How Medicaid And Pensions Are Crushing State Budgets

by Rodney Johnson at Economy and Markets

It used to be that when economic times got tough, people sought out public employment. The pay was less than in the private sector, but the job security was pretty good, and at the end you got a pension.

Nowadays, when including all the benefits, public sector pay is higher than what you can get in the private sector, so the jobs are that much more attractive.

Unfortunately, those jobs are harder to get today than they were in years past, and chances are they won’t come back anytime soon.

This usually isn’t the case coming out of a recession, when public employment typically grows faster than the private sector. When the economy turns down, people depend more on public services. That creates even more demand for what governments provide, and requires more workers to meet those needs.

In fact, this is exactly what has occurred since the 1950s… until now.

The Rockefeller Institute studies the financial aspects of state and local government.

According to their research, public employment six years after the end of a recession was always higher – and sometimes much higher – than when the recession started, going back to 1957.

The years of the recessions they reviewed, and the employment change six years later, are as follows.

Change in State and Local Employment After Recessions

The latest downturn is an outlier when it comes to public employment. But I doubt it’s an anomaly. It’s much more likely a harbinger of what lies ahead.

The problem isn’t that states want to offer less service. Our population has grown between 6% and 8% in each of these time frames. There’s plenty more people to serve.

The problem is that they can’t afford it. More specifically, state budgets are getting overwhelmed with Medicaid costs.

Medicaid expenses increased by 28.7% between 2008 and 2013. To put that in context, education spending moved up just 1.7%… expenditures for police, highways, and natural resources was actually down 5.8%… and administrative spending was down 7.7%. Overall, state expenditures were up just 3.7%.

On the revenue side, state tax revenue is just 5% above where it was before the financial crisis. If it were following prior recessions, it would be more like 12% to 20%.

Some of this is due to stagnant wages. When constituents don’t earn a lot more, the only way to increase tax revenue is to raise the tax rate. And while unpopular, it’s exactly what’s happened in California and a few other states.

At the same time, muted consumer spending has also held back sales tax revenue. After previous recessions, personal consumption increased between 20% and 30%. But this time, it’s only up

This situation will only intensify in the years ahead as the boomers get older and eventually retire.

As they progress through their empty nester years, they’ll likely keep a lid on their spending as they try to sock away more assets for retirement. That lack of spending is the same constraint that’s held back consumption since the financial crisis, which, again, affects sales tax revenue.

But Medicaid and lack of consumer spending aside, there’s still another issue – pensions.

From 2008 to 2013, state pension contributions increased $6.7 billion – a 17% jump.

It gets worse when you consider that as the boomers retire, they’ll rightfully demand their pension payments. So as state’s pension liabilities grow, they’ll have to make larger contributions to their pension funds, leaving even fewer funds for other services.

Keep in mind that states regularly fail to make their required pension contributions. As the problem grows, they’ll just push more of the liability down the road, requiring even larger contributions in the future.

The upshot is that our state governments are slashing headcount as they try to make ends meet with only modestly-growing revenues, even though the claims on their resources keep growing.

But at some point states won’t be able to cut their employment roll to make ends meet. Rising Medicaid and pension costs won’t decline anytime soon, and the funding issue is only going to get worse. That means they’ll have to find other ways to plug their budget gaps.

It might take time, but eventually states will use the same tactic as California – a “temporary” tax hike that somehow becomes permanent.

This is a syndicated post, which originally appeared at Economy and Markets
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