Municipal Finance

Illinois Pension Reform Legislation Is Legally Justifiable and in the Best Interest of All


Illinois Pension Reform Legislation Is Legally Justifiable and in the Best Interest of All ( )

by James Spiotto

On November 21, 2014, the Circuit Court for the Seventh Judicial Circuit in Sangamon County, Illinois presiding over the consolidated Illinois State Pension Reform Litigation ruled that the pension reform legislation passed by the State Legislature and approved by the Governor was unconstitutional. The court cited the recent decision by the Illinois Supreme Court in the Kanerva v. Weems case to the effect that the enforceable contractual relationships arising out of membership in one of the state’s pension retirement systems cannot be impaired or diminished. The Illinois Supreme Court in the Kanerva v. Weems case extended the protection of the Pension Clause of the Illinois Constitution to healthcare benefits.

Similar Reforms Have Been Enacted by Other States

Many states and cities are addressing pension underfunding in a manner they believe will be successful. Over 40 states between 2010 and 2012 have addressed pension reform (8 in 2012, 32 in 2011, and 21 in 2010). Between 2009 and 2011, 28 states increased employer contributions and 7 states have increased employee contributions for new hires. Also, between 2009 and 2011, 28 states have increased the retirement age and service requirement and 18 have reduced post-retirement benefit increases such as COLA. In addition, since 2008, 8 states have allowed, for at least some public employees, optional, hybrid or mandatory defined contribution plans providing a fixed payment with no risk of loss on the employer as compared to the traditional defined contribution with the risk of loss on the government. Each of the general elements of the Illinois 2013 Pension Reform legislation has been successfully implemented by other states and determined to be legally justified.

The Practical Reality

It should be noted that identifying the reason for the pension underfunding is critical to finding a solution. If pension underfunding is due to an unwillingness to fund and not an inability to pay then the answer is simple. Just raise taxes to pay the required amount and cure the underfunding. To the extent pensions are affordable, they should be paid in full. Public workers deserve no less. If pension underfunding is due to inability to pay, namely if you raise taxes and reduce services, corporate and individual taxpayers will leave and the resulting tax revenues will be less, then those pension benefits that are unaffordable and unsustainable must be adjusted for the sake of all. The Illinois legislature determined that pension reform was necessary because of a clear inability to fund, and not an unwillingness to pay. The failure to address this underfunding issue now will have dire consequences the longer dealing with the problem is delayed.

The Illinois legislature determined that pension reform was necessary because of a clear inability to fund, and not an unwillingness to pay.

This is especially true for younger workers who may suffer the disproportionate pain of an unaffordable promise. As the Civic Federation of Chicago has noted, there is approximately $100 billion of state pension underfunding and contributions in FY 2015 to the state’s five pension retirement systems are $6.05 billion (a 64% increase in five years) and debt service on the state’s pension bonds is $1.5 billion for a total of $7.5 billion or 24.7% of state General Fund revenues. With one out of four General Fund dollars going to pay pension benefits, the concern of the legislature is clear, present and real.

The Lower Court’s Ruling

The Sangamon County Circuit Court in its ruling noted that the Constitution provides that the pension obligation is that of a contract. That Court also noted that the pension protection clause in the Illinois Constitution could not be rewritten. The Court did not believe that the State’s claim that it has a sovereign power reserved to it to adjust pension benefits in order to preserve and protect necessary essential services and infrastructure to ensure preservation of the health, safety and welfare of its citizens is well established under the case law in Illinois. The Court noted that no precedent from prior Illinois cases was cited in support of this reserved sovereign power.

With one out of four General Fund dollars going to pay pension benefits, the concern of the legislature is clear, present and real.

The article How Municipalities in Financial Distress Should Deal with Unfunded Pension Obligations and Appropriate Funding of Essential Services, 50 Willamette L. Rev. 515 (2014) addresses the lower court’s concern. Namely, as the U.S. Supreme Court has consistently ruled, municipalities and states cannot abdicate, contract away, surrender or otherwise avoid their inalienable governmental power and mandate to provide essential services and infrastructure to preserve the health, safety and welfare of their citizens. (A litany of U.S. Supreme Court cases have refined and reaffirmed this as outlined in the article). If public pensions are not affordable and sustainable, they must be reasonably adjusted to assure that the reasons for the existence of government are not impaired. The Sangamon Circuit Court in its ruling did note the Illinois Supreme Court decision in Felt v. Board of Trustees of Judges Retirement System where the Court held the record was not defensible to justify an impairment of pension benefit contract as a reasonable exercise of police power. However, the Illinois Supreme Court in Felt specifically noted these U.S. Supreme Court cases permitting reasonable adjustment of a contract in order to balance the overriding mandate of a higher public interest against a claim of impairment of contract.

Adjustment of Unaffordable Pension Benefits is Not Impairment or Diminishment but Recognition of Reality

In fact, the U.S. Supreme Court in the City of Asbury Park case clearly noted that state and local governments in financial distress may lack the ability to collect sufficient funds to pay certain unsecured obligations and, therefore, there is no impairment or diminishment in the adjustment of those unsecured obligations to that which can be paid. Applying this precedent, there is a recognition of the reality of the circumstances that if there are insufficient funds both to pay pension obligations in full and to satisfy the mandated priority of appropriate funding of essential governmental services and infrastructure, there has to be an adjustment. In the U.S. Supreme Court ruling in the case of the City of Asbury Park, it also noted the paper rights of contractual obligations are subject to adjustment under the reasonable exercise of the government’s police powers so that the mandated continued funding of essential services can be assured.

… continued reinvesting in Illinois by full funding of needed essential services and infrastructure improvements will stimulate economic growth, increase business expansion, and create new jobs.

The Supreme Court also acknowledged that dedicated tax payments to bond obligations are not subject to such modification. The Illinois Pension Clause was intended to change the prior custom and practice of treating pension benefits as a gratuity to be paid when convenient and desirable. After the change under the Pension Clause, pension obligations were to be contractual obligations that were enforceable and no longer to be paid solely at the whim of the government.

The Illinois Pension Clause Should be Interpreted Consistent with the Purpose of Government and Other Constitutional Provisions

The lower Illinois court noted that the Illinois Supreme Court has ruled that the plain language of the Illinois Constitution Pension Clause cannot be rewritten. However, this Pension Clause should also be interpreted consistent with other Constitutional provisions. Specifically, the Preamble states that the purpose of the Constitution, for which the other clauses are established, is to provide for the health, safety and welfare of the people. The other clauses of the Constitution should not be interpreted as in any way abdicating or contracting away that basic mandate for the existence of government. In addition, Article VIII of the Illinois Constitution specifically provides that the state budget shall be balanced and appropriations for any fiscal year shall be no greater than the estimate of funds available and that the appropriations for a fiscal year shall not exceed the funds estimated by the General Assembly to be available for that year. These provisions of the Constitution cannot be ignored in favor of the Pension Clause. The terms of the Constitution must be interpreted to give meaning to each provision. Accordingly, unsustainable and unaffordable pension obligations, which crowd out the funding of essential governmental services and infrastructure necessary for the health, safety and welfare of the state’s citizens, cannot alter or override the mandate for the existence of the government. To the extent that funds are not available after providing for essential governmental services and infrastructure to pay in full those pension obligations, their adjustment is not an impairment or diminishment because there is no reality to their payment. To raise taxes and reduce services to fund that which is unaffordable only causes corporate and individual taxpayers to leave the state with resulting reduction of tax revenues and the ultimate death spiral of the government. Between 1995 and 2010, 850,000 people left Illinois, taking with them $35 billion of taxable income, according to the Illinois Policy Institute. Fortunately for Illinois, during that same period, its overall population continued to grow by one million. Everyone would have benefited from a 1,850,000 population increase during that period.  But, we should never overlook the fact that continued reinvesting in Illinois by full funding of needed essential services and infrastructure improvements will stimulate economic growth, increase business expansion, and create new jobs especially for younger citizens that will increase tax revenues for the benefit of all.

The Tree That Does Not Bend in the Wind Is Uprooted

The Illinois Pension Clause does not specifically state that pension obligations shall be paid under all circumstances even to the exclusion of the full funding of necessary services for the health, safety and welfare of the people. Reasonable adjustments to make pension benefits sustainable and affordable are not a diminishment or impairment, but rather are the recognition of reality of the limited revenues. The failure to fund the necessary essential services and infrastructure would eventually lead to a loss of corporate and individual taxpayers that would result in less revenues to pay for workers, retirees and all concerned. The wisdom of the U.S. Supreme Court cases should reinforce the appropriate interpretation of the Illinois Pension Clause that unaffordable pension benefits whose funding would interfere with the appropriate funding of governmental services and infrastructure must be reasonably adjusted for the sake of all concerned.

James Spiotto is a Co-Publisher of MuniNet Guide.

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