Can States Use “Police Powers” to Cut Pensions?

Posted by Jeffrey Brown on Jun 9, 2010

Filed Under (Retirement Policy, Uncategorized)

Mark Guarino of the Christian Science Monitor published a piece yesterday (“States cap workers benefits to reduce shortfalls: Is your pension fund at risk?”) that discussed the status of state pension funds.  

Most of the article discusses points that I and others have made on this blog before, such as large size of the shortfall, the fact that it is politically difficult to fix, and the State of Illinois’ efforts to reduce costs by cutting pensions on future workers 

There was one thing in the article, however, that struck me as new and, quite frankly, frightening.  I am not sure if this is purely “academic” (and as an academic myself, I do not use the term disparagingly) or whether this is something that has any real practical potential.  But Amy Monahan of the University of Minnesota law school points out in the article that states have “police powers” which “given them fundamental rights to protect the welfare of their citizens in a crisis, which in this case would allow a legal ‘out’ in providing benefits.”  The use of this power to cut constitutionally protected benefits is an idea that has never been tested in the courts, but even so, there are two aspects of this possibility that are disheartening. 

The first is obvious – namely, that perhaps the constitutional guarantee of benefits may not be as strong as participants would like or expect.  Although, in reality, I think it is still clear that the constitutional provision is still the strongest guarantee that one can find anywhere – stronger than unfunded promises from Social Security, and stronger than underfunded promises from a private employer that are guaranteed by an underfunded PBGC.  So, as scary as it sounds, I am still not inclined to believe it more than an extremely remote possibility.

The second aspect is more subtle, but also more pernicious.  As I have written in earlier posts, in a competitive labor market, the perceived value of future pension benefits serve as a substitute for other forms of compensation.  Thus, the more employees have a perception that the Illinois public pension benefits are not secure, the less value employees will place on those benefits.  As a result, either taxpayers must pony up more cash to pay these employees in another form (e.g., higher wages), or many of them will take jobs elsewhere.  

The worst situation from a state’s fiscal perspective is one in which the benefits are actually inviolable, but that nobody believes this to be true.  In that situation, the states’ total compensation costs go up in the short-run – we have to pay employees more to make up for the perceived risky pension – but do not come back down in the long-run if the pensions actually end up being paid.