Can States Reduce Unreasonable Pensions? California Supreme Court Will Review

The 'California Rule' is a staple of public sector retirement systems, but could this be its undoing? Many states and cities should hope so.



The California Supreme Court will review a lower court ruling that tossed a longstanding rule preventing public sector pensions from being reduced in any way.

It's a case that could have far-reaching consequences. The ruling would apply only to California, but if the state Supreme Court decides to uphold a lower court ruling that pension benefits can be reduced in some circumstances, it would be an important signal to the many other states grappling with unsustainable pension burdens and similar rules forbidding benefit cuts. It would also signal that courts are willing to reconsider the balance between public workers and the states (and the taxpayers in those states) writing their checks.

"A ruling that works against the California Rule would certainly be noticed in other places," said Len Gilroy, director of government refom at the Reason Foundation, which publishes this blog. "Certainly, you have state courts that watch each other in terms of interpretation and precedent."

The case has its origins in a pension reform measure passed in 2012 by the California state legislature. Marin County, just north of San Francisco, used that law to reduce pension benefits for some of their employees by refusing to allow them to cash-in unused vacation days, sick days, and other benefits in exchange for a larger pension payout. This is known as "pension spiking" because it allows employees to claim a significantly higher final salary prior to retirement—the basis for benefits in many pension systems.

In August, a state appeals court ruled that Marin County was within its authority to make those changes as a way to reduce pension spiking, but that wasn't all. In the unanimous opinion, Judge James Richman seemingly opened the door to further reforms that could help state and local governments get their massive pension debts under control.

"While a public employee does have a 'vested right' to a pension," he wrote. "That right is only to a 'reasonable' pension—not an immutable entitlement to the most optimal formula of calculating a pension. And the legislature may, prior to an employee's retirement, alter the formula, thereby reducing the anticipated pension."

As long as those modifications do not deprive public workers of "reasonable" pensions, Richman concluded, they do not violate California's constitutional prohibition against reducing pension benefits—a measure known as the "California Rule" that can be found in several other states, either as a constitutional provision or a state law.

Labor unions appealed that ruling and the state's highest court decided on Nov. 22 to accept the appeal. A ruling isn't likely until next year.

Either way, the outcome will be important for other states.

"California because of its size tends to be a bellwether state in many areas including public pensions," Rick Dreyfuss, a retired actuary and senior fellow on pension issues for the Commonwealth Foundation, a Pennsylvania-based think tank, told Reason via email. "Therefore, I would expect the ruling would be used by the prevailing side to further leverage a similar outcome in other states."

If the California Supreme Court upholds the lower court ruling, Dreyfuss said, it would introduce a whole new dimension to policy discussions over pensions: the question of what counts as a "reasonable" one.

The answer to that question is anyone's guess at the moment, but it could mean the end of the gravy train for many public workers. According to data from Transparent Califrornia, a project of the Nevada Policy Research Group, more than 20,000 retired public workers in California pulled down more than $100,000 in retirement benefits during 2015. Meanwhile, the CalPERS pension fund is more than $139 billion in the red, an amount that would require every man, woman, and child in California to pay $11,000 if it were divided evenly.

Denting the power of the California Rule would be a significant step towards helping cities and states get out from under the crushing debt of future pension bills.

As Steve Greenhut wrote in Reason shortly after the August ruling in the appeals court, the so-called California Rule isn't really a rule, but "a precedent derived from a variety of rulings that date back to 1955. Ultimately, it says that once a legislative body (city council, board of supervisors, the state Legislature) grants a pension-benefit increase, that increase is indeed immutable; it can never be rolled back. Employees can never be forced to contribute more to their pension plan unless they get something of equal or greater value in return."

In short: under the California Rule, states are obligated to come up with the money to pay their pension promises, no matter what other services have to be reduced or what taxes must be raised.

If the California Supreme Court upholds Judge Richman's ruling, "the legal door will be open for Californians to begin to take reasonable actions to save pension systems and local governments from fiscal disaster," said former San Jose Mayor Chuck Reed, who now serves as a board member on the Retirement Security Initiative, a national group working to ensure the sustainability of public pension plans.

"The importance of it is the flexibility that you have as an employer to make prudent benefit adjustments relevant to circumstances like the solvency of the fund," said Gilroy. "That's an important thing."

Illinois, which has more than $110 billion of unfunded pension debt, the highest such total in the country, discovered the hard way how the California Rule can limit that flexibility. It's one of several states to have a version of the California Rule written directly into the state constitution, and it was that constitutional prohibition against reducing pension benefits that sank a 2013 pension effort by Gov. Pat Quinn to reduce annual cost of living adjustments for Illinois public workers.

Without changes, Illinois could be the first state to go over the pension cliff, but New Jersey and others are close behind. Chicago is already getting close to the edge. In California, the cities of Stockton and Vallejo have gone through bankruptcy to deal with pension costs.

Striking a legal blow against the so-called California Rule won't fix the pension crisis, but might make the problem a little easier to tackle.