State budgets are in disarray

When an errant SUV crashes through your picture window, you may not notice that your barbecue tipped over and caught your house on fire. So it is with the U.S. economy these days.

All the focus on our national debt, sequester cuts and federal tax increases is obscuring a smoldering problem in the states. Declining tax revenues, budget deficits and underfunded pensions have legislatures scrambling for revenue. Many states are taxing and borrowing more just to make ends meet.

The State Budget Crisis Task Force, led by former New York Lieutenant Gov. Richard Ravitch and former Federal Reserve Chairman Paul Volcker, studied fiscal conditions in six heavily populated states — California, Illinois, New Jersey, New York, Texas, and Virginia — which together account for a third of the nation’s population and almost 40 cents of every dollar spent by state and local governments.

Their conclusion: The recession has made the situation worse, but the problem with state finances is structural, and the current trajectory of taxing and spending is unsustainable.

The issue is huge because state and local governments spend $2.5 trillion a year and employ 19 million people — 15 percent of the nation’s workforce.

The task force identified common threats to state finances, including rising Medicaid costs, shrinking federal subsidies, underfunded public employee pensions, poor budget practices and unstable local governments.

Public employee pensions constitute one of the biggest hurdles, with Harvard University estimating that state and local governments have up to $4.4 trillion in unfunded pension liabilities.

The city of Stockton, Calif., recently became the largest city to declare bankruptcy, and analysts predict that, if bankruptcy judges allow municipalities to renegotiate their pension obligations, more cities may follow suit.

The deteriorating situation has renewed talk of changing federal law to allow states to declare bankruptcy. Critics complain that just talking about state bankruptcies could spook bond markets and increase borrowing costs.

Adding to these woes are looming increases in health care costs. The federal Affordable Care Act extends health care to millions of lower income people by expanding Medicaid — a program partially funded by the states. The federal government promised to subsidize the higher costs — 100 percent for the first three years and 90 percent thereafter — but mounting federal deficits could jeopardize those payments.

Health care costs will be an even bigger headache for state leaders in future years as baby boomers retire. A recent RAND Corporation study found that health care expenses for heart disease, cancer and dementia totaled $288 billion in 2010.

The study reported that about 3.8 million elderly Americans have dementia. By 2040, that number is expected to swell to 9.1 million, costing between $379 and $511 billion a year.

With the national debt approaching $17 trillion, Congress and the president will, at some point, have no choice but to shift expenses to the states.

So what’s the answer? As the old saying goes, when you find yourself in a hole, stop digging.

States may have to freeze cost of living adjustments, adjust pension benefits, raise the retirement age and require greater employee contributions to state benefit programs.

In Washington state, pension reforms and a constitutional requirement for a balanced budget have kept us out of the financial abyss. But our budget process has now been made more difficult by a state Supreme Court ruling ordering the state to increase education funding. To keep Washington competitive, legislators must hold the line on other spending so we can fully fund education without imposing new taxes and fees that will slow economic growth.

There are no easy solutions, but the longer our elected officials wait to address the problems, the greater those problems will become and the more harm they will cause.

Don Brunell is the president of the Association of Washington Business. Formed in 1904, the Association of Washington Business is Washington’s oldest and largest statewide business association, and includes more than 8,000 members representing 700,000 employees. AWB serves as both the state’s chamber of commerce and the manufacturing and technology association. For more about AWB, visit www.awb.org.