Invasion of the Budget Snatchers: The Looming State Financial Crisis
Like the beginning of a horror movie, the end of a budget process is often bright with people smiling, shaking hands, and congratulating themselves on passing a balanced budget. But the dark secrets of financial obligations are the burial ground lurking under the surface. Underfunded pensions, other post-employment benefits, and bonded obligations are nightmares for many states. Arising from promises made long ago and sometimes forgotten, state financial obligations will make their way to the doors of state legislative chambers across the country and announce their presence with a Poe-like rap.
Following the Great Recession, many state pension funds are only realizing a fraction of their assumed returns on investment. Combined with unrealistic benefits, increasingly risky investments, and astronomical fund management fees, state contributions are insufficient to fully fund pension programs. The American Legislative Exchange Council’s (ALEC) annual report Unaccountable and Unaffordable 2017, estimates greater than $6 trillion in unfunded public pension liabilities.
Remarkably, state pension funding ratios decreased following fiscal year 2016, as states still did not make the proper contributions required to meet accrued liabilities in many cases. The 2018 economy is booming and state revenues are reaching new records. If states cannot find space in the budget to fully fund pensions in a strong economy, pension funding will be devastated in the event of another recession.
Unfunded other post-employment benefits (OPEB) are often ignored but are just as threatening to state budgets. OPEB includes benefits such as dental, life, health insurance, and Medicare supplemental programs. Unlike pensions, many OPEB plans are not pre-funded and are instead funded on an annual basis by the legislature. Even states that have put aside funds for OPEB liabilities tend to be neglectful in funding them. Using a risk-free rate of return, ALEC’s Other Post-Employment Benefit Liabilities report found that OPEB liabilities exceed $894 billion. Just five states (Hawaii, Alaska, New Jersey, Delaware, and Connecticut) account for half of total liabilities.
While pension and OPEB debt accrues, states purposefully issue debt for projects such as capital improvements, buildings, and transportation. ALEC’s State Bonded Obligations 2018 report found that states have issued more than $1.1 trillion in bonded debt.
The looming state financial crisis has a price tag of nearly $8 trillion. Some argue that states should raise taxes as a method of reducing these financial obligations, but the economic effects of taxing citizens to pay down such a massive liability would be disastrous for state economies. ALEC’s annual Rich States, Poor States report tracks the competitiveness of state tax policy. States with competitive tax rates tend to attract businesses and residents from states with burdensome tax codes. Raising taxes to pay down accrued liabilities becomes increasingly unworkable as the tax base shrinks from businesses and residents leaving for states with more responsible tax policy.
Fundamentally, the debt beast is a creature of state policy. Just like the townsfolk confronted Frankenstein’s monster, states must pass pension and OPEB reform to preserve retirement security for hard-working public employees. To get debt under control, bond issuance should be done with the greatest of care to ensure future generations aren’t paying down massive debt on projects they never benefited from. When legislators open the chamber door to the rap of the financial crisis, they should do so with careful reform and conscientious policy.