bargaining units currently have contracts of two years in length.

Agreements Lock in State Expenditures for Many Years. As discussed above, it is difficult for the Legislature to modify pay raise provisions of MOUs once the agreements are in place, even though the Legislature has the power to do so. Given the volatility of the economy and the state’s revenue structure, this can mean the Legislature faces pay raise commitments in more dire fiscal conditions than when MOUs were approved.

MOUs Have Given Arbitrators Enormous Power in Agreements

Binding Arbitration Often Is a Dispute Resolution Mechanism. Many bargaining unit MOUs include provisions directing certain disputes between employees and the state over the interpretation of the agreement to grievance mechanisms and, in some cases, binding arbitration. Binding arbitration is intended to provide an alternative forum to the courts to resolve disputes. State law governs many of the rules and procedures related to arbitration proceedings.

Recent Ruling Had Major Fiscal Impact. In November 2006, an arbitrator ruled that the state had miscalculated pay increases and health benefits that he decided were owed to correctional officers beginning in 2005-06 under the terms of their 2004 renegotiated MOU. The arbitrator decided that correctional officers were entitled to an extra 3.125 percent pay raise and an increase in state contributions to their health premiums under the MOU. In January 2007, DOF announced that the arbitrator ordered the state to pay $280 million of expenditures attributable to 2005-06 and 2006-07. In addition, the Governor’s budget proposes $160 million of costs in 2007-08 to continue paying officers the compensation levels ordered by the arbitrator. In total, the effect of this decision was to increase state expenditures by $440 million.

Arbitrators’ Ruling Relied on Information Not Available to Legislature. The arbitrator’s decision cited certain sections of the correctional officers’ MOU in reaching his decision—including a vague section implying that the state had obligations to limit the differences between CHP and correctional officers for other types of compensation not even listed in the agreement. Nevertheless, a large portion of the opinion was devoted to detailed accounts of oral exchanges between DPA negotiators and union officials. The arbitrator relied extensively on the oral understandings that these parties had about what the pay raise formula meant and how it was to be calculated. It seems that these oral agreements—not the written documents presented to the Legislature for consideration—were the key factors behind the arbitrator’s ruling. Thus, the information that ultimately determined the compensation awarded was not information available to the Legislature when it made its appropriation decisions. This is because the Legislature could not possibly have known about the extensive set of oral understandings between the administration and the officers’ union when it approved the 2001 MOU, the 2004 renegotiated MOU, or the 2006-07 budget.

MOUs Are Long and Complex Documents

Hundreds of Pages That Drive Costs and Departmental Operations. The state’s 21 MOUs are significant documents because they (1) drive the state’s personnel-related costs and (2) influence departmental operations. Under the Dills Act, the provisions of MOUs are intended to deal only with wages, hours, and other terms and conditions of employment. Nevertheless, the terms of MOUs—typically 100 or more pages in length—often control key aspects of how state departments function. Under the terms of the correctional officers’ agreement, for example, overtime costs have tended to increase, and a specific provision of this agreement—known as the “entire agreement clause”—requires state officials to meet and confer with the officers’ union in certain instances when proposed changes in operations affect the working conditions of a “significant number” of officers. According to DPA, the entire agreement clause “requires the state employer to negotiate continuously” with the union “over the impact of matters within its management discretion.” This type of provision may allow rank-and-file employees to exert significant influence over the management direction of affected state departments. This, in turn, may undermine the ability of managers to execute policies of the administration and the Legislature.

Outdated References, Errors, and Vague Phrases Surprisingly Common. In 2006, our office released fiscal analyses of each proposed MOU to the Legislature. We have been struck by the frequency of typographical errors, outdated references, and vague phrases in the proposed MOUs. For example, in our analysis of the Unit 10 professional scientists MOU, we noted that the text of the tentative agreement presented to the Legislature did not define a term central to administering one pay raise provision of the agreement. (In that case, DPA and the union produced summaries of the agreement that had similar descriptions of what negotiators meant to say.) As discussed above, vague references in the 2001 correctional officers’ agreement were among the passages cited in the recent arbitrator’s decision concerning correctional officers.

Administration Actions Have Undermined Legislature’s Role

In the previous section, we discussed how some administration-negotiated MOUs contain provisions that limit the ability of the Legislature to assess their long-term fiscal implications. In addition, we have found that certain administration actions undermine the Legislature’s ability to oversee, set, and change employee compensation levels. There are two key issues in this regard. First, the administration claims to have a great deal of authority to raise employee pay without explicit legislative approval through the budget or MOU process. Second, the administration—particularly in exercising its significant authority to set supervisor and manager salaries—sometimes has not provided the Legislature with regular, consistent information on compensation issues for these groups of employees. In this section, we discuss these administration actions.

Administration Claims Broad Authority to Raise Pay

Chapter 499 Clarifies Administration’s Disclosure Responsibilities. Chapter 499—which took effect in 2006—clarifies existing requirements for DPA to present labor agreements to the Legislature. Specifically, Chapter 499 makes explicit the requirement that DPA submit to the Legislature side letters, appendices, or other addenda to previously ratified MOUs. Those MOU amendments requiring the expenditure of $250,000 or more are submitted to the Joint Legislative Budget Committee (JLBC) for review to determine if they make substantial changes not reasonably within the parameters of the MOU approved by lawmakers. Those not requiring the expenditure of funds also must be identified by DPA. (Chapter 499 does not explicitly address MOU amendments requiring annual expenditures of less than $250,000, but current law already prohibits implementation of any MOU fiscal provision without the provision of funding.)

Administration Claims Broad Authority to Raise Pay. In 2006, DPA began complying with the provisions of Chapter 499. From its submissions to the Legislature under the new law and from discussions with administration officials, we have found that the new disclosure requirements mark a big change for DPA. In the past, we understand that DPA frequently took actions to raise employee pay without legislative funding approval, since the department asserted that it had authority to do so under existing statutes and MOUs. The administration’s claims that it possesses this type of authority were discussed in communications from DPA or DOF to the JLBC between July and November 2006. In one case, DOF informed JLBC that the administration intended to approve a new pay differential for a group of attorneys in order to reduce the differential between their pay and that of their supervisors. This was presented despite explicit legislative action earlier in 2006 to set that differential at a higher level. In another case, DPA informed JLBC that even though it had not included a provision to increase mileage reimbursements in one MOU that was ratified by the Legislature earlier in the year, it now planned to provide this reimbursement to the group of employees. The department characterized the action as “non-fiscal” (seemingly in an attempt to avoid the requirement for legislative ratification), despite the fact that the reimbursement would require tens of thousands of dollars of state expenditures. (Upon the JLBC’s recommendation, DPA later submitted this provision to the Legislature for approval, which was granted.)

In some cases, DPA seems to assert that provisions of approved MOUs giving it the authority to implement pay differentials to address recruitment, retention, or similar problems are the basis for its actions. In other cases, DPA seems to believe that if the administration is not asking for an additional appropriation (by requiring a department to “absorb” the increased costs), no legislative approval is required for the pay raises it wishes to implement unilaterally. Finally, the administration claims authority to raise pay when a department’s recruitment and retention problems rise to the level of an emergency that affects public health, safety, or essential departmental operations.

The Problem With the Administration’s Claims of Authority. The problem with the administration claiming the authority to raise pay unilaterally without legislative review during the budget process is simple: pay raises are not free. Pay raises—no matter what they are called (salary increases, pay differentials, or bonuses) or how they are implemented—require the expenditure of funds, and under both the Constitution and the Dills Act, the decisions about how the state expends funds are made by the Legislature—not the executive branch. The nearby box discusses an example of the problems with the administration raising pay without legislative review.

An Example: How These Pay Raises Undermine Legislative Authority The annual budget process involves the Legislature making decisions concerning administration proposals about how much money and how many staff to allocate to each program in each department. As an example, assume that the Legislature approves a new administration-proposed initiative in a public safety department that includes spending authority for a dispatcher and two peace officers. After the end of the legislative session, the department is having a difficult time recruiting dispatchers. In the contract for the bargaining unit representing the dispatchers, there is general language about the department having the authority to implement pay differentials to address recruitment problems. The Legislature did not provide funds to implement any such differential during the budget process, but the administration decides to institute a 10 percent pay differential for dispatchers anyway in order to help address the recruitment problems. The administration probably would claim that the department will be able to use its salary savings (the money saved from not filling the dispatcher position for part of the year) to cover costs of this new pay increase. Under this reasoning, since no additional appropriation is needed during the fiscal year, the administration might claim that no legislative action is required to approve expenditures of funds for the pay raise. We believe this justification for implementing pay raises runs counter to the letter and spirit of the Dills Act. First, pay raises always require the expenditure of funds, and the budget process involves a department-by-department consideration of personnel expenditures, including pay increases. Second, these unilateral increases of pay by the administration leave the next year’s Legislature with unnecessarily difficult choices. If the dispatcher position is filled by the time the next fiscal year begins, salary savings will not be available to fund the costs of the new 10 percent pay differential. The next Legislature may face these unpalatable choices in this example: (1) increase funding to the department to continue the differential implemented during the prior year, (2) stop funding for the differential and hope the dispatcher stays with the program, or (3) remove funding for one of the peace officers in the program in order to fund the costs of the dispatcher pay differential. It is also possible that the administration will not call this particular problem to the Legislature’s attention the next year; in this case, it may cut funds from other programs to continue funding the differential and thereby reduce the department’s overall services to the public.

Administration Needs to Pay Attention to Manager and Supervisor Pay Annually

Eroded Pay Differentials for Supervisors and Managers. The administration has broad authority over supervisory and managerial salaries, as described earlier. The state—as well as other public and private employers—generally establishes a guideline for a minimum pay differential between senior rank-and-file employees and supervisory personnel. At times, this minimum pay differential has been eroded when DPA does not give comparable raises to supervisors that rank-and-file personnel receive. This gives rise to “compaction,” a situation in which salaries of rank-and-file personnel rise to a level close to or even above that of supervisory and management personnel. Compaction is a problem because it reduces incentives for employees to seek promotion to supervisory positions, and it encourages supervisors to demote to highly paid rank-and-file positions.

No Consistent Method for Administration to Inform Legislature. In 2006, the administration proposed and the Legislature approved a set of pay increases for all excluded state employees that included funds to address many of the key departmental problems with compaction. Nevertheless, there has not been a consistent, coordinated process for the administration to analyze these issues and inform the Legislature where such problems exist. In the past, the Legislature has often learned of compaction problems from labor groups or individual departments. Also, it appears that sometimes DPA has not considered the effects of rank-and-file employees’ nonsalary compensation (including pay differentials and overtime payments) in contributing to compaction problems.

Recommendations to Enhance Legislative Oversight of Employee Compensation

In this section, we make several recommendations to improve the state’s compensation policies and enhance legislative oversight of employee compensation.

End Automatic Pay Raise Formulas

We recommend that the Legislature not approve any new automatic pay raise formulas in future memoranda of understanding and repeal the statutory formula for California Highway Patrol officers when that bargaining unit’s current labor agreement expires.

Implementing this recommendation would require the Legislature to (1) reject any proposed MOUs that include an automatic pay raise formula tied (for example) to growth in local government salaries and (2) pass legislation repealing the CHP statutory pay formula to take effect no later than the expiration of that bargaining unit’s current MOU in 2010. This action would give the Legislature more flexibility to consider the appropriate pay raises—whether smaller or larger than those under the previous pay formulas—for each group of state employees. So that the Legislature can consider the pay and benefits of comparable employees elsewhere in the public or private sector, DPA should present salary survey information for key MOUs.

Arbitrators’ Authority to Order Unanticipated State Spending Should Be Curbed

We recommend that the Legislature amend the Dills Act or the state’s arbitration laws to limit the authority of arbitrators to order large payments without legislative involvement.

Most arbitration decisions interpreting MOUs result in minor costs for state departments. The recent correctional officers’ arbitration award was a notable exception. We believe that binding arbitration often is an appropriate method to address differences in interpretations of MOUs. In our view, however, arbitrators should not have the authority to approve the expenditure of funds to implement a provision of an MOU. To prevent this problem from becoming more significant in the future, we recommend that the Legislature enact legislation to limit the authority of arbitrators to impose payment obligations on the state based on their interpretation of provisions of any future MOU. (We do not propose to change arbitrators’ authority in current or prior MOUs.) The Legislature has several options in this area. For example, it could limit arbitrators’ authority to order payments over a given amount—$10 million, perhaps, in one-time or annualized costs. Alternatively, the Legislature could require that (1) such large settlements be approved by lawmakers before they are finalized and paid from state funds or (2) arbitrator orders of this type will have a legal force and effect only if some amount of time (perhaps six months) passes without the Legislature enacting a bill to overturn the order. These measures would ensure that the Legislature’s interpretation of the expenditures it approved for MOUs takes precedence over those of an arbitrator.

Approve One-Year or Two-Year MOUs

We recommend that the Legislature not approve any proposed memoranda of understanding in the future that have a term of more than two years.

Given the state’s volatile revenue structure, we believe that it is not advisable for the Legislature to give an implicit commitment to groups of employees that the state will be able to raise their pay by a given amount more than one or two years in advance. As we have discussed, the Legislature actually has the authority under the Constitution and the Dills Act to set the compensation levels of each employee each year during the budget process. In practice, however, employees expect to get the pay raises included in an MOU, and the Legislature has few attractive options when state fiscal constraints make it difficult to actually fund these raises. We believe that shorter-term MOUs give the Legislature more budgeting flexibility, and we believe they represent a firmer commitment to state employees about the level of compensation the state will be able to afford in the future.

Joint Hearings on Selected MOUs With Major Fiscal or Policy Impacts

We recommend that the Legislature convene joint hearings with members of policy and fiscal committees to consider the fiscal and policy ramifications of some proposed memoranda of understanding prior to approving or rejecting the labor agreements.

The state’s 21 MOUs drive a significant portion of state operating costs and significantly affect departments’ capacities to meet their statutory responsibilities. Given the importance and complexity of these documents, we believe that joint policy and fiscal hearings on some MOUs—those with the most significant fiscal and policy effects—would be helpful for the Legislature in evaluating the merits of proposed agreements. These hearings could consider the estimated costs of the agreements, as well as how each agreement addresses staffing and operational problems at affected departments. Such hearings would be a way for members of the Legislature to suggest changes to MOUs if appropriate.

More Time Before Voting on MOUs

We recommend that the Legislature—either formally (through changes in law or legislative rules) or informally—decide to take at least three weeks to consider and review memoranda of understanding presented by the administration.

Given the length and complexity of the MOUs, we have found it challenging to provide analyses to the Legislature within the ten-day time frame established for LAO review in Chapter 499. Given our own difficulties, we believe it is very difficult for legislators, committees, and interested parties to consider all of the issues associated with this type of a document within a short time frame. For instance, the Legislature approved $1.2 billion for increased pay and benefits for state employees in 2006-07. For the agreement involving the Service Employees International Union, the documents totaled 1,729 pages. While the Legislature often took several weeks to consider agreements presented to it in 2006, it did not in some cases. Given the magnitude of the policy and fiscal issues at stake, a minimum of three weeks for legislators to consider these lengthy documents, receive public comments, and consider our findings would be advisable.

Require Administration to Submit Excluded and Exempt Pay Proposal Annually

We recommend that the Legislature enact legislation to require the administration to submit their proposed increases (if any) for all excluded and exempt employees each year by the time of the May Revision.

While the Legislature has granted the administration broad authority to increase excluded and exempt employees’ pay, we have found that the administration’s actions for these groups often have been an afterthought, as compared with the higher-profile MOU process used to determine rank-and-file employees’ pay raises. This is one reason why the compaction problems we discussed earlier have persisted. It has also made it difficult to consider (1) issues concerning supervisor and manager compensation, recruitment, and retention, and (2) the budgetary ramifications of pay increases for these groups. The administration has stated that the timing of its release of the excluded employee pay package so late in the legislative calendar results from the need to conclude MOU negotiations first. By the May Revision, however, the administration should know the general proposals it is discussing with unions on pay raises (and, in other cases, does know the pay raises to be provided to unionized employees in current MOUs). Moreover, even if the administration presents such a plan prior to May Revision, it may amend this plan later when it submits proposed MOUs to the Legislature. The administration should include with this annual pay plan any proposals to increase departmental directors’ compensation under Chapter 240.

Administration’s Flexibility to Increase Pay Should Be Limited

We recommend that the Legislature adopt budget bill language clarifying that budgeted funds may be used only for compensation levels approved in bargaining unit memoranda of understanding or other legislative measures.

Limiting Administration Flexibility. Under the Dills Act, the Legislature’s authority to control expenditures used for employee compensation is clear. The administration needs to seek and receive explicit legislative approval for implementing pay raises—except in cases of emergency or court orders, when the budget act and applicable laws already provide the administration with separate funding options. To end any confusion about what existing law is, we recommend that the Legislature adopt the following budget bill language as part of the budget item (Item 9800) that appropriates money for the administration to distribute to departments to address the costs of each year’s employee compensation increases:

The funds appropriated in this item and in other items of this act may be spent to increase the compensation of various classifications of state employees after the date of passage of this act only in accordance with: (1) memoranda of understanding that are approved by the Legislature either before or after passage of this act; (2) side letters or other amendments to memoranda of understanding that are approved by the Legislature either before or after passage of this act; (3) regular adjustments in employee pay based on tenure, years of service, employee performance, promotions, or similar factors (including, but not limited to, merit salary adjustments) that were authorized prior to passage of this act; (4) pay actions that were instituted prior to passage of this act or approved by the Legislature as a part of this act; (5) pay differentials that were instituted prior to passage of this act or approved by the Legislature as a part of this act; (6) pay differentials explicitly authorized by an act of the Legislature after passage of this act; (7) binding judicial, grievance, or arbitration decisions; and (8) the provisions of Item 9840 of this act, which provides funds to address state contingencies and emergencies.

In our opinion, this language would clarify the meaning of existing law and limit the ability of the administration to unilaterally grant pay increases that infringe on the Legislature’s authority to control the expenditure of state funds.

Summary

The recommendations discussed above—summarized in Figure 3—would enhance the Legislature’s leadership role in determining the pay and benefits provided to state employees. They also would assist the Legislature in focusing state employee compensation expenditures within the context of a balanced budget.

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