NCPA - National Center for Policy Analysis

A $2-TRILLION FISCAL HOLE

October 12, 2006

State and local governments are amassing huge obligations in the form of unfunded retirement benefits for their workers.  Aside from underfunded pension plans, governments have also run up large obligations from their retiree health plans.  While new Governmental Accounting Standards Board (GASB) rules kick in next year and reveal exactly how large this problem is, retiree health benefits could be a $1.4 trillion fiscal time bomb, say Chris Edwards, a tax policy director at the Cato Institute, and Jagadeesh Gokhale, a senior fellow at Cato.

  • The new GASB regulations will require accrual accounting of state and local retiree health benefits, thus revealing to taxpayers the true costs of the large bureaucracies that they fund. 
  • Edwards and Gokhale reviewed unfunded health costs across 16 states and 11 local governments that have made actuarial estimates, and found an average accrued liability per covered worker of $135,000.
  • Multiplying that by the number of covered state and local employees in the country yields a total unfunded obligation of $1.4 trillion -- twice the reported underfunding in state and local pension plans at $700 billion.

To put these costs in context, consider the explicit net debt of state and local governments:

  • According to the Federal Reserve Board, state and local credit market debt has risen rapidly in recent years, from $313 billion in 2001 to $568 billion in 2005.
  • But unfunded obligations from state and local pension and retiree health plans -- about $2 trillion -- are still more than three times this net debt amount.

The key problem is that the great majority of state and local governments finance their retiree health benefits on a pay-as-you-go basis.  In coming years that will create pressure to raise taxes as Baby Boomers age and government employees retire in droves, says Edwards and Gokhale. 

Source: Chris Edwards and Jagadeesh Gokhale, "A $2-Trillion Fiscal Hole," Wall Street Journal, October 12, 2006.

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