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Wednesday, July 06, 2011

The Legality of Public Pension Reform

State pension systems have been in the news lately. For good reason: Novy-Marx and Rauh’s paper last year noted that the states themselves report unfunded liabilities for state pensions as totaling $1.2 trillion (p. 10).

But that number depends on a crucial assumption: that the pension systems’ assets will grow at about 8% per year indefinitely. If you make the safer assumption that assets will grow at the risk-free Treasury rate, the unfunded liabilities more than double to $2.49 trillion (p. 28). Either way, there’s a lot of money that states need to contribute to their pension systems over the next few decades.

Many states have been passing pension reform laws. (Handy and thorough summaries of both proposed and enacted legislation are available through the National Conference of State Legislatures.) In many cases, states merely change the pension terms applicable to newly hired employees. These changes are much easier to enact, given political realities, but they do nothing to remedy any financial shortfall until decades in the future.

A few states, however, have been enacting more ambitious legislation, touching not only current workers but even occasionally the benefits given to people who are retired right now. Colorado and Minnesota are prime examples: in both states, the legislatures reduced the cost-of-living adjustments that were being given to current retirees.

As might be expected, these states were promptly sued on the theory that changing the terms of pensions for existing retirees violates the Contracts Clause (and associated state constitutional provisions). But in both Colorado and Minnesota, plaintiffs recently lost.

The Colorado state judge held that “while Plaintiffs unarguably have a contractual right to their PERA pension itself,” in light of the long history of changes to the cost-of-living adjustment (or COLA), “they do not have a contractual right to the specific COLA formula in place at their respective retirement, for life without change.” The Minnesota judge went further, explaining that a court order guaranteeing a particular pension formula for life would strip “the legislature’s ability to respond to fiscal integrity concerns, which in turn would be an extraordinary expansion of the Contract Clauses of the United States and Minnesota Constitutions.” (The Minnesota judge also curiously referred several times to the plaintiffs’ burden to demonstrate unconstitutionality beyond a reasonable doubt, see pp. 2, 3, 14).

We’ll soon see what happens with the similar pension lawsuits pending in New Hampshire, Rhode Island, Florida, South Dakota, and Cincinnati. I suspect that whatever the merits of a Contracts Clause argument, few state judges will be willing to order large expenditures at a time when state budgets are in so much trouble.

Posted by Stuart Buck on July 6, 2011 at 12:39 PM | Permalink

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