The Impact Of Growing Pension Obligations On States' Financial Health


Summary:

  • George Mason’s Mercatus Center recently released the latest update of their analysis of the financial health of all 50 US states. Their work is often reported in terms of a state’s relative rank within a 2015 context. However their most recent study also reveals how much the aggregate financial picture has deteriorated for most states since 2014.  

  • The largest changes since 2014 were driven by accounting changes that require states to bring their pension liabilities “on-balance sheet.” Even without accounting changes, however, state pension liabilities are growing faster than state personal income.

  • State’s medical obligations to their future retirees are not yet on many state balance sheets, but must be reported on-balance sheet within the next 2 years.

  • States could fund their negative net unrestricted asset positions either by increasing taxes and/or decreasing expenses. However some states with large negative net positions already have relatively high taxes and/or low expenses

2014 to 2015; Change In States’ Financial Health

In July, the Mercatus Center released their latest financial analysis of the 50 US states based on the latest state financial data from 2015. Much of the reporting focussed on which states had moved up or down in relative rank and which states were in the top and bottom 10 only within a 2015 context. However, the reported fiscal health of most states deteriorated from the prior Mercatus report based on 2014 data.


Thirty seven states increased taxes as a percentage of total personal income. On the expense side, 26 states decreased expenses as a percentage of total personal income. While increased revenues and decreased expenses (for some states) should have improved net asset positions, only 4 states saw an improvement in their net asset position relative to personal income!


Table 1 summarizes dynamics for the 10 states with the greatest deterioration in their ratios of unrestricted net assets to personal income. States like Kentucky and Connecticut attempted to raise revenues and decrease expenses, however these changes were dwarfed by the massive increase in their recognition of unfunded pension obligations.


While the majority of the increase was due to implementation of new accounting standards, organic growth in states’ pension obligations (independent of the assumed pension discount rate) were also quite high as shown in the right hand column of Table 1. On a population weighted basis the organic growth in pension obligations was 23% (compared to 3.7% growth in state revenues).

Table 1: 2014 to 2015 - 10 States With Greatest Deterioration In Unrestricted Net Assets/Personal Income



State
Tax/Personal Income Change
Expense/Personal Income Change
Unrestricted Net Assets/Income Change
Non Current Liabilities Growth
"Treas. Rate" Pension Liability Growth
Alaska
-83.4%
11.5%
-30.1%
217.1%
7.3%
Kentucky
0.4%
-4.8%
-13.8%
135.8%
16.8%
New Jersey
2.6%
5.0%
-11.8%
81.6%
18.9%
Illinois
-4.7%
-0.3%
-11.5%
99.5%
15.7%
Connecticut
0.3%
-14.2%
-9.0%
75.3%
13.7%
West Virginia
0.4%
-2.0%
-6.7%
79.3%
14.9%
Hawaii
2.9%
-2.0%
-6.2%
45.2%
16.2%
Massachusetts
3.3%
-1.0%
-6.0%
60.2%
22.5%
Rhode Island
3.8%
0.1%
-5.4%
102.4%
18.0%
Vermont
2.4%
1.7%
-3.9%
83.3%
81.6%


This “reported” deterioration is a foretaste of further deterioration that will become apparent when states are required to report their retiree medical obligations in two years. For example, Connecticut had a $46.8 Billion negative unrestricted net asset position in 2015, but that excluded approximately $11.9 Billion of unrecorded retiree medical obligations.

Solving Negative Net Asset Positions

One way to think about states with negative net asset positions (38 states in 2015) is to ask how they might solve their deficit. As shown in Figure 1, some analysts convert negative net asset positions into a “deficit per taxpayer” amount that the taxpayer is theoretically burdened with (unless they move out of state!).

Figure 1: Illinois “Taxpayer Burden” = Negative Net Asset Position/Number of Taxpayers



Table 2 looks at two alternative ways of examining negative net asset positions. The first set of columns looks at the percentage increase in the tax burden as a percent of personal income that would be required if a state chose to “pay off” its current asset deficit via higher taxes over 30 years at a 4% interest rate. This is equivalent to thinking of the current “Taxpayer Burden” as a debt like mortgage debt that can be amortized over an extended period of time. So Illinois, for example, could immediately do a one time increase of 23.8% of their tax/personal income ration (taking it from 6% to 7.5%) and maintain that new level for 30 years to fund its asset deficit. The “rank” columns show how a state’s tax burden relative percentile rank would change if every state chose to do this compared to the state's current tax/income rank.


Alternatively, the second set of columns looks at how much states would have to reduce expenses/personal income to solve their 2015 negative net unrestricted asset position over 30 years. Again the state’s expense/personal income rank is shown with this change relative to the its current expense/income percentile rank.

Table 2: Top 10 States By Required Increase Of Tax/Personal Income Ratio To Fund 2015 Negative Unrestricted Asset Position Over 30 Years At 4%



State
Required % Increase Tax/Personal Income
Adjusted Tax/Income Percentile Rank
Current Tax/Income Percentile Rank
Required % Reduction In Expense/Income
Adjusted Expense/Income Percentile Rank
Current Expense/Income Percentile Rank
New Jersey
23.8%
76%
50%
-11.0%
40%
50%
Illinois
21.6%
84%
64%
-11.1%
28%
42%
Kentucky
18.5%
88%
80%
-8.3%
72%
82%
Connecticut
18.1%
80%
70%
-10.1%
18%
32%
Massachusetts
12.5%
70%
68%
-5.5%
64%
70%
Louisiana
8.1%
16%
16%
-2.6%
56%
64%
Rhode Island
7.9%
62%
66%
-3.4%
74%
78%
California
7.2%
78%
82%
-3.9%
50%
52%
Maryland
7.1%
54%
44%
-3.6%
34%
34%
Hawaii
6.0%
94%
94%
-3.5%
82%
84%


Illinois, for example, could fund their negative net asset position over 30 years by their tax rate 21.6% (causing them to go from 64th percent highest tax burden to 84th percentile, assuming all states followed suit). Alternatively they could decrease expenses as a percentage of personal income by 11% (causing them to fall from 42nd percentile to 28th percentile lowest amount of expenses relative to personal income).


These figures illustrate the very difficult set of policy choices some states face. Higher taxes can cause businesses and residents to flee the state, but reduced expenses deprive residents of services they have become accustomed to.They also show how pension obligations can squeeze out everything else in a state's’ operating budget. Of course some states are in better financial health and face much easier futures.


This analysis is also static and does not consider the continued growth in retiree obligations and/or the negative feedback consequences of higher taxes or lower services on future state revenues. Finally, this analysis is only at the state level. Many municipalities also have unfunded pension obligations financed via property taxes. Those local taxes add to the overall tax burden faced by state residents.





Transparent and reproducible: The R code used to produce all tables is available in “PensionState.r" on github.

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