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Defining State Debt

State borrowing takes on so many forms that it's hard to figure out what the total is.

It is not news that states are in increasingly desperate fiscal shape. As a recent report by the Pew Center on the States documented, California is only the largest and most prominent example of a state facing fiscal crisis. The report, "Beyond California: States in Fiscal Peril," found nine others where finances are currently hanging in a precarious balance. A "failed state" could mean deep cutbacks in services coupled with punishing levels of charges and taxes for those services that survive.

One of the options for forestalling this result is to mimic what the federal government is doing. That is, borrow with abandon. But states generally are prohibited from intentionally borrowing to cover operating deficits -- although it happens -- and they can't print money. With a few significant caveats (states can issue scrip to pay bills, as California did recently), they are required to troop down to the private capital markets to raise funds.

The amount of state debt outstanding was not a factor Pew used in tallying its dismal list. That got me thinking about how one should define state debt. It can take several forms, some of which are pretty straightforward (bonds and notes) and others that are less visible to the public (pension and post-retirement health care liabilities). To this mix could be added more esoteric forms of non-financial debt, such as deferred replacement and maintenance of infrastructure. Taken together, these financial and physical liabilities represent claims on the future that must be met if levels of service are to continue. But, depending on the strength of contracts and the supply of political will, that may or may not happen.

Rather surprisingly, not much analysis has been done of the aggregated "indebtedness" of the states. A recent study by Loop Research, the "2009 Pension Funding Review," attempted to go at least part way. To estimate what it called the "economic debt" of the states, it added up state debt outstanding and unfunded state pension fund liabilities and subtracted general fund balances.

To get a more complete picture, one can patch together some rough and ready facts. Counting just bonds and notes, state government debt outstanding comes to about $1 trillion. Pension obligations of the states are offset by the accumulated assets of their pension systems, which will help meet future claims. Unfortunately for those who like precise numbers, the "true" value of these assets is hard to determine. There is no generally accepted definition of how to value them; states are free to employ their own systems. What this means is that they are permitted to even out the value of their pension investment portfolios over the investment cycles as opposed to having to "mark to market" on current values. Moreover, any shortfalls in value in a given year can be amortized by increasing the required contributions for years to come. That said, unfunded pension debt is around $800 billion.

Last is the "newfound" liability of post-retirement health benefits promised to state employees. These are payments that, along with all health costs, have exploded in recent years. This is no small matter. These costs, now equal to about 2 percent of payroll costs, are projected to rise to about 5 percent of them in the next 20 years. Today, these unfunded liabilities represent another $400 billion in debt.

So, the full compass of the financial obligations that represent state "debt" is likely around $2.4 trillion, or almost two- and-a-half times the amount reported as state bonded debt. By comparison, publicly-held U.S. federal debt now is about $6 trillion. The unfunded pension numbers are likely to get worse for the states since it will take their pension funds a few years to fully record the impact of the present financial recession.

By negligence (or design), much of the information regarding a hefty part of our economy is hard to find and difficult to analyze. The full extent of state financial obligations remains a mystery -- even though the provision of public services and state and local fiscal conditions should be a national, not a parochial, concern.

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.
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