How flexible is the "California Rule" for public-employee pensions?

Readers of this blog may be familiar with my posts about constitutional protection for public-employee pensions, in particular the special California constitutional-law doctrine, called the "California Rule", that's very protective of pensions. I wrote a Federalist Society white paper about it (here, also reprinted here by the Reason Foundation), and I've blogged about it here, here, here, and here (not a complete list).

Today, I have a blog post on the Reason Foundation web site about Marin Ass'n of Public Employees v. Marin County Employees' Retirement Ass'n, a recent decision by the California Court of Appeal that upholds a state statute limiting pension spiking. The bottom line is that this state appellate opinion, by upholding a pension-limiting state statute, seems to weaken California's high level of constitutional protection for pensions and introduce some flexibility into the California Rule. (Or, rather, the Court of Appeal's argument was that this flexibility was built into the California Rule from the start.) Those who are familiar with my work know that I'm no big fan of the California Rule. I favor strong constitutional protection for contracts, and I favor seeing public-employee pension terms as contractual, but I oppose the California Rule's prohibition on making purely prospective changes to pension rules. Nonetheless, I think the Court of Appeal's decision was really iffy as a matter of California law, and I think it's likely that this opinion will be reversed by the California Supreme Court.

Here's an excerpt from the blog post, which is called "How Flexible is the California Rule? A Tale of Four Cases". (Which four cases? I give background for the Marin case by discussing three previous California cases: Lyon v. Flournoy, Betts v. Board of Administration, and Allen v. Board of Administration.)

California is notorious for having a constitutional doctrine that is highly protective-some would say overprotective-of public-employee pensions. The "California Rule," which has spread to several other states (see this May 2016 post), has stood as an obstacle to public-employee pension reform for over half a century. (See my July 2014 policy study on the California rule.)

Seeking at least some relief from rising pension costs, the California Legislature passed a statute in 2013 limiting the practice of "pension spiking," by which government bodies allow public employees to artificially inflate their ending compensation in order to increase those employees' pensions. And this statute was recently upheld in an August 2016 ruling by a California appellate court in Marin Ass'n of Public Employees v. Marin County Employees' Retirement Ass'n. If the California Supreme Court upholds this decision, it could ease the state's pension woes to a certain extent. But the Court of Appeal's reasoning is questionable and rests on a strained reading of past California cases. It wouldn't be surprising if the Supreme Court eventually reversed this decision.

. . .

After dealing with various nonconstitutional issues, the court came to the Contract Clause argument. First, the court wrote: "There is no absolute requirement that elimination or reduction of an anticipated retirement benefit 'must' be counterbalanced by a 'comparable new benefit.'" This argument proceeded in several steps. First, the court focused on the word "must." Consult the "comparable new benefit" language in the cases discussed so far, and you'll see that Allen v. City of Long Beach and Betts say "should," while the appellate court in Lyon and the Supreme Court in Allen v. Board say "must." Legal usage often distinguishes between the mandatory "must" and the hortatory "should," and the court concluded that, since "should" is the Supreme Court's preferred expression, it's unlikely that the use of "must" in Allen v. Board signaled a fundamental change in doctrine. Moreover, the Court in Allen v. Board actually upheld the pension reform.

This is true, as far as it goes: there is no inflexible requirement of comparable new advantages. But it should be clear from the foregoing discussion of Lyon and Allen v. Board that the result there was based on a highly unusual historical circumstance, which isn't present here. The Marin County employees actually spent time working under a system in which pension spiking was allowed-not just allowed, but common, and well-known (as the court itself conceded, in describing the practice as a widespread and much-reviled abuse). The plaintiffs argued that employees expect to be able to spike; that the increased pension payments resulting from pension spiking are taken into account actuarially in employees' retirement contributions; and that the prospect of spiking induces employees to accept lower salaries than they otherwise would. Whether or not all these claims are fully accurate, it's certainly not true that the increased pension payments resulting from spiking are unexpected.

The court went on to hold that in any event, there is a new benefit provided by the Pension Reform Act. Because the Act reduces pension payments, it also reduces employees' retirement contributions every pay period: "Put simply, the new benefit is an increase in the employee's net monthly compensation. Put even more simply, it is more cash in hand every month."

Perhaps: but an employee who is now close to retirement would only benefit from having more cash in hand every month for a short period, and that benefit would be far from commensurate with the reduced pension benefit.

Aside from these arguments, the court focused on the fact that the change was moderate and reasonable, that it was prospective only, and that it was made necessary by the state's pension crisis. But moderate and reasonable changes have been struck down in previous cases. At pp. 29-30 of its opinion, the court cites half a dozen cases to support the proposition that "reductions in promised benefits," "changes in the number of years service required," and "a reasonable increase in the employee's contributions" can count as "acceptable changes." But every one of these cases is plainly distinguishable. In some of the cases, comparable advantages were actually present; in some of the cases, the pension reduction was merely derivative of a change in the retirement age, and California courts have never held that there's a constitutional right to length of tenure; in one of the cases, upward or downward flexibility was built into the employee contributions by the requirement that contributions would be "computed on the basis of actuarial advice"; and one of the cases was from 1938, before the California Rule was invented!

As to the fact that the change was prospective, Allen v. City of Long Beach itself struck down a purely prospective change. Moreover, previous cases have refused to make exceptions on the basis of a fiscal emergency, since the fiscal emergency is the government's own fault ("a contract may not be impaired because of a crisis created by the state's voluntary conduct," a couple of cases have said); and the emergency can be remedied without reducing current employees' expected pensions, for instance by increasing taxes.

The Court of Appeal's decision in Marin Ass'n of Public Employees, then, is in substantial tension with the California Supreme Court's doctrine on the Contract Clause and the California Rule. Anything can happen on appeal, but it wouldn't be surprising to see this decision reversed by the Supreme Court.

Read the whole thing. In addition, you can see a complete list of my recent Reason blog posts here, which includes several posts on public-employee pensions, privatization, private governance, and antitrust.