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States face funding crises

By ANNE KNOWLES and PHIL DRAKE

Montana Watchdog

A new report on the financial outlook for the nation’s states says Montana could reach a debt-driven “tipping point” in 2038.

“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.

But Roxanne Minnehan, executive director of the Montana Public Employees Retirement Administration, disagrees.

“The writer states that public pensions are invested in ‘risky’ investments. This is not the case,” she said.

She said Montana pension funds are invested in a diversified portfolio to mitigate risk.

“There will be years where we won’t make the assumed rate of return and years where we will do better,” she said, adding a reasonable rate for a balanced portfolio is the average rate over time.

“The average rate over time has been approximately 8 percent; therefore, the assumed rate of return adopted by the board: 7¾ percent is reasonable,” she said.

“That being said, we do need to receive the actuarial required contribution rate.”

Last valuation, the fund’s shortfall was 5 percent of compensation, Minnehan said. During the legislative session, The PERS board proposed increasing the employer contribution rate along with some benefit and eligibility changes.

The changes to benefits and benefit eligibility passed, but the request for funding was amended out of the bills.

“Changes for new hires are good for the long-term sustainability of the fund,” she said. “But the short-term requires additional funding.”

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.

Montana’s current debt ratio, using a formula based on a lower discount rate for its pension liabilities, is 18.1 percent. According to estimates, it would reach its tipping point by 2038.

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.

Here are other conclusions Miron offers in his paper:

1. State government finances are not on a stable path; if spending patterns follow those of recent decades, the ratio of state debt to output will increase without bound.

2. If spending trends continue and tax revenues remain near their historical levels relative to output, most states will reach dangerous ratios of debt to Gross Domestic Product within 20 to 30 years.

3. States differ in their degrees of fiscal imbalance, but the overriding fact is that all states face fiscal meltdown in the foreseeable future.

 

Anne Knowles writes for the Nevada News Bureau. Montana Watchdog Editor Phil Drake contributed to this story. The Montana Watchdog operates as an independent, news-gathering organization that shares its research and findings. Visit its  website at www.montanawatchdog.org.

 

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