Briefing Report: California Pension Reforms and Legal Opinions - An Overview

Thursday, August 15, 2013

“In liberal logic, if life is unfair then the answer is to turn more tax money over to politicians, to spend in ways that will increase their chances of getting reelected.”
- Thomas Sowell

In 1999, California public sector workers had their contracts broken and were provided with luxurious increases to their pensions.  In 1999, Governor Davis signed into law, SB 400, which made various so-called “improvements” in the state Public Employee's Retirement System, doling out luxurious increases to public pensions.  Union bosses back then, filed no complaints regarding the significant changes to public retiree contracts and seemed quite content with the valuable pension gifts received.1  Flash forward to 2012 during the severe nationwide economic downturn and the fiscally dire need for true public sector pension reform.  Public sector union bosses were barking the loudest protesting how contracts will not and cannot be broken and all contract changes should be negotiated at the bargaining table…yet a limited reform was signed into law and the union bosses paid lip service to the reform, but made no stink in a court of law.  See chart and summary below that illustrates why union officials balk at any kind of public pension reform.2

CA Public Pension Obligations in 2010

Courts, legal scholars, and stakeholders have adjudicated contract law, and provided legal opinions on the topic of public sector pensions and the alterations of contracts between a public sector union and the government.  The following are brief summaries of case law and opinion pieces on where California pension reform stands and what legally may be done to reign in the mounting costs of public sector spending on lavish life pensions.3

Alicia Munnell, director of the Center for Retirement Research at Boston University provides a brief description why public sector pensioners believe they have ultimate protection: “Most states protect pensions under a contracts-based approach.  The federal Constitution’s Contract Clause and similar provisions in state constitutions [CA Const. Art. 1, § 9] prohibit a state from passing any law that impairs existing contracts, whether public or private. [Bankruptcy courts break business contracts all the time, but unions and retirement systems are fighting hard to maintain that courts do not break their contracts so businesses lose money, taxpayers lose money, and union pensioners do not lose anything.] To determine whether a state action is unconstitutional under the Contract Clause, the courts undertake a three-part test. First, they determine whether a contract exists…. Second, the courts determine whether the state action constitutes impairment…. Third, if the impairment is substantial, then the court must determine whether the action is justified by an important public purpose and if action taken in the public interest is reasonable and necessary.”  With cities throughout California preparing to, or already have declared bankruptcy, will the courts maintain a liberal agenda in their decisions or move toward fiscal responsibility and allow for public sector contracts to be broken for the sake of all public sector services?

According to Girard Miller, current chief investment officer for the Orange County Employees Retirement System and former columnist for Governing Magazine:

“The federal Constitution authorizes Congress to create bankruptcy courts, which routinely overturn contracts, although I doubt that municipal bankruptcy proceedings will be the solution to pension problems….  There is no question that some state constitutions declare the pension promise to be inviolable, and some state courts have held that the pension promise is a contract.  In "normal" economic times when the pension plan is properly funded, almost everybody would agree that contractual pension obligations should be fulfilled.  But these are not ordinary times, and dozens of major public pension plans are facing the potential for depletion of their assets during the lifetimes of current employees if nothing is changed.  Ultimately, some municipal employers will face a genuine financial emergency if they don't significantly revise their plans' benefits structures.  We have already seen such actions upheld in Colorado and Minnesota, where courts held that benefits changes could be made, in order to preserve a reasonable benefit for everybody in the plan.  Rhode Island just enacted a law to change benefits including the retirement age for incumbent employees.  The city of Cincinnati took similar actions.  In some states, these "breaches of contract" will go to court, but what the plaintiffs often do not understand when they file suit is that several courts have supported the police power of the state to make plan modifications if they are necessary — provided that the remaining benefits are reasonable, and if the plan change is the minimum change required to fix the plan.  The simple economics of pension plans inform us that the sooner you fix them, the less pain the beneficiaries will suffer later on.  This does not mean that every underwater pension plan should stiff its retirees; the plan must clearly be at risk and alternative remedies should be explored.  In fact, the courts typically require such efforts before they impair contracts and reduce vested benefits.”4

To better understand in part, why California lawmakers are continually increasing the portion of the budget to cover employee pension costs, we must look at a key court case.  In 1955 the California Supreme Court case, Allen v. Long Beach determined that “changes in a pension plan which result in a disadvantage to employees should be accompanied by comparable new advantages.” This ruling had a devastating effect on governments seeking to save costs by distributing cuts or rollbacks to all public programs, instead all public programs, except employee wages, pensions, benefits, etc. could not be used to save on costs.   This means that public sector costs, under current case law, will never see a decrease and taxpayers will forever be accountable to higher and higher public sector union mandated costs.5

Yet, is there a way to fix the fiscal calamity that majority party politicians and liberal judges continue to perpetuate?  University of Minnesota Law School Professor Amy B. Monahan wrote about a 1917 California court decision, now known as the “California Rule,” and how to fix the contract breaking issue in California. Her thesis dictates:

“This Article demonstrates that by holding that benefits not yet earned are contractually protected, without explaining the basis for finding that such a contract exists, California courts have improperly infringed on legislative power and have fashioned a rule that is inconsistent with both contract and economic theory.”6

In discussing Monahan’s legal opinions, Liam Dillon of the Voice of San Diego blog wrote, “At issue in that 1917 decision was the legal status of pensions. Are they bonuses granted to employees after their service to the government? Are workers’ property akin to their houses or other possessions, or part of their employment contracts? The 1917 decision didn’t make a definitive call. Instead it used the three words, ‘in a sense,’ to link pensions to unbreakable contracts for the first time.

In the 95 years since that initial decision, courts in California and other states have expanded on that three-word phrase to the point where we are now with pensions. The article calls the legal principle the ‘California Rule.’ The article’s author, University of Minnesota law professor Amy B. Monahan, argues the California Rule is off the mark. She contends the state’s court system improperly infringed on legislative power and the pension rule doesn’t fit with both contract and economic theory. Her review of case law found the state Legislature never said pensions were untouchable. ‘California courts have put in place a highly restrictive legal rule that binds the legislature without the court ever finding clear and unambiguous evidence of legislative intent to create a contract,’ Monahan wrote (emphasis in original).”7

Monahan concludes that a fix is possible, but political will is necessary.  “In addition to the legal hurdles associated with attempts to get state courts to reconsider the California Rule, there is also a significant political difficulty associated with such efforts. The only avenue for requesting that a court reconsider the California Rule is for the state to pass a law that infringes on the rights implicated by the California Rule. In other words, the state would have to find the political will to pass a law reducing the rate of future pension accruals for current employees in a situation where legislators are keenly aware that the state will be sued following passage, and where the legal outcome of such a challenge is uncertain.”8

The odds of the union sponsored majority party in the California Legislature to pass a law that their sponsors will allow is 200 billion to 1. Coincidently, the current state government unfunded pension liability is $200,000,000,000, and growing quickly, and that does not include the unfunded liabilities of cities and counties in California.9  The taxpayers of California deserve fiscally sound and honest government service for their public safety, for their roads, and for their small business job creating efforts.  To start reigning in the ever-increasing public sector employee costs, a pension reform initiative needs to be placed on the ballot, focusing on issues discussed by Monahan.  Allowing citizens most affected by the diminishing government services to vote for an overhaul of their accelerating public sector pension costs is the right thing to do for Californians now and for the fiscal well-being of the state. 

“Life in general has never been even close to fair, so the pretense that the government can make it fair is a valuable and inexhaustible asset to politicians who want to expand government.”
- Thomas Sowell

For more information on this report or other Public Employment or Retirement issues, contact Gary Link, Senate Republican Office of Policy at 916/651-1501.

1 SB 400, which increased pension increase benefits retroactively and prospectively for all public sector employees passed out of the Legislature in 1999.  The costs for the pension contributions were $463 million toward the employer share of contributions to fund retirement, in FY 2012, the state paid $4.6 billion. 

2“Public Pensions For Retirement Security,” Little Hoover Commission, February 2011.  Pg. ii.  The financial health of these systems has worsened since this data was tabulated. 

3 Alicia Munnell, State and Local Pensions: What Now?, (The Brookings institution: 2012) “Some states, such as Illinois and California, where pension costs could well approach 15 percent of state and local revenues even without any new financial crisis, will require a dramatic restructuring of their pension system.  Without changes, the state will have to cut back on its support for roads and other infrastructures,  universities and colleges, health services for the low-income individuals, and other expenditures that contribute to the quality of life within the state.” pg. 223.

5“An Initial Response to the Governor’s Proposal,” Legislative Analyst’s Office, November 8. 2011. Pg. 18.

6 Amy B. Monahan “Statutes as Contracts? The “California Rule” and Its Impact on Public Pension Reform” Iowa Law Review. Pages 1029-1083. Pg. 1029

8 Monahan, pg. 1082.

9 Joe Nation & Evan Storm “More Pension Math: Funded Status, Benefits, and Spending Trends for California’s Largest Independent Public Employee Pension Systems” Stanford Institute for Economic Policy Research, February 21, 2012. Pg. 6-7.