(Bloomberg) -- It’s hard for states to fix pensions--just lookat New Jersey and Illinois.

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And even when legislators in California agreed two years ago ona way to keep the teachers’ retirement fund from going broke, itleft the state’s finances more exposed to financial-marketswings.

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Read: 10 questions employees can ask a pension fundmanager

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Under the plan, California, school districts, and teachers willgradually increase their contributions to make the second- biggestU.S. public pension fully funded in 30 years.

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The catch: the state’s share depends on whether the fund hitsits 7.5 percent annual investment target, meaning it could jump inbad years or plummet in good ones, according to the LegislativeAnalyst’s Office.

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Three decades from now, the difference between market winningand losing streaks could mean as much as $5 billion.

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The uncertainty over the state’s future payments to theCalifornia State Teachers’ Retirement System, which overseesbenefits for about 896,000 people, underscores the risks in bettingon a continual surge in California, where the government’s fortuneshave tracked the booms and busts of the equity market.

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Read: DOL takes on IAM pension plan,trustees

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For now, California’s still reaping a revenue windfall from thepost-recession bull run that crested in the middle of lastyear.

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“This could certainly add to fiscal pressure on the state in theevent of a down market,” Gabriel Petek, a credit analyst in SanFrancisco for Standard & Poor’s, said of the pensionoverhaul.

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In July, S&P boosted the state’s rating to AA-, thefourth-highest rank, marking the third upgrade in as manyyears.

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While the investment returns don’t start affecting the state’scontribution until July 2017, the lackluster performance in 2015highlights the potential pitfalls.

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After stocks tumbled from record highs, state and city pensionseked out median returns of 0.36 percent, according to theWilshire Trust Universe Comparison Service. It was the smallestincrease since 2008 and far short of what they expected.

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Nationwide, state and local governments have about $1.7 trillionless than needed to cover all the benefits that have been promised,according to Federal Reserve Board data. The need to boostcontributions has led to downgrades for Illinois and New Jersey,where Democrats and Republicans have clashed over how to meet thegrowing obligations.

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Before California legislators acted, the teachers’ system wasfacing a $74 billion shortfall.

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Unlike most public pensions, the board needs lawmakers’ approvalto require school districts, the state and employees to increasewhat they pay into the fund.

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Because of the 2014 changes, the payments from school districtswill more than double to 19.1 percent of payroll by 2020 from 8.25percent.

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By July 2016, employees would kick in 10.25 percent of theirchecks, up from 8 percent, and the state’s portion grows to 6.3percent of payroll.

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Beginning in mid-2017, California would pay less if thesystem bests its earnings assumption and more if it falls short,due to a formula that divides the responsibility for the unfundedliability between the state and districts, according to theLegislative Analyst’s Office, a nonpartisan agency that conductsresearch for lawmakers.

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Any such impact from the pension-overhaul law can be mitigatedbecause it allows for the governor and legislators to review thesystem’s funding every five years to see if any corrections shouldbe made, said H.D. Palmer, a spokesman for Governor Jerry Brown’sfinance department.

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Another buffer: a successful ballot measure that Brownchampioned requires the state to save a portion of excesscapital-gains revenue to cushion the impact of swings that doggedthe state in the past.

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Those fluctuations can be dramatic. In the fiscal year thatended in June 2010, its capital-gains taxes tumbled to $3 billion,one third of what they were two years earlier, only to rebound whenshare prices jumped. In the current budget, California’s expecting$13.4 billion from such levies, about 11 percent of its revenue.Some will be socked away to help cover the next round ofdeficits.

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In a down market, “not only is the state getting less money fromthe way the tax structure is comprised, but it also forces them toincrease their payments for their unfunded pension liability,” saidHoward Cure, head of municipal research in New York at EvercoreWealth Management, which oversees $6.2 billion of investments. “Itcompounds the vulnerability of their tax structure.”

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There is a limit to how high the state’s contributions couldrise: 0.5 percent annually.

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That could slow the state’s progress toward eliminating thepension shortfall if the markets reverse course after a period ofgood years that allowed California to cut its contributions, saidRyan Miller, principal fiscal and policy analyst at the legislativeoffice.

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”We have a very volatile revenue system,” Miller said. “It’spossible that we could lose tens of billions of dollars over amulti-year period following a recession and that might cause thesesorts of constraints in a budget where we couldn’t address thisproblem.”

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As state leaders deliberate on the budget for the fiscal yearthat starts in July, Brown has advocated fiscal restraint. Thegovernor “is not going to support ongoing higher levels of statespending that broadly speaking could be susceptible to a downturnin revenues,” Palmer said.

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The state should act now, while revenue is surging, to make itsteacher contributions simpler and less susceptible to marketvolatility, Miller said.

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“Its role here is going to be far less certain than thedistricts’ role,” Miller said. “In some scenarios, the state’sshare of this problem could be very, very big.”

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