Volcker Sounds Alarm Over States' Budget Gimmicks, Pension Assumptions

The Volcker Alliance, founded by former Fed chairman Paul Volcker has sounded an alarm over budget gimmicks. The alliance seeks Truth and Integrity in State Budgeting.

In the report, the Volcker Alliance examines in detail the budgeting practices of California, New Jersey and Virginia, assessing the effectiveness of each state’s practices.

The report highlights the need for effective and transparent budgeting practices by “shining a spotlight on opaque and confusing practices and by identifying more appropriate approaches” when creating state budgets and fiscal policy.

Executive Summary

EVEN AS THE REVENUE OF STATE GOVERNMENTS in the United States recovers from the longest economic downturn since the 1930s, many states continue to balance their budgets using accounting and other practices that obscure rather than clarify spending choices. These practices make budget trade-offs indecipherable, lead to poorly informed policy - making, pass current government costs on to future generations, and limit future spending options. Further, they weaken the fiscal capacity of states to support the cities and counties that depend on their aid.

In 49 states, “balanced budgets” are required by constitution or by statute; Vermont, the sole exception, follows the practice of its peers. In truth, however, there is no common definition of a balanced budget, and many states resort to short-term sleight of hand to make it appear that spending does not exceed revenue. The techniques include shifting the timing of receipts and expenditures across fiscal years; borrowing long term to fund current expenditures; employing nonrecurring revenue sources to cover recurring costs; and delaying funding of public worker pension obligations and other postemployment benefits (OPEB), principally retiree health care.

While these actions temporarily solve budget-balancing challenges, they add to the bills someone eventually has to pay. Yet few states include information about these long-term spending obligations in the budgets that governors propose and state legislatures debate. This precludes accurate, informed consideration of policy trade-offs.

A primary aim of this preliminary study is to lay the groundwork for a common approach toward responsible budget practices in all 50 states. A continuing comparative analysis should provide a framework for a scorecard with respect to budgeting and financing practices. By shining a spotlight on opaque and confusing practices and by identifying more-appropriate approaches, we hope to provide incentives for officials to clarify financial issues and encourage debate on basic policy choices.

We invite and encourage governors, budget officers, and legislators to commit to work with us in developing useful approaches toward effective financial policies. Recent experience demonstrates the need. Mounting fiscal stress in Illinois, the bankruptcy of Detroit, and the impending financial crisis in Puerto Rico all indicate the relevance of the initiative that the Alliance has undertaken.

Preliminary Budget Report Card



Many Pensions, Many Standards

While the Governmental accounting Standards Board (GASB) provides recommendations for public employee pension funds’ reporting, comparing liabilities between states is difficult because they are based on actuarial assumptions and calculation methods that differ from one plan to another.

The actuarial assumption that has received the most attention over the past 15 years is the investment return. Any change in this assumption has a substantial impact on the calculation of liabilities. For example, when Utah shifted to a 7.75 percent from an 8 percent assumption in 2008, its funding level dropped to 95 percent from 101 percent. If it had raised the investment rate assumption to 8.5 percent, the funding level would have risen to 113 percent.

Of the three states studied by the Volcker alliance, the Virginia retirement System assumes a 7 percent rate of return. New Jersey’s public employee and teachers’ systems use a 7.9 percent rate of return; and both the California Public Employees’ Retirement System (CalPERS) and the California State Teachers’ retirement System (CalSTRS) use 7.5 percent.

A number of independent experts have questioned whether the pensions’ assumptions are higher than justified by existing circumstances and future probabilities. These and other calculations need to be considered when looking at the plan’s calculations of its unfunded liabilities.

At the end of 2013, the state portion of the New Jersey pension system was 54 percent funded;  the Virginia Retirement System was 65 percent funded. In California, the public employee portion of CalPERS was 75 percent funded, 24 while CalSTRS was 67 percent funded.

Cash Accounting

States should move away from strictly cash budgeting and toward the type of accounting, used in their audited comprehensive annual financial reports, that shows the true present value of future spending obligations. The use of cash-based fund accounting methods by most states and localities creates the temptation as well as the capacity to shift the costs of today’s services onto coming generations by ignoring future spending for which taxpayers are already obligated.

For example, Virginia, California, and New Jersey have failed to make their recommended contribution, as determined by actuaries, for full funding of public employee pension systems. Yet the states’ enacted budgets show only the amount governors and legislators chose to appropriate for each fiscal year or biennium studied. In addition, New Jersey and California, particularly, have amassed billions of dollars in obligations for public workers’ retirement health care benefits.

The three states have substantial deferred long-term infrastructure maintenance needs that are not reflected in their budgets, and California and New Jersey have failed to reflect the cost of future obligations for K-12 spending required under statutes or judicial orders.

California

Once tied with Illinois for America’s lowest state general obligation credit rating, California now stands out as a budget reformer. Since 2013, its general obligation bond debt has garnered multiple upgrades from Moody’s, S&P, and Fitch.

California has also taken steps to improve teachers’ pension funding, though this is being accomplished in part by pushing the costs from the state to local school districts. Risks remain for California. The state is still saddled with $94.5 billion in bond debt supported by tax revenue, and it has amassed another $195 billion in unfunded promises to pay pension and other retiree benefits. Its revenue remains highly dependent on capital gains taxes, which means the state is hostage to the vagaries of the stock and real estate markets. Further, California has a $64.6 billion shortfall in deferred infrastructure maintenance, according to the California Five-Year Infrastructure Plan of 2014. It remains too early to tell if the state’s fiscal culture has changed permanently or if California will revert to its previous tactics in the next economic or stock market downturn.

Status of Pension and OPEB Funding

California is carrying a total of $131.1 billion in unfunded pension liabilities and $64.6 billion in unfunded retiree health benefits for state workers, teachers, and local school administrative personnel. The combined amounts equal more than 9 percent of the state’s $2.1 trillion economy, a burden of about $5,100 per resident.

There is much more in the 60-page report.

I side with the independent experts in regards to pension plan assumptions.

The California pension assume 7% returns. I suggest there will be -2 to +2% percent returns over the next seven years. For further discussion, please see Seven Year Negative Returns in Stocks and Bonds; Fraudulent Promises.

Such returns would devastate California and crucify Illinois. Sadly, there have been no reforms at all in Illinois.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.