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Court rulings show fate of state pensions likely in voters’ hands

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Voters may be tasked with ultimately deciding the fate of state pensions after the Arizona Supreme Court ruled for a second time that provisions of a 2011 reform law passed by the Legislature are unconstitutional.

In an attempt to stabilize the underfunded pension apparatus, the Legislature in April 2011 passed a series of reforms to state retirement systems that included hikes in employee contribution levels and decreases in cost-of-living adjustments.

Thom Reilly

Thom Reilly

The state high court ruled this month that such actions violated the Arizona Constitution, and that elected officials and public-safety officers who since 2011 were required to pay more for their pensions must be reimbursed. Local governments must cover the projected $220 million cost to an already seriously unfunded Public Safety Personnel Retirement System.

The court decision likely will affect thousands of other state and local government pension plans – including the much larger Arizona State Retirement System, which covers state and local government workers and teachers. That’s because the ruling essentially prohibits governments from decreasing benefits or requiring employees to share in the increasing costs of pension coverage. Any changes to state pension formulas apparently would require a constitutional amendment, which can only be accomplished by a vote of the people.

The soundness of many state and local pension plans are of grave concern nationally. Unfunded liabilities for state and local pensions in the United States range from $1.1 trillion to more than $4 trillion, depending on varying assumptions and scenarios.

Pension costs have been rising faster than inflation for several reasons. For example, low interest rates have reduced the returns on pension funds used to pay benefits and retirees are living longer. Furthermore, many of the promises made to public employees are simply not sustainable. As a result, many jurisdictions are struggling to make payments into these systems, leaving less money each year to spend on core governmental services.

Some Arizona cities have delayed or suspended the hiring of additional police and firefighters because of the costs associated with the retirement contributions. Such obligations hobble governments’ capacity to act and crowd out essential services for citizens.

Arizona is one of seven states (Alaska, Hawaii, Illinois, Louisiana, Michigan and New York being the others) that have constitutional protections for public pensions. In fact, Arizona, New York and Illinois have the strongest public pension protections in the country.

Voters amended the Arizona Constitution in 1998 to essentially declare that public retirement programs are a contract and, therefore, benefits cannot be cut. Based on court interpretation, such protection seems to include both current and future benefits.

My colleague, associate professor Laura Coordes from the Sandra Day O’Conner College of Law at Arizona State University, and I recently explored possible predictors of municipal insolvency in the United States. We identified 42 cities (Glendale was among them) with populations of over 15,000 that were determined to be in fiscal distress, either because of municipal bankruptcy filings since 2008 or below-investment-grade-rated bonds since 2007, or both.

Labor union density and unfunded pension liability were the two most prevalent factors. It was not surprising that many of these financially troubled cities fell within the states with the strongest constitutional protections for public pensions. When mandated pension increases and unions create pension obligations that cannot be supported by city revenues, fiscal distress is virtually inevitable.

To ensure local governments are able to provide essential services, voters again may be asked to consider changing the Arizona Constitution to eliminate the pension clause that provides “public system retirement benefits shall not be diminished or impaired.” Given the recent ruling about pensions violating the Gift Clause of the Arizona Constitution, specific language also might be needed to either invalidate the Gift Clause outright or exempt pensions from the Gift Clause.

Arizona voters made key changes to pension funds and the Constitution last May with their overwhelming approval of Proposition 124. The successful ballot measure is estimated to save $475 million in mostly long-term costs by linking retirees’ pension cost-of-living adjustments to the regional Consumer Price Index and capping annual COLAs at 2 percent.

The recent Arizona Supreme Court rulings underscore the unprecedented tension between municipal financial distress and state constitutional protections for public pensions. And there remain fundamental barriers to making the state’s retirement systems solvent.

Many pension experts have reached the conclusion that even with stronger market returns, the public-pension system would not be able to cover retiree benefits in the long term without some type of combination of raising taxes, cutting benefits and/or changing how retirement plans are structured and designed. Reducing benefits for new employees would not be enough to keep pensions solvent either, and the Arizona Supreme Court essentially has ruled that benefits cannot be reduced or contributions increased for existing employees.

While the recent Arizona Supreme Court rulings underscore the unprecedented tension between municipal financial distress and state constitutional protections for public pensions, they also give a sense of urgency and potential new avenues to address the challenge.

One possible solution is to consider curbing benefit accruals for current employees. This would require an amendment to the Arizona Constitution, clearly stating that benefits earned by public employees to this point in time are protected, but benefits going forward could be modified.

Since local and state governments are allowed to change salaries on a going-forward basis, it makes absolutely no sense to say they cannot change pension accruals going forward.

This is how it is done in the private and non-profit sectors.

This change also would address the two-tiered benefit system currently in place in many public-sector organizations. Due to recent reform efforts, employees entering the public sector today have less-generous benefits than their predecessors. Even though employees are doing the same job, longer-serving employees enjoy richer benefits than their newer colleagues.

This change – again, which could only come about at the ballot box – would put everyone on the same playing field moving forward. In addition to being fair and equitable, it would help put state pensions on a path to solvency and stability.

Thom Reilly is director of the Morrison Institute for Public Policy and a professor in the School of Public Affairs at Arizona State University. He is the former County Executive/CEO for Clark County, Nevada (the Las Vegas Valley). An expert on pension policy, he often is called upon for related legal testimony or as a consultant.

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The views expressed in guest commentaries are those of the author and are not the views of the Arizona Capitol Times.

2 comments

  1. This makes sense only if the salaries of public employees are increased to market levels. Many public employees take government jobs and sacrifice current income in the expectation of future retirement benefits which will provide an adequate retirement. To withdraw the latter, without adjusting the former would be a travesty.

  2. The authors conclusion at the end is written from the employees bottom line perspective. He fails to mention that if such a referendum did occur, long serving employees benefits could be stripped away and they would have no time to recover. Long term employees sacrificed wages in exchange for retirement plans including health care benefits. The only way to recover from that is for the state to repay all the lost wages, plus interest for work already performed based on a promise the state would be reneging on.

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