Want to read this regularly? Subscribe to "The Week in Public Finance" newsletter for free.

Retiree Health-Care Liabilities Are Dramatically Increasing

State governments’ cost of keeping all their promises to retirees is “unsustainable.” That’s the conclusion of a report this week by S&P Global Ratings that looked at the growth in total retiree health-care liabilities across state governments.

In just two years, so-called "other post-employment benefit" (OPEB) liabilities have increased 12 percent, to $554 billion for states alone. This reverses a trend of stable to declining liabilities found in S&P’s past two annual surveys.

The agency cautions that its report, which looks at 2015 figures, does not take into account more recent data available in some states. If it did, the picture might look a little better, as 17 of the 41 states reporting new data show an annual decline in health-care liabilities.

“Nevertheless,” the report said, “the growth in total state OPEB liabilities underscores the magnitude of liability growth states can experience over a short period of time.”

The Takeaway: Governments generally don’t try to pre-fund their health-care coverage promises to retirees like they do with their pension liabilities, which are managed out of a separate fund. Instead, most annual retiree health-care costs are paid directly out of the state's overall budget.

In most states, the payment amounts to 3 percent or less of a government’s total general fund spending. So in the past, this kept many officials from considering the long-term trends of that budget item -- and therefore controlling those costs was not a big priority.

Also at play is the fact that retiree health-care benefits are largely regarded as unprotected, meaning governments could slash them if they needed to cut costs. That's in contrast to pensions, which are constitutionally protected.

In recent years, these benefits have been getting more attention from lawmakers. For example, Hawaii is ramping up its contributions to its OPEB fund while Tennessee cut those benefits for new hires to save costs. Both of those approaches will soon reflect a lower unfunded liability.

That's important because new accounting rules now require governments to report their OPEB liabilities on their overall balance sheet. While this doesn’t impact a government’s operating budget, it does -- for nearly all governments -- subtract from the overall financial position of a government. Governments that want to improve their financial position will have to consider their OPEB liabilities.

Why Texas Is an Oil State Not in Crisis

Texas’ comptroller announced the state’s official year-end tally this week. And while the numbers aren’t as good as originally expected, no one’s ringing the alarm bells (yet).

In fact, for a state with a lot of business in the flagging oil and gas industry, it’s doing pretty well. General fund earnings totaled $49.9 billion, which is 1.3 percent below projections.

Oil revenue was nearly 8 percent below projections, while natural gas tax revenue was one-third below expectations. But the state's general fund isn’t reeling from that.


Because it sets aside most of that revenue for its rainy day fund and the State Highway Fund, creating a buffer from what is a volatile industry.

Texas stands out from other oil and gas states like Alaska, Louisiana, North Dakota and Oklahoma. According to the federal Bureau of Economic Analysis, it was the only oil state whose economy didn’t contract during the first quarter of this year.

And although revenue collections were down, Texas was still able to set aside $879 million from its oil income for its savings and transportation funds. Its rainy day fund now totals $10.1 billion, a record high.

The Takeaway: Texas wasn’t always so buffered from the oil and gas industry. The last time oil prices took a prolonged dip after a boom period was in the 1980s, and the state famously faltered and went into a recession. Since then, it has diversified its economy with job growth in technology, health-care and construction. It also created a savings policy that helps isolate excess oil and gas revenue: When either oil production or natural gas production tax revenues exceed 1987-level collections, three-quarters of the excess is transferred to the state’s savings and transportation funds.

This notion of isolating volatile revenue streams has become more popular, particularly in the years following the 2008 financial crisis. California, for instance, was particularly hard hit by the crisis because its budget is highly reliant on investment income tax revenue, or capital gains. It established a policy in 2014 that diverts excess capital gains revenue toward paying down debt and into a rainy day fund. Massachusetts, another state with wealthy people who have substantial investment income, has a similar policy.

Alaska, the state whose budget is most reliant on oil, is considering a substantial overhaul to its revenue system that would include diverting much of its oil revenue into an investment fund. Money earned on those investments would supplement the state’s annual budget.

Cities: Unique Problems, Unique Solutions

While it’s helpful to know that the average city’s expenses and revenues have not fully recovered to pre-recession levels, there’s just one problem with looking at averages.

“When I show them the national average data, most officials can’t make much of [that information],” said the National League of Cities’ Christiana McFarland. “They’ll just say, ‘That doesn’t look like my city.’”

McFarland’s comments came Thursday during a discussion at the Urban Institute in Washington, D.C., on the fiscal health of cities. The discussion focused on moving away from simply looking at overall trends in city health to understanding the broad variation across municipalities and the different ways they adapt.

The Takeaway: More people are moving to metro areas, and cities now account for 90 percent of the nation’s total economic activity. So the fiscal performance of  major cities in a state will significantly influence that state’s overall economic performance. When a major city is doing poorly, it reflects poorly on the state. It’s one of the reasons Detroit’s bankruptcy in 2013 was a Michigan problem, not just a Motor City issue.

To that end, the fiscal policy structures and local economies create vastly different problems -- and different solutions -- across states. Michael Pagano, dean and professor at the University of Illinois at Chicago, outlined those divisions by showing the variation in cities’ taxing authority, state aid, reliance on its own revenue to pay for the budget, and on taxing or expenditure limits. (The raw data is also available online.) Connecticut cities, for example, can only issue a property or sales tax. But they have no tax and expenditure limits. California cities can tax property and/or sales and income. But they rely heavily on their own revenue and have spending and property tax limits imposed upon them.

The composition helps explain why struggling Connecticut cities have extremely high taxes and still can’t rein in their expenses while California cities tend to face quickly-growing expenses they can’t afford.