States cannot declare bankruptcy. Unlike cities and companies, there is no legal provision for states to shed debt, even if that debt becomes overwhelming.
The Council of State Governments recently asked a constitutional lawyer, Kenneth Katkin, to weigh in on what laws would have to change to allow states to declare bankruptcy.
According to Katkin, it would take congressional action to broaden the federal bankruptcy code to include states, and the Supreme Court would have to decide if, under the contracts clause, states could change or amend contracts.
What is alarming is that this question even needs to be asked.
The most obvious beneficiary of a change in bankruptcy laws would be Illinois. There, Gov. Bruce Rauner is finding few legal or legislative avenues open to deal with the state’s $110 billion pension debt. Meanwhile, the city of Chicago is also facing bankruptcy because of its pension problems.
While Connecticut isn’t as bad off as Illinois, it isn’t that far behind.
Between our pension debt, and our growing bonded debt, by many measures Connecticut is actually the most indebted state in the nation. And if, as the signs indicate, we’re about to enter another rough period for the stock market, things could get really bad really fast.
Obviously bankruptcy is the nuclear option — and our elected leaders should do everything they can to avoid it.
That’s why it’s encouraging that Gov. Dannel P. Malloy is showing signs that he’s ready to revisit public employee benefits, including pensions. He recently released a plan addressing the state’s budget crisis, which included changes to the way the state handles its pension funds.
While there are some good things about the plan, it misses the mark because it avoids the thorniest but most important issue: What the governor plans to do to reform government employee pensions to protect the state’s taxpayers in the future.
There’s a reason so many states have under-funded pension systems — it’s easy to put off paying for things today, and to instead promise to pay for things tomorrow. It’s a very human problem.
That’s essentially what the unions and state leaders did for years here in Connecticut, and elsewhere. The risk that this could happen again should be enough of a reason for the state to put all new employees into a 401(k)-style retirement plan, which the state couldn’t put off paying for, and which takes the investment risk off taxpayers.
But human weakness isn’t the only risk — the current pension system also puts all of the investment risk on taxpayers. The state assumes it will earn an 8 percent return on its funds every year — if that doesn’t happen, taxpayers are on the hook to make up the difference.
When Gov. Malloy took office in November 2010, the state employee retirement fund was 44 percent funded. This year, despite several years of healthy stock market returns, and the state meeting its obligations to pay its annually required contributions, the fund is only 43 percent funded.
What gives?
Malloy’s budget presentation answers that question — only 25 percent of the underfunding is related to missed contributions. Much of the rest is made up of mistaken assumptions, one being the state’s assumption that its pension funds would earn at least an 8-percent return every year.
The state uses that assumption to decide how much it should pay into the pension fund every year. If you assume you’re going to earn more money off the stock market, then you get to put less money into your pension account.
To his credit, Malloy wants to change the assumed rate of return from 8 percent to 5.5 percent. Just yesterday, the Teacher’s Retirement Board lowered its assumption from 8.5 percent to 8 percent, which means the state will have to put an extra $180 million into the fund in 2018, according to a state Office of Policy and Management press release.
Moving the state to 5.5 percent would be a politically brave move, because, while on the up side, it will give us a more accurate picture of how much pension debt we owe, it will also show everyone that the state is actually billions of dollars more in the hole than it said.
This is also an expensive proposition — as we can see with what happened when the teachers’ board changed its assumptions, this will mean much higher up-front costs for state employee pensions. On the plus side, this will give us a truer representation of the actual cost of these benefits.
Maybe that’s why Malloy also wants to split the pension fund in two: One portion for “Tier 1” employees — state workers who were hired before 1984, who have the platinum-plated plans that led to over 800 retirees receiving pensions of over $100,000 this year; and another portion for everyone else.
He wants to pay Tier 1 pensions on an as-you-go basis, and roll all current savings into a fund for other retirees. This, Malloy says, would make the pension fund almost fully funded.
Except it wouldn’t — it would actually increase our pension debt in the short- and long-term, and would stretch out how long we’ll be paying for that debt. Federal laws governing private pension plans would never allow a business to do what the state wants to do.
Some say this is a good idea, because it saves Connecticut from the huge bump in pension payments that is approaching on the horizon.
The problem is, Malloy’s changes would also mean that taxpayers would be paying for Tier 1 employees, and their survivors, for decades after they’ve all retired. Malloy’s chart ends at 2044, but payments to these retirees would last for years after that.
It’s classic kick the can.
But is it also necessary to avoid bankruptcy, or some kind of federal bail out? That’s hard to know.
What we need to ask is if the Malloy administration has really done all it can to reduce the state’s pension liabilities. It certainly didn’t propose anything nearly as bold as what Gov. Gina Raimondo did in Rhode Island.
Raimondo asked state retirees to forego cost of living increases until the state’s pension fund was solvent again. She also moved the state to a hybrid system — where employees earn both a smaller defined benefit pension, and also save for their retirements using a 401(k)-style account.
While Rhode Island and its public sector unions ended up in court, ultimately they worked out an agreement.
Malloy’s attempt to split the pension fund may also be dicey for another reason: How would Connecticut report its pension debt if it split its fund in two? If Malloy hopes to move a huge portion of the state’s pension debt off the books, he may find himself at odds with bond buyers, credit rating agencies, and others who want a clear and honest accounting of our state’s pension debt.
Also, what would happen with the state’s spending cap? This past session, lawmakers moved pension debt out from under the spending cap. It would have to put that money back if it decided it wasn’t debt anymore.
Yes, we’re in a mess. But before we embrace Malloy’s plans, we need some clarification. And we need assurances we won’t find ourselves in this mess again.
Suzanne Bates is the policy director for the Yankee Institute for Public Policy. She lives in South Windsor with her family. Follow her on Twitter @suzebates.
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