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Supreme Court Ruling on Pensions May Cost States Billions of Dollars

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Washington--A recent U.S. Supreme Court decision requiring states to tax federal and state retirees' pensions equally could potentially drain billions of dollars from the treasuries of 23 states.

Officials in the affected states said the ruling's implications for education are enormous, threatening not only state budgets for public schools but also the benefits of retired teachers and school employees.

"This is one of the most significant rulings by the Supreme Court affecting state finances in recent years," said Gerald H. Miller, executive director of the National Association of State Budget Officers. "It's going to be a difficult issue for a number of states."

In a decision that caught many state officials off guard, the Court on March 28 struck down a Michigan law that exempted state and local employees from paying state income tax on their retirement benefits, while requiring federal workers to pay the tax.

The Court's 8-to-1 decision in Davis v. Michigan Department of Treasury (Case No. 87-1020), however, left it up to the states with similar laws to decide whether to apply the tax to all state and federal retirees or to exempt all of them from it.

According to a survey by the Federation of Tax Administrators, 19 states--Alabama, Arizona, Georgia, Iowa, Kentucky, Louisiana, Michigan, Mississippi, Missouri, Montana, New Mexico, New York, North Carolina, Oklahoma, Oregon, South Carolina, Utah, Virginia, and West Virginia--currently exempt retired state employees, but not federal retirees, from paying income taxes on their pensions.

Four other states--Arkansas, Colorado, Kansas, and Wisconsin--exempt some, but not all, federal pensioners from paying the tax. It is unclear whether the ruling will affect these states, the study said.

According to the survey, the states would lose revenues totaling from $463 million to $505 million annually if they decided to provide the tax exemption to all employees.

In addition, the states could face an extra one-time loss of up to $2.5 billion if they are required by courts to provide retroactive tax refunds to federal retirees. State officials said two other cases pending before the Supreme Court could clarify that issue.

State officials also say the fiscal ramifications of the Davis ruling could be even wider if private-sector pensioners successfully convince legislatures to extend tax exemptions to them as well.

The Supreme Court "begged the issue of the private sector," said state Senator Hunter B. Andrews of Virginia. He said he believes the Court's decision applies to all retirees.

Attorney General Michael J.8Bowers of Georgia, however, said he disagreed with that assessment. "The Court did not decide this as an equal-protection case," he said.

Mr. Miller that although the private sector may not be affected legally, "it clearly is a political issue."

Ron Snell, senior program director for fiscal affairs for the National Conference of State Legislatures, agreed, noting that several newspapers in the Denver area, where the ncsl is based, already have called for private-sector pensioners to be treated on an equal basis with government retirees.

"This case is turning the spotlight on the whole area, so people not receiving tax breaks equal to public retirees will be demanding the same exemptions," said Mr. Snell.

The impact of the Court's ruling is already being felt in Virginia, which ranks first nationally in the amount of revenue received from taxes on federal retirees' pensions.

The state, home to several military bases and adjacent to the nation's capital, has nearly 200,000 retired federal workers who pay $150 million a year in state income taxes.

Gov. Gerald L. Baliles has called lawmakers into special session this week to decide whether to extend the income-tax exemption to federal workers or to tax the benefits of state and local retirees.

"The issue is not that complicated. You either tax them all or exempt them all," said Mr. Andrews, who, as chairman of the Senate finance committee, recently held hearings on the topic.

Mr. Andrews said lawmakers would consider a number of options and were also awaiting recommendations from the governor.

Meanwhile, powerful lobbying groups on both sides of the issue are gathering their forces for what promises to be an all-out battle.

Madeline Wade, president of the Virginia Education Association, said the teachers' union would urge the legislature to tax retired teachers' and state employees' income, but also to increase their benefits by a corresponding amount to offset the tax.

Ms. Wade said the union wants to avoid any reductions in revenue that would result from extending tax exemptions to federal retirees. Such exemptions, she said, would cut $300 million from the state's biennial budget and would mean that "education would lose money."

Educators also fear, according to Ms. Wade, that if legislators extended the tax exemption to retired federal workers, they would be opening the state up to demands for refunds for the past three to five years.

She said the issue was already affecting next fall's elections for governor and the legislature. A few candidates for governor, she said, have recommended extending the tax exemption to retirees from the private sector.

"It really is going to be a political football, which I think is ridiculous," said Ms. Wade.

Retired federal civil-service and military workers, meanwhile, are pressing their demands for tax exemptions and refunds.

Busloads of federal pensioners traveled to Richmond to testify before Senator Andrews's committee, and groups representing them have promised to make a show of force when the legislature convenes.

Judy Park, legislative director of the National Association of Retired Federal Employees, noted that in most states, retired public employees, including teachers, wield tremendous influence over legislators.

"It's simply going to be a matter of complying with the decision without pitting" state and federal retirees against one another, Ms. Park said.

But, she added, "it's not going to be easy."

Mr. Miller predicted that otherel10lstates will closely watch how Virginia handles the situation before embarking on their own plans to comply with the Court's ruling.

They also will be watching Missouri, which may become the first state that is forced to give retroactive tax refunds, a situation that educators said would wipe out hopes for a $50-million increase in school aid in the new fiscal year.

Last week, Attorney General William L. Webster issued an advisory opinion indicating that Missouri would have to provide retroactive refunds dating back to 1985 to its 70,000 federal pensioners.

Federal retirees in Oklahoma and Georgia, meanwhile, have filed class actions in their states' courts seeking retroactive refunds.

In Georgia, a state appeals court has ordered the state to set aside funds in an escrow account. Attorney General Bowers said his office has appealed that ruling to the state supreme court.

If Mr. Webster's opinion in Missouri stands, the state may have to give back at least $179 million and possibly more to federal retirees, said Duane Benton, the director of revenue. The state currently receives more than $45 million annually by taxing federal pensioners' benefits.

Mr. Webster's opinion has prompted legislators to consider increasing taxes on corporations and cigarettes in order to offset the effects of the retroactive tax refunds.

Gov. John Ashcroft said last week that "extensive budget cuts are going to have to be made unless the General Assembly takes action to resolve this problem," according to Yolanda Murphy, a spokesman for the Governor.

Unlike their counterparts in Virginia, leaders of Missouri's largest teachers' union say they will oppose efforts to remove their retired members' tax exemptions.

"We are willing to support whatever plan is presented to help recover this money as long as it does not involve taxing retired teachers," said Ronald A. Crain, associate executive secretary of the Missouri State Teachers Association.

Mr. Crain said the Supreme Court's ruling and Mr. Webster's opinion have caused a great deal of confusion in the legislature.

"We're not certain what's going to happen right now," he said.

In Michigan, officials say they are awaiting a decision from the state appellate courts that will indicate how they should comply with the High Court's ruling, said Robert Kolt, a spokesman for the state treasurer.

In Arizona, another state with large numbers of retired federal workers, the governor has recommended that the legislature exempt the first $2,500 of income for all retired government workers from taxation, and then increase benefits for state and education retirees to offset the tax increase.

According to the report by the Federation of Tax Administrators, only West Virginia's legislature has dealt with the issue. Before adjourning this month, lawmakers adopted a measure that exempted from taxation a portion of the income received by retired federal civil-service workers. Such an exemption had already existed for state pensioners and retired military employees.

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