No Way Out: The Role of the Pension Clause in Illinois’ Fiscal Crisis

Although Chicago’s gleaming downtown, world-class restaurants, and manicured waterfront parks offer the image of a wealthy and thriving metropolis, this surface view once occluded the decades of financial mismanagement used to fund such amenities. These days, however, Chicago’s rotting financial infrastructure is reaching a visible level. With credit downgrades from Moody’s and Fitch Ratings, nearly 1,500 layoffs at Chicago Public Schools, and a projected 2016 city budget shortfall ranging from 426 million to 1 billion dollars, the extent of the city’s fiscal woes is becoming clearer with each new headline from the Chicago Tribune. Much as in Chicago, no news is good news when it comes to the finances of Illinois. It is common knowledge that Illinois’ pension funds are not in great shape, to say the least. News coverage of the situation abounds with titles like “Pension doomsday,” “Illinois’ decades-long pension debacle,” and “America’s Greece.”

Sadly, these descriptions cannot merely be passed off as hyperbole. Illinois’ pension problem is grave, especially after the state’s and Chicago’s legislative pension reforms were struck down by the Illinois Supreme Court and the Cook County Circuit Court as unconstitutional. Both rulings hinged on the “pension clause” of the Illinois Constitution: “Membership in any pension or retirement system of the State, any unit of local government or school district, or any agency or instrumentality thereof, shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired.” The pension clause is clearly a crucial component of understanding today’s crisis and the avenues of resolution that remain possible. The Gate investigated and found that the history of this single sentence speaks volumes about how today’s crisis came to be. Ultimately, the fatal flaw of the pension clause was that it contained a protection for pensions without any mandate for local governments to actually fund those pensions, leaving Illinois in its current predicament: massively underfunded plans, and no legal method of minimizing its obligations.

First, some background information on the crisis is useful in understanding the pension clause. Illinois’ five pension systems, which serve teachers, state employees, state university employees, judges, and legislators, collectively had 84.2 billion dollars in unfunded liabilities (the amount owed in pension payments to workers not covered by the fund’s assets) in FY 2012 and an overall liabilities-to-assets funding ratio of 39 percent. For comparison, Standard and Poor’s latest analysis based on 2013 valuations found that U.S. state pension funding ratios averaged 71.2 percent. Wisconsin was in the best shape, with 99.94 percent of its liabilities funded. According to experts, the standard number for a healthy funding ratio is 80 percent, based on the assumption that some people will die early or retire late. Separate from the state’s pension crisis is Chicago’s astronomical debt. According to a Morningstar report, Chicago’s unfunded pension liability stands at 19.4 billion dollars, or 7,149 dollars per capita. Citing Chicago’s unfunded pension liabilities as its primary reason, Moody’s recently downgraded Chicago’s credit rating to the “junk” level of Ba1 with a negative outlook, making borrowing even more expensive for the city.

In 2013, under Governor Pat Quinn, the Illinois State legislature managed to pass a landmark pension reform law. Under the law, annually compounded 3 percent cost-of-living adjustments (considered to be the largest driver of pension costs) would be replaced with smaller adjustments for the highest earners; some workers could freeze their pension and start saving with a defined contribution plan; and the retirement age would be raised for those 45 and younger. This plan would have decreased the amount owed to the funds over 30 years from 374 billion to 214 billion dollars. Most importantly, it would also contain a mandate for lawmakers to make the full annual contribution to the pension funds annually, fully funding the systems by 2044. The law was struck down by a unanimous State Supreme Court in 2015. The Court’s language is unusually strong and certain, and the main thrust of the opinion follows:

The purpose of the clause and its dual features have never been in dispute. As we noted in People ex rel. Sklodowski v. State, 182 Ill. 2d 220, 228-29 (1998), the clause “served to eliminate any uncertainty as to whether state and local governments were obligated to pay pension benefits to the employees,” and its “plain language” not only “makes participation in a public pension plan an enforceable contractual relationship,” but also “demands that the ‘benefits’ of that relationship ‘shall not be diminished or impaired.’ ” The “politically sensitive area” of how the benefits would be financed was a matter left to the other branches of government to work out. Id. at 233.3 That article XIII, section 5, created an enforceable obligation on the State to pay the benefits and prohibited the benefits from subsequently being reduced was and is unquestioned.

Chicago’s 2014 pension reform was struck down as well a few months later, with Judge Rita Novak saying she was bound by the State Supreme Court’s precedent. Chicago’s law called for an increase in employee contributions to their pensions from 8 to 11 percent, reduced the 3 percent annual compounded cost-of-living adjustment to a raise tied to the inflation rate, and required city taxpayers to put an additional 50 million dollar per year into the funds. This would have allocated funds from an increase in the city’s 911 phone tax to make the first 50 million dollar payment.

But how did Illinois get into such a deep hole in the first place? Illinois pensions have been underfunded since they were created. The state’s contributions to the five systems—the Teachers’ Retirement System (established in 1939), the Judges’ Retirement System (1941), the State Universities Retirement System (1941), the State Employees’ Retirement System (1944), and the General Assembly Retirement System (1947)—are not mandatory, so lawmakers more often than not preferred to direct funds for immediate use, rather than fully funding the pensions. By 1949, barely ten years after the first of the five systems was founded, pension underfunding was a cause for concern in the reports from the Illinois state Pension Laws Commission, which noted the “tremendous, ever-increasing and disproportionate liabilities being imposed upon present and future generations of taxpayers” due to underfunding. In 1959, the Commission’s report stated, “Of principal concern to the Commission is the accumulation of large unfunded accrued liabilities resulting for the most part from the inadequacy of government contributions in prior years.” By the late ‘60s and ‘70s, the five systems were scarcely better funded than they are today, having an aggregate funding ratio of 41.8 percent.

It is out of this fiscal environment that the pension clause arose. State university employees, concerned about the underfunding of their pension system, and firefighters and policemen, concerned that municipalities would abandon their contributions, began to lobby for stronger protections for their benefits. They based the wording of the clause off New York’s pension clause, passed in 1938: “After July first, nineteen hundred forty, membership in any pension or retirement system of the state or of a civil division thereof shall be a contractual relationship, the benefits of which shall not be diminished or impaired.”

It is tempting to believe that the recent court rulings were an unintended consequence, rather than the desired effect, of the pension clause. It is difficult to imagine that the delegates who ratified it would have been comfortable with enacting such restrictions on pension reform. Upon a first read of the Illinois Supreme Court’s pension reform opinion, this statement seems incongruous with the opinion’s prevailing characterization of the clause: “Despite Delegate Green’s hope that prohibiting the State from diminishing retirement benefits would induce the General Assembly to meet its funding obligations, as the legislature in New York State had done when the same pension protection provision was adopted there, that did not occur." Here, it seems as though the pension clause was designed expressly to promote the state’s fiscal health by prodding the legislature to meet its funding obligations—a mission at odds with striking down the crucial pension reforms passed by the state and Chicago, both of which would have been effective means of protecting their fiscal health and the funds from insolvency. Was the court being too literal in its interpretation of the clause, instead of looking at the context under which it was passed?

For more information about the intent of the delegates, the Gate spoke to Professor Ann Lousin of the John Marshall Law School, who was a research assistant at the Sixth Illinois Constitutional Convention, where she worked on the drafting of the 1970 Constitution—including, of course, the pension clause. From her perspective, the pension clause was intended to do exactly what it said, in line with how it has been construed by Illinois courts this year. ”Pensions may not be diminished or impaired” really does mean that they may not be diminished or impaired. Lousin described Illinois’ current situation as a “manufactured crisis” created by lawmakers refusing to allocate enough funds to the pensions and preferring to spend their money on projects that would reap immediate rewards and please their constituents. “As soon as the conventions were elected,” Lousin noted, “a number of local employees and state university professors started lobbying. At the local level, police and firefighters were realizing that their pension funds were not being properly paid into. When asked, their local governments responded, ‘We don’t have the money to put into the fund right now.’ ”

Consequently, public employees began lobbying the convention’s Bill of Rights Committee and the Local Government Committee. However, the pension clause never actually went through committee. They refused to consider the idea, viewing it as politically untenable. Nevertheless, delegates brought it to the floor, arguing that there was a serious problem with pension funding. They warned that without a statement declaring that pensions were a contractual obligation, employees would have found it very difficult to sue for their benefits in the event that the legislature decided to diminish them. Interestingly, Lousin added, the Illinois Pension Commission itself “objected on the grounds that it was too strong.” The clause was included in the 1970 Constitution, despite cries from opponents that it would “hamstring the legislature.” Ultimately, Lousin concluded, it was acknowledged by all that “the provision adopted was enormously strong.” The delegates knew exactly what they were doing—the current situation is not an unintended consequence of the pension clause, but rather an outcome that delegates fully acknowledged may happen.

So, what is next for pensions in Illinois? In order to make a recent $634 million pension payment, Chicago Public Schools had to both borrow $1 billion in bonds and implement up to 1,400 layoffs. Without reform, state and local governments will have to either cut spending or raise taxes in order to meet their massive pension liabilities. Raising Illinois’ infamously high taxes—property taxes are second only to New Jersey, and Chicago’s sales tax will rise to 10.25 percent on January 1, 2016, the highest in the nation—would be an incredibly difficult proposition for politicians. Furthermore, Illinois was the only state in the Midwest last year to lose residents, its population shrinking by nearly 10,000 due to a net loss of 95,000 people to other states. Higher taxes are unlikely to help this problem. Several ideas have been floated around for ways to pay the state’s unfunded liabilities, such as a tax on retirement income (which Professor Lousin has argued for), or by passing a constitutional amendment that would allow municipalities to reduce pensions, which is unlikely in union-dominated Illinois politics.

Although many elements of Illinois’ fiscal future are uncertain, one thing is for sure—the pension clause will remain an incredibly strong protection for Illinois workers. As the Illinois Supreme Court noted, it is in times of crisis that individual rights are most at risk, and constitutional protections most vital: “Adherence to constitutional requirements often requires significant sacrifice, but our survival as a society depends on it. The United States Supreme Court made the point powerfully nearly a century and a half ago when it struck down as unconstitutional President Lincoln’s use of executive authority to suspend the writ of habeas corpus during the Civil War, a period of emergency that, by any measure, eclipsed the one facing our General Assembly today.” It will take an incredible amount of innovation, compromise, and, indeed, sacrifice, to pull Illinois off of the precipice of its current fiscal cliff.

The image featured in this article is licensed under Creative Commons. The original image can be found here.