‘Hidden’ Public Employee Benefit Costs in California State and Local Governments

David Kersten
David Kersten is president of the Kersten Institute for Governance and Public Policy (www.kersteninstitute.org). Kersten is also an adjunct professor of public finance and economics at the University of San Francisco.

Most public agencies in California, including the State of California, are financially insolvent because their liabilities exceed their assets. This essentially means that they have a negative ‘net worth,’ or ‘net value’ (aka ‘net position’) in terms of public finance.

What is far less understood is the roots cause(s) of this trend. From a financial perspective the biggest driver, without a doubt, is public employee benefit unfunded liabilities, particularly pension and retiree health care, based on my extensive research into the finances of state and local governments in California.

These two expenditure categories are single handedly responsible for taking hundreds of public agencies in California from a significant positive net position, to a significant negative net position.

Pension and retiree health care expenditures is essentially a ‘hidden’ expenditure, and was not even scheduled to be included in the official accounting ledgers of public agencies until just recently as a result of rule changes by the Government Accounting Standards Board (GASB).

Public agencies in California have amassed hundreds of billions of dollars, into the trillions of dollars when totaled together, in unfunded pension and retiree health care debt over the last 10 years. Moreover, this debt has accumulated year after year because it is essentially ‘hidden’ in public agency financial statements, and continuously either not funded at all or continuously underfunded.

These debts and expenditures rarely if ever show up in a public agency’s annual budget documents. And only recently began appearing in public agency audited financial statements, documents which most people do not even know exist.

The magnitude of the debt accumulation for these two expenditure categories is simply staggering, even to someone who has studied and analyzed public financial figures their whole professional career.

A second major driver of financial insolvency is routine ‘deficit’ spending by public agencies—which means they continue to spend more on an annual basis than they raise in revenues.

‘Hidden’ Public Employee Benefit Costs Have Created a ‘Nightmare’ Scenario for Public Agency Finances in California and Elsewhere

Taken together, these two trends have created a ‘nightmare’ scenario for public agency finances in California and elsewhere. These two factors are driving the ‘unit’ cost of government higher and higher, which provides taxpayers with less and less value for their money.

In summary, by my conservative rough calculations government in California costs more than 50% more than it did 10 years ago, even though staffing has stayed fairly constant and even declined in many localities. This far outpaces the rate of inflation and revenue growth which have climbed relatively slowly, compared to expenditure growth.

Hypothetical Public Agency Balanced Budget on Paper but Ran 20% Annual Budget Deficit by Failing to Fund ‘Hidden’ Benefit Costs

The magnitude of these two trends can be best understood by looking at a hypothetical example, or actual public agency finances. I will use a hypothetical example for purposes of simplicity, although these figures are in the range of what I have seen for typical public agencies in California.

In 2005, “Insolvent County” had annual total revenues of $100 million, and annual total expenditures of $100 million (let’s assume the budget was balanced on paper on a cash basis). At that time, the county had zero public employee compensation unfunded liabilities.

By 2015, “Insolvent County” had annual total revenues of $120 million, and annual total expenditures of $120 million. This represents a 20% increase in both total revenues and expenditures from 2005 to 2015. But over that same period, “Insolvent County” amassed a $100 million unfunded pension liability and $100 million in unfunded retiree health care liabilities—for a total of $200 million in unfunded public employee benefit liabilities by 2015.

On the public agency’s official books, its budget was balanced each year, with total expenditures matching total revenues—but the public agency had actually ran a significant budget deficit each year when these ‘hidden’ liabilities are accounted for.

Specifically, the cash accounting for “Insolvent County” showed that its revenues and expenditures increased from $100 million to $120 million over the 10-year period—an average increase of 2% per year. But over that same period, unfunded liabilities increased by $200 million or an average of $20 million per year—equal to approximately 20% of the agency’s annual budget expenditures.

Thus, the public agency actually ran a $20 million per year budget deficit or 20% average budget deficit over the 10-year period. This is a huge deficit by any accounting standards, but on the order of what many of California’s public agencies have actually amassed in public debt each year! And all this spending was essentially ‘off the books’ and ‘hidden’ from public view—perhaps the biggest travesty in public finance in recent history.

Compounding this problem in the case of most public agencies, is the fact that they not only amassed huge public debts over this period, but also ran significant budget deficits in many of the years in question—adding yet more public debt to an already large accumulation of debt.

The obvious questions becomes who is going to pay for all this debt? Ultimately the state and local taxpayers living in the jurisdictions of the public agency that accumulates the debt.

Graphic Illustration of Public ‘Nightmare’ Debt Scenario a ‘Living Reality’ for Many Public Agencies

To further illustrate this troubling trend, I have created a simple graphic (see below). The x-axis represents time and the y-axis represents dollars. The top curve labeled “Public Employee Benefit Debt Curve” starts at zero and shows the increasing run up in public employee benefit debt as time increases. The bottom curve labeled “Public Agency Net Value” starts at zero and shows the decreasing net value of the public agency as time increases—a trend driven by the top curve.

These starting and end values vary by agency but I have found that the overall trends hold for most public agencies in California, and things continue to get worse as opposed to better. These trends will be further accelerated by any future decline in economic growth.

The obvious first step would be for public agencies to truly live within their means and pass budgets that fund all public employee compensation costs on a ‘pay as you go’ method, as opposed to running debts up even higher. But that is not something that most public agencies have chosen to do, mostly due to political factors and the simple fact that all this debt accumulates largely ‘hidden’ from view of taxpayers and the public.

A major goal of Insolvent Film is to present the ‘true’ cost of government, which has been increasing at an alarming rate on what I call a “per unit” basis, as opposed to an “overall basis.”

To further illustrate, most public agency’s have relatively the same staffing that they did 10 years ago, but the cost to maintain that level of staffing, and the public services they provide, has increased exponentially—likely on the order of 50-100% when all ‘hidden’ costs are accounted for!

Nothing short of shocking. This trend is the root cause of why most taxpayers feel they are paying more for a government that continues to do less–because that is exactly what is happening in locality after locality as well as at the state level in California.

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