Illinois's Pension Reform Goes Down In Flames

On Friday the Supreme Court of Illinois unanimously declared unconstitutional, under the Illinois State Constitution, the 2014 pension reform law by which Illinois's legislature had sought to bring the state's pension costs under control.  The whole exercise represents a major lost opportunity for Illinois, and for the cause of state pension reform generally.  

The decision of the Illinois Supreme Court is here.  The basis of the decision is that the attempted reform, embodied in a statute called Public Act 98-599 (effective 2014), violated Article XIII, Section 5 of the Illinois Constitution that reads:

Membership in any pension or retirement system of the State . . . shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired.  

In the face of that provision, the Illinois legislature enacted a statute that reduced the pension annuities that state employees could earn over the course of their careers, without making explicit that pensions already earned as of the date of the statute were protected.  It's not possible to know how the court would have come out if the legislature had explicitly protected all pensions already earned.  Perhaps this court would have come out the same way, particularly given the level of anger and hostility evident in its opinion.  But if the legislature had taken the route of explicitly protecting all pension earned to date, they would have had a powerful, and ultimately correct,  argument that what they were doing did not violate the constitutional provision.  Even if they had lost this case, they would have had a more than good shot of prevailing in the long run.  Now, it's back to the drawing board.

As enacted, this statute appears to reduce both pensions earned before its effective date and also subsequent accruals.  Here is a list from the Supreme Court opinion of some of the changes:

First, it delays, by up to five years, when members under the age of 46 are eligible to begin receiving their retirement annuities. . . .  Second, with certain exceptions and qualifications, it caps the maximum salary that may be considered when calculating the amount of a member’s retirement annuity. . . .  Third, it jettisons the current provisions under which retirees receive flat 3% annual increases to their annuities and replaces them with a system under which annual annuity increases are determined according to a variable formula and are limited. . . .

Without explicit protection of pre-enactment accruals, the state was left in the position of having to argue that it could use its police powers to override pension contracts -- in the face of a specific constitutional provision protecting the pension contracts (not to mention a provision in the federal Constitution barring states from impairing rights under contracts).  Here is the state's brief in the Supreme Court.  I can't say I'm surprised that the Supreme Court did not buy the state's argument, which would essentially mean that the state could ignore the clear constitutional provision by the simple of expedient of declaring some kind of "emergency" whenever it wants to spend the money on something else.  Moreover, the court seems to have been particularly offended by the fact that the statute exempted judge's pensions from the reforms.  Although the legislators may have thought that they would buy the judge's support by the exemption, the judges were smart enough to realize that if they upheld the reforms for everyone else, then the reforms could be extended to judges the next day.

So Illinois is now in the position of having to start over in the face of a hostile and skeptical Supreme Court.  Worst is that the distinction between pensions accrued-to-date and future accruals was never clearly presented in this case.  Not explicitly protecting already-accrued pension benefits was a huge mistake by the Illinois legislature.  That omission took away from the state the potential winning argument and also led to sloppy language in the Supreme Court's opinion that may suggest that the constitutional provision protects future accruals. For example, here is a quote from page 20 of the opinion:

Accordingly, once an individual begins work and becomes a member of a public retirement system, any subsequent changes to the Pension Code that would diminish the benefits conferred by membership in the retirement system cannot be applied to that individual.   

But is it really the case that the Illinois constitutional provision (and comparable provisions in many other states including New York) means that an employee who begins work for as little as one day at age 25 is then entitled to have his pension accruals continue at an undiminished rate for an entire career of 40 years or more, even if those accruals are at a completely unsustainable level for the state and its taxpayers?  The obvious flaw in this logic is that the obligation to pay for pension accruals based on future service does not yet exist, and the state has not committed itself to make such an obligation come into existence.   The constitutional provision protecting pensions does not give an employee a constitutional right to have his job. Therefore, he can be fired, or can quit, before earning additional pension benefits.  So a reduction limited to future accruals does not "diminish or impair" anything to which the employee has an existing contractual right.       

Where does Illinois go from here?  The Supreme Court's opinion does not actually direct the legislature what to do, and only enjoins implementation of the statute previously enacted.  But the court seems to think that the legislature will now only have one option, which is to fully fund the pensions under existing accrual rules, raising taxes to the extent necessary to do so.  I see several other options:

  1. The legislature can do what it should have done in the first place, and enact a new statute explicitly protecting prior pension accruals while reducing future accruals.  Without doubt the same cast of characters will challenge such a new statute.  But the new statute will make the court focus this time on the distinction between past and future accruals and either allow the future reduction or take the extreme and ridiculous position that one day of work for the State of Illinois brings with it a lifetime entitlement to a given pension scheme.
  2. The state could start systematically getting rid of (laying off) senior employees with unsustainable pension accruals and replacing them with new employees with much reduced pension promises (or perhaps, defined contribution plans).  Will the Illinois Supreme Court then hold that employees have a constitutional right to their jobs, even if the constitution has no such provision and the senior employees with unreduceable pension accrual obligations cost double or more the cost of replacements?
  3. Or then there's the option that seems to be the choice of New Jersey: just stop putting money into the pension plans and see what happens.  The Supreme Court can declare a statute unconstitutional, as it has done here, without too much stress; but it is quite another thing for a court to order a legislature to appropriate money.  It is likely (but not certain) that the court will pull back before taking that step.  According to the Supreme Court opinion, the state pension plans at issue are currently about 41% funded.  And that's with the stock market at record levels!    With no additional contributions, one good stock market crash could have these pension plans bouncing checks within as little as ten years.  Bring it on!

Or Illinois can do what the court wants and raise taxes greatly to try to rescue these badly underfunded plans.  That course would risk putting Illinois into accelerating economic decline relative to its neighboring states.  And Illinois is already the economic laggard in its Midwestern neighborhood.  I say, try one of # 1, 2 or 3.