Recipe For Fiscal Disaster: Pension Obligations And Health Care Costs

(Anne Knowles/NPRI) – A new report on the financial outlook for the nation’s states says Nevada could reach a debt-driven “tipping point” in 2034.

The Fiscal Health of the U.S. States, a report by Jeffrey Miron with the Mercatus Center at George Mason University, says a more sober assessment of states’ pension funds liabilities as well as projected growth in health care costs show that all states are in worse fiscal shape than generally believed.

Part of the issue is that officially reported pension liabilities assume a certain interest rate when discounting future payouts (typically, about 8 percent, the historical return on stocks), but this is a “risky” and “problematic” approach, according to Miron.

“The pension obligations of state and local governments, the future payouts owed to those already collecting pensions, and the future payouts to those not yet retired but contributing are certain in the sense that state and local governments have legal obligations to make these payments,” he says.

“Standard financial economics holds that non-risky future payments should be discounted at a non-risky interest rate, which is much lower than 8 percent. A lower interest rate makes the appropriate present values larger,” Miron concludes.

The result of faulty projections will be $1.3 trillion more in total state liabilities than is commonly believed, according to Miron.

Miron says all states could reach debt ratios exceeding 90 percent – the so-called “tipping point” – sometime this century. Alabama, Kentucky, Michigan and South Carolina could be the first, starting in 2023, and others, such as Alaska, wouldn’t reach the tipping point until 2068.

Nevada’s current debt ratio, using a formula based on a lower discount rate for its pension liabilities, is 16 percent.

The report says rising health care costs, though, are an even bigger problem for the states than pension obligations.

The report cites rising Medicaid costs as the primary cause of skyrocketing costs, although it doesn’t provide projections. The report suggests changing the way states receive funding from the federal government for the program.

“One possibility is converting Medicaid into block grants to states, with each state having substantial leeway to determine exactly who and what is covered under the state plan,” the report says.

For the block grant approach to make a difference, though, the formula for adjusting it over time would have to limit the rate of increase relative to the past several decades. In the short term, such a change could mean less care is available for state Medicaid beneficiaries, the report acknowledges.

The report also cites the new health care exchanges established under the Patient Protection and Affordable Care Act as a contributing factor to rising costs, although states can presently receive federal assistance to either set up the exchange or opt out, requiring the federal government to implement it.