Most people don’t care whether pensions are underfunded. After all, retirement is far in the future. But if their income taxes are going to go up because state pensions are underfunded — that’s another story.
One advantage Illinois has is that the state has a low individual income tax rate. But now some legislators want to raise it from 3.75 percent to a max of 9.75 percent. That would be the fourth highest individual income tax rate after California, Oregon and Minnesota.
This tax hike is proposed partly because unfunded liabilities for Illinois’ pension plans stood at $111 billion for fiscal year 2015, and shortfalls have grown faster than the state’s ability to fund them. Liabilities increased by more than 450 percent between 1999 and 2013 after adjusting for inflation. For fiscal year 2016, $7.6 billion is scheduled to be transferred into state pension funds.
Even tax hikes that large would not fix the problem because unfunded liabilities grow exponentially. The only way forward is to change the obligations and add new funding. Politicians tried to fix the pension problem in 2013, but potential reforms were overturned in 2015 by the Illinois Supreme Court.
What to do?
One new idea that has not yet been proposed is for Congress to empower states to have the ability to reform their insolvent pension plans. Such legislation would pre-empt state laws that prohibit states from making necessary reforms. It would allow pension reform laws passed by state assemblies to take effect.
To anticipate your first legal question: Yes, owing to the Supremacy Clause of the U.S. Constitution, Congress does have the authority to override the pension protection clause of the Illinois Constitution — the wording that says participation in a public pension system is “an enforceable contractual relationship, the benefits of which shall not be diminished or impaired.” That is, Congress can empower the Illinois legislature to make the changes to state and municipal pensions that the Illinois Supreme Court has blocked.
And yes, pensions to current and future retirees could be affected, depending on how the state legislature wants to reform the system.
In order to accomplish this, Congress can create a “Proceeding to Protect Essential State Actions” as a new Section 113 of the U.S. Bankruptcy Code. This would allow states to reform their pensions after the state legislature has voted to do so. This would not allow states to declare bankruptcy. I have drafted model legislation in a longer paper titled “Empowering Illinois Pension Reform.”
This proposed legislation would give states the tool they need to reform their pension systems without calling for handouts or bailouts. Nor would this be an infringement on states’ rights. Rather, it would give states’ governors and legislatures the option to use the new federal law to enact state solutions in the same manner in which they enact other bills. States would retain their sovereign powers, ensuring that the states themselves approve any plan to reduce pension debt.
The proposal does not hurt state bondholders and other creditors. It only gives state legislatures and governors an option to reform their public pension systems. And states could have the opportunity to solve their pension problems even if existing state laws prohibit changes to such obligations. States would publish their respective analyses after a public notice, and then file a proceeding in federal court to identify suggested changes.
A bit more detail: States would be authorized to enact pension benefit changes only after determining that funding obligations damage the performance of essential state services. They would publish the basis for their determination, conduct public hearings and file a proceeding in a bankruptcy court to identify changes. Affected parties could seek judicial review of these changes by filing a challenge with the court.
Authority for such a federal law comes from the Constitution, which gives Congress the power to enact “uniform laws on the subject of bankruptcies throughout the United States” and to “guarantee to every state in this Union a republican form of government.”
During the Great Depression, Congress created Chapter 9 to allow municipalities to continue providing essential services. The U.S. Supreme Court has deferred to Congress’ exercises of its bankruptcy powers on numerous occasions, finding that the Bankruptcy Clause is a malleable tool that permits legislative acts aimed at addressing the pressing economic needs of the day.
This proposed legislation would involve only pension debt, and not the entire debt of the state. In the past, the U.S. Supreme Court ruled that it is not necessary to have identical treatment for every class of creditor. In 1982 the court stated that the Constitution “does not impair Congress’ ability under the Bankruptcy Clause to define classes of debtors and structure relief accordingly.”
If such a law had been in effect in 2013, the Illinois General Assembly could have passed legislation and the state could then have sought to implement it through the actions of a U.S. bankruptcy court. Instead, Illinois taxpayers are stuck paying an ever-growing share of an ever-growing state pension program. The prospect of pension fund insolvency is expanding, not shrinking. The proposed income-tax hike will drive residents and businesses to other states, hurting all Illinoisans.
Forty-six states have pension funding ratios lower than 50 percent. This suggested federal legislation would help all states and municipalities that want to reform their pensions but are prevented from doing so by existing state laws.
No one wants a big tax hike. Illinois legislators’ hands are unfairly tied, and Congress needs to allow them to do their jobs.
This article was originally published in the Chicago Tribune and can be read here.
