- State spending per capita has quadrupled since 1970, even after accounting for inflation
- Pension liability suffers from a “false impression of solvency” and is likely ten times larger than reported
- Recommendations include TABOR-style spending limits and conversion to defined-contribution pension plan
North Carolina’s total state government spending now consumes twice as large of a share of the state’s economy as it did in 1970, and per capita spending nearly quadrupled – even after adjusting for inflation – during that time.
These are among the many findings of a newly published paper released by the Mercatus Center of George Mason University. Entitled “To Be, Rather than to Seem: Fiscal Responsibility and the Political Economy of North Carolina,” the study examines a wide array of measures of the fiscal health of the Tar Heel State.
Written by two economists from Western Carolina University, the study raises serious concerns about North Carolina’s long-run state spending trends and unfunded pension liability – to name just two.
In their assessment of the 9th largest economy in the nation, the paper’s authors find that North Carolina still ranks only 39th among U.S. states in per capita income, but has enjoyed a state GDP growth rate slightly above the national average since 1970.
More interesting, however, are the red flags raised by the study’s authors regarding the unsustainability of state spending trends and the “false impression of solvency” presented by the commonly-reported state pension liability.
Total state spending – including the General Fund, transportation and federal aid – ballooned by 600 percent from 1970 to 2012, after adjusting for inflation. Population growth does not explain away this whopping increase, either. Per capita spending, even after adjusting for inflation, grew nearly fourfold during this time.
In short, state government is spending virtually four times as much money per person than it was four decades ago.
Indeed, by 2012 total state spending had grown to 8.8 percent of the state’s GDP, double the 4.4 percent share in 1970.
Clearly, state government has grown well beyond just providing the core functions of government. It has morphed into something that would have been unrecognizable just a generation ago. For the lower- and middle-class families that find themselves having to work longer and harder just to stay even, the growing burden of state government is an important culprit.
A significant part of North Carolina’s state government spending problem is the lavish nature of pensions for state retirees. The study notes that state spending on pensions grew an astonishing 2,000 percent from 1970 to 2012, even after adjusting for inflation. This growth rate dwarfs the spending growth on education during that time, which totaled about 500 percent. Pensions grew from about 4 percent of total state spending in 1970 to more than 11 percent by 2013.
Moreover, in spite of reports coming from state Treasurer Janet Cowell’s office bragging on the relative health of the state pension fund, the study’s authors warn of the smoke and mirrors being used to obscure a more realistic – and alarming – unfunded pension liability.
Like most states, North Carolina uses unrealistically rosy projections for the returns on the funds invested in the pension fund. The state treasurer manages the $90 billion pension fund, which is one of the primary sources of payments for pension obligations. The higher the investment returns, the better equipped the pension fund is to handle future pension obligations. But, of course, the lower the returns, the more perilous the fund’s financial outlook.
Using the state treasurer’s current 7.25 percent expected returns, North Carolina’s unfunded pension liability is calculated at $3.4 billion. A growing number of financial experts, however, strongly recommend using a more realistic discount rate. The study’s authors recommend using 3.84 percent, roughly the going rate for a 15-year Treasury note. Using this expected rate of return, the unfunded pension liability grows tenfold to $34.5 billion – which equates to nearly $14,000 per North Carolina family of four.
Making matters worse still is the state’s growing debt. Per person state debt in North Carolina increased fourfold between 1970 and 2005, even after adjusting for inflation. Debt levels have dropped some since then, but still remain well over three times 1970 levels. These figures may become relevant in the current debate over the “Connect NC” bond referendum.
The study addresses several other areas of North Carolina political economy, including education spending, transportation, health care, state debt and insurance regulations.
The study’s authors conclude with several recommendations to improve North Carolina’s fiscal health. On taxes, the study declares that the state’s 2013 tax changes represented “significant steps toward reform,” but “did not go far enough.” Continuing down the path of lower income tax rates while broadening the tax base and simplifying the tax code will make North Carolina still more attractive relative to our neighboring states, according to the study.
To stem out of control state spending growth, a path the study calls “troubling” and “unsustainable,” the authors recommend strict spending limits at a constitutional level, favorably mentioning Colorado’s Taxpayer Bill of Rights (TABOR) passed in the 1990s.
And to address the sizeable and growing state pension liability, the study recommends converting state workers to a defined-contribution retirement plan, such as the 401(k)-style plans already available to full-time state employees in the UNC system.
North Carolina’s fiscal health has been on the mend of late, but unfortunately – as this new academic study reveals – the state has suffered for decades from massive spending growth and accumulation of debts and unfunded liabilities. Only through significant policy reforms can North Carolina truly get its fiscal house back in order.
To learn more about the state’s fiscal history, take a look at our Budget Policy Guide.