Pa. pension reform is step one; Medicaid reform is next

Last week Pennsylvania policymakers took a major step in healing some self-inflicted wounds of the past two decades by finally passing meaningful pension reform. While it is only a first step, it is a vitally important one that must now be followed up by even bolder action in the years ahead.

Our commonwealth has been essentially living off of its credit card for almost 15 years now. States in general cannot borrow for operations like the federal government because of balanced budget requirements, but in the years running up to the Great Recession Pennsylvania and other states figured out a practical way to do just that.

Each year a state is required to pay a certain amount of money into its pension funds to keep them solvent. When a fund's investments do well the state owes less, and when they do poorly the state owes more. If a state fails to make a payment, then just like your credit card at home, it builds up an unpaid balance, compounded by the investment earnings it should have provided to the fund.

Fail to make that payment enough times, and you can find yourself with quite the outstanding balance on your hands. In 2003 our pensions were fully funded. Today we owe roughly $75 billion, or almost $6,000 for every man, woman, and child in the state.

Anyone who has ever run up a credit card debt knows that the first step toward recovery is to stop the bleeding by cutting up your credit card. That's why this reform legislation is so important. The new law gets us back to a more sustainable pension path going forward. But before we uncork the champagne, we still need to figure out a way to pay down that $75 billion.

Furthermore, it's important to remember that our pension missteps haven't been the only things contributing to our budget problems. One of the main reasons why we've had to short our pension payments in the first place, Medicaid, hasn't changed a bit. And this will continue to make it difficult for us to pay our $75 billion bill.

What's more, there is a lot less that we can do as a state to deal with the Medicaid problem given the program's expansion under the Affordable Care Act. Medicaid is a partnership between the federal government and the states to provide health care to the poorest Americans. It is a vitally important piece of the social safety net, but it is also the single largest driver of state budget troubles in the United States.

Despite its success in getting people coverage, the program grows at an incredibly unsustainable pace. In the last weeks of the Obama administration, the Department of Health and Human Services released a report projecting that state Medicaid spending would need to increase by around 6.5 percent per year over the next decade. For context, state tax revenues have historically grown around 5 percent per year.

That means that every year money will need to be taken from somewhere else in the budget, whether from classrooms, roads, or pensions, and put into Medicaid. This reduces the state budget process to just divvying up what's left over after Medicaid and pension projections are finalized.

Though policymakers have now addressed pensions, the Medicaid problem is still more acute in Pennsylvania, where we spend more of our budget on Medicaid than any other state but one. In 2003 we spent almost 29 percent of the overall state budget on Medicaid. Today we spend more than 37 percent, with the increase crowding out spending on other vitally important programs from education to infrastructure. Because our options for reform are limited by the federal government, Pennsylvanians should be pushing for two things.

First, we should be pushing our congressional delegation for comprehensive Medicaid reform. The block-grant proposal included in the House passed American Health Care Act still needs work, but it is a good start to the conversation. Sens. Pat Toomey (R., Pa.) and Bob Casey (D., Pa.) should be working hard on the Senate version to protect our state budget, and make Medicaid more sustainable for future generations. It's too important a program to let fail.

Second, depending on how Medicaid reform fares in Congress, Pennsylvania should consider filing a new waiver with the federal government to reform its own program to be more sustainable. Medicaid expansion in Pennsylvania started under the waiver program during the term of Gov. Tom Corbett, but was enlarged to a traditional expansion by Gov. Wolf. Several other states, most notably Indiana, have already seen success adapting the Medicaid expansion to best meet their own needs through the waiver program.

The legislature and governor should be applauded for their laudable compromise on pension reform. However, this marks only the first step along the path to fiscal responsibility. Several extremely difficult decisions still remain before us, particularly with health care. These decisions won't be easy or popular, but doing the right thing rarely is.

Dan White is a director at Moody's Analytics in West Chester, as well as an adjunct professor of economics at Villanova University. daniel.white@moodys.com