I was recently asked: “Can the State of Illinois declare bankruptcy so it can renege on its public pension obligations?”

Can the State of Illinois declare bankruptcy so it can renege on its public pension obligations? No, the State of Illinois cannot (no matter what Illinois Senator Mark Kirk and others have said previously).

Though the State’s liabilities continue to increase, and the State of Illinois has a cash-flow problem, bankruptcy is not an option.  Why?  Bankruptcy would destroy the State of Illinois’ credit rating completely and its ability to borrow at affordable interest rates; the State’s budgets would be slashed; bond sales would plunge, and the bond market would destabilize. Most importantly, the U.S. Constitution prohibits any state from declaring bankruptcy or “impairing the obligation of contracts” (Article 1, Sec. 10).

Two years ago congressional legislator Newt Gingrich asserted that U.S. law should be changed to allow a state to file bankruptcy, thus, giving it more leverage to renegotiate labor contracts.  In other words, Gingrich and other legislators perhaps believed that state governments could break the unions’ resolve to protect public employee pensions by using bankruptcy as their trump card; moreover, Gingrich wanted us to know that the federal government was no longer in the “bailout business.”  This is quite ironic, considering the depletion of trillions of dollars from taxpayers to bail out bankers, corporations, and the wealthy that had devastated the U.S. economy and the lives of millions of people.

Mark Kirk agreed with Gingrich and advocated for a law that would allow a state to declare bankruptcy, even though state bankruptcy would invariably rob public employees of their contractual right to an earned pension.  It is true that if a state declares bankruptcy, all fiscal contractual obligations would be placed under court jurisdiction.  State employee contracts would be under court authority and subject to its revisions, resulting in cuts not only to pension funds, but to salaries, benefits, and bondholder obligations.  Thus, pension funds could be liquidated entirely, and the State bond market would be rendered ineffectual for earning further capital. (See *footnote)

What might have prompted discussions regarding a state’s option to declare bankruptcy was a bill introduced by U.S. Representatives Paul Ryan and Devin Nunes, entitled the Public Employee Pension Transparency Act (H.R. 567) two years ago.   This bill required more reporting from state and local pensions and prohibit federal bailouts of states:  “…state or local government employee pension benefit plans are becoming a large financial burden on certain state and local governments and have already resulted in tax increases and the reduction of services.  

“In fact, a recent study published in the Journal of Economic Perspectives found that the present value of the already-promised pension liabilities of the 50 States amount to $5.17 trillion and that these pension plans are unfunded by $3.23 trillion…

“Some economists and observers have stated that the extents to which state or local government employee pension benefit plans are underfunded is obscured by governmental accounting rules and practices, particularly as they relate to the valuation of plan assets and liabilities. This results in a misstatement of the value of plan assets and an understatement of plan liabilities, a situation that poses a significant threat to the soundness of state and local budgets…  

“[Hence,] the United States shall not be liable for any obligation related to any current or future shortfall in any state or local government employee pension plan. Nothing in this Act (or any amendment made by this Act) or any other provision of law shall be construed to provide Federal Government funds to diminish or meet any current or future shortfall in, or obligation of, any state or local government employee pension plan” (H.R. 567). 

We must be aware that it’s not only a few members of Congress that have lost their lucidity.  As stated by the Center on Budget and Policy Priorities (January 2011), “various pundits [also suggest] enacting federal legislation that would allow states to declare bankruptcy, potentially enabling them to default on their bonds, pay their vendors less than they owed, and abrogate or modify union contracts.  Such a provision could do considerable damage, and the necessity for it has not been proven.”

The Center on Budget and Policy Priorities affirms that “it would be unwise to encourage states to abrogate their responsibilities by enacting a bankruptcy statute.  States have adequate tools and means to meet their obligations...  Confusion between short-term cyclical deficits and debt, pensions and retiree insurance – and the overstatement of the magnitude of the latter set of problems – draw attention away from the need to modernize state and local budget and revenue systems and address structural problems that have built up over time in these systems.  

“States suffer from ‘structural deficits’ or the failure of revenues to grow as quickly as the cost of services… Structural deficits stem largely from out-of-date tax systems, coupled with costs that rise faster than the economy in areas such as health care.  Fixing these structural problems would help states and localities balance their operating budgets without resorting to [desperate measures]… It is far more constructive to focus on fixing these basics of state and local finance than to proclaim a crisis based on exaggerations of imminent threats.”  

Consider in Lansing Michigan, “an Ingham County judge says Thursday's historic Detroit bankruptcy filing violates the Michigan Constitution and state law and must be withdrawn…” (Michigan judge rules Detroit bankruptcy unconstitutional). 

Also read: Detroit bankruptcy on hold, Snyder administration smacked down by judge for “cheating good people who work.”  

In Illinois, the State Constitution (Article XIII, Section 5) is quite explicit about public employees’ guaranteed pensions. Furthermore, “pensions will not run out of money… [That] assumes that at a future date, state pensions will just cease and all outstanding financial obligations will come due… Unlike a corporation, a state government cannot go out of business… [Accordingly,] state law empowers TRS (40 ILCS 5/16-158c)… Payment of the required state contributions and of all pensions, retirement annuities, death benefits…, all other benefits…, and all expenses are obligations of the state… The state has waved its sovereign immunity in regard to the teachers’ pension because TRS is a qualified pension plan under the tax-deferred provisions of the IRS code.  Federal law would protect all claims… Pensions [are not] the problem [or] why Illinois has been unable to pay its bills.  The reason is the dramatic fall-off in state revenues over the years, costing the state billions” (Dave Urbanek, Public Information Officer at TRS, 2011).

According to Alicia Munnell, Director of the Center for Retirement Research at Boston College, the Illinois State Constitution (Article XIII, Section 5) is the legal basis for protection of public pension rights under State laws for both past and future accruals. Two other states have this protection as well: New York and Alaska; for past and "maybe" future accruals: Arizona; for past only or protection of benefits earned to date: Hawaii, Louisiana, and Michigan (State and Local Pensions: What Now?). 

-Glen Brown

Most of this essay was originally posted in August, 2011.

For several constitutional analyses, please Click Here.

*“…[According to Eric Madiar], if the Illinois Supreme Court were confronted with a circumstance where a pension fund was on the verge of default and pension payments were diminished, then the court would most likely permit a mandamus action to proceed and resolve that action in the same manner as Jorgenson v. Blagojevich [2004]. In that case, the court held that where a constitutional or statutory provision ‘categorically commands the performance of an act, so much money as is necessary to obey the command may be disbursed without any explicit appropriation.’ The court applied this principal to compel the State Comptroller to pay judges from the State Treasury, without an appropriation, the cost of living increase that was part of their constitutionally-protected salaries under Article VI, Section 14 of the Illinois Constitution. As noted, that provision bars the diminishment of judicial salaries just as the Clause prohibits the diminishment of pension benefit rights. Accordingly, the Supreme Court would most likely grant pension participants the same relief provided in Jorgenson by compelling the Comptroller to pay the needed funds from the State General Revenue Fund, especially since the State Pension Funds Continuing Appropriation Act requires automatic appropriations be made from the Fund to the five State pension systems…”