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Stabilizing State and Municipal Finances

on October 11, 2010 Source: Policy Dialogue on Entrepreneurship

Shortfalls in state and local budgets affect entrepreneurs. As Robert Litan, vice president for research and policy at the Kauffman Foundation explained that "these budgets directly impact businesses and entrepreneurs. They can't plan for the future without knowing what their tax liabilities will be and what services will still be around for them and their employees." To address these concerns the Milken Institute and the Kauffman Foundation led a study of current state and municipal budget challenges, which includes an analysis of back-to-basics solutions.

The study report, Ensuring State and Municipal Solvency, argues that, even when the economy fully recovers, cutting back on services and increasing taxes won't be enough to address fiscal challenges facing states and municipalities, such as unfunded pension and health-care obligations. Its authors argue that it's going to require real paradigm shifts, namely a fundamental restructuring of budgets and the entire budgeting process, sustainable revenue generation, new efficiencies and federal/state partnerships.

Of course, there isn't a one-size-fits-all solution for the more than 91,000 local governmental units in the United States. The report captures the potential solutions that were discussed during the Financial Innovations LabTM created by the two organizations to vet the various potential remedies. The lab, a part of the Milken Institute's continuing leadership in promoting financial innovations to help solve ongoing social, economic and environmental challenges, pulled together a diverse group of state and local officials, union representatives, experts from the capital markets, money managers, academics, public-sector attorneys and representatives from bond rating agencies.

Key data points include:

  •  At the aggregate level, state and local government pensions suffered losses of $835 billion during the 2007-08 financial meltdown. Through the first quarter of 2010, less than 50 percent of those losses had been recouped.
  • In FY2000, half the states had fully funded pensions; by FY2008 only four (Florida, New York, Washington and Wisconsin) had fully funded plans.
  • Health-care costs at the state and local level are expected to double by 2050.

Proposed solutions include:

  • Preemptive and collective burden sharing—all key stakeholders (bondholders, union representatives, public-sector employees and taxpayers) take a financial hit to ensure long-term stability
  • Adopting standardized actuarial assumptions, more similar to corporate-sector accounting standards,  to ensure more realistic rate-of-return scenarios when determining public-sector pension liabilities
  • Implementing multi-year budgeting plans/rainy-day funds
  • Reassessing possible economies of scale from shared services/consolidation with other governmental entities
  • Establishing control boards as a last resort for states and municipalities in extreme distress
  • Providing short-term federal aid to states and municipalities that actively implement steps to restructure their finances, possibly using a "Race to Solvency" modeled after the Department of Education's "Race to the Top"

The Policy Dialogue on Entrepreneurship would like to congratulate the Kauffman Foundation and the Milken Institute for this much needed exploration of fiscal challenges at the state and local levels. We hope that the outlined solutions will guide policymaking.

The report can be downloaded here, or you can order a hard copy from the Milken Institute.

Category:  Growth & Poverty  Tags:  taxes, budget

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