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For the past year or so, as the public pension crisis has been exposed across the country, unions have cited the law as the reason that states cannot restrain their retirement system costs. Pension deals between government and workers are ironclad, their legal theory went, and compensation can't be trimmed even for workers' future years of service. So when three states, Colorado, Minnesota and South Dakota, cut the cost-of-living allowances (COLA) in their pension formula last year, their reform efforts were expected to be scuttled by the courts in favor of the union plaintiffs.
Instead, judges last week in Colorado and Minnesota threw out the suits and therefore opened the door to further reform. In Denver, District Judge Robert Hyatt decreed that saving the state's pension system from spiraling out of control "is a legitimate governmental interest" which neither side in the case disputed in their briefs. His counterpart in Minnesota, Judge Gregg Johnson, wrote that the retirees "have not met their burden to show unconstitutionality beyond a reasonable doubt" in regards to the COLA change. The New York Times noted that before these rulings public pensions were considered "bulletproof", but now "the legal tide may be changing for public pensioners."
For most policymakers, pension reform so far has meant changing the model to cut the costs of future workers. This is necessary, but doesn't put a dent in the unfunded liabilities held by the states, which have been calculated by some economists to be as high as $3 trillion. The retirement systems in twelve of those states are so bad that they are on course to run out of money by the end of the decade.
Cutting the COLA is one of the reforms needed (along with rolling back excessive pension accruals, eliminating the practice of "spiking," and raising the retirement age) to stave off pension insolvency. Along those lines, the American Legislative Exchange Council, an organization of nearly 2,000 conservative state legislators, earlier this year adopted model legislation drafted by the American Principles Project that caps pension payouts at the private sector median. By green-lighting the COLA adjustments, the two court rulings signal to lawmakers that they may proceed to do what's needed to make their retirement systems sustainable.
If states don't act to bring down their unfunded liabilities, they'll have to fall back on a combination of spending cuts below socially acceptable levels and tax increases above what is economically tolerable in order to direct revenue into pension payouts. It will be a wealth transfer from younger workers to government retirees. It makes no sense, but this is the outcome of a defined benefit retirement system run amok.
There is relatively little case precedent for pension reform, but recently we've seen assumptions turned on their heads. Vallejo, Calif., wouldn't go so far as to touch pensions in its bankruptcy organization plan, but a small town in Alabama cut off payments when it ran out of money. COLAs, like the rest of vested workers' pensions, were thought to be legally untouchable by most pension-watchers until those two judges ruled otherwise.
South Dakota is still waiting for the same affirmation, and New Jersey Gov. Chris Christie last week signed a law eliminating his state's COLA. During the next round of state legislative sessions, expect to see more lawmakers and governors take aggressive action.
The law is ultimately founded on common sense, and common sense on this issue dictates that public pensions shouldn't be straightjackets on state governments.
Rich Danker is Project Director for Economics at American Principles Project, a Washington policy organization
