The Choice Between Two Unconstitutional Options is Not Constitutional

Filed Under (Other Topics, Retirement Policy, U.S. Fiscal Policy) by Nolan Miller on May 29, 2012

As I’ve said before, I’m not a lawyer.  But, since the Illinois House Democrats have decided to move into incentives, why not?  The details of the pension reform proposal that passed an Illinois House committee today are still vague, but here is a write up about it.

Simply put: the proposals currently under consideration in which members are offered a “choice” between options, as currently constructed, are not constitutional.  Here’s why.

The Illinois Constitution says that membership in a state pension program is a contractual relationship the benefits of which shall not be diminished or impaired.

Any contractual relationship has to have, well, a contract.  In this case, the terms of the contract are spelled out in the Illinois Pension Code.

The Illinois Pension Code specifies the way in which pension benefits will be calculated.  The details are slightly different for different pension funds, but I’ll talk about the part that pertains to Tier I participants in the State Universities Retirement System (SURS).  In particular, the amount of the retirement annuity is specified in Section 15-136 of the Pension Code.  Here it is:

Rule 1: The retirement annuity shall be … for persons who retire on or after January 1, 1998, 2.2% of the final rate of earnings for each year of service.

That seems pretty clear.  The “final rate of earnings” is defined in Section 15-112.  For a person who first becomes a participant before Jan. 1, 2011 (i.e., Tier I participants), the final rate of earnings is defined as:

For an employee who is paid on an hourly basis or who receives an annual salary in installments during 12 months of each academic year, the average annual earnings during the 48 consecutive calendar month period ending with the last day of final termination of employment or the 4 consecutive academic years of service in which the employee’s earnings were the highest, whichever is greater. For any other employee, the average annual earnings during the 4 consecutive academic years of service in which his or her earnings were the highest. For an employee with less than 48 months or 4 consecutive academic years of service, the average earnings during his or her entire period of service.

That also seems pretty clear.

One more excerpt from the Pension Code.  This one has to do with annual cost of living adjustments (COLAs).  From Section 15-136

The annuitant shall receive an increase in his or her monthly retirement annuity on each January 1 thereafter during the annuitant’s life of 3% of the monthly annuity provided under Rule 1, Rule 2, Rule 3, Rule 4, or Rule 5 contained in this Section. The change made under this subsection by P.A. 81-970 is effective January 1, 1980 and applies to each annuitant whose status as an employee terminates before or after that date.

Beginning January 1, 1990, all automatic annual increases payable under this Section shall be calculated as a percentage of the total annuity payable at the time of the increase, including all increases previously granted under this Article.

This part of the Pension Code also seems clear: COLAs are to “include all increases previously granted under this Article.”  In other words, COLAs compound rather than being based on the original amount of the annuity.  And, COLAs start the January after retirement.

So, let’s review.  The Illinois Constitution says that membership in a pension system is a contractual relationship. The terms of that contract are given by the Pension Code, and the Pension Code specifies the way in which final pension benefits should be computed.  In particular, it specifies that the final rate of earnings is average earnings over the final 4 years of service, or the 4 consecutive years in which earnings were the highest.  Thus, the Pension Code states that future pay raises will be included in future pension benefits.  The Pension Code also states that COLAs are to begin immediately after retirement and be computed on a compound basis.

So, let’s return to the “choice” that would be offered to members of the pension system under the proposal.  Details are sparse, but the basic choice to be offered to members will be:

(A)  Keep the current pension plan, but give up the state subsidy for retiree health benefits and having future raises be included in pension benefits, and

(B) Keep the state subsidy for retiree health benefits, but receive a less generous cost of living adjustment (COLA) where annual increases are based on the pension payment at the time of retirement rather than the most recent year’s pension.  That is, the COLA is not compounded over time.  Further, the COLA will not kick in until 5 years after retirement or age 67, whichever comes first.  There is also language in at least the governor’s proposal that will limit the COLA to a simple 3% or ½ the increase in the consumer price index, whichever is lower.

Now, supporters of this approach claim that is constitutional because it offers participants a choice.  This claim is invalid.  While a choice might be constitutional, in order for this to be the case, it must be that one of the options does not impair or diminish the benefits of the current pension system.  This is not true here.  Option (A) denies members their contractual right to have the final annual rate of earnings be based on their highest 4 years of earnings, which would include future raises.  Option (B) denies members their contractual right to have COLAs be 3% compounded each year.  Since both options impair and diminish the benefits of the pension, if members are forced to make a choice between A and B, their pension benefits will necessarily be reduced.

Constitutionally speaking, two wrongs don’t make a right.

Consequently, to me it seems clear that the proposals are not constitutional.  Given that so many of our legislators are backing these proposals, there must be an argument for why the proposal is constitutional.  I can’t see it, though.

ADDENDUM (5/30/12):  This isn’t a post about whether it is right or fair to reduce retiree health benefits (it isn’t), but rather whether it is constitutional (it probably is).  Retirees who began working for the State of Illinois before April 1986 (at least in the case of SURS) may not be eligible for Medicare Part A.  In this case, removing health insurance benefits would leave workers exposed to significant financial and health risk even after the age of 65.  The state also does not contribute to Social Security, so state workers who retire are also not eligible for Social Security (unless it is by virtue of having worked for another employer).  Obviously, removing employer-sponsored health benefits and reducing the COLA is going to expose retirees to substantial new risks, and the proposal becomes much more complicated and controversial in this case.


Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Oct 18, 2010

Last Friday, the Social Security Administration (SSA) announced that there would be no Cost of Living Adjustment (COLA) in 2011 for the second year in a row.  Apparently, some view this move as callous given economic difficulties we have been through: the AARP and similar groups are upset.  But this decision is “hard-wired” into the law, and for good reason.  The COLA is meant to adjust benefits only when consumer prices have risen in order to protect the purchasing power of Social Security checks.  But consumer prices – at least as measured by the Consumer Price Index (CPI) – have not risen, and therefore there is no need to increase benefits.  To suggest otherwise is a pure case of what economists call the (unfortunately) pervasive phenomenon of “nominal illusion.”

As a bit of background, it is worth noting that the COLA policy in its present form has been around for decades.  In 1972, President Nixon approved P.L. 92-336, tying the COLA to the CPI and scheduled increases to begin in 1975.  Furthermore, this legislation ensured that in the event of deflation, benefits would not go down (even though the logic of a COLA suggests they should!)  So this is hardly a bad deal for seniors.  Prior to this bill, Congress had to legislate increases for those receiving social security; imagine the pandering, especially in election years!

If prices have not risen on average, then calls to increase benefits anyway essentially amount to asking whether seniors ought to get a “raise” in real terms, at a time when much of the normally-taxpaying public is looking for work and going without raises of their own.  On this issue, “where you stand depends on where you sit.”  Seniors obviously would like to see an increase.  Younger taxpayers – who are already facing enormous unfunded liabilities for Social Security – would be better off sticking with current law.  Who gets to decide?  Politicians, who are likely depending on seniors for their votes in a few weeks.

As an economist, the logic of adjusting benefits for cost-of-living is quite strong.  And making such indexation automatic (on both the upside and the downside) eliminates the gaming that results from leaving this as an annual Congressional decision.  The current system has worked to seniors’ advantage for nearly 35 years by protecting the purchasing power of their benefits.  While no increase was awarded in 2010 either (see my column from August 2009), one would be hard pressed to prove the current structure has disadvantaged recipients in any way.  In fact, inflation rose so much in 2008 thanks to high oil prices that 2009 yielded the highest COLA increase in 25 years of 5.8%.  (See here for maximum payment after 1975 along with the COLA).

Of course, all of this assumes that the CPI accurately measures increases in the cost of living.  On this point there is legitimate room for debate.  The Department of Labor’s website indicates that the CPI only accurately represents 32% of the population – though that statement itself strikes me as having a degree of false precision.  Naturally any estimate is going to overshoot for some and undershoot for others, depending on how any one individual’s consumption patterns compare with that used in the computation of the index. There are a number of well-known flaws with the CPI (ranging from how it treats new goods to timing of data collection to its treatment of substitution of goods).  But most studies suggest that the net effect is that the CPI overstates inflation.  In short, seniors may have gotten bigger increases over all these years than the “true” average inflation rate would indicate.

Given that this is an election year, I was not surprised by the timing of another announcement that came out last Friday – this one from White House officials in which they declared support for a $250 check to be sent to those receiving benefits, to be paid out of current unspent stimulus funds.  But it is important to keep in mind that just because we have “unspent” stimulus funds does not mean we can afford to do this.  After all, even if we eliminated all remaining stimulus spending, the federal government would still be running enormous deficits this year.

All-in-all, the approach to adjusting Social Security benefits for changes in the CPI may not be perfect, but it sure beats allowing politicians to spend money we do not have to pander for votes at election time.  Let’s hope that as soon as the election is over, this temptation to spend our grandchildren’s money quickly passes.