Funding Crisis Will Force States to Cut Services
Looming pension obligations will put governors and state legislatures in a cash crunch. For some, that means tax hikes.
By Richard Sammon, Senior Associate Editor, The Kiplinger Letter
Mark Willen, Senior Political Editor, The Kiplinger Letter
March 29, 2006
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With the economy chugging along and tax revenues on the rise, most state budgets are in the black. Indeed, most states have plans to splurge on roads, schools and other initiatives in the next few years. But...
State budgets face another crisis just over the horizon. And this time it's the kind of long-lasting, deeply rooted problem that will keep state and local officials on the financial ropes for a decade or more. No uptick in the economy and increased tax base will turn it around quickly. What's more, the coming state crisis foreshadows what Washington policymakers can expect.
The problem is, in a word, retirements. Although some years down the road the federal government faces a huge gap between what the Social Security program takes in and what it is obligated to pay out, state officials will find themselves ensnared within just a few years. Huge pension obligations loom as thousands of government workers, most of them baby boomers, start to retire from long-held jobs. Many of them will opt for early retirement, seeing an opportunity to cash in after long years of service while they're still young enough to take other jobs in the private sector.
By decade's end, state and local governments will be paying retirees about $170 billion a year, 44% more than what was paid out in 2004. And unlike the federal government, states are barred from running budget deficits. Also, there's no surplus built up in a trust fund to draw from during short years.
Few states will have the money to pay. In fact, most government pension plans are underfunded, with a projected 40-year shortfall of between $300 billion and $600 billion, depending on the economy and market returns.
There's no doubt that some states will have to increase taxes. Almost all will reduce services, including education and health care for the poor. Many will also go the same route as private companies—trimming benefits for future workers and relying more on 401(k)-style plans. Some states may even try to cut payments to current retirees, but courts may prevent that. Others will borrow using special bonds and look for investments with higher returns.
Fortunately, the pinch is still a few years away. In fiscal year 2006, 45 of the 50 states will run surpluses. But only three—Tennessee, Washington and West Virginia—will put money aside in rainy-day funds to help prepare for the impending retirement calamity. The others will spend this year's surplus to appease voters, many of whom want to restore government services cut back during the austere years brought on by the economic downturn in 2001.
States will have $30 billion in surplus money to spend this year. California will apply a $5-billion windfall to schools, roads and police. Indiana is earmarking $119 million for tax incentives to lure biotech firms. Missouri, Michigan and Iowa will direct extra funds to health care for the poor. Arizona and New Mexico will each spend about $675 million on roads and tax cuts. Florida plans to use some of its $3-billion surplus for property tax relief.
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