* The usual bluster from a Wall Street Journal editorial earlier this month entitled “Illinois Pension Suicide Pact”..

The Constitution isn’t a suicide pact, but the same can’t be said for the way government unions run Illinois. Behold the new union strategy to kill the state’s pension reforms using Social Security as the political cudgel.

Following state credit downgrades, Illinois Democrats in 2010 reduced pension benefits for new state and local government workers. Current workers weren’t affected. The modest reforms raised the retirement age to 67 from 60, capped the final earnings that are used to calculate annual pension benefits, and reduced retiree annual cost-of-living adjustments.

These so-called Tier 2 modifications are saving the state and its localities billions of dollars a year. Yet unions now claim they violate a 1990 federal law that requires government worker pensions to be at least as generous as Social Security benefits. Otherwise, public employers and employees must pay the 12.4% Social Security payroll tax.

* Fitch Ratings has a new report out entitled “Illinois Tier 2 Pension Basic Policy Option Likely Neutral for State Credit”…

For many public sector employees in Illinois, their pension serves as a Social Security replacement, meaning they (and their employers) do not pay Social Security taxes (Federal Insurance Contributions Act, FICA, taxes). The IRS establishes a minimum standard of benefits replacement that plans must provide to maintain this FICA exemption. Analysis by CGFA and other organizations suggest Tier 2 is unlikely to meet the safe harbor requirements, primarily because the pensionable earnings cap is lower than the Social Security wage base (SSWB).

If Tier 2 does not meet safe harbor requirements, the state risks paying (and requiring employees to pay) FICA taxes, likely at significant expense. Proposals that simply raise the pensionable earnings cap will likely result in modest increases in the pension liability and budgetary demands .

The governor’s proposed budget for fiscal 2025 suggests that Illinois’ pension boards and the legislature consider raising the Tier 2 pensionable earnings cap to match the SSWB. A CGFA-commissioned actuarial analysis from June 2023 estimated this would slightly increase the state’s unfunded pension liability by $285 million (less than 1%) and raise the 2045 annual contribution by $625 million, roughly 3% higher than under current law. Total cumulative annual contributions from 2023 to 2045 would rise $5.6 billion, or 1.7%, if the state raised the Tier 2 earnings cap to the SSWB. This level of changes would not shift Fitch’s perspective on the credit implications of the state’s long-term liability burden or high carrying costs.

* More from the Bond Buyer…

“Being in violation of IRS rules is generally never a good place to be, so addressing this potential safe harbor [issue] is something that the state recognizes [it needs to do] — the governor has put a proposal in his legislative budget; the legislature has been talking about this,” Eric Kim, head of U.S. state ratings at Fitch, told The Bond Buyer. “The state and the local governments do need to address the Tier 2 issue. It’s just a question of how they do that.”

Kim noted that Cook County confronted the issue last year with House Bill 2352, which brought the county into alignment with IRS safe harbor provisions.

For the state, “there are a number of different options,” Kim said. “Our view is that the most basic option, simply raising the pensionable earnings cap to match the Social Security wage base, seems like it would be the most credit-neutral. Getting rid of Tier 2 entirely does pose some risks from a credit perspective.” […]

Fitch’s Kim had some laudatory words for one of the governor’s other policy proposals regarding pensions: a plan to add three years to the amortization cycle and target 100% funding of the pension liability.

“We think [that] would be potentially a significantly positive move,” he said. “We’re waiting to evaluate and see, one, is the legislature open to that … and what does an actuarial analysis look like? But we have consistently said that one of the challenges for Illinois is its significantly large long-term liability burden.”