Forty U.S. States Cannot Afford To Pay All Their Bills

by Mayra Rodriguez Valladares: Forty states do not have enough money to pay all of their bills, according to quantitative analysis in Financial State of the States, the ninth annual report published this evening by Truth in Accounting (TIA). TIA is a non-partisan, not-for-profit government finances watchdog. To balance the budget, “elected officials have not included the true costs of the government in their budget calculations and have pushed costs onto future taxpayers.” TIA’s comprehensive analysis of the fiscal health of all 50 states is based on the states’ fiscal year 2017 comprehensive annual financial reports (CAFRs).

“With the robust growth in the economy, you would have expected a big improvement in state finances” stated TIA CEO Sheila Weinberg. “Unfortunately, that is not the case. State finances still deteriorated. While unfunded pension liabilities slightly decreased due to a 7% increase in the value of pension assets, this decrease was more than offset by an increase in unfunded retiree health care benefits.”

TIA’s analysis found that because government financial statements do not report all liabilities of a state, elected officials and citizens are making financial decisions without knowing the true financial condition of their government. A major challenge for investors is the lack of transparency and accuracy in a lot of government accounting. This makes it difficult for even experienced analysts of government financial documents and municipal bond investors to understand and evaluate a public-sector entity’s true financial health.

The total unfunded debt among the 50 states increased by $53.4 billion to more than $1.5 trillion in fiscal year 2017. Most of this debt comes from unfunded retiree benefit promises, such as pension and retiree healthcare debt. TIA’s analysis found that unfortunately “one of the ways states make their budgets look balanced is by shortchanging public pension funds. This practice has resulted in a $837.5 billion shortfall.” Other post-employment benefits, mainly retiree healthcare liabilities, totaled $663.1 billion.

TIA has a grading system for the states to give greater context to each state’s Taxpayer Burden or Taxpayer Surplus. To arrive at a taxpayer’s burden or surplus, you divide the state’s shortfall or surplus by the number of a state’s taxpayers.

• A grade: Taxpayer Surplus greater than $10,000 (3 states).
• B grade: Taxpayer Surplus between $100 and $10,000 (7 states).
• C grade: Taxpayer Burden between $0 and $4,900 (12 states).
• D grade: Taxpayer Burden between $5,000 and $20,000 (18 states).
• F grade: Taxpayer Burden greater than $20,000 (10 states).

Only 6% of states have a grade of A, while 56% of states received a near failing grade of D or the failing grade F.

States with a surplus are Alaska, North Dakota, Wyoming, Utah and South Dakota. Alaska is the state in the best financial condition, because it can pay all of its bills and has a surplus of $56,000 for each taxpayer in Alaska. However, there is room for improvement, Alaska is not fully transparent with taxpayers. “None of its other post-employment benefits are reported in the financial statements.” Given the level of energy resources that Alaska has, this surplus is not surprising. However, if energy prices were to decline significantly, that surplus would be at risk.

The state in the worst financial shape is New Jersey. It only has $25.5 billion available in assets to pay $221 billion worth of bills. This $195.5 billion shortfall means that each New Jersey taxpayer is on the hook for $61,400. The state did report all of its pension debt, but according to TIA the state “continues to hide $34.3 billion of its retiree health care debt. Moreover, New Jersey’s net position is “inflated by $27.7 billion, largely because the state defers recognizing losses incurred when the net pension liability increases.” Other states that are leaving their taxpayers with significant tax burdens include Connecticut, Illinois, Kentucky, Massachusetts, Hawaii, Delaware, California, New York, and Vermont.

A new financial reporting rule taking effect for the 2018 fiscal year will require states to report all unfunded other post-employment benefits (OPEB), particularly retiree health care liabilities, on their balance sheet. In FY 2017, total unfunded OPEB liabilities among the 50 states was $663.1 billion. Two-thirds of that, or $439.5 billion, however, was not reported on states’ balance sheets. Essentially this is “hidden debt.”

These states have the largest difference in reported vs.
total unfunded retiree health care promises, or hidden debt.TIA

In addition to analyzing states’ finances, TIA has also analyzed the financial condition of the most populated cities in the U.S. two years in a row. 64 out of the 75 most populated cities do not have enough money to pay all of their bills. These cities have racked up $335.4 billion in unfunded municipal debt. TIA found Irvine and Stockton, California to be in the best financial shape and New York and Chicago to be in the worst shape. The next update to the Financial State of the Cities is planned for January 2019.

Recently, TIA has also started branching out to analyze the state of finances of other municipalities. This September, TIA gave Westchester County and the Village of Scarsdale, both in New York state, a near-failing grade of ‘D.’ TIA’s analysis found that “Westchester County's elected officials have made repeated financial decisions that have left the county with a debt burden of $2.8 billion, according to the analysis. That burden equates to $8,400 for every local taxpayer. Westchester County's financial problems stem mostly from unfunded retirement obligations that have accumulated over many years. Of the $5.8 billion in retirement benefits promised, the county has not funded $173.5 million in pension and $2.5 billion in retiree health care benefits.” According to the report about the Village of Scarsdale, its “financial condition is not only disconcerting, but also misleading as government officials have failed to disclose significant amounts of retirement debt on the village’s balance sheet. As a result, residents and taxpayers have been presented with an inaccurate and untruthful accounting of their government’s finances.”

In order to provide more transparency and accountability in the budgeting process, TIA recommends that municipalities use Full Accrual Calculations and Techniques (FACT) based budgeting. The purpose of FACT is to get states and municipalities to move beyond cash-based methods to include accrual of all expenses. This would provide a “full-cost” and more truthful basis for budgeting. According to Weinberg, TIA is also currently working “to improve the Financial Reporting Model for state and local governments, so governments would be required to report their general and other governmental funds' balance sheets and income statements using a full accrual basis.”
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Mayra Rodriguez Valladares is a contributor on Banking & Insurance on Forbes. She is managing principal of MRV Associates, which provides consulting, research and training services on capital markets and financial regulation. @MRVAssoc. She has been dedicated to providing clients high quality financial consulting, research, and training services on Basel III, risk management, risk-based supervision, capital markets, financial derivatives and more recently Dodd-Frank for over 25 years.  H/T Bill Bergman at Truth in Accounting.

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