On Pension Reform, Trying to Fit a Square Peg in a Round Hole

Politicians can't fix pension abuses with voting rules alone.
by | April 19, 2012

The venerable and astute leader of the Illinois state house of representatives, Michael Madigan, is trying to fix the Illinois pension problem with the wrong tool. With all due respect, his proposal to amend the state constitution to raise the majority-vote requirements for pension benefits increases is well intended, but it's the wrong fix. Rather than address the root of the problem, he has narrowly focused on "inside baseball" rules that only matter to politicians and lobbyists. It's no wonder that the unions immediately renounced the idea: They are the consummate insiders in this game.

One of the big, big problems in Illinois (and in several other states, including California, New York, Pennsylvania and Tennessee) is that a pension-benefit increase in that state is legally asymmetrical: Once granted, it can't be taken away, even for future service. And worse, it can be granted retroactively, which accomplishes nothing for the employer or the taxpayers, as I first explained in a 2008 column. These two important problems need to be addressed by constitutional action in some states, and by statutory amendments in others where the legal scholars agree that's a sufficient remedy.

Nobody needs to take away vested benefits of employees and retirees for service already performed, unless the employer and the benefits plan are in such dire financial straits that federal bankruptcy or an equivalent state-level receivership remediation process becomes the only way to save the system. Federal courts have made it pretty clear that such an extraordinary measure must be proved to be necessary, the adjusted (reduced) retirement benefit must be reasonable, and the modification should be the least necessary to make the plan sustainable. But the entire country would benefit if the handful of states with these upward-ratcheting, asymmetrical retirement benefits laws would change the legal ground rules for benefits increases, so we don't keep repeating the same mistaken boom-bust funding cycle of the past 20 years.

First, it should be illegal by statute or constitution — whatever is necessary — to award retroactive pension and retiree medical benefits or benefits increases. "Retro rewards" do not attract or retain employees, as is often posited, because the retroactive benefits do nothing for new hires. They actually make it easier for senior employees to head for the exits with their sweeter retirement package. Professionals at the Government Finance Officers Association recommend they be avoided.

Second, the state laws must be changed to provide that henceforth, any increase in a retirement plan benefit can be subsequently rescinded or modified downward with respect to future service. Thus an employer that grants an increase in the pension multiplier from 1.6 percent times years of service to 1.8 percent could later revert the multiplier back to 1.6 percent for service in the remainder of the employee's career. In this example, the employee would be vested at the 1.8 percent rate for the intervening period. What may or may not be legal in this scenario would be a reduction of the same employee's future multiplier to 1.4 percent, depending on what a state's laws say about making changes prospectively. In any event, these prospective adjustments would be completely consistent with the federal Employee Retirement Income Security Act (ERISA) which governs private-sector pensions but lacks jurisdiction over states and localities.

If these two essential reforms are not included in the legislative package, it doesn't matter whether the voting rule requires a majority or a supermajority in states like Illinois. In many instances, a powerful union can push through a benefits increase with supermajority votes, so the voting rule is really just shuffling the deck chairs on the Titanic. Taxpayers are far better protected by the structural reforms described above.

For a checklist of pension and retirement plan reforms that state legislatures would be better advised to enact, and a brief rationale for each, see my 2011 article published by the Council of State Governments for legislators to consider.

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