In an interview with News Bureau business and law editor Phil Ciciora, finance professor Jeffrey R. Brown, who’s also the director of the Center for Business and Public Policy in the College of Business and was a senior economist with the President’s Council of Economic Advisers from 2001-02, discusses the latest twist in the state of Illinois’ pension predicament.
Can you briefly summarize last Friday’s Illinois Supreme Court decision on the pension law?
The Illinois Supreme Court threw out the entire pension reform law. They unambiguously ruled that all of the provisions that reduced benefits were a violation of the nonimpairment clause of the Illinois Constitution, that the state does not have the power to overrule those protections even in the face of financial strain, and, therefore, the entire law is null and void.
This is great news for pensioners and current pension participants. It effectively makes their pensions risk-free. Social Security benefits, private pension benefits and public pensions in many other states can be changed. Pensions in Illinois cannot.
Of course, this is also terrible news for Illinois taxpayers and beneficiaries of any other government program because the state has little choice but to find the money it needs to pay pension benefits, unless we change the constitution.
Now that it’s back-to-the-drawing-board time for the Illinois Legislature, what alternatives are available to solve the pension and budget crises? Reamortize the pension debt over an even longer time horizon? Raise income and business taxes back to their previous levels? Tax more services and begin to tax retirement income above a certain threshold? All of the above?
The solution requires all of the above and much more. To put it as simply as possible, unless we change the constitution, there are only two options remaining. First, we raise taxes. Second, we cut nonpension spending. Every policy is simply a variation on one or both of these two themes. Even if the law had been upheld, the state of Illinois was still going to face large structural deficits. The fact that the reform was thrown out means those deficits are now even larger. Even if we cut every spending program to the bone, we still won’t have enough money to pay our bills. This will place Governor Rauner in a strong position to argue for spending cuts, but a weak position for avoiding tax increases.
You’ve co-written a few different plans for how the state of Illinois can extricate itself from its pension and budgetary quagmires. What solution do you favor now?
It’s going to take a very long list of small changes to restore us to fiscal health. I would start by broadening the tax base in Illinois. At current tax rates, we could raise billions in additional revenue by including currently excluded items like retirement income in the income tax base.
Although painful and unpopular, a very gradual shift of part of the expense of future pension accruals down to school districts, universities and community colleges should be considered. To be clear, I fully understand that this will create enormous strain for these institutions, which is why it needs to be done gradually. But in the long run, it is much better to have the entities making personnel decisions have to bear the full cost of those decisions. Right now, a school district or university can hire someone without any concern about the pension costs because those are borne by the state.
It is much more difficult to think of any legally feasible changes we can make to the retirement systems themselves. One could imagine offering a pension buyout in which participants get a lump sum now in return for a reduced pension. Governor Rauner suggested a version of this. But, unfortunately, today’s ruling makes that less attractive to participants. A lump-sum buyout or conversion to a 401(k)-style plan also increases the short-run cash strain on the state. Finally, government accounting rules are so poorly designed that even if such an activity saved us money, it may give the misleading appearance of increasing our unfunded liability.
This problem was many decades in the making, so it will take many decades to dig out of it.
In terms of creditworthiness, the state of Illinois is already the lowest-rated state, and the city of Chicago is two notches above junk-bond status. Should we expect further downgrades from Wall Street?
I would not be surprised if the rating agencies further downgraded our debt. By declaring that pension benefits must be paid, the court has effectively placed pension obligations at the head of the line. Thus, debt holders now face more risk that the state will default on the bonds. That should drive up interest rates on borrowing, and thus make it even more expensive for us to borrow money in the future. And, yes, it is very bad news for Chicago, too, because the same nonimpairment clause also constrains their policy options.
The governor’s office argues that a constitutional amendment clarifying the distinction between earned benefits and future benefits should be part of any solution. But what about trying to pass a modified version of Illinois Senate President Cullerton’s contractual approach, in which employees are offered something extra in return for moving from the defined-benefit pension system to a defined-contribution system?
I would favor a constitutional amendment that protects already-accrued benefits but provides flexibility to change future benefits that have not yet been earned. I will leave it to others to determine the political feasibility of this.
I am open to new ideas on providing something to workers in consideration for reduced pensions, but it is unrealistic to think that offering financial incentives to accept a pension reduction is going to save us much money. First of all, the “something of value” that is offered in return is itself costly to offer. Second, this could accelerate the cash-flow crunch. For example, if we put everyone in a 401(k)-type system going forward, the state will still have to fund the remaining defined-benefit plan while simultaneously having to come up with the money to fund defined-contribution plans. Combined with the fact that the employees in the defined-contribution plan will no longer be contributing to the defined-benefit plan, the state would have to come up with far more money over the next few decades than under current law. This might be a good long-run idea, but it will force us to face our day of reckoning sooner.