As Pennsylvania legislators labor to enact a balanced budget, struggling to close yet another multi-hundred-million-dollar gap, a stark reality lies ahead: They are almost certain to face this same grim struggle for years to come.
Each year, cities and states across our country are locked in this same battle. Why? The biggest factors are almost always the same — perpetually rising pension costs, the task of restoring pensions to fully funded levels, and rising Medicaid costs. For years, these expenses have been crowding out investment in areas like education and infrastructure.
Let me hasten to say that I am in favor of pensions for existing state employees and for the benefits that come from Medicaid. But their rapidly rising costs are impossible to ignore.
Over the last several decades, our nation’s state and local government costs have been surprisingly flat at roughly 12 percent of gross domestic product. But in the last 15 years, pension and Medicaid costs have grown from roughly 17 percent to 26 percent of this total.
Flat total expenses combined with rising pension and Medicaid costs has meant a relative decline in spending in other areas. Nationally, the primary victims have been education and infrastructure, on which spending has declined from 54 to 48 percent in this same period. Since states and local governments account for roughly 90 percent and 75 percent of all education and infrastructure spending, respectively, this has contributed to our country’s already abominable global rankings in those areas.
In Pennsylvania, the trends are similar, and the risk to education, infrastructure, and other government investment just as acute.
So how do we control these expenses?
The fact that our national health care expenses are now 17 percent of GDP, while the average for other developed countries is 11 percent, would suggest major short-term opportunities for improvement. But not with the current morass in Washington.
Over the longer term, however, truly radical health care cost improvements will come as we cure the most pernicious diseases — cancer, heart disease, Alzheimer’s, and diabetes — that collectively account for as much as 80 percent of all health care costs. Breakthroughs at the University of Pennsylvania in cures for certain forms of cancer are powerful examples of this opportunity. Medical research such as this at world-class academic institutions is the most important long-term path for improved costs, but the federal government continues to starve academic institutions of needed funding. And states will be wrestling with rising health care costs for years to come.
How about pension costs, which are rising because of an aging workforce and the failure of most states to fully fund their pension plans? The economic and accounting issues surrounding pensions are unforgiving, which is why most corporations abandoned them years ago in favor of defined contribution plans for new employees. Some states, including Pennsylvania, are taking very hard-fought steps to address their pension issues, but in most cases not enough to make the needed difference, and state and local pension contributions are projected to grow by $30 billion per year across the nation and by hundreds of millions of dollars each year in Pennsylvania.
States need to protect the pensions of current employees but convert new employees to defined contribution programs, which will cap our liability for existing pensions. These can be as generous as defined benefit plans but will eliminate the accounting issues and the possibility of underfunding.
If this is done, the solution I propose is to do away with the requirement that states fully fund their remaining pension obligation. After all, why do we require that states do this? We do it as a credit guarantee — to ensure the money will be there when a given employee retires.
We need such a guarantee for private-sector pensions, because a given company might not still exist when that employee retires. But the issue is different for states, because they cannot declare bankruptcy and they have the full power of taxation.
Instead of requiring pensions to be fully funded, we should instead simply require a reserve — perhaps at a level of, say, 30 percent. If we did that, and allowed states to reduce contributions so funded levels decline to that 30 percent over a gradual period, say 20 years, states across the nation would have $150 billion more each year to spend on other needs. For Pennsylvania, this benefit could be $1 billion or more each year. A powerful boost.
There are countless obstacles, including state and local laws, IRS requirements, court cases, union contracts, and more that stand in the way of these changes, but the issues and needs are acute. It is time for radical new thinking in both of these areas.