Expanding the "Fairness" Calculus in Illinois' Pension Debate

It's time for a balanced discussion of "fairness" in the debate over Illinois pension policy toward current employees and retirees. 


The Wall Street Journal published a justifiably critical opinion piece about the decision in Kanvera v. Weems. This is the case where the Illinois State Supreme Court ruled 6-1 that retiree health insurance subsidies are protected from reduction under the clause within the Illinois Constitution that prevents the impairment of pension benefits. I expressed my disagreement with the justices, as well as my concerns about what the decision will mean for Illinois' fiscal future in a previous post. The Journal offers forth a similar analysis:

The ruling is a dreadful precedent for sensible pension reform. The court majority opined that the state constitution is "aimed at protecting the right to receive the promised retirement benefits, not the adequacy of the funding to pay for them" and "must be liberally construed in favor of the rights of the  pensioner." And unions have sued to block last year's de minimis pension fixes that tweaked cost-of-living adjustments, raised the retirement age for younger workers and capped annuities for employees making six figures.

The conclusion of the article zeros in on the real issue:

But if retirement benefits are held inviolable, lawmakers will have no choice but to raise taxes to the hilt and the judiciary will be a co-equal partner in the state's collapse.

This makes for a good entry point into a discussion about "fairness." The term "fairness" is frequently invoked as a talking point by members of the affected retirement systems and the unions that represent participating employees. The argument made is that current benefit levels are promises, employees always paid their full contribution, the state didn't fulfill its contribution requirements, and honoring the benefit levels is the only fair thing to do. The union-backed lawsuit against the benefit reductions in SB 1 is based almost entirely on these premises. 

It's widely agreed upon that the state grossly mismanaged the public pension funds by deliberately underfunding and even skipping payments entirely in some years. This historical mismanagement put the funds on the ropes. The 2008 market collapse dealt the knock-out blow.

State leaders are trying to tunnel out of the immense hole by reducing benefits, causing pension fund participants to scream foul about having to shoulder the financial burden through reduced pensions. They believe this is unfair and that the moral argument is squarely on their side.

But is it really? Something, or rather someone, always seems to be left out of the "fairness" calculus in the Illinois pension debate. We need to ask the following question. If it's unfair to reduce pension benefits for public employees, then what's the remedy to fix the pension systems and avoid a financial collapse of state government? There has to be a remedy. 

If you can't cut spending, the only other realistic remedy is to raise revenue. And this means tax increases. 

Is raising taxes to address the pension crisis "fair?" Let's consider a few numbers. 

The following data is from the most recent biennial report from the Illinois Department of Insurance. The report was published in 2013 and includes data from 2012. The Department's published data almost always lags behind by two years. For the sake of consistency, I'll use 2012 data throughout this post. 

According to the report, there were just over 500 thousand participants in the four state-funded pension systems that were included within the pension reform law (SB 1). This number includes active employees and beneficiaries.   

A look at Illinois' 17 public pension systems shows that slightly more than 1 million Illinois workers currently receive, or will eventually receive a guaranteed benefit from a public pension system. About half of these employees (state-funded systems) also receive, or will be eligible to receive generous taxpayer-funded retiree health insurance subsidies. 

Based on December 2012 numbers from the United States Department of Labor, almost 6 million Illinoisans were employed (and paying taxes). This employment number remained around 6 million in more recent years.

This means that about 5 million out of approximately 6 million workers employed in 2012 were not enrolled in systems that provide guaranteed pension benefits or fully-subsidized health insurance benefits. Those fortunate enough to be enrolled in a pension plan most likely have a defined contribution plan subject to the vagaries of the market. 

It's also important to note that most public pension plan retirees are guaranteed income protection through a cost-of-living adjustment. This is not the case with defined contribution plans.  

It should also be acknowledged that SB 1 results in a "haircut" for existing benefit levels. Using one example, the reforms don't entirely do away with the guaranteed cost-of-living adjustments. The law just reduces them from being compounded at 3 percent a year to a number that more accurately reflects actual inflationary growth. But the annuity is still guaranteed growth. Wouldn't 401k participants gladly take that deal?

Advocates of increasing taxes so that the state can act "fairly" and honor its "promise" to public employees must believe that it's completely "fair" to compel approximately 5 million people who don't enjoy guaranteed pension benefits and fully-subsidized retiree health insurance to see their pay reduced so that not one single retirement dollar comes out of the checks of about 500 thousand state-funded pension plan participants (SERS, TRS, SURS, GARS) -- or about 8 percent of the total number of employed workers in Illinois as of 2012. 

A tax increase would leave this silent majority with less money in their checks to pay their mortgages, pay for health care, set-aside funds for college, and pay everyday living expenses. These taxpayers broke no promises to state public pension fund participants, yet may find themselves on the hook for the remedy. They are too often forgotten in a "fairness" debate that only seems to include two actors -- public employees being victimized by the poor fiscal management of elected state leaders. We can't forget that Illinois taxpayers are essentially innocent bystanders that may be forced to participate in a solution to a problem that isn't of their making. Now THAT'S the real unfairness. 

My argument isn't that tax increases should be off the table. Illinois' finances are a mess and tax increases may very well be part of the long-term solution. I only suggest that those invoking the concept of "fairness" should consider that they don't own the moral high ground when their preferred remedy is to have their neighbors bail out the pension systems. 

A tax increase remedy is unfair to the vast majority of Illinois taxpayers who may be compelled to bail out the pension systems without receiving anything in return for themselves. And they won't have recourse to file lawsuits if their checks are "impaired" by a higher tax rate in order to shore-up the state pension systems. 

Illinois' Constitution Does Not Have to be a Financial Suicide Pact

The Illinois State Supreme Court ruling in Kanerva v. Weems cast a dark and foreboding shadow over Illinois' already gloomy financial picture and may create a backlash that will end with a significant change to the Illinois Constitution.

In Kanerva, the Court found that state retiree health insurance subsidies are protected by the "impairment" clause of the Illinois Constitution. This clause reads as follows:

Membership in any pension or retirement system of the State, any unit of local government or school district, or any agency or instrumentality thereof, shall be an enforceable contractual relationship, the benefit of which shall not be diminished or impaired.

The immediate ramification of the ruling is that a class action lawsuit against the state's authority to reduce the health insurance subsidies can proceed. The 2012 legislation to eliminate the full health insurance subsidy and require state retirees to pay some portion of the cost was an important piece of the overall state fiscal reform puzzle. This is big money. Here's what the State Journal-Register reported in May of 2012 as the bill was winding its way through the legislative process:  

House Minority Leader Tom Cross, R-Oswego, a co-sponsor of the bill, said the state spends $876 million on retiree health insurance. He said 78,000 state retirees pay no premiums for their health insurance, something that costs nearly $7,400 per person.

The Court's decision appears to have wiped out hundreds of millions in savings to Illinois taxpayers. But the broader ramification concerns how the Court is likely to rule on legislation to reduce pension benefits for existing employees of state and local governments. 

Prior to this ruling, the impairment clause was largely understood as applying only to benefits awarded under the Illinois Pension Code. In what can be viewed as nothing less than an ill-timed bombshell for Illinois taxpayers, the justices ruled that all of the benefits that are limited to, conditioned on, and flow directly from membership in the state's public pension system must be considered to be benefits of membership in a state pension or retirement system. In short, retiree health insurance subsidies qualify for protection under the "impairment clause" and, consequently, cannot be reduced. 

I'm admittedly not a constitutional scholar, but the reasoning employed by the Court on this point strikes me as a pretty radical reach in logic. Here's what appears to be the crux of the Court's argument:

“Health care benefits are not referred to in the pension clause, but neither is there any limitation imposed concerning them,” according to the Illinois Supreme Court. “It is a well settled principle that pension rights should be liberally construed in favor of the rights of the pensioner.”

Simply put, because the Constitution doesn't explicitly say that health insurance benefits are not covered by the pension impairment clause, then we're just going to presume that they should be included. With apologies and all due respect to the justices, this appears to be tortured logic. It's also chilling that Kanerva was a 6-1 decision.

In stating that "pension rights should be liberally construed in favor of the rights of the pensioner," the Court has likely tipped its hand that it will find a handful of bills that reduce benefits for state and Chicago municipal employees unconstitutional. The 2013 law that reduced benefits for 4 of the 5 state-funded pension systems was estimated to save $160 billion over 30 years (insofar as these estimates are accurate). It now appears more likely than not that these savings will not materialize once the Court rules on the law. State leaders will have to go back to the drawing board and revisit pension reform without any expectation that public employee unions will cooperate by negotiating an agreement. Why should union leaders cooperate if they believe that the Illinois Constitution and Supreme Court are squarely on their side?

And that's why Illinois taxpayers may need to choose between considerable and permanent tax increases or a serious effort to change the state constitution. The latter solution presents a more attractive option to voters, but will potentially set in motion a battle royal between voters and entrenched public employee unions. 

Fox Chicago has a good segment on the Kanerva decision.