Tax Analysts Blog

The Myth of the Budget Surplus

Posted on Feb 5, 2014

There seems to be a lot of good news about state budgets lately. Newspaper headlines have changed from doom and gloom over budget crises during the recession to questions about how states will manage budget surpluses. Unfortunately, there are financial problems lurking beneath the surface, and one of the largest may be the underfunding of state and local government pension and healthcare plans.

The 2008 recession hit state budgets hard. States had to pare down to the point of questioning the provision of even the most basic services and to determine what was truly vital. Millions of employers, including state governments, were forced to lay off workers. Recovery from the recession was slow and painful, but the signs now are undoubtedly positive.

The National Association of State Budget Officers reports that state fiscal conditions are modestly improving in fiscal 2014, that signs of distress continue to subside, and that states expect revenue and spending growth. But what these numbers don’t indicate is that many -- if not most -- states have looming debts. The presence of a surplus doesn't mean a state is debt free.

State and local government pension and healthcare plans have been underfunded for years. A report recently issued by the Rockefeller Institute on public sector defined benefit plans cautions that while these systems pay benefits to more than 8 million people and cover more than 14 million, they are “deeply troubled.” Public sector pension plans are underfunded by anywhere between $1 trillion and $3 trillion, depending on the economic measures used.

While it is good news that state budgets are recovering, states cannot bask in the glory of a surplus when they are unable to keep the pension promises they made. This is not a can that can be kicked down the road. Given that states must balance their budgets each year (and must stop shifting funds to achieve a balanced budget), the level of underfunding already affecting state and local government pension and healthcare plans, and the ever-present potential for a decrease in federal funding that could strain state budgets, states do not have the ability to put off planning for the future. They must plan for more than one year at a time.

Read Comments (3)

David BrunoriFeb 5, 2014

Cara, excellent post! This remains one of the great myths in public finance.
Most state balanced budget requirements are for operating budgets, not capital
or long term funding (like pensions). The problem is that people want more
government than they are willing to pay for -- a desire that political leaders
are far too willing to accommodate.

amt buffFeb 5, 2014

Our current political system is structurally incapable of rewarding long-term
fiscal responsibility or penalizing long-term irresponsibility. New fundamental
incentives are needed.

For example, suppose governments at all levels had market-driven share prices,
just like public corporations? Share prices might provide the necessary
corrective signals. Pension promises and other future liabilities could be
denominated in those shares.

David Cay JohnstonFeb 5, 2014

Quite right, Cara.

Underfunding of public worker pensions is a purely political matter -- and a
subtle form of wage theft to the workers and abuse of future taxpayers by
current elected leaders.

We know how to calculate the sums that should be set aside today to meet future
obligations and for large numbers. The reserves needed for this are tiny
compared to individual reserves required in 401(k) style plans, making public
worker pensions the most efficient mechanism to provide for retirement.

Not setting aside the necessary sums is a way for politicians to get credit for
spending more on benefits to voters or taxing less, while delaying the damage
until they leave office, sometimes long after.

This is an entirely a bipartisan problem.

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