State and Local Finances Still Sinking

While corporations and American households have improved their finances markedly since the 2008-09 financial crisis and great recession, the same cannot be said of government.  Washington maintains its usual mess, occasionally employing accounting fictions to obscure the fundamental inability of revenues to meet its goals and cover its other obligations.  Debt continues to grow, absolutely and as a portion of the gross domestic product (GDP).  State and local governments present a more mixed picture.  Despite sometimes herculean efforts to set matters right in some quarters, unsupportable pension obligations have forced a further deterioration in their finances.

In one sense, state and local governments generally responded to the crisis in a prudent way.  They worked hard to keep current outlays in line with current receipts.   In 2010 for example, the sector’s overall receipts rose 3.6 percent and tax receipts by 5.1 percent, but despite the increased flow of funds, budgeters cut current outlays 5.1 percent.   Between 2011 and 2014, they contained the growth in current outlays to a mere 0.9 percent a year even as tax and other receipts rose at a 3.0 percent annual rate.  Only since 2015 have outlays, growing at a 3.5 percent annual rate, outpaced receipts, which have grown at a 2.7 percent rate.  Even at this, the difference seems prudent next to the gaps recorded in the years prior to the crisis.  The relative level of borrowing among states, cities, towns, counties and school districts fell about 40 percent between 2009 and 2016.

Though all this effort has worked to help state and local government finances, it has failed to offset the adverse impact of growing pension obligations.  For years, state and local governments have bought peace from public sector employees and their unions by offering remarkably generous pension plans.  These had great appeal to the politicians, for they had a minimal effect on immediate budgets.  But the obligations have continued to accrue.  These governments will have to pay them eventually and burden their taxpayers accordingly.  The Federal Reserve (Fed) reports that the current value of those future obligations has already begun to overwhelm revenue increases and efforts to contain other forms of spending.

In recent years, the present value of pension obligations has increased 11.5 percent a year.  So even as the budget control of recent years has allowed a 3.5 percent yearly jump in the sector’s total assets and held the growth non-pension liabilities to 1.4 percent a year, overall liabilities have still increased almost 4.5 percent a year. As of September 2016, the most recent period for which data are available, state and local liabilities stood at 1.84 times assets, higher than ever, absolutely and relative to all other budget and income measures.

It is hard to see in the circumstance how these governments can avoid a continued deterioration in their finances.  The courts have made it clear that the pension obligations are immutable.  The best that state and local governments can do is place new employees into a different, more supportable pension plan and so engineer a distant future when the sever obligations will begin to lift.  Some governments that have gone down this path have been able, on the basis of this future relief, to borrow to cover more pressing current obligations.  But that relief will wait a very long time indeed.  In the meantime, the situation will continue to squeeze state and local abilities to serve their citizens, either by providing them with services or tax relief.

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