The Oldest State

Gone are the comforts of an era when an ever-expanding economy coupled with growing populations could pay the future freight.
May 2005
John E. Petersen
By John E. Petersen  |  Columnist
John E. Petersen was GOVERNING's Public Finance columnist. He was a Professor of Public Policy and Finance at the George Mason School of Public Policy.

The headline is a tease. I am not referring to Virginia (the first colony) or Delaware (first to ratify the Constitution) but to West Virginia, which is the oldest state in terms of the average age of its population. This bucolic home of rugged mountains and great sports teams is also where the nation's demographic future is on view: There are only two workers for every retiree, and health care and retirement costs are the biggest items in the state budget.

So, let's take a look and see if there fiscal lessons to be learned by us young-uns from the older Mountaineers.

Economically, things are pretty favorable for West Virginia right now. Buoyed by high energy prices, coal production has taken off and so have tax receipts--revenues grew at a healthy 5.4 percent rate the first quarter of 2005, notes Michael Dougherty, a professor at West Virginia University. But expenses increased by 5.6 percent, and this has been the persistent problem in West Virginia: an inability of revenues even in good times to keep up with rising costs. But in West Virginia, the mismatch is not the result of easing up on the fiscal oars.

A dissection of the state's budget shows what the problem is: 31 percent of total spending is on health care and human services. You can add to this the substantial chunk of employee compensation devoted to health insurance. So, even with buoyant revenues, nothing matches the relentless double-digit march of health care costs, be they vendor payments under Medicaid or health insurance premiums for teachers and state workers. The older and poorer the state, the greater the chasm. But there is more. As Governing's February issue on "Grading the States" noted in its assessment of West Virginia, a huge unfunded pension liability requires 11 percent of state revenues just to keep from getting worse. Balancing the state budget is all about paying for the past rather than investing in the future.

Several of West Virginia's problems are situational. Its natural resource base--coal--drives much of its economy but faces volatile demand. So, income and taxes are sensitive to swings in energy costs. The state in the past was able to tap corporate income and severance taxes, but the traditions of heavily unionized industries left a legacy of substantial employer-financed worker benefits that was transferred into the public sector. Unlike industries that can close and move away, the state government is stuck where it is.

Other problems are institutional. A lot of chores are assigned to the state: It provides two-thirds of local school funding and tends to most of those country roads, streets and highways.

The Mountaineers do not shirk on taxes, which is one of the problems. State tax revenues are 8.3 percent of personal income, the third- highest burden in the nation. The state sales tax is applied to a very broad base at a hefty 6 percent rate. But, with more than half the population living in counties that are immediately adjacent to other states, the state is open to tax competition on all sides. With already high taxes, West Virginia has been ginning up more revenues by promoting gambling, moving steadily from lotteries to casinos and video games. The social costs of that policy are an issue, but the lure of attracting out-of-state dollars to help pay the state's bills appears too strong to resist.

West Virginia is not heavily indebted when it comes to direct state borrowing. It has only modest general obligation debt outstanding and court decisions have limited its use of moral obligation financing. The state has not as yet borrowed to pay into its underfunded employee pension plans, but the 11 percent drain on the budget has led to efforts to debt-finance the accumulated-fund deficits with a $4 billion pension bond issue. That would nearly quadruple the tax- supported debt and likely have negative repercussions for the state's bond rating. Legal snags have inhibited the sale. But, it illustrates that gambling on the future is increasingly attractive in a state with an intractable long-term budget deficit.

West Virginia may seem a special case, tucked away in the mountains and filled with sleepy hideaways and retirement homes. But it is instructive of the perils of fiscal over-reach and failing to plan for the future. High tax rates cannot offset the fiscal erosion of activity slipping away to other places. Gone are the comforts and security of an industrial age featuring an ever-expanding economy, where bountiful natural resources coupled with growing populations could be counted on to pay the future freight. As populations age and economies change, so must fiscal planning and efforts to stay competitive with an ever-shrinking and more mobile work force. These are challenges few politicians wish to embrace publicly, but ultimately they must.

Keep an eye on West Virginia. It may represent the road ahead.