State pension systems are in financial trouble. According to a 2011 Pew report, state pensions are collectively some $660 billion short of the funding needed to meet their actuarial liabilities.1 More alarmingly, that figure depends on the assumption that pensions' current investments will appreciate at about 8% per year indefinitely.2 Under more realistic and less volatile assumptions, the unfunded liabilities rise considerably to as much as $3 trillion using the state debt interest rate, or $4.4 trillion using the zero-coupon Treasury yield.3
In light of these looming actuarial deficits, numerous states have begun taking steps to reform their pension systems, with some states making modest changes and others beginning to enact serious and fundamental pension reform.4 In Rhode Island, State Treasurer Gina Raimondo spent all of 2011 warning of a looming $9 billion or so deficit in the pension systems there-a deficit so large that the state would soon be unable to pay what is needed for schools, roads, libraries, and more.5 Despite weighty political opposition from the state's powerful labor unions, Rhode Island enacted groundbreaking pension reform in late 2011.6
Many states have found that reform legislation is just the beginning. Within the past few years, at least twenty-five jurisdictions have faced lawsuits alleging that pension reform is unconstitutional, including Colorado, Minnesota, South Dakota, New Hampshire, New Mexico, Massachusetts, Florida, New Jersey, and Rhode Island.7
The most significant claim raised against pension reform legislation is that it violates the federal Contract Clause or a state constitutional parallel. In both the U.S. and state constitutions, a contract clause provides that the government may not pass laws that abrogate contractual responsibilities. Thus, the argument runs, a pension promised to a state employee is essentially a contract: the state employee was offered work in exchange for a compensatory package that included both salary and a pension benefit.8 When legislation diminishes pension benefits, it alters the terms of the state's contractual obligation to provide the bargained-for remuneration, and is arguably unconstitutional.
A second claim raised against pension reform is that it violates the takings clauses of state and federal constitutions. These clauses prevent the government from taking away someone's property without just compensation. The argument is that state pension benefits are a promised stream of monetary payments with present economic value, and therefore arguably constitute an employee's "property."9 Thus, if the state diminishes that stream of payments without some countervailing compensation, then some of the employee's property has been "taken" away.10
The claim that pension rights are contractual is not only plausible but has often succeeded in prior state court lawsuits.11 As a result, many policymakers and courts have suggested that pension reform must be limited to changing the terms applicable to newly hired employees.12
However, states ought to have more options available to them with respect to current employees' benefits. Courts faced with pension reform questions have rarely considered exactly what types of pension reform ought to count as unfair contractual changes. Instead, most published decisions involved patently unfair pension changes, such as reducing the pension benefits for retirees who worked for their entire careers with the expectation that they would receive a higher benefit.13
This article will argue, however, that more modest changes to current workers' benefits ought to be allowed consistent with federal and state contracts clauses. In particular, it would be more consistent with the underlying considerations of established case law for state workers to be presumptively entitled to the pension benefits that they have actually accrued for past work, even while changes to future accruals are permissible. …