- North Carolina was identified as one of 40 states that has more outstanding financial obligations than funds available to meet them.
- Unfunded pension and retiree healthcare liabilities are the leading cause of the state’s unfunded taxpayer burden.
- Outstanding debts should caution policymakers against government spending growth and highlights the need for state retiree benefit reform.
The nonprofit and nonpartisan organization Truth in Accounting (TIA) recently released its “Financial State of the States” report. The report ranks states based on their ability or failure to meet outstanding financial obligations.
North Carolina ranked 27th and received a “D” grade on the report.
TIA estimates that North Carolina has over $56 billion in outstanding obligations and only $31.7 billion available to pay those obligations. This leaves a $24.3 billion shortfall, which equates to an approximately $8,100 obligation per North Carolina taxpayer, according to the report. Thirty-nine other states are also estimated to have more outstanding financial obligations than available money to meet them.
This may be shocking to the average North Carolinian, considering the state’s balanced budget requirement. How can the state be so far in the negative if each year’s budget has to balance?
That’s because each year’s budget merely needs to include that year’s minimum required payment for debt obligations and unfunded liabilities. It’s sort of like making the minimum required monthly payment on your credit card debt. The minimum payment meets the legal annual obligations, but the bulk of the money owed remains.
The primary reason for North Carolina’s low grade is its unfunded state retiree healthcare obligations. This is no surprise to government finance researchers, such as Civitas Executive Vice President Brian Balfour. On the subject of liabilities, Balfour explains that fully funding pension and retiree healthcare obligations would cost the state $4.2 billion annually, which is about 18 percent of the state’s current $23.9 billion annual budget. That huge annual expense is the result of ballooning costs with which the state has not been able to keep up.
One way to reduce the unfunded health care liability going forward is to reduce costs from healthcare providers. State Treasurer Dale Folwell expressed that his office has had ongoing difficulty getting straight-forward answers about the actual cost of services for which state insurance plans are paying. Adding transparency to healthcare costs is one way to help consumers make more informed healthcare decisions, saving individuals and the state money in the long-term. In addition, price transparency may also increase competition, which can help drive down the price of healthcare.
Another significant portion of the state’s outstanding financial obligations is the state pension unfunded liability. According to Folwell, the state pension plan has underperformed for the past 20 years in terms of expected returns. This is no small discrepancy since currently 18 percent of state payroll goes into the pension system. State employees contribute 6 percent of their salaries and the state contributes an additional 12 percent. This amounts to around $1.5 billion in taxpayer contributions, up from $800 million just six years ago.
In response, Folwell says they have lowered the expected rate of return for the pension fund to more realistically plan for future pension performance and obligations. This is useful in illuminating the true amount that taxpayers will be obligated to subsidize.
Reversing the Trend
Financial obligations that are not factored into the balanced budget requirement should not be ignored by the public or state policymakers. If anything, they should warn against frivolous spending on recurring general fund expenses. How can policymakers consider a $5 billion increase to the state’s General Fund expenditures when we have $24 billion outstanding financial obligations? To do so would be extremely irresponsible.
Some may cite this looming financial threat as a reason to oppose the proposed constitutional amendment to cap the income tax rate at 7 percent. That’s muddled thinking because the current personal and corporate income tax rates are well below the proposed 7 percent ceiling at 5.25 and 2.5 percent, respectively, effective 2019. Even under the lowered cap, an additional $5.5 billion could be generated through income tax increases. However, raising taxes is not an effective long-term solution to the unfunded liabilities problem because it does not address the root of the problem: overpromising of retiree benefits.
Ultimately, the unfunded liability problem originated with the overpromising of retiree benefits, not the underfunding of the pension and health plans. From 2013 to 2016, the state’s pension liability grew by 80 percent. For comparison, the state’s GDP grew at only 66 percent during that same time period. This disparity illustrates that taxpayers simply cannot continue to support a pension system that is growing at that rate. Systemic reform is needed to reverse this alarming trend.
Legislators should continue to support efforts by the state treasurer to better manage the unfunded liabilities. Additionally, budget writers should consider the full scope of the state’s financial obligations when making spending decisions. Limiting government spending allows the state to avoid exacerbating the unfunded liabilities problem, but larger reforms are the only true long-term solution. That involves overhauling the current system of pension and retiree healthcare benefits to find a workable solution to improve the state’s unfunded liabilities problem.