Oct. 17 (Bloomberg) -- One of California’s leading advocates for pension reform, San Jose Mayor Chuck Reed, has begun an uphill campaign to amend his state’s constitution so that governments there can make changes to employee retirement plans. If he succeeds with his voter initiative plan, his effort may spur movements to loosen pension protections in other states.
Reed’s effort might also bring clarity to one of the most confusing parts of the pension debate -- namely, constitutional limitations on changing government-employee retirement systems.
In the private sector, pensions are governed by the federal Employee Retirement Income Security Act. Although a private employer may not cut benefits that a worker has already earned, ERISA allows a business to change the rate at which a worker accrues future benefits.
ERISA, however, doesn’t apply to government employee pensions. Instead, in the states, local laws and court decisions govern how public-worker retirement systems are treated, and in many cases the states depart, sometimes radically, from the standard set by the law.
In more than two dozen states, including California and New York, courts have blocked government employers from making substantial changes to pension plans even with respect to work that an employee has yet to do. That means that once a cop or firefighter or teacher or sanitation worker becomes vested in a pension system, he or she has the right to earn benefits at the same rate for an entire career. Because this restriction confines retirement-plan changes to new workers, it severely reduces the savings of pension reform.
Many legal protections given to public-sector pensions arise from court decisions that treat laws governing public retirement systems as a contract between the state and a worker. That puts pensions under the jurisdiction of the contract clause of the U.S. Constitution, or under state contract law.
Led by the California Supreme Court, state courts have stretched the limits of contract law to protect pensions. In a series of decisions dating back decades, the California court has ruled that state pension legislation creates a contract for government workers that is formed on the first day of a worker’s employment, “and is of open duration, thereby protecting both past and future pension accruals,” according to a 2012 Iowa Law Review article by Amy Monahan, a professor at the University of Minnesota Law School.
In Monahan’s words, “the position of the California court is difficult to explain” in terms of federal court decisions, which have held that prospective changes to contracts aren’t unconstitutional. Still, more than a dozen other state supreme courts have adopted the California rule on pension law, creating the biggest single bloc of states where courts have refused most, and in some cases all, changes to pension systems. This group includes states as diverse as Massachusetts, Alaska and Nebraska.
California courts have not only applied this precedent to pensions, but they also have recently been expanding it to other benefits. In 2011, the state Supreme Court ruled that retiree health-care benefits are, like pensions, a vested contractual right that can’t be changed. In September, a Los Angeles judge used that precedent to rule that the city couldn’t freeze retiree health-care benefits.
Reed’s proposed ballot initiative to change the state constitution would specifically eliminate the notion that employee benefits are a contractual right that bars all future changes. He is pushing for the amendment because workers are challenging a San Jose pension measure approved by 70 percent of the city’s voters last November. Reed, a Democrat, promoted that local initiative to lower pension costs, because he said the change was essential to preserving the city’s fiscal future and public services. Annual payments by San Jose to fund government pensions have risen to $245 million in 2012 from $73 million in 2002.
No state has recently altered its constitution to the extent that Reed proposes on pensions. In November, however, New Jersey voters approved a minor change to their constitution that allowed previously enacted pension reforms for judges to proceed. Judges had argued that 2011 legislation requiring them to contribute more to their retirement was unconstitutional because state law forbids diminishing their compensation. When a state judge blocked the pension reforms for her fellow judges, the New Jersey legislature quickly put an amendment on the ballot to change its constitution, and 83 percent of voters approved it.
Reed’s effort might resonate most loudly in Illinois, recently judged by Moody’s Investors Service to have the worst state pension crisis in the nation. Illinois’s constitution currently says that membership in a state pension system “shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired.” Public-union leaders have argued that this means Illinois can’t make any changes to its pension system for current workers. By contrast, the prominent Chicago law firm Sidley Austin LLP issued a brief last year saying the clause only protects benefits that have already been earned.
In the wake of this debate, pension-reform advocates have urged the Illinois legislature to enact changes and see if they pass muster with the state Supreme Court. If not, the state constitution would have to be amended, a tough task but one that might gain more supporters as the burden of Illinois’s pension system grows. This year the state is spending $6 billion from its $31 billion general fund budget on pensions, up from just $1.8 billion in 2008.
Courts in other states are taking a hard look at the California approach. After Colorado’s legislature in 2010 reduced annual cost-of-living increases for pensions, retirees sued to stop the changes. A Colorado district court ruled in 2011 that there was nothing in pension legislation suggesting that cost-of-living adjustments couldn’t be changed. A superior court reversed that ruling, and the state’s Supreme Court is now considering the case. Previous Colorado court decisions have followed the so-called California rule barring almost all changes to government pensions.
Reed, meanwhile, faces a difficult struggle in California, where public-employee unions have spent tens of millions to defeat past initiatives aimed at curbing their powers or benefits. But without flexibility to alter retirement benefits yet to be earned, California will struggle to cope with hundreds of billions in pension and retiree health-care costs in coming years.
(Steven Malanga is a senior fellow at the Manhattan Institute, which is holding a conference on Oct. 24 titled “Save Our Cities: Reforming Public Pensions to Protect Public Services.”)
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