Time to Step Up

by John Hood

Newly elected Republican Gov. Pat McCrory and the newly reelected Republican legislature may have an ambitious agenda for dramatically cutting taxes or adding new programs to the state budget. But there is a fiscal constraint on any such agenda: Past governors and legislatures didn’t pay for what they spent.

Like almost all states, North Carolina has a constitutional requirement that its budget be balanced. But the rule applies only to current expenses in the General Fund operating budget. It doesn’t constrain the issuance of debt for capital expense. It doesn’t account for depreciation. And it doesn’t apply to promises made during a fiscal year to pay employees in later years.

Essentially, the state’s fiscal rules operate on a cash basis. They don’t preclude the state from accruing liabilities to be paid from future revenues not yet collected or even projected at current tax rates.

So how large is the pile of unpaid bills McCrory and the legislature have inherited? My lowball estimate is $72 billion. Let’s break it down.

The unfunded liability gaining the most political attention right now is the $2.5 billion the state owes Washington for unemployment-insurance payments in excess of UI payroll-tax collections. But that’s one of our smaller debts. If you add up bonds and other obligations, the state’s formal debt stood at about $8.5 billion last year, most of it in the form of special obligations (not authorized by referendum).

So far, we’re at $11 billion. Next, add $30 billion. That’s the current estimate of how much the health plan for teachers and state employees is in the hole for promised future spending on supplemental health benefits. If nothing is done, you can expect that number to exceed $40 billion within a few years. But let’s stick with the current $30 billion estimate for now.*

Next, add another $30 billion. That’s one estimate of the unfunded liability in North Carolina’s pension fund for retired teachers and state employees that would be revealed if the system used more-realistic projections of future investment gains. Some analysts believe the liability may only – only! – about $12 billion. Others argue that it is far north of $30 billion.

Next, we need to account for the future cost of deferred maintenance in government infrastructure. In transportation alone, the figure starts at $1 billion (remember, this is to repair existing roads and bridges, not add new capacity).

It would be bad enough if the preceding $72 billion in unpaid bills was the end of the story. But it isn’t. Remember that all North Carolina taxpayers are also federal and county taxpayers, and many reside in municipalities. These other governments have built IOU piles of their own. Just for crumbling water and sewer systems, North Carolina’s localities collectively have a $10 billion liability. At the federal level, a conservative estimate of total liabilities would be $72 trillion – or $16 trillion in marketable debt plus the unfunded liabilities for Social Security, Medicare, and other entitlements. By population, North Carolina’s share of that is $2 trillion.

These federal and local debts at least constrain how much more indebtedness or taxation can be imposed on North Carolinians by the state. In some cases, they may also impinge directly on future state budgets – as the cash-strapped federal government pushes additional unfunded liabilities down and some cash-strapped localities get their liabilities pulled up into the state budget.

The truth is that some public liabilities will never be financed. They can’t be. Federal entitlements will be cut. So will North Carolina’s retiree health benefits. But the state can’t repudiate all past promises to pay. So the new leaders of the state have two fiscal responsibilities. The first is to begin to accumulate cash to satisfy existing debts and unfunded liabilities. The second is to offset any new state programs or tax cuts with budget cuts (remember, any apparent General Fund surplus doesn’t account for the unfunded liabilities).

Past politicians didn’t even try to do these jobs. It’s time for grownups to step up.

John Hood is president of the John Locke Foundation and an NC Spin Panelist