Illinois Pension Is ‘Cruel Game’ for Young Workers, Spiotto Says

Dec. 5 (Bloomberg) -- The Illinois pension plan, the worst-funded in the U.S., is an “illusion” for younger workers because the state is falling further behind on its promised benefits, said James Spiotto, a bankruptcy attorney and partner at Chapman & Cutler LLP in Chicago.

Spiotto also discussed the state’s capacity to raise taxes again and this year’s trio of California bankruptcies for today’s Bloomberg Brief: Municipal Market newsletter.

Q: Would there be a legal precedent if Illinois were to reduce promised benefits to retirees?

A: You can impair contract obligations where it’s necessary for a higher public good. That’s why you can condemn property. The higher public good is that we’re not going to forfeit essential public services to pay for pensions that are not affordable. That’s part of the legal basis.

You could set up a quasi-judicial body that makes fact determinations. The city and the state and the unions could present their sides and they’ll make the determination.

Q: What are your thoughts on the growing unfunded pension liabilities in Illinois?

A: What the workers have to realize is that it’s better to get a piece of something as opposed to a promise that turns out to be nothing. It’s just putting it in that perspective. They worked for it, so you’d really hope they get paid as much as they can or paid in full.

A defined benefit that isn’t capable of being funded is not a defined benefit -- it’s an illusion. For younger workers, it’s a very cruel game. It’s broken, and we don’t need a Band-Aid that kicks the can down the road, but a permanent fix.

Q: What sort of solution would you suggest?

A: You have to decide what essential services you should be providing and at what level. Then you have to come up with a recovery plan. If you can’t afford it, and it will adversely affect providing essential governmental services, you have a big problem.

The solution is coming up with what they can afford, what revenue stream they can project and what they have to pay for essential services. Whatever is left over is what they can pay for unfunded pensions and other matters.

Q: Illinois raised its tax rate in 2011 to help close a budget deficit. Is there still room to tax more?

A: If you raise taxes in one community too much, people can move to the next community. If one state has taxes too high, they can go to another state. That’s part of the check and balance to keep it reasonable.

Q: Are you surprised that there have only been three local governments -- Stockton, San Bernardino and Mammoth Lakes in California -- to file for Chapter 9 protection this year?

A: Only 62 cities, towns, villages and counties have filed Chapter 9 since 1954. And they’ve been small ones, except for Bridgeport, Connecticut, in 1991, Orange County in 1994, Vallejo in 2008, Harrisburg last year -- but they got dismissed -- Boise last year and then Jefferson County. Then Stockton and San Bernardino this year.

They don’t want to give up the right to fund infrastructure locally and borrow money locally at a low cost. And if you file Chapter 9, access is either going to be limited or you’re not going to have it. That’s why I’m not surprised there have only been three. They’re for the most part only small municipalities. Big cities have to work with the state to try to find a solution. If they go into bankruptcy, the stigma of that could be fatal.

Q: What’s the most common misconception about Chapter 9?

A: People don’t realize until they get in it how complicated, time-consuming and uncertain it is -- and it costs money. Vallejo spent more than $10 million in attorney fees. That’s $10 million you could have paid to creditors.

It’s there as a last resort. It will get you results, but you probably won’t like it. It’ll probably take longer than you thought, and it’ll probably be far less efficient than you thought. But you will get there. In other countries, states and municipalities just kind of melt away.

To contact the reporter on this story: Brian Chappatta in New York at bchappatta1@bloomberg.net.

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net