KEEGAN: When it comes to cutting public pensions, you can and must

By   /   September 14, 2012  /   1 Comment

By Frank Keegan | State Budget Solutions

Frank Keegan

If current state and municipal workers and retirees refuse to accept their fair share of sacrifice on retirement benefits, the looming taxpayer backlash will sweep away a century of progress.

Workers must act voluntarily now, because politics and law never will resolve this crisis before the money runs out, and the legal protections they are counting on may be as false as politicians’ promises.

Even as California Gov. Jerry Brown this week signed pension legislation he admits does nothing about his state’s $500 billion retirement debt, that debt continues to grow by billions of dollars.

All over America, our 3,418 public pension plans are crashing faster than lagging data and analysis show. Earnings and investment value continue to fall far short, and the debt continues to grow beyond any hope of economic growth, tax increases and service cuts to pay it.

The true numbers are so bad some economists have suggested a national bailout, and some politicians have pledged to oppose it.

Now, a Boston University School of Law professor who compares public pensions to Bernie Madoff takes a look at the legal ramifications of bailout.

In “The Public Pension Crisis,” scheduled for publication in the Washington and Lee Law Review, Jack Michael Beermann takes an openly sympathetic look at the “recipe for disaster” state and municipal workers face, including “some risk of nonpayment in the future.”

He repeats the warning made in other studies: “Retirees face the risk of reduced pension payments and current employees face the risk of receiving less generous retirement benefits than the promises that they have been depending upon.”

Recent studies by economists at the Cleveland Federal Reserve Bank, Harvard Kennedy School Mossavar-Rahmani Center, Notre Dame and Maastricht universities, and The Center for Retirement Research at Boston College confirm that public pension funds eventually will run out of money, and current policy is just setting them up for that to happen sooner than later.

The most recent calculation of true pension debt by economist Andrew Biggs for State Budget Solutions, using universally accepted accounting, puts the total at $4.6 trillion as of last year, more than seven times the official estimate.

Beermann, who cites Biggs’ study, acknowledges debate over how huge pension debt is. He states that, “Although the matter is not free from doubt, this article proceeds on the assumption that there is at least some truth to the conclusion reached by many, that pension obligations will present a serious fiscal problem in the not too distant future. …

“My sense is that while there may be some exaggeration out there, the pension funding crisis is real.”

He also confirms, “The situation with health care promises to retirees may be even worse than the pension problem because fewer state and local government entities have set aside any funds to pay for those expenses. Coupled with serious inflation in the cost of health care and health insurance, the failure to set aside funds to pay for this may prove disastrous as more workers retire.”

Next he dives into the question, “Are Pension Promises Excessive or Abusive?” because if they are, constitutional and statute protections of benefits would not apply.

Beermann reviews extensive studies and raging debate over this issue and includes specific examples of prevalent atrocious violations of legislative intent on retirement benefits.

“The looming fiscal problems caused by unfunded promises to retired government workers has occurred due to the making of legally binding promises … without setting aside the funds to pay for those promises. To a certain extent, the pathology is typical of deficit spending by government,” he writes.

That pathology includes allowing “… current officials to provide services without requiring taxpayers to pay for them until much later, when they may be out of office …” and “… pension promises help politicians shore up support among government workers, or at least avoid opposition from government workers which would be substantial if significant reductions in pension benefits were opposed.”

He also points out that “… information on the extent of unfunded liabilities is not readily available, and what information there is may be difficult to interpret. Taxpayers may simply not know that public employees have been promised overly generous pensions or that tax revenues are insufficient to fund them. This problem is aggravated by the use of overly optimist projected rates of return …”

Then Beermann acknowledges the reality that “Excessive or abusive pension promises also occur due to the nature of the relationship between government employees and elected officials. Government employees are often among the most ardent supporters of incumbent politicians because such employees depend on politicians for their jobs, levels of pay, and working conditions.”

He points out that “… patronage still exists at high levels and various pockets of government … even if only a small percentage of employees are in a close relationship with elected officials, whatever system of pay and benefits is created will normally be designed to cover everyone. In other words, the desire to be generous to ‘connected’ employees contributes to excessive compensation for all employees.”

As a result, he warns, “Taxpayers may be waking up, …but it may be too late to avoid severe fiscal hardship.”

Beermann documents that unfunded retirement promises are explicit violations of deficit spending limits and balanced budget requirements. “This raises questions of whether the failure to fund pension obligations constitutes unlawful deficit spending, and whether such a violation would justify renunciation of some portion of unfunded obligations.”

When it comes to legal protections for public pension benefits, Beermann repeats the conventional wisdom that, “In many states, the weight of constitutional law is with state employees rather than the taxpaying public.”

And he cites U.S. Constitutional protections for enforcing contracts and against unlawful taking, as well as reviewing issues dealing with state sovereignty.

The big question on contract protections is whether “… pension promises are overly generous, and subject to abuse by legislators and other officials handing out political favors, and by employees using loopholes and tricks to spike their pensions. It is one thing for the government to breach a simple arms-length contract with a supplier …. It is quite another for government to attempt to reign in excessive pension promises made to secure the power of incumbent politicians at the expense of taxpayers.”

He also raises the question of whether retired municipal workers’ “… pension promises are no longer considered executor contracts. … This means that theoretically, retired workers could see their benefits subjected to severe restrictions.”

That could come in the form of future taxpayers “… resisting tax increases to pay for pension liabilities incurred in the past ….”

“However, just because state action violates federal law does not guarantee an effective remedy. … states cannot be sued for damages in federal court without their consent, even for actions that violate the Constitution of the United States,” though individual state officials may be sued.

Of course, workers in states with constitutional and statutory protections of pensions could try to enforce funding through state courts, but there are no legal precedents on what happens when pension funds run out of money and few requirements for states to pay into pension funds.

With a sympathetic nod to state and municipal workers, Beermann says, “In a sense, public pension recipients are in a similar position, but on the lower end of the economic scale, to the victims of Bernard Madoff’s Ponzi Scheme.”

He fails to point out that so are taxpayers, who now are the only ones being asked to sacrifice for this crime against the common good.

According to Beermann, “… if pension promises are viewed as the product of a corrupt or incompetent political system, then perhaps adjustments beyond those that would be tolerated on a strict contractarian view should be allowed.”

What he does not state is the obvious conclusion that nothing in constitutional, statute or ancient common law requires any government to enforce contracts entered into fraudulently, through coercion or to bypass other laws — such as balanced budget amendments — even if that contract is with the government itself.

Clearly, as Beermann’s conclusions and extensive documentation prove, that is the case when it comes to state and municipal retirement promises.

“Fairness aside, if the financial situation … does not improve, many state workers and retirees may suffer severe reductions in their pension benefits as public entities find it economically or politically impossible to meet their obligations to retired workers. …

“These possibilities may give pension plan participants strong incentives to negotiate over their pension benefits, perhaps resulting in the acceptance of significant reductions that are less painful than what would have otherwise occurred.”

He then briefly discusses “One modest proposal” of a federal bailout, but warns, “There are many practical reasons to be cautious about bailing out public pension funds. The most obvious is that it would be very expensive: in the trillions of dollars especially if health care promises to retirees are included.”

Beermann points out the obvious “moral hazard problem … In some states and localities, corruption has contributed significantly to extravagant pension promises. Unless serious consequences are attached to abusive behavior … losses may continue after bailouts.”

He picks up the refrain for fundamental reform now because, “Investment volatility and political considerations are likely to continue to threaten the financial viability of pension funds if they continue as currently structured.”

False pension “reforms” such as those signed into law this week by California Gov. Brown do nothing about the current structure of public pensions.

State and municipal workers must take the lead in restructuring them now, or risk the wrath of taxpayers destroying them in the near future.

Frank Keegan is editor of a project of The State Budget Solutions Project is non-partisan, positive, pro-reform, proactive and anchored in fundamental-systemic solutions. The goal is to successfully engage political journalists/bloggers, state officials and opinion leaders in a new way of thinking about state government and budgets, fundamental reforms, transparency and accountability. [email protected]



  • Mongolia3

    1970 was a very bad year for Illinois. The beginning of a nightmare. At the 1970 Constitutional Convention, the pension protection clause was added to the Illinois State Constitution, stating public sector pensions cannot be diminished or impaired. That was phase 1 of the scheme. Once the guarantee was in place, the politicians moved to phase 2. Phase 2 was politicians passing pension boosting legislation in exchange for campaign contributions and votes from public sector union workers. Phase 2 continues to this day. It’s an annual event. Pension boosting legislation occurred every year except 2 from 1971 to 2011 according to researcher Bill Zettler. Can you think of a better scheme. Guarantee the pensions in the State Constitution, then increase the pension benefits in state law. It’s all legal. But not financially sound and in fact it turns out to be a ponzi scheme because the money coming in is not nearly enough to pay the benefit increases that have occurred. Now if there had not been 38 years of new pension boosting legislation, Zettler asserts the pensions would be in good shape. If benefit levels would have remained at 1970 levels, Zettler states we would be fine. So the politicians destroyed through benefit increases what was previously a perfectly acceptable pension plan.
    Also at the 1970 Constitutional Convention, Home Rule was added as an option for Illinois municipalities to borrow without voter approval. Home rule has resulted in some municipalities over borrowing significantly and the voters were unaware the extent of the borrowing and risks associated with borrowing because the process in which the borrowing took place was not as transparent as it could have been, and the risks of borrowing were minimized. Wouldn’t want to scare the investor (taxpayer).
    As a result of pensions injected with legislative steroids and municipal borrowing risks being minimized and sometimes the deals themselves being ushered through quietly, Illinois has catered to the special interests at the expense of Everyday Joe. Joe’s not educated enough and not voting enough.
    Michael Madigan was a delegate to the 1970 Constitutional Convention, first elected State Representative in 1970, assumed office 1971, 11 years later in 1982 was voted Speaker of the House, a position he assumed in 1983 and has retained every year for the last 29 years except 1995-1996 when Republicans controlled the House.