Coming to a state near you

Wall Street Journal, 8/4/12.

The slow-motion collapse of the government status quo across the Western world is obvious, but the reality is the opposite of what Twain said about Wagner’s music—it’s worse than it sounds. That’s the message of a recent report from Richard Ravitch and Paul Volcker that deserves far more attention than it has received.

Since 2010 the former New York Lieutenant Governor and Federal Reserve Chairman have been scrutinizing the balance sheets of six of the largest states—California, Illinois, New Jersey, New York, Texas and Virginia. Their conclusions make clear that Washington is not the only part of the government headed for the fiscal cliff.

Some of the problems the State Budget Crisis Task Force identifies are familiar: growing health-care spending and unfunded pension liabilities, for example. Others are not. Taking in “the totality of the problems,” Messrs. Ravitch and Volcker write, “the storm warnings are very serious” and the “existing trajectory of state spending, taxation and administrative practices cannot be sustained.”

• Medicaid. This state-federal program that increasingly pays for middle-class health care is the major albatross. Spending has grown faster than the economy every year since the 1960s, 7.2% annually over the last decade. It is now the largest part of state budgets—24% on average—and “the imbalance (or structural budget gap) can no longer be absorbed without significant cuts to other essential state programs like education or unpopular tax increases or both.”

The panel also found that these costs are driven by states choosing to increase enrollment and create new benefits, rather than by rising underlying medical costs. One of four New Yorkers is on Medicaid, and 70% of the coverage is not required by federal law.

Some 29% of California’s population is in Medicaid, though it only accounts for 11.8% of the Golden State budget, well below the national average of 15.8%. But that share is so low only because California spends so much on other things too. New York spends more on Medicaid than Florida, Texas and Pennsylvania—combined.

Medicaid costs over the decade are due to jump 8.1% annually, as required by the Affordable Care Act’s expansion. Without ObamaCare, the yearly rise would still be 6.6%.

• Pensions. The burgeoning retirement benefits that states owe their public employees are well-known. But the Ravitch-Volcker task force emphasizes that, unlike federal entitlements, state pension obligations are almost always constitutionally protected. In other words, they are non-modifiable contracts, not merely political promises.

California has 62 state and local pension systems, Texas 75, Illinois 457. The 1990s and 2000s saw a reckless benefit build-out—California even increased pensions for people who had already retired. The states are supposed to prefund these liabilities so they are able to pay out once vested, but by and large they don’t. States then assume an 8% return on their investments, which means they can stint on their taxpayer contributions and make their pensions look healthier than they really are.

The bad news is that today they already look like they belong on a gurney at Antietam, despite such gaming. Using more conservative assumptions, the task force calculates that the unfunded liabilities in the six states comes to $386.2 billion, or about a quarter of every dollar they will eventually be required to spend.

The task force also does the service of noticing retiree health insurance benefits, which states (unlike corporations) are not required to disclose. At a minimum, the panel figures the six states owe $539 billion, with no plan to defuse this time bomb.

Combining pensions and other special public employee privileges, Illinois’s totalunfunded liability works out to $15,800 per citizen—the only all-in data the task force could acquire. The true number may be far higher in the other five states.

• Budget gimmicks. The other novel Ravitch-Volcker observation is that no one knows for sure how deep these problems run, because the states are running bookkeeping cons that disguise the fiscal realities. The task force uncovered “chronic dependence” on gambits like assets sales, “temporary” raids on rainy-day funds, and shifting current spending to future years “as an ongoing budget strategy.”

New York created an Albany-guaranteed “local government assistance corporation” to hide spending that would have run through the general fund. Illinois is borrowing short term for cash flow to make unpaid bills.

California, Illinois, New Jersey and New York are even securitizing their future tax revenue—that is, not merely borrowing with bonds that must be serviced but selling their projected tax collections to investors. So to “balance” their budgets today, they’re making it far harder to correct them in the future and locking in higher tax rates. Even Greece doesn’t do that.

The message of the Ravitch-Volcker report is that some large portion of the states are replicating the dysfunctions of Washington—adding to entitlements that crowd out priorities like schools and bridges, and then concealing the real danger when they’re not ignoring it. State and local governments now spend $2.5 trillion, and rising. Without 49 more Scott Walkers, the fiscal mayhem has only begun.

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