California: Overprotecting Public Employee Pensions

July 21, 2014

California courts have ruled that public employees have a right to maintain their pension levels, making it difficult for the state to enact pension reform.  Alexander Volokh, economist and professor at Emory Law School, explains the effect of the rule in a new report from the Reason Foundation. 

The U.S. Constitution's Contract Clause reads, "No State shall...pass any...Law impairing the Obligation of Contracts." Additionally, most states have contract clauses within their own constitutions.

That clause has been applied to pension plans -- "contracts" between public employees and state and local governments. But while some states have ruled that prospective retirement plan modifications do not violate the Contract Clause (believing that benefits do not vest until they are earned), California courts disagree. In California: 

  • Public employees "acquire a vested right to a pension" when they accept public employment.
  • Furthermore, California courts have ruled that the right to a pension is "based on the system then in effect," meaning that the employee has the right to continue to earn benefits according to the same generous terms that applied when he began his employment.

While courts will allow some modifications to pension plans, the changes must be "reasonable" and disadvantages must be "accompanied by comparable new advantages." This is known as the "California rule," an approach followed by twelve states.

Volokh explains that, because California has its own Contract Clause in its state constitution, the state is free to protect pensions beyond that which might be protected under the federal Contract Clause. Even so, such broad protection is bad policy, as it makes it difficult for states to deal with financial problems.

  • Because other terms of employment lack this protection (salaries, tenure or other benefits), the inability of a state government to adjust to fiscal pressures by changing retirement benefits means that salaries and other benefits will be cut. Many employees would prefer more generous salaries, not pensions.
  • Taxpayers may see government services cut in order for the state to meet its pension obligations.
  • Because the rule limits the ability of public employers to change benefits, the state may offer less generous benefit packages up front.

The California rule gives states little leeway in the case of a fiscal emergency, especially as any pension modifications require the state to offer new advantages to compensate for those disadvantages.

Volokh suggests that states instill flexibility into their pension statutes -- for example, by creating benefits that depend on actuarial advice or assumptions.

Source: Alexander Volokh, "Overprotecting Public Employee Pensions: The Contract Clause and the California Rule," Reason Foundation, July 10, 2014. 

 

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