As pension reform heats up, both here in California and in Congress, it’s important to understand the underlying economic context – and why slashing benefits would be a stunning act of madness, likely to prolong our recession and budget problems instead of solving either one, at the expense of our basic standard of living.

We live in an economic era characterized by too much debt, itself a symptom of low wages and high costs of living. Although much of our media discussion of economic policy is still locked in the 1970s, obsessed with an obsolete worry about inflation, the reality is that households are not making enough money to pay the costs of living in 21st century California.

High taxes aren’t the problem – how could they when taxes are at their lowest point in 60 years? No, the problems come from elsewhere. As Dave Johnson showed in charts, wage stagnation that began with Ronald Reagan has led to a decline in the savings rate and a massive concentration of wealth at the higher end of the income scale.

Meanwhile, the cost of living has soared. Gas prices are now permanently at a level unimaginable at any time after 1981, and are likely to rise for the foreseeable future. Health care costs are still rising at an unaffordable rate. Even with the market crash, housing is still unaffordable to most Californians unless they’re willing to move to the urban fringe, savings which are canceled out by the cost of the commute.

Overall the economic situation is that of what Richard Koo called a balance sheet recession – where the private sector is scaling back on spending to purge debt, creating a long-term recessionary environment. The only solution is to increase wages and create more jobs. The absolute last thing you want to do is to slash wages – or pensions, for that matter.

Cutting pensions would be like taking a shotgun, aiming it at our feet, and pulling the trigger. It would cause a cascade of economic problems that would dramatically worsen our economic crisis.

But that’s exactly what some people are now arguing needs to be done. Last week Governor Arnold Schwarzenegger announced a pension reform deal with several state employee unions, including AFSCME. The deal preserves current pension payments, and creates a two-tier system whereby new hires pay more of their wages into the system. It’s not an ideal solution, but it’s better than the alternative.

In assessing the pension deals, California political commentator and friend Joe Mathews argues that the deals don’t go far enough, and that what’s needed is to slash the benefits of current workers.

Below the flip is my explanation of why this is a very reckless approach, and if implemented, would produce long-term recession.

Here’s Joe Mathews’ response to the pension deals:

Current workers, particularly baby boomers, are virtually certain to get so much more out of the system than they pay into it that they ought to be arrested for generational theft. They need to take more of the hit for this. That’s a difficult position to take, politically and legally, but it’s also the right one.

I could not disagree with this more strongly if I tried. There are many things wrong with this assessment, and I’ll take them in turn.

First, the “generational theft” argument. Generational theft is a very real problem. Young folks, those of us under 35, have been systematically robbed for the last 30 years. Our K-12 education was weakened through budget cuts. We were made to take on unaffordable student loans to get the same university education that our elders received for a fraction of the price. Older generations use Prop 13 to subsidize their own wealth while making it almost impossible for younger Californians to purchase a home of their own. When teabaggers in their 50’s complain about debt because of the burden it will leave to the young, they are shedding crocodile tears, because they are systematically destroying the future of those same young people they misleadingly claim to care about.

But that does not mean the answer is to engage in our own generational warfare by slashing their pensions. Already many retired Californians struggle to make ends meet. Too many have to choose between pills and other costs, including housing costs. Cutting the pensions of those already retired would merely redistribute those costs onto everyone else, working people already struggling with low wages and high costs of living.

Mathews didn’t appear to be calling for slashing pensions to those already retired, but for those currently working. But the outcome would be the same anyway. I’m 30, and my parents are in their mid-50s. One is fully vested in CalSTRS, the other has lost most of their 401k retirement to the market downturn. I cannot possibly imagine how my economic future would be improved if they had less money at retirement. I’d have to make up the difference if they had medical costs, housing costs, or other costs that they might struggle to afford of their state pensions and their Social Security benefits are slashed.

In fact, it would be yet another form of generational warfare against my generation if the pensions of my parents and their generation are slashed.

The better solution is to go after the massive wealth possessed by the top end of the income scale. California is still an extremely wealthy state. We just don’t tax most of that wealth, and we should. Yet Mathews argues we shouldn’t do it. Nowhere in his column does he indicate higher taxes should be on the table. Mathews suggests that the wealthy and corporations should “give back,” but frames it as a general call for sacrifice, when in fact we need a fundamentally different approach to taxation that seeks new revenues from the rich without slashing benefits for others.

Instead he makes this sound like we have no alternative but to cut pension benefits. Remember what he said in the section I quoted above:

They need to take more of the hit for this. That’s a difficult position to take, politically and legally, but it’s also the right one.

It’s neither necessary nor right that current workers see their benefits cut. We have choices, and one of those options is to raise taxes on the wealthy to bring in the revenue we need to sustain current pensions.

Of course, we also have to remember that the current bill for pensions is artificially inflated because of the recession. If we have economic recovery and growth, then state pension funds will be in a much stronger position. But if we give in to the desire to have widespread austerity, recovery will collapse, the state budget deficit will grow and persist, and the pension funds will continue to struggle.

California’s unions understand this basic reality. Mathews argues they don’t:

But these unions are one important part of the problem. While they don’t always seem to recognize it, they have a strong interest in being part of solutions to make state government fiscally solvent.

And yet the solution being proposed – slashing benefits – will do absolutely nothing to make state government fiscally solvent. It will mean there’s less money available to spend, meaning less sales tax revenue. Less consumer activity means there’ll be less jobs available, meaning less income tax revenue. With fewer jobs available, and wage stagnation, and now the added financial burden of paying the costs of retired family members that used to be borne by the pensions and other state services that have been cut, younger folks won’t be able to sustain the economy. Retirees and baby boomers will have to sell their homes for the cash, and in a recessionary environment where the young aren’t able to afford the present market value, home values will spiral downward, causing further economic ripple effects as well as reducing property tax revenues.

It is a senseless outcome. California’s unions are absolutely right to fight it. While they are framed as solely defending the wages and benefits of their members – as if there was anything wrong with that – these unions are also defending the economic prosperity and fiscal viability of the state of California. Their unwillingness to embrace deflation and depression should be lauded, not chided.

Mathews concludes by reasserting his claim that slashing benefits is necessary to our state’s future:

But savings on pension obligations can’t be the only money that elected officials and voters grab to balance the budget and put the state on a better long-term footing. Everyone needs to give back — from those who rely on public services to the wealthy and corporations, who have seen their taxes cut even as Californians experience government service cuts and income and sales tax increases.

Of course, those income and sales tax increases have not damaged the state’s economy. Since they went into effect in April 2009, the state has experienced a very halting and slow recovery – but it has not slid deeper into the recession. Had those tax increases not been accompanied by Hooverism – including but not limited to the loss of nearly 30,000 teaching jobs – California might be starting a more robust economic recovery.

More importantly, the notion that “everyone needs to give back” just doesn’t make sense given our economic distress. We’ve already given back too much. We gave back our wages. We gave back our ability to afford health care and housing and transportation. We gave back the robust public sector services that created widespread prosperity in the 1950s and 1960s. We gave back affordable, quality education. And too many of us have given back our future.

No, it’s time for someone else to give back. It’s time for the wealthiest Californians, and the large corporations, to give back. For 30 years now they have benefited from economic policy designed to take money and benefits from the rest of us and give it to those who already have wealth and power. Mathews agrees the wealthy and corporations should give back – but that ought to be the centerpiece of the solution, instead of being linked to a downward spiral in living standards and economic prosperity.

We are now experiencing the predictable outcome of such policies – the worst recession in 60 years, an intractable downturn. The way out isn’t to worsen the crisis by slashing pensions. The way out is to return to the sensible tax rates of the 1950s and 1960s and make the rich pay.

It’s the right choice for California. Let’s hope that’s the choice we wind up making.