Retroactive Taxation, Unfunded Pensions, and Shadow Bankruptcies

• Author: Julie A. Roin
• Position: Seymour Logan Professor of Law, University of Chicago Law School
• Pages: 559-604

Retroactive Taxation, Unfunded Pensions, and Shadow Bankruptcies Julie A. Roin * ABSTRACT: Academics and journalists criticize politicians for the dismal financial situations of many state and local jurisdictions. And certainly, politicians routinely make inaccurate fiscal claims. However, the voting public bears some of the blame for continuing to vote for politicians peddling what amounts to fiscal “magic.” This Article suggests a mechanism for holding them at least partially accountable for their carelessness: retroactive taxation triggered by objective measures of fiscal distress. Retroactive taxes would provide jurisdictions with a mechanism for recouping some of the differential between the cost of services provided to past residents and the taxes they paid in earlier years. Although such retroactive taxation is incapable of providing a complete solution to the financial troubles of states or localities, it could help by reducing the incentive residents have to flee as such distress becomes evident. Further, the prospect of being subjected to such taxation might encourage more voters to vote for politicians willing to confront unpleasant fiscal choices early on, making later distress less likely, or less severe. I. INTRODUCTION ............................................................................. 560 II. THE JUSTIFICATION FOR RETROACTIVE TAXATION OF FORMER RESIDENTS OF DISTRESSED JURISDICTIONS ................................... 564 A. A D EFENSE OF R ETROACTIVE T AXATION ................................... 565 1. The Analogy Between Retroactive Taxation and Debt Financing .............................................................. 565 2. The Analogy Between Retroactive Taxation and Claw Backs in Bankruptcy ............................................. 571 3. The Analogy to Balanced Budget Requirements ........ 573 4. Potential Claw Back Defenses ....................................... 574 i. “Paying Backward” ................................................... 574 ii. “Overpaid Employees” ................................................ 575 * Seymour Logan Professor of Law, University of Chicago Law School. I am indebted to Saul Levmore, Douglas Baird, and participants in the University of Chicago Law School’s Works in Progress workshop for their comments on earlier drafts. Mistakes remain my own. 560 IOWA LAW REVIEW [Vol. 102:559 iii. “Overpaid Bondholders” .......................................... 578 B. B EYOND D EFENSIBILITY : W OULD R ETROACTIVE T AXATION B E S ENSIBLE ? ............................................................................... 580 1. Who Benefits? ................................................................ 580 2. Who Pays? ...................................................................... 582 3. Nonrevenue Effects on Shifting Tax Liabilities .......... 583 III. WHAT RETROACTIVE TAXATION WOULD LOOK LIKE ................... 585 A. H OW R ETROACTIVE ? ............................................................... 586 B. T HREE - TO -F IVE Y EARS FROM W HEN ? ........................................ 588 C. H OW M UCH R EVENUE ? ............................................................ 589 D. A LLOCATING T AX L IABILITIES ................................................. 590 IV. THE LEGALITY (OR NOT) OF RETROACTIVE TAXATION ................ 593 A. D UE P ROCESS C ONCERNS ......................................................... 593 1. Due Process Concerns Outside the Transitional Period ............................................................................. 593 2. Due Process Concerns Within the Transitional Period ............................................................................. 594 3. The Extension of Retroactive Taxation to Nonresidents and Former Residents ........................... 598 B. S TATE T AX AND E XPENDITURE L IMITATIONS ............................ 600 1. Expenditure Limitations ............................................... 600 2. Revenue Limitations, Including Tax Caps .................. 602 V. CONCLUSION ................................................................................ 603 I. INTRODUCTION Academics and journalists have been quick to criticize politicians for the dismal financial situations of many state and local jurisdictions. In addition to the usual allegations of mismanagement (“fraud, waste, and abuse”), 1 critics have pointed out the perverse incentives created by the electoral process: politicians can further their own careers by hiding the costs of popular governmental programs and ballooning public debt from constituents, while leaving the eventual fiscal collapses to be dealt with by their successors in 1. See Richard F. Dye, Balancing Illinois’ Budget Will Be Painful, Guaranteed , ST. J.-REG. (Mar. 25, 2014, 1:07 AM), http://www.sj-r.com/article/20140325/opinion/140329814 (“[O]fficeholders and candidates argu[e] that cutting ‘waste, fraud and mismanagement’ in state programs will solve our budget woes.”); Michael Tanner, Math vs. Myth , NAT’L REV. (Oct. 19, 2011, 4:00 AM), www.national review.com/article/280504/math-vs-myth-michael-tanner (“We can balance the [federal] budget by cutting ‘fraud, waste, and abuse.’ This [idea] is the Republican flip side of the Democrats’ reliance on higher taxes . . . .”). 2017] RETROACTIVE TAXATION 561 office. 2 I am among those people who have advocated accounting and institutional correctives to make governmental fiscal situations more transparent and, therefore, less amenable to such schemes. 3 Yet it would be wrong to let the voting public entirely off the hook. Even when the precise amount of governmental revenue shortfalls have been hidden, reasonable voters in most of today’s currently distressed jurisdictions knew or should have known that it had been years since governmental revenues matched governmental expenditures. 4 Newspapers, news programs, and magazines— not to mention candidates for public office—detailed the financial sleightsof-hand politicians employed to “balance the budget” or generate operating funds to avoid running into the “third rail” of American politics—raising taxes. 5 Time and again though, voters chose (and continue to choose) candidates who promise to provide public services without raising the taxes necessary to fund them. 6 Although it is tempting to ascribe such misbehavior 2. See Clayton P. Gillette, Fiscal Home Rule , 86 DENV. U. L. REV. 1241, 1259 (2009) (“Debt can be a dangerous tool in the hands of local officials who have incentives to spend money in the short term, especially money that has to be repaid only when they have left office.”); Maria O’Brien Hylton, Combating Moral Hazard: The Case for Rationalizing Public Employee Benefits , 45 IND. L. REV. 413, 415 (2012) (“[T]he core moral hazard problem . . . [is] the apparently irresistible tendency of state legislators and executive branch officials to spend taxpayer dollars to enhance benefits and decrease contributions during flush economic times in exchange for voter support at the polls.”); David A. Skeel Jr., States of Bankruptcy , 79 U. CHI. L. REV. 677, 688 (2012) (“[P]oliticians have strong incentives to spend in the present and push their repayment to the future.”); Matt Bai, State of Distress , N.Y. TIMES MAG. (Oct. 20, 2009), http://www.nytimes.com/2009/10/25/magazine/25corzine-t.html (“[New Jersey’s governors] find themselves retreating to a kind of fiscal Honalee, a make-believe world in which the state can magically raise less revenue and spend ever more of it.”). 3. See Julie A. Roin, Privatization and the Sale of Tax Revenues , 95 MINN. L. REV. 1965, 2029–31 (2011) (advocating for rules aimed at increasing the transparency of privatization transactions). 4. For example, Illinois’ fiscal woes can be traced to the 1990s, if not before. See STATE BUDGET CRISIS TASK FORCE, ILLINOIS REPORT 16 (2012), https://macfound.org/media/files/2012_Illinois_ Report.pdf (“[T]he origins of the structural gap between spending growth and sustainable revenues can be traced to the 1990s.”); Eric M. Madiar, Illinois Public Pension Reform: What’s Past is Prologue , 31 ILL. PUB. EMP. REL. REP. 3–8 (2014), http://www.nasra.org/Files/State-Specific/Illinois/IL%20 pension%20history.pdf (tracing the “chronic underfunding” of Illinois state and municipal pension-plan funding from 1917 to the present). 5. See, e.g. , Skeel, supra note 2, at 679 & n.8 (“Projecting a $25 billion deficit last year, California Governor Arnold Schwarzenegger proposed to sell the San Francisco Civic Center and other state properties to raise funds. . . . Governor Jerry Brown later canceled the sales.”); see also Hal Dardick & Bill Ruthhart, Mayor’s Record on Debt Mixed , CHI. TRIB. (Sept. 6, 2015), www.pressreader.com/ usa/chicago-tribune/20150906/283283161450400 (describing the “scoop-and-toss,” long-term borrowing for short-term expenses and other ploys used by Chicago mayors to delay property-tax increases); Cezary Podkul & Allan Sloan, Behind Christie’s Budget Claims, a More Controversial Legacy , WASH. POST (Apr. 17, 2015, 4:05 PM), https://www.washingtonpost.com/politics/behind-christies-budget-claims-a-more-controversial-legacy/2015/04/17/7f8fb066-dece-11e4-a1b8-2ed88bc190d2 _story.html (“[Governor Christie] has resorted to many of the financial maneuvers used by some of his predecessors: reducing state payments to pension plans, shifting money out of trust funds dedicated for specific purposes and borrowing to patch chronic budget gaps.”); Elizabeth Lesly Stevens, State Poised to Sell Trophy Buildings to Unidentified Investors , N.Y. TIMES (Dec. 25, 2010), http://www.nytimes. com/2010/12/26/us/26bcbuildings.html. 6. For example, Illinois voters recently elected Bruce Rauner as governor, who supported 562 IOWA LAW REVIEW [Vol. 102:559 to ignorance or a lack of financial sophistication, it bears noting that politicians are not the only participants with perverse short-term incentives. It is...