California Supreme Court Examines Pension Spiking

In May, the California Supreme Court heard a case with the potential to set a new precedent for pension reform across the country. The court’s decision will impact the pensions of over one million public employees and will either confirm or limit the government’s ability to adjust pension benefits after they are promised to public employees.

The case addresses the 2013 Public Employees’ Pension Reform Act enacted under the administration of Governor Jerry Brown. The most controversial component of the law banned a practice known as “pension-spiking.” Given that a worker’s year of highest earnings was used to calculate pension payments, public employees were able to work overtime and cash in accumulated vacation and sick pay to increase their earnings for one year in order to enjoy more lucrative benefits during retirement.

The financial savings incurred by the law for the California Public Employees’ Retirement System (CalPERS) fall between $28 billion and $38 billion over the next 30 years. Although huge sums, the savings are relatively meager considering the overall $300 billion in the retirement system. The California State Teacher Retirement System fund would see similar savings: almost $23 billion for the $200 billion system. Despite the relatively modest savings, Governor Gavin Newsom called for the California Supreme Court to uphold the law.

The state’s lawyers argued that public employees should be prohibited from using payments other than their salaries for pension calculations. They asserted that pension-spiking was an unauthorized practice and the state carries a responsibility to eliminate loopholes which allow employees to unlawfully tamper with their benefits, especially when the alternative includes layoffs and furloughs. Although judges are not supposed to consider current events in their decision, the current economic context certainly plays an important role in the need to enact cost-saving measures.

The unions challenging the pension reform argued that the reform violates the “California Rule,” a 60-year old law which stipulates that public employees are entitled to the pension benefits they were promised at the beginning of their employment. According to them, upholding the law would set a precedent allowing “retroactive reductions in pensions already earned”. They also argued that “pension-spiking” has long been accepted as a legal practice and therefore, the new law unconstitutionally violates both the California Rule and an implied contract.

Given California’s prominence, other states will be attentively watching the outcome of the case, which tests the government’s ability to institute pension reform. The Court could choose to make a decision without addressing the California Rule by very specifically limiting “pension-spiking” without addressing the underlying, larger questions. This certainly impedes the government of California’s progress to balance their retirement system but lacks the long-term implications that would accompany a broader decision.

On one hand, striking down the California Rule would help California make headway towards a better-balanced budget. Allowing adjustments for pension budgets would relieve city managers of some pressure to enact budget cuts, furloughs, and layoffs. The decision opens the door to future pension reform, and the ability to legislate changes to the pensions of current public employees. Although this ability could certainly be manipulated, any reforms will undoubtedly be challenged in court.

Upholding the California Rule, on the other hand, would be a blow to retirement systems in desperate need of cuts, especially given the current economic context. CalPERS, the state’s largest pension system, only secured 70% of its funding before the pandemic delivered economic chaos. In order to offset the deficit caused by strict limits on pension cuts, furloughs and layoffs would be forthcoming. A future with the California Rule in-place would significantly impede the progress of pension reform.

California was already in billions of dollars of pension debt before the economic consequences of COVID-19 hit. Unfortunately, unions and state governments disagree on the methods to successfully balance the budget. Given that significant budget cuts loom in the state’s future, the court’s decision will play a role in whether retirement systems can be reduced and the extent to which state governments can do so.