Lesson 10: Legacy Costs Justin Marlowe PBAF 522 – Public Financial Management and Budgeting Autumn 2015

Key Takeaways Many state and local governments face significant long-term financial challenges related to entitlements, infrastructure funding, pensions, OPEB, debt affordability, and other issues Medicare and Medicaid (especially for the states) will consume an ever-larger share of the federal and state budgets, respectively; that growth is almost entirely a function of demographics and health care cost inflation Absent major changes in the structure of these programs, they will continue to grow and put pressure on government and non-profit budgets everywhere Liabilities for pensions and OPEB are based on estimates, and those estimates are sensitive to assumptions about discount rates, financial market conditions, inflation, etc.

The federal government is expected to run massive budget deficits for the next 30 years Federal government revenues and spending, actual and projected; source: Congressional Budget Office

What’s driving most of this? Demographic Change

Another Big Problem: Pensions and OPEB State and local governments collect and invest money to pay future pension and other post-employment benefits (OPEB; mainly health care) The ratio of those investment assets to expected long-term pension/OPEB spending is known as the funding ratio Estimated total unfunded state and local government pension liability is $1-2 trillion; unfunded OPEB liabilities are around $2 trillion State and local governments can affect their funding ratios by changing how they invest their pension assets, changing their discount rate on investments and liabilities, or changing the structure of pension/OPEB benefits

State and local government unfunded pension liabilities compound the problem Unfunded state and local pension liabilities as a share of national GDP; source: Pew Research Centers

Pension Funding Ratios vary a lot across states Pension Funded Ratios by state, as of FY 2012; source: Standard & Poors

Most states have done little to fund their OPEB liabilities OPEB Funded Ratios by state as of FY 2014; source: S&P

Don’t forget about the others Unfunded Infrastructure Maintenance According to the US Society of Civil Engineers, it would cost around $2 trillion to upgrade our “critically deficient” roads, bridges, and other infrastructure and… It would cost around $5 trillion to upgrade all our “moderate to critically deficient” infrastructure; that’s about the total amount of the entire municipal bond market No obvious alternative funding source in sight Growth in state Medicaid spending mirrors growth in Medicare; demographic change and health care cost inflation