One of the biggest issues facing state and local governments is growing unfunded public employee pension and retiree health care liabilities. The total state and local pension deficit has been pegged at anywhere from $1 trillion to several trillion dollars (see here, here, here, and here). It is generally assumed that state constitutions prevent governments from addressing this burden by curtailing benefits for current retirees, but a case before a Minnesota court is being closely watched by governments across the nation anxious to see if the state’s cutbacks will stand the court’s scrutiny. A Wall Street Journal article discusses the case:
States have responded to budget shortfalls by raising the retirement age and cutting pension benefits for new hires. Minnesota last year replaced its previous pension formula, which increased retiree benefits annually based on investment gains and inflation, with a flat 2.5% increase. This May, the state lowered that increase for some retirees and eliminated it for others, until the pension plans are 90% funded, a level that could take decades to reach.
A group of Minnesota retirees already receiving benefits under older pension formulas sued the state in May, seeking class-action status.
State courts generally have ruled that states can’t reduce benefits for workers who already have retired. While a ruling allowing Minnesota’s new pension formula to stand wouldn’t establish a single legal precedent across the country, it could encourage other states, hit by deep budget deficits and a wave of baby-boomer retirements, to try to reduce benefits for current employees and retirees.
Cases similar to Minnesota’s are pending in South Dakota and Colorado, and other states are watching the Minnesota case closely as they ponder solutions to their own pension dilemmas.
Minnesota argues that retirees do not have a legal right to expect any particular benefits formula to remain (or, at least, to never be reduced) in perpetuity. Interestingly, the Minnesota council of the American Federation of State, County and Municipal Employees (AFSCME) supported the state’s action, albeit reluctantly, “because it protected our defined-benefit pensions by taking responsible actions to stabilize the pension funds.”
The WSJ article also provides a map showing pension reform efforts in various states.
Unfortunately, such reform efforts are not likely to be enough to address the significant and mounting costs of existing public pension systems, however, as they preserve the current volatile and unsustainable defined-benefit systems. In order to truly address the problem, state and local governments must address growing gaps in public- and private-sector employee compensation by switching to more reasonable 401(k)-style defined-contribution retirement plans for their employees and establishing pay and benefits comparable to those received in the private sector. As liabilities from existing pension systems continue to rack up and consume greater shares of state and local budgets, governments will need to undertake a serious reevaluation of their spending priorities, implement budget reforms such as privatization to save money without sacrificing service quality, and reduce spending in other areas of the budget.