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December 26, 2005

Unfunded Public Liabilities – The Problem

The cost of already-promised public sector retiree health care benefits is going to become visible in 2006.  This isn’t a prediction; it’s a fact.  The Government Accounting Standards Board (GASP, of course) is set to require governments to reveal the current cost of future benefit promises in the same way that corporations have had to do since 1994.  The result is liable to be years of labor turmoil.

Here’s the problem: many if not most government units around the country have promised their workers lifetime healthcare coverage.  However, almost none of them have put aside any money to pay for the cost of this benefit.  According to a NY Times story today, which is the source for many of the facts in this post, only 38% of companies with over 200 employees offer any sort of retiree benefits and only 9% pay any of the cost of purchasing Medicare supplements.  New York City and New York State, by contrast, both have promised to pay the full cost of Medicare supplements for their retirees.  Where the money is going to come from is TBD.

It’s easy to see how we got into this mess: a dollar in extra salary is very visible.  It either has to be paid for by increased taxes or it adds to a government deficit (except when there are surpluses).  A dollar PROMISED to buy a future benefit – up until 2006 – has been invisible.  So when negotiations get tough, it is easier for politicians or beleaguered school boards to promise two dollars in future benefits than pay an extra dollar in current salary.  Union negotiators know the value of these future benefits to their members; they accept the tradeoff.

As an example, the New York Transit Authority is spending an estimated $165 million annually to provide current health care benefits for retired workers.  This is the number that gets reported and gets subtracted from Transit Authority revenue each year in calculating the bottom line.  The true current cost of health care benefits promised for the future may be as high as $1.6 billion each year.  A scary thing is that no one is even sure what this number is since accounting for it is not required.  Whatever this number is, however, the Transit Authority will have to report it by the end of 2006.

Corporations used to make unaccounted-for promises like this, too.  Corporate chieftains at airlines and car makers were no less short-term in their thinking than politicians.  Why hurt reported earnings on your watch if you can defer the pain until your successor’s successor is in the corner office?    After the change in accounting rules, the temptation was reduced but the piper still had to be paid.  Airlines went bankrupt and shifted some of their pension liabilities to the Pension Benefit Guarantee Corporation. GM and Ford may still collapse under the weight of their retiree health care costs.

Now cities, towns, states, school districts and public colleges will all have to report the current cost of future benefits – not only for new promises made but for all the promises made in the past.  They will even have to account for the cost of catching up on past promises which haven’t been funded.  Ouch.  In some cases, it will become clear that there is no way that taxes or fees can be raised high enough to cover past profligacy.

Some say: “Don’t worry; this is just an accounting change.  It doesn’t affect current cash flow.”  That’s like saying that finding out that you’re going to run over a cliff in the next five minutes doesn’t matter because you’re not falling yet. 

The first practical effect will be higher interest rates for those with the worst problems.  Interest rates DO affect cash flow.  Business may decide not to locate in places where taxes clearly have to be raised a lot; home buyers will start to prefer jurisdictions which have been fiscally responsible.  That means that revenues will be impacted in the areas that need the revenues most to meet their future obligations.

Once we get through the pain, this will turn out to be a healthy accounting change (this is a prediction but you won’t know whether I was right or wrong for years to come).  With phony accounting, administrators who hid future costs looked like they were doing a better job than those who were prudent.  The incentives were backwards.  Corporations have been improved by the accounting change of a decade ago.  Government will be improved by this change, too.

But here’s some of the pain we’ll feel in the meantime:

  1. some municipal bankruptcies;
  2. some sort of national bailout;
  3. increased threats of public sector strikes since politicians lose the ability to hide unfunded promises AND have to find savings to pay for the old promises;
  4. increased pressure on heath care delivery since Medicare relies on the fact that its low reimbursements are subsidized by those who pay higher rates which some will no longer be able to do;
  5. tension between taxpayers (programmers and auto workers, for example) whose salaries are restrained by global competition and the government workers they pay whose jobs cannot so readily be outsourced.

Just to show how far we have to go before government bodies deal with reality, retiree health care costs were hardly mentioned during the NYC transit negotiations.

I promise to post some suggested solutions before the New Year and not end the year on this depressing note.

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