Overprotecting Public Employee Pensions: The Contract Clause and the California Rule

The Contract Clause, which prohibits states from making laws impairing the obligation of contracts, is commonly used to challenge state and local public pension reform efforts. Courts in California, and in other states following California’s example, follow a particularly strict rule: they hold not only that public employees are entitled to the pension they’ve accrued by their work so far, but also that they’re entitled to keep earning a pension (as long they continue in their job) according to rules that are at least as generous. Thus, in states where the California rule applies, one can’t constitutionally increase employee contribution rates or reduce cost-of-living allowances. This rule is properly viewed either as an application of the federal Contract Clause, which usually defers to state law on the threshold question of whether there’s a contract and what it covers, or as an application of a more generous state Contract Clause. Thus, there’s nothing legally invalid about the California rule. But the rule is unsound as a policy matter, insofar as it locks governments and public employees into compensation structures different than what they would otherwise negotiate, and makes it harder for states to reform their pension systems.