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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 DEFENSE OF RETROACTIVE TAXATION ................................... 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.
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560 IOWA LAW REVIEW [Vol. 102:559
iii. “Overpaid Bondholders” .......................................... 578
B. BEYOND DEFENSIBILITY: WOULD RETROACTIVE TAXATION BE
SENSIBLE? ............................................................................... 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. HOW RETROACTIVE? ............................................................... 586
B. THREE-TO-FIVE YEARS FROM WHEN? ........................................ 588
C. HOW MUCH REVENUE?............................................................ 589
D. ALLOCATING TAX LIABILITIES ................................................. 590
IV. THE LEGALITY (OR NOT) OF RETROACTIVE TAXATION ................ 593
A. DUE PROCESS CONCERNS ......................................................... 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. STATE TAX AND EXPENDITURE LIMITATIONS ............................ 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 . . . .”).
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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 sleights-
of-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), ht tp:/ /ww w.na sra .org /Fi les/ Sta te-S pec ific /Il lino is/ IL%2 0
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