Economics, Entitlements

Can Detroit’s pension benefits be cut? Should they be?

Image Credit: Shutterstock

Image Credit: Shutterstock

One major issue in the Detroit bankruptcy is whether retired city workers will take a hit to their pensions. Pension and health benefits for city employees cost the government roughly one-third of its total revenues, and so some argue that retirees — along with bondholders — are likely to get a haircut. Others, including a Michigan judge, counter that public employee pension benefits are protected by the Michigan state constitution and thus are off limits.

Here’s what the Michigan state constitution says with regard to pensions:

Sec. 24. The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof which shall not be diminished or impaired thereby.

As a non-lawyer, here’s how I read this passage: it pretty clearly prohibits an arbitrary reduction in public pension benefits. Congress, for instance, could pass a law tomorrow reducing Americans’ Social Security benefits and individuals would have no legal recourse because those benefits are non-contractual. The Michigan state constitution appears to outlaw such changes.

But does it outlaw pension cuts taking place during bankruptcy? The key issue is that, contractual obligation or not, bankruptcy is defined as a period in which a debtor may break its contractual obligations due to an inability to meet them. The Michigan state constitution, at least on my crude reading, doesn’t afford public employees any additional protections to those granted to others, such as municipal bond holders who have contractual obligations with the city. So at least some benefit cuts might be on the table.

But does this mean that retired city workers should take the same haircut as municipal bond holders? I really don’t think so. Anyone loaning money to the city of Detroit was knowingly taking the risk that the city might not repay; that’s why bonds issued by Detroit paid a higher yield than Treasury securities, which are assumed to be riskless. As with any risk investment, sometimes it pays off, sometimes it doesn’t.

City employees, on the other hand, exchanged services today — along with employee contributions to their pension plan — for benefits to be delivered in the future. Sure, employees should consider the financial stability of their employer in its ability to deliver what is promised, but city employees seem to be a qualitatively different group than municipal bond holders. And, as much as I believe that public employee pensions may be overgenerous and that the costs of such plans are a burden to city and state governments, a promise once made should be kept, at least insofar as is possible. Does this mean no cuts for retired Detroit city workers? Probably not. But should they be paid the same pennies on the dollar that is being offered to municipal bond holders? I really don’t think so.

7 thoughts on “Can Detroit’s pension benefits be cut? Should they be?

  1. I am also not a lawyer. I don’t even play one on TV, nor did I recently stay at a Holiday Inn Express. However, bankruptcy is a federal law and proceeding. I think it likely that the Michigan constitution would be irrelevant in this instance due to the doctrine of federal supremacy. I.e., when a state law conflicts with a federal law, the federal law wins unless it is ruled to be an invalid intrusion on rights reserved to the states under the Constitution.

  2. Promises made should be kept, but only if the means to do so exist and IF (note the capital letters) the promises were made in good faith.

    That isn’t the case here. No city in their right mind would have agreed to pay the pension benefits Detroit agreed to pay (take your pick: the ridiculously early retirement ages? the padding on pension benefits by lumping overtime into the calculation?). That they did so is prima facie evidence that there was something wrong and as such, ‘future’ Detroit shouldn’t be held to pay for the corrupt ‘past’ Detroit.

  3. I would think that all pensions in Detroit [and other cities with similar problems], over a certain amount, should be investigated for fraudulent practices. Most of the little people are innocent victims [except for how/who they voted for & why] .My guess is that in 90% of cases where a pension is in the top 10%……FRAUD will be found.

  4. The public employee unions took advantage of the political system and backed officials who would give them lavish pension benefits instead of pay hikes because the officials wouldn’t have to pay the benefits. That would fall upon future officials and future taxpayers.

    Basically, the unions took advantage of the youth who were too young to vote. Now that the unionists have retired and moved south, the youth can repay them the favor and take advantage of the fact that out of state retirees can’t vote.

    • You are 100% right. There are a lot of cities, like Detroit, that have given Public Employees lavish Pensions, so they would back the office holders. The only way out of the Detroit pension mess is to cut the pensions back to a reasonable rate, like what people on social security get.

  5. There are dozens of cities and states which face this common problem: retirement benefits were promised by politicians, for decades, who never included these debts in their tax plans. There never was any money to pay these benefits. The pols bought their job via fraud, often in cahoots with union leaders who supported the rip off. In the private sector, this would be a crime.

    The first group to get a hair cut are any leaders who took theirs and ran. All Detroit mayor, counsel members, department heads, and union leader retirees should get nothing except a law suit and jail time. The industries that fled should be subpoenaed and any federal or state regulator who drove them away should have their salary and retirement benefits cut to cover the loss. And any parent whose student child is failing the No Child Left Behind standards (some 97% in Detroit) should lose their benefits. Their teachers should be fired, trimming costs further. Then all abandoned land should be rezoned as farm land and sold off.
    Then the hair cuts should begin, in Detroit and throughout our failed, corrupted governments. This will change our society, for the better.

  6. The arm’s length principle is the condition or the fact that the parties to a transaction are independent and on an equal footing. It applys specifically in contract law to assure an equitable agreement that can withstand legal scrutiny. As Ms. Romanova aptly observed, the parties in the City of Detroit were not independent. Therefore, such a contract would be unenforceable. Even the arch-liberal Democrat FDR opposed collective bargaining for public employees for this obvious reason.

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