The CP allows accruing debt for pension shortfalls, solving social spending crises.

However, that the most aggressive ideas about cutting pensions are unwise does not mean that nothing should be done. States should reform their constitutional debt limitations to include pension underfunding, which would be consistent with the suggestions in Chapter 8 about accrual accounting. They should probably not create statutory liens for general obligation bondholders of the type discussed in Chapters 5 and 9. But they should also repeal the most aggressive constitutional protections for pensions.

The case for debt limit reform is straightforward enough. There is extensive debate about whether debt limits make any sense at all, as they limit the ability of governments to borrow and make investments. But if there are going to be debt limits (or balanced budget rules), there is no reason to exclude from those limits all obligations governments undertake and cannot easily ignore. As long as pensions are protected by state constitutions, underfunding pensions should be understood as debt.

Statutory liens for general obligation bondholders in theory put them in the front of the line in the case of a bankruptcy. Statutory liens turn bondholder claims to tax revenue into secured claim, with a property interest in the revenue stream. Jurisdictions do this to make creditors more likely to lend. But doing so puts them at risk of not being able to adequately protect pensions, which will negatively impact their ability to hire, as the Detroit plan of adjustment decision argued. And as we saw in Central Falls, they require an extreme solution, bondholders to get paid in full (or close) before pensions get paid at all. As a result, they hold up the ability of jurisdictions to design balanced solutions to their fiscal problems during bankruptcies.

State constitutional pension reform can also help. How pension obligations are protected by state constitutions varies by states. Under the “California Rule,” the terms of public employee pensions are protected from revision on the day an employee’s career begins, even for pensions they have not yet earned.14 The California Rule, which applies in a number of states, limits the ability of a government to balance the costs of a fiscal crisis across multiple stakeholders by making it impossible for a jurisdiction to reduce not-yet-earned pensions for current workers, even as part of a broader package of reforms in which many interests see losses. Other states have less dramatic protections that only protect the parts of pensions that workers have already earned. These rules protect the interests of workers while allowing states flexibility to make all interested parties in the state take losses when times are tough. It would be wise to move away from the California Rule and toward state constitutional protections for pensions that lock in gains workers have already earned, but allow for futureoriented pension changes for current workers.

State constitutional changes—by amendment or by judicial interpretation— would make reform easier. There are real questions, though, whether state constitutional changes would help in a crisis, given the interaction between state law and the federal constitution. Most states consider pensions to be contracts with public workers. As such, the federal Contract Clause protects pensions.15 If the state repeals its state constitutional pension clause and then seeks to reduce pensions, public workers can argue that the state has repealed of the terms of a public contract, violating the federal Contract Clause. Exactly how a court would decide such a case is uncertain.

However, the exact same logic presents an argument in favor of repeal in advance of a crisis. Not having to deal with strong-form California Rule protections would give a state or city with much more flexibility in how it responds to a debt crisis.

Strong state constitutional pension protections limit the ability of state governments to balance among competing demands along the trilemma. If a state is able to slightly impair pensioners on a going-forward basis during a crisis, reducing cost of living adjustments, say, or increasing the retirement age, it may be able to avoid a true crisis, and it may be able to avoid layoffs, salary reductions, or other types of cuts that create very substantial harms.