Pension reform hinges on Gov. Arnold Schwarzenegger's promise that he'll veto any budget proposal that does not include "two-tier" retirement benefits, according to Republican lawmakers. "There is a really good chance he will keep his promise," said state Sen. Bob Dutton, R-Rancho Cucamonga. "He's got nothing to lose."

Under a two-tier system, current workers would keep the retirement plans they've been promised, but all new employees would get reduced benefits.

Over the past decade, pension costs for public workers have increased 2,000 percent and are grossly adding to the insolvency of state and many municipal governments, said state Sen. Bob Huff, R-Walnut.

"The solution is simple," Huff said. "California must reduce the benefits for newly hired state workers."

But that proposal did not sit well with Senate Public Employment and Retirement Committee. Last week, it thwarted Senate Bill 919, which would require new hires to contribute more and work longer in order to receive pensions.

The party-line defeat followed a request from the California Public Employees' Retirement System that the state pay $3.9 billion to cover its employee pensions in the new fiscal year - a $600 million increase in funding.

CalPERS administers retirement and health benefits for 1.6 million active and retired public employees and their families on behalf of more than 3,000 employers.

It adjusts employer contribution rates every year based partly on whether the pension fund gains or loses in its investments.

The need for last week's hike was attributed to retirees living longer and workers retiring slightly earlier. It was also to compensate for the fund's investment losses during the recent recession.

Dutton said he was concerned with the fund's sustainability.

"Public pensions have become very generous, and not only that, but unsupportable," he said.

The state contribution to CalPERS in fiscal year 1998-99 was $800 million - about one-fifth of the current funding demand.

An April study released by Stanford University's School of Public Policy showed that, in the next 16 years, the state's three biggest public-employee pension funds will be $500 billion short of meeting their future obligations.

These costs are creating a quickly expanding financial sinkhole that taxpayers will be forced to fund when CalPERS investments are not able to, Huff said.

Like Schwarzenegger and Huff, Dutton is also in support of a two-tier pension system.

"New hires would be told, 'Your pension is accumulated at an x rate, and will you accept the job, yes or no?"' he said. "That is the easiest thing to do. It makes sense, and it's more sustainable. But the pressure from the unions has caused S.B. 919 to fail."

State Sen. Gloria Negrete McLeod, D-Montclair, said dealing with public pension issues requires input from public employers.

"Generally, we can't touch pensions outside of government or city districts," McLeod said. "If it goes through, the cities will file suits. ... You can't just say you want pension reform and that's it."

According to California State Employee Association, reducing retirement benefits for future retirees will not translate into more money for schools, roads and health care for decades to come.

"Savings for the state and local budgets would not be seen until those employees retire - around 20 (to) 30 years from now," CSEA stated on its website.

Although there are some pension abuses, a claim that public employee pensions are too generous does not hold water, CSEA said.

The average pension retirement check in California is about $25,000 - less than what's needed to get by a year.

Retirees receive an average of a little more than $2,000 a month in benefits and cutting these benefits for future workers is unfair and will force these workers to retire in poverty, the statement said.

Schwarzenegger said in April that the pension system's unfunded liabilities represent the single biggest threat to California's fiscal health.

"I refuse to pass this crisis on to the next governor or the next Legislature," Schwarzenegger said. "Because if you don't act, if you continue to sweep those problems under the rug, you're just going to be piling on more and more debt onto our children and grandchildren."

Schwarzenegger last week signed tentative contract agreements with four state employee unions that could save the state $72 million in the next fiscal year.

The agreements that cover 23,000 employees represented by the Association of Highway Patrolmen, Department of Forestry Firefighters, Association of Psychiatric Technicians and American Federation of State, County and Municipal Employees, will roll back the expansion of pension benefits adopted in 1999 and will increase employee pension contributions to a minimum of 10 percent.

To sign off on the budget, the governor is seeking similar pension reform to that proposed in the now-defeated S.B. 919: rolling back the expansion of pension benefits adopted in 1999 for all new hires, a permanent 5 percent increase in employee contributions and calculating the retirement rate based on the highest three years of wages instead of the highest single year.

"I am absolutely committed to getting pension reform done because we cannot continue down this unsustainable path that has taxpayers on the hook for $500 billion in debt," Schwarzenegger said.

Instead of declaring ultimatums to the Legislature, the governor should continue negotiating with the labor unions, said Jean Ross, an executive director of California Budget Project.

"Collective bargaining process seems to be an appropriate way to deal with this issue," Ross said.