Public employee pensions and the Contract Clause

I have a new post up on the Reason Foundation website about Contract Clause challenges to state public pension reform statutes. Here’s an excerpt:

Faced with public pension crises, many states have recently enacted pension-reform laws—increasing the rates at which their employees must contribute to their pension funds, reducing or eliminating cost-of-living adjustments, increasing the retirement age, or even converting to an entirely different type of pension system. Public employees and retirees have aggressively challenged these reforms, arguing that the makeup of their pension plans was part of the employment contracts they agreed to years ago. One of their main weapons is a relatively forgotten part of the constitution: the Contract Clause.

The text is simple: “No State shall . . . pass any . . . Law impairing the Obligation of Contracts.” The Contract Clause is one of the few restrictions against states to be contained in the original constitution, rather than in the Bill of Rights or the post-Civil War amendments, and is also one of the few economic-rights provisions. In the early Republic, courts used this clause aggressively to protect the obligation of private and public contracts alike: states were restricted in how much they could relieve debtors of the obligation to pay their creditors, just as they were restricted in repudiating their own bonds or reneging on their promises of tax exemption. James Ely writes that the Contract Clause was “the most litigated provision in the Constitution and was the chief restriction on state authority.”

This changed gradually throughout the late 19th and early 20th centuries, as the Supreme Court increasingly deferred to state economic regulation, especially during “emergencies.” The protection of public contracts was the quickest to go, but private contracts lost protection as well. Since the New Deal, the Contract Clause, much like other economic rights, has been afforded a relatively low level of protection.

But examining the current crop of cases by public employees and retirees challenging pension-reform laws—there are at least a dozen such cases just in 2013 so far—shows that the Contract Clause (as well as similar state constitutional Contract Clauses) nonetheless remains a vibrant area of litigation.

These are important challenges for many reasons. At the most general level, presumptively everyone, even governments, should keep their promises, since contractual security is an important feature of a free-market economy. Still, figuring out what’s part of the contract and what’s merely an alterable state policy can be tricky. Public-sector contracts have the added twist that they’re politically determined and can be used to transfer resources from taxpayers to politically preferred groups, and—especially in tough budgetary times—keeping them may be beyond a state’s means. These challenges are also important for the future of privatization, since part of the appeal of privatization is the high cost of paying public employees; while reforming pensions at public employees’ expense may improve a state’s finances, it might also hide the true cost of in-house provision of government services.

. . .

The future of pension reform thus depends heavily on this constitutional issue. On the one hand, it seems right that a state shouldn’t be able to violate its contracts whenever they seem too expensive, even if the contracts were ill-advised to begin with, and even if this will cost the taxpayers. After all, the state can’t take private property without paying for it (obviously, at taxpayers’ expense); why should it be able to “take” a contract right for free? If public employment is really so expensive, perhaps state officials will learn next time not to make promises that are too generous. On the other hand, in most states, a great many pension-related promises aren’t contractual, especially ones that only relate to future periods of work. This seems to give states substantial leeway in crafting pension-reform bills that will withstand constitutional scrutiny.

You can see my other Reason posts here, including one on privatized regulation and antitrust and one on the antitrust state action doctrine.

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