By: Mark Glennon*

 

If a leading voice for Illinois Democrats and public unions on the legality of pension reform is correct, this is the consequence: No Illinois constitutional amendment, act of the United States Congress or Federal bankruptcy can ever, for eternity, reduce unfunded liabilities in our municipal and state pensions. Only voluntary trades made at the discretion of  pensioners, which obviously can’t accomplish much, are permissible, he says. Statewide, those unfunded liabilities total $371 billion, according to recent data compiled by the Stanford Institute for Economic Policy Research and based on more accurate “market based” numbers.

 

Eric Madiar is a prominent Democratic lawyer who works on pension reform issues. He was chief counsel to Illinois Senate President John Cullerton. Cullerton runs most of the show on pensions for Illinois Democrats and is the go-to guy for public unions. I think it’s fair to say that Madiar states legal views consistent with those of Cullerton and most public unions. He recently published a detailed legal piece on what he sees as Illinois’ permissible options for pension reform. His article was summarized on Monday by Greg Hinz at Crain’s under the headline, What are Illinois real pension options now?

 

That dire consequence of permanent doom results from a novel argument made by Madiar, which is that the Illinois Constitution’s pension protection clause should be read to mean that the state could never give its consent to municipal bankruptcy. That consent is required under the United States Bankruptcy Code and Illinois, unlike states like Michigan and California, hasn’t given it. There’s no Federal preemption issue here because the Bankruptcy Code expressly requires that consent. As Madiar sees it, the Illinois Constitution bars any branch of government from giving that consent because bankruptcy indirectly means cutting pensions.

 

And amending the Illinois Constitution to loosen or delete the pension protection clause isn’t an option, according to Madiar — an opinion that others have expressed before. They think any such amendment would be invalidated under the United States Constitution (the Contracts Clause and “Taking” theories). That’s a plausible argument, though we still need a credible, independent, constitutional expert to weigh in on it. Regardless, the amendment process and legal challenges would take many years, so even some ardent pension reformers I’ve spoken to aren’t placing much hope in an amendment. Perhaps more importantly, amending the constitution is politically impossible to implement for years. A three-fifths vote of both houses of the General Assembly would be needed, and the majority is beholden to public unions.

 

So, the key is that first point: Would courts really rule that authorizing municipal bankruptcy is unconstitutional in Illinois? That would mean the concept of bankruptcy — an orderly readjustment meant to share losses fairly and provide a fresh start — that has been around for over 500 years — isn’t available to governments in Illinois. It would be more like ancient Greece, where debtors and their family members became enslaved to their creditors.

 

Accepting Madiar’s view would require an absurdly broad reading of the pension protection clause, I would say, but you can’t dismiss the chance that an Illinois court would rule absurdly. Just look at the 2014 Kanerva decision in which the Illinois Supreme Court added healthcare to the list of constitutionally protected benefits for state retirees. That ruling added over 50% to the state’s unfunded pension liability, even though “healthcare” isn’t even mention in the constitution.

 

Before I go through Madiar’s list of options and why they won’t accomplish much, here are two he didn’t mention:

 

Just don’t fund the damn things

Don’t laugh — we’re largely doing that already and support for doing more is growing behind the scenes. Annual pension contributions set by Springfield for Illinois state and local pensions fall far short of what’s needed even to keep their unfunded liabilities from increasing further, with a tiny number of exceptions. We’ve written often about that, and it will only worsen since the post-recession bull market for their stock investments ended last summer and interest rates remain stuck near record lows. And I’ve heard more and more folks in position of influence, in both parties, say in private there’s no choice now except to starve the pension beast if we want to maintain basic government services, and hope that somehow an answer appears in later years.

 

Not funding them only compounds the ultimate liability, of course, but pensioners seem content knowing that if the pensions bleed dry they can always sue directly on their pension obligation, which the Illinois Supreme Court recently ruled is the case for Chicago. They might take further comfort in a line from that Greg Hinz article, which foolishly says that pensions are “effectively guarantied by a first lien” on the government’s assets. Wrong. Pensioners are unsecured creditors for the unfunded liabilities and general obligation bonds have a payment priority. If pensioners ever end up going to court to get a judgement and try to execute on assets they also will find that most or all assets are already mortgaged to secure other bonds.  A judgment lien won’t help.

 

Move

People and employers are already fleeing, we know, but the exodus would become a stampede if taxes were ever raised enough to adequately fund pensions. That’s why no reform opponent, none, ever states the size the tax increase that would be needed, and nobody in either party has the guts to propose that increase. Willful blindness, denial and outright dishonesty prevail. Personally, I sure won’t stick around if this isn’t fixed by when my youngest graduates from high school, about six years from now. Pension promises were made through a combination of error, fraud and graft, and I, like many, have no intention of helping pay them in full.

 

The rest of Madiar’s list of options, and why they can’t accomplish much, is below. It’s important to remember as you go through these that all unfunded pension liabilities are owed for work already performed.

 

Cullerton’s Contractual Proposal

Madiar and Cullerton have long focused on giving pensioners the option of foregoing their automatic three percent COLA in exchange for a promise that all future salary increases would be pensionable. In other words, a voluntary trade would be offered for something that’s not the employee’s right.

 

Fine, offering a trade that employees can ignore if they want sure wouldn’t seem to be a legal problem. The obvious question, however, is how much net savings there would be for the state. If it’s a swap pensioners would want to take, wouldn’t that be a swap the state should not take? Maybe, maybe not — it would depend on individual circumstances and people aren’t always rational. Madiar says it would result in a little less than $1 billion in annual pension contributions, and there’s supposedly an actuarial report around supporting that, though it has never been published. But how about the other part of the trade? If the state has the right to cap pensionable salaries at current levels, shouldn’t it already be doing so, and what’s the cost of giving up that right?

 

The bottom line on this is that we should do it if it will save money, but show us all the numbers. And even if it saves a full $ 1 billion per year, that hardly solves the problem. For a little perspective, the state’s total pension contribution is over $7 billion per year, and that’s at least $3 billion less than pensions need from sinking further.

 

Cash buyout option

A few hundred million dollars per year might be saved in pension contributions if pensioners were offered the option of taking a buyout equal to about 75% of the present value of their projected pension, Madiar and others think. This one is hard to take seriously. Actuaries I have talked to scoff at it because the first takers would be heart attack sufferers, cancer victims, AIDS victims, severe diabetics, overweight smokers and the like. Neither Madiar’s article nor anything I have seen on this idea addresses that problem. The present value of a projected pension could not be adjusted to reflect individual longevity chances. The folks who would stay in the pension system would be the healthiest ones who account for the biggest projected liability, so the numbers would backfire. In any event, the supposed savings of few hundred million dollars in annual savings aren’t much in light of the size of the problem.

 

Restructuring Contributions

The annual contribution schedule for the state could be flattened and made longer, lowering near term contributions, which has also been called “reamortization.” This is actually the “just don’t fund the damn things” option under a different name. It’s not “reform” because it would do nothing to reduce costs. In fact, lowering near term contributions and postponing the liability increases the ultimate cost.

 

Pass the buck to locals

The idea of making local school districts and community colleges responsible for part of TRS (the state teachers’ pension, which accounts for about 60% of the state’s unfunded liability) and SURS (for colleges and universities) has been discussed in many forms. Obviously, it might help the state but would just make local taxpayers liable. The key issue there is whether that shift would be accompanied by elimination of the mandate to participate in those pensions. If so, that would impose some needed discipline in the system. Either way, however, most of these proposals focus only on shifting “normal cost,” which is the new annual cost incurred for pensions that year. It would not reduce the unfunded liabilities taxpayers face.

 

Other proposals not mentioned by Madiar

A number of other proposals address future work and new hires. A list of some of those proposals was published by the Illinois Policy Institute. Most of them should have been done long ago, and should be done now. However, they would not reduce unfunded liabilities but only attempt to cap the problem, and reducing the unfunded liabilities is what’s essential.

 

Conclusion

The real point of Madiar’s article, and of Greg Hinz’s positive review of it, was the same as public unions and Illinois Democrats always are trying to make: We just have to pay up by raising taxes. If that happens, or if Madiar’s legal analysis is correct, you can pretty much wipe Illinois off the map.

 

*Mark Glennon is founder of WirePoints. Opinions expressed are his own.

 

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Andy S.
I strongly disagree with the notion that the pensions cannot be paid, for a very simple reason: recent empirical evidence shows fairly conclusively that the State of Illinois has virtually unlimited taxing power. Thus, from a purely economic perspective, the state can generate whatever revenues are necessary to pay all of its contractual obligations, as well as those of its local government units, in full while still providing its citizens with a decent level of public services. Let me briefly review this empirical evidence, and at the same time apologize for the wonkiness of my exposition. All of the figures below are from either the tax facts… Read more »
izod
“The overwhelming consensus on this site appears to be that if taxes are raised, then people will move out of state, work less, and/or find ways to report less of their income, thus resulting in substantial revenue leakage and potentially creating a “death spiral” for the state. ” Except for the fact because of that tax increase and the pension obligations I relocated my main business to FL and all but one of my employees migrated once they saw the combined income tax & property tax savings as well as the intangibles I listed. I employ 16 people. all earning over 100K a year. Most have working… Read more »
nixit71
I’ll take the bait. So let’s say a family with $100K household income can absorb a doubling of the tax rate to 7.5%. Absorb is a loose term because that implies that family has a $3,750 surplus every year in their family budget. So where was that surplus going previously? Family trip? OK, no trip, now you lose the multiplier effect of that spending. Household improvement or large purchase? Same impact. But what if instead that surplus went into an IRA or college savings account? What’s the long-term impact of compounded interest lost year after year? Sure, the state gets its money, but doesn’t seem to care… Read more »
James Gordon
While I think your basic argument is a sound one the example used exaggerates one’s extra tax liability. It fails to account for the fact that a doubling of the IL state’s income tax rate usually does not result in a doubling of one’s out-of-pocket income tax oblgation due to various deductions and/or credits applied against it. The most obvious case for those who itemize is the deductibility of one’s state income taxes against the federal tax obligation. Consequently, I think it is entirely likely that on average someone who theoretically owes an extra $3,750 in your example would more likely have an out-of-pocket expense of something… Read more »
nixit71

But if that added tax, whatever it is, comes at the expense of a Bright Directions 529 deposit for college savings, I’m forgoing a state income tax deduction, thereby compounding the new tax liability. Or if I reduce my 401k contributions a couple of percentage points to pay for the added state income tax, my corresponding federal and state tax liability increases as well.

But in both instances, I jeopardize my family’s financial well being to fund someone else’s retirement.

Adam

P.S. Highest property taxes in the nation along with a 10% income tax rate that would also be one of the highest in the nation also? GET REAL. Not going to happen, and me and half the state would leave if it did. Your pensions are toast as is.

Adam

If you think people will not leave in droves if the income tax rate is raised to 10% then you are a fool. Anyone that can move will move with an income tax rate that high in this dump of a state; not possible. There is no such thing as unlimited taxing power as people can only pay so much in taxes in reality.

Adam

The pensions cannot be paid in full Mark. At some point the state will have to allow bankruptcy, or reality will do it for them. They are not going to be able to just sink the state for pensions only, if nothing else, the federal government will have to step in and pass a law that trumps state constitutions on lowering public pensions, because Illinois isn’t the only state that will in time not be able to fund their pensions in any realistic way. What are your thoughts on how this will play out in reality? Greg Hines is a union stooge by the way.

Tom-- Vernon Hills
Mr Glennon– this analysis is from a clearly partisan Democrat, just like the guys trying to block the legislative boundary referendums. And you are close to Rauner. NOthing wrong with either one. Your comment is correct we need bipartisan– or non-partisan– analysis of these numbers. It is very complicated for the regular guy like me. I run a carpeting store and have no background in most of this. But I am a business man and can read a balance sheet and an income statement. The math doesn’t lie. For goodness sake. WE all live here . this is our state. It is going down the drain. When… Read more »
Rick

Only in Illinois would a ponzi scheme be elevated to a level worthy of constitutional protection. With an army of generally non constructionist judges, insisting to suddenly be constructionists on this one issue. Maybe it’s because they have a conflict of interest, they need to protect this system and even add things like lifetime health care, cola’s, prevailing wages, pick ups, etc. basically anything you can mention falls into the clause.

J.A. Herzrent
In Jespersen v. Minnesota Mining and Manufacturing, the Illinois Supreme Court stated “the rule that contracts of indefinite duration are terminable at will has long been followed in Illinois (Joliet Bottling, 254 Ill. at 219, 98 N.E. 263; Davis, 208 Ill. at 385, 70 N.E. 359), and our courts have applied the rule in a variety of contexts including employment contracts (Duldulao, 115 Ill.2d at 489, 106 Ill.Dec. 8, 505 N.E.2d 314), credit card agreements (Garber v. Harris Trust & Savings Bank, 104 Ill.App.3d 675, 683, 60 Ill.Dec. 410, 432 N.E.2d 1309 (1982)), money market fund accounts (Langendorf v. Irving Trust Co., 244 Ill.App.3d 70, 79, 184… Read more »
Mike
Since the Illinois State constitution states the pensions are an enforceable contractual relationship, the taxpayers at very least should be able to easily locate the contract changes over time. That is currently not the case. The Legislative and Executive Branch of Illinois government, which modified the contracts, should produce a spreadsheet listing every single Public Act that created and subsequently modified any public sector pension and retiree healthcare system in Illinois. With a note of which pension system or retiree healthcare system is associated with each Public Act. Including the House or Senate bill number. And a brief note describing the Public Act (not the bill Short… Read more »
Jeanne Ives

Bill Zettler’s Pension Scam book does much to list the public acts. I have always argued that in fact “you didn’t earn it” to pensioners because many of the benefits given over time were just allotted to beneficiaries who never paid for the benefit to begin with. If in every case, you did a history of all the inputs vs. the benefits received for each pensioner, this would be clear.

Mike
To put it into perspective, Bill Zettler’s book mentions less than 10 Public Act numbers. There are well over 500 Public Act numbers that created and modified pensions and retiree healthcare spanning over 100 years. I don’t know if it would see the light of day, but perhaps you could sponsor legislation to produce such a list. It’s outrageous the taxpayers don’t even have a listing of the pension and retiree healthcare contracts (Public Act numbers). The lawmakers indebted taxpayers to ever expanding pension and retirement system contracts which were never compiled in one location. Such a list would not identify all pension and retiree healthcare system… Read more »
Michael Lucci
The bumps and spikes undoubtedly makes it less clear to the public. So does the use of optimistic discount rates, along a debt size that becomes so tremendous that it’s meaningless. Mark is describing a very worthy project, which is to answer the question “What would it take to actually fund these in full?” A good friend of ours from Texas took a stab at it in this article and he says it would require an 18% tax hike across the board for all taxes, taking IL’s total state plus local tax burden from 11% of state income to 13%. That’s likely not survivable, and depending on… Read more »
Robert Zeh

I don’t think a Federal Bankruptcy judge is going to agree with Madiar. Here’s a quote: “We in bankruptcy impair contracts all day, every day. That is what we do.”

Bross

Isn’t it called the death spiral? More people moving out. Taxes go up. Businesses stay away or leave. More people move out…it’s already started…

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