Pension Hybrid Plans, Constitutional Challenges, and the Ethical Path to Take
Recently, a colleague sent me a brief about the State of Rhode Island’s pension reform. That state’s current reform proposal features a hybrid plan that combines a defined-benefit and defined-contribution plan. Imagine an option that would divide a teacher’s contribution as follows: from a 9.4 percent contribution, perhaps 5 percent would be contributed to a defined-benefit plan and 4.4 percent would be contributed to a defined-contribution plan, where both the employer and the employee would share the market risk with the supposition that the earnings from the defined-contribution plan would still reap the financial recompenses of group investing.
Now consider another hypothetical hybrid plan: once an employee no longer reaps the benefits of his or her contributions to his or her defined-benefit plan because it has been capped (as is in the case for new employees in Illinois), then a defined-contribution option is offered to the employee with matching employer contributions thereafter. In other words, “a defined-contribution plan could be stacked on top to provide additional retirement income for those at the higher end of the pay scale. Such an approach would ensure a more equitable sharing of risks and would also prevent headlines generated by the occasional inflated public pension benefit” (Center for Retirement Research, April 2011).
We might ask whether there are legal repercussions for such pension reforms. In Rhode Island, for instance, “pension reform is more than just an educational, financial and political issue. It’s also a legal issue” (Education Sector Policy Briefs, November 2011).
It’s an educational issue because an essential goal for any state when considering pension reform is to attract and retain the finest possible teacher candidates available. It’s a financial issue because pension reform should be fair, affordable and address the issue of continued sustainability of the pension system. This has been duly noted elsewhere that “saving the pension system entirely on the backs of new teachers will not only fail to solve a state’s financial problems, more important, it will rob its future by making it more difficult to recruit new teachers” ” (Education Sector Policy Briefs…). This factor has apparently been forgotten by legislators in Illinois.
Furthermore, it’s a political issue because it entails the distinction among assumptions, values, beliefs and facts; the necessity for conflict resolution; and the application of powerful decision-making that will affect hundreds of thousands of people’s lives. Finally, it’s a legal issue because pension reform should be concurring with constitutional law and, therefore, safeguarded.
Indeed, we are aware that a challenge to a state’s constitution might take the form of a state’s exercise of “power as a sovereign to protect the health, safety, and welfare of its citizens” (Education Sector Policy Briefs…). In regards to the “diminishing or impairing” of a clause or contract that protects citizens’ rights, the United States Supreme Court has held “that the court must establish that impairment is reasonable and necessary to serve an important public purpose, such as ‘the remedying of a broad and general social or economic problem.’ To show that a change is necessary, the state must establish that no less drastic modification could have been implemented to accomplish the state’s goal; and that the state could not have achieved its public policy goal without modification” (Education Sector Policy Briefs…).
This particular option has seldom been brought to the test, and for good reasons. To declare that a state is in an “emergency state,” will no doubt ignite legal questions and litigation about the competency and ethical motivations of policy makers and whether they had truly exhausted every alternative available to them for resolving a state’s financial debts before challenging a constitutional contract.
In a recent decision concerning the reduction or elimination of a statutory exemption for public-pension incomes, for example, one state’s Supreme Court’s conclusion was unequivocal: “the people can and should expect shared sacrifice; however, it cannot come at the expense of constitutional nullification, and the legislature cannot expect to balance the budget on the backs of state workers” (State of Michigan in the Supreme Court, August 2011).
If we want “everyone” to share the burden for our state’s financial problems besides the new and future public employees of Illinois who, as the result of SB 1946, are now paying down the state’s mounting service debt, a way for legislators to collect needed revenue ethically is to raise the taxes of the wealthy and bring to a halt the corporate blackmailing of state government and the awarding of lucrative tax breaks. The Institute on Taxation and Economic Policy (November 2009) maintains that the top 5 percent of income earners in Illinois pay the least amount of sales, excise, property, and income taxes because of federal deduction offsets or substantial tax savings from itemized deductions, such as capital gains tax breaks and deductions for federal income taxes paid that are coupled with an antiquated flat-rate tax structure.
Legislators should also consider spreading the tax base in Illinois: “A high-quality revenue system relies on a diverse and balanced range of sources… If reliance is divided among numerous sources and their tax bases are broad, rates can be made low in order to minimize the impact on behavior. A broad base itself helps meet the goal of diversification since it spreads the burden of the tax among more payers than a narrow basis does. And the low rates that broad bases make possible can improve a state’s competitive position relative to other states” (National Conference of State Legislatures, June 2007).
What is more, legislators should consider including the taxation of services instead of raising state income taxes. Consistent with creating a broader tax base, the Chicago Metropolitan Agency for Planning (July 2011) argues that the tax system in Illinois and most other states do not reflect today’s economic realities. States that do not tax services, such as Illinois, “probably could increase [its] sales tax revenue by more than one-third if [it] taxed services purchased by households comprehensively” (Center on Budget and Policy Priorities, July 2009).
Let us not forget the underlying reasons that have caused the pension systems’ unfunded liability in the first place. The unfunded liability of the pension systems in Illinois grew exponentially because of the state’s inconsistent funding methods, the state’s unreliable accounting methods, and the special deals made by legislators and other stakeholders that were to be funded with future monies.
The scapegoating of public employees in Illinois began when greed and corruption, particularly flagrant in the financial sector, exploded into the Great Recession. This, of course, came after eight years of inordinate military spending for two costly wars, deregulation and unprecedented tax cuts for the wealthy by the federal government. This tsunami of debt contributed to every state’s budget deficits.
A final question and answer for us to ponder: now who found it self-serving to confound the facts of the matter and shift the blame for the resultant economic debacle occurring in Illinois?
The answer is those who benefit most from ignoring the injustices inherent in our state’s archaic system of income distribution, regressive tax loopholes for the wealthy and flat-rate taxation. In other words, Tyrone Fahner’s Civic Committee of the Commercial Club of Chicago; its doppelganger, Laurence Msall’s Civic Federation; and their mouthpiece, the Chicago Tribune have hoodwinked the citizenry of Illinois, made quite evident by Fahner’s million-dollar-plus Illinois Is Broke advertisements and his reinvention of a three-headed-tiered Cerberus that the Civic Committee wrote into SB 512 to guard the obscene profits that flow along the River Styx of Chicago and then a few blocks east to the doors of 21 South Clark Street.