In this piece, we provide a "101" on the types of municipal bonds and give a credit perspective on the various parts of the market.
The decision is a credit positive, but its effects may not be felt immediately.
On Thursday, the Supreme Court effectively established a national right-to-work law for state and local government employees in Janus v. AFSCME; in right-to-work states,1 public sector workers represented by a union are not legally required to contribute a share of fees for the bargaining done by the union on their behalf. The ruling is meaningful for municipal credit insofar as it may weaken the bargaining power of public unions. It likely increases issuers’ fiscal flexibility, especially during times of distress. However, it is not a panacea for every issuer’s credit ills, and investors should keep the decision in proper perspective.
Janus addressed whether the state of Illinois could require public employees to pay union “agency fees” even if they are not union members. Agency fees support costs associated with collective bargaining, such as hiring attorneys or accountants, soliciting union members’ input, or other costs. In right-to-work states, these fees are voluntary for non-union members; in all other states, they are owed by any employee covered under a collective bargaining agreement—whether that employee is a union member or not. The court concluded that free speech rights are overly impinged when a state requires non-members of a public union to pay agency fees. The court rationalized that in the public sector context, agency fees amount to “forced subsidies” of union policy preferences such as overtime rules, healthcare benefits or other union leanings.
The Janus ruling will likely make it easier for issuers to win concessions from employees, especially when a state or local issuer is under fiscal stress. Agency fees can be costly for public workers, and if the choice is between accepting reduced take-home pay or cutting back on agency fees, many employees will choose the latter. Over time, a feedback loop may develop: the employees shortchange the union of agency fees, and then the union is less able to advocate for their interests. As a result, the terms of labor contracts weaken, and more employees drop their membership because they find less value in the union.
The data broadly support the conclusion that union membership, and clout, will decline. Consider Illinois. There, the average union member paid $663 in annual agency fees in 2014, or about 1 percent of average state-local employee pay.2 That is not an insubstantial sum. Figure 1 illustrates that the percentage of state and local workers who are union members tends to decline with growth in the number of right-to-work states.
In the municipal market, the immediate beneficiaries of Janus are likely issuers in the several states with credit challenges and high unionization rates. This includes issuers in Illinois, New Jersey and Connecticut. Issuers in California, Rhode Island, New York and Massachusetts also stand to benefit, although these states are in better fiscal health than those mentioned immediately above.
Janus Does Not Eliminate All State Labor Issues
Despite the benefits the ruling provides for state and local government, investors should not necessarily think of Janus as a permanent turning point for municipal credit. This is true for several reasons.
- First, right-to-work states are not free from labor strife or credit stress, even though unions are potentially at a disadvantage in those states. Notably, the four states that experienced teacher strikes in 2Q18 (Arizona, Kentucky, Oklahoma and West Virginia) are right-to-work states. These states and others are presently challenged to staff schools and other essential service jobs precisely because they are failing to offer competitive pay. At some basic level, below-market pay underscores an unwillingness to finance essential public needs at the expense of debt service and other priorities. This is a pattern that, in the end, could prove unsustainable.
It’s also true that there is a limited relationship between large unfunded pension debts and public sector unionization rates. Large pension plans in Kentucky, Mississippi and South Carolina face substantial funding shortfalls. All three states are right-to-work (Figure 2). By contrast, plans in New York, Washington and Washington, D.C. are well funded despite having relatively strong unions.
- Second, there is limited history, if any, to judge whether a federally mandated right-to-work rubric will prove as effective in denuding union power as state right-to-work laws. The Supreme Court has essentially upended the labor-management relationship overnight, without voter input or public debate. It is unclear how jurisdictions with strong union support will react.
So Janus’ effect may differ from the labor regulations put in place in Wisconsin in 2011,3 or in Missouri in 2017. In those situations, elected representatives changed labor laws with voter consent, and they were accountable to voters for their decisions. One wonders how members of the New York Metropolitan Transit Authority or Chicago Public Schools’ unions will respond to the Janus decision in the absence of voter support for a public sector right-to-work law. The pressure on union members to continue paying dues will likely be strong, and many members will likely still want to pay them.
- Third, it is important to distinguish the establishment of a right-to-work approach from the full elimination of collective bargaining rights. Some observers note that Wisconsin witnessed a dramatic reduction in public union membership after enacting public sector labor reforms in 2011.4 However, in Wisconsin, lawmakers ended collective bargaining for most public workers (Figure 3). This is materially worse for unions than merely being forced to give up mandated agency fees. As one commentator notes, “Collective bargaining laws are the single most important factor in determining the tone and character of public employer-employee relationships in state and local government.”5
- Fourth, states that prefer a stronger union presence can frustrate the intent of Janus. For example, states can enact laws that require employees to agree to paying union dues only during a short window of time. Sometimes, these are as short as a couple of weeks. Provisions like these benefit from inertia. Many employees may work for years before they timely notify their union they wish to stop paying agency fees.
- Fifth, a future U.S. Congress could alter the landscape for public employment. During the 1970s, Congress considered federal legislation to impose a uniform collective bargaining process on states and local governments.6 Despite the Janus decision, federal lawmakers retain the power to enact a similar bill today. This risk is presently remote, but one day after the Janus decision several members of Congress announced the Public Service Freedom to Negotiate Act, which would essentially require states to allow public sector collective bargaining.7
For now, the Janus outcome is a win for state and local credit. Breckinridge will be monitoring how the Janus decision impacts state and local budgeting, especially for the most distressed issuers.
 There are currently 28 right-to-work states.
 Frank Manzo and Robert Bruno, “The Application and Impact of Labor Union Dues in Illinois,” April 13, 2016.
 2011 Wisconsin Act 10 was enacted March 11, 2011. It curbed the power of public-employee unions to bargain collectively. Bill located at https://docs.legis.wisconsin.gov/2011/related/acts/10.pdf.
 The law exempted most public safety workers.
 Kearney, Richard. Labor Relations in the Public Sector, 3rd Edition, p. 62, (2001).
 At least one proposal, known as the National Public Employment Relations Act or the Clay-Perkins Bill, received strong union support.
 Douglas-Gabriel, Danielle. “After Supreme Court ruling, congressional Democrats mobilize to fight for unions.” The Washington Post. June 28, 2018.
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