May 15, 2015

Stay Focused: West Virginia’s Fiscal Challenges

Eileen Norcross

Senior Research Fellow
Summary

West Virginia has a good track record of tackling hard fiscal truths — from economic shocks and budget gaps to health care liabilities. And that needs to continue. An underfunded pension system can quickly become a major problem during economic downturns. To avoid the fate of other states West Virginia has a chance to become a leader in pension reform and an example of how fiscal discipline is the best preparation against economic uncertainty.

Contact us
To speak with a scholar or learn more on this topic, visit our contact page.

In an upcoming study for the Mercatus Center at George Mason University, I rank West Virginia’s fiscal condition 43rd among states. This sounds alarming, but the ranking doesn’t tell the whole story.

The state has shown admirable fiscal restraint and weathered the post-recession period better than many. But to prepare for the future and improve their long-run outlook, policymakers must double down on discipline and tackle long-term risks.

First, the good news: A robust Revenue Shortfall Reserve Fund — or rainy day fund — along with an alertness to the economic and revenue impact of the state’s shift from coal to natural gas production and discipline in funding employee benefits are all reasons for the state’s AAA+ credit rating. A closer look at the state’s audited financials for FY 2013 confirms this picture.

The Mountain State has enough cash on hand to pay its short-term bills 1.5 times and a little bit of slack to balance the yearly budget, realizing a small surplus of $116 per capita in FY 2013. On a long-run basis, West Virginia carries $2.1 billion in debt or a modest 3.3 percent of residents’ personal income.

However, declining energy prices and escalating pension liabilities threaten to throw things off course and redirect spending away from essential services like education, public safety, and transportation.

First, consider energy prices. As Governor Tomlin notes in his recent budget message for FY 2016, natural gas prices are falling, as is demand for coal. That translates into sluggish severance tax revenues. Couple market forces with a warm winter and the government can anticipate weaker collections from a tax that accounts for about five percent of revenues. With about 12 percent of annual appropriations, or $477 million of funds, set aside in the rainy day fund for natural disasters or fiscal crises, the fund was tapped several times for weather emergencies and only once to balance the budget in FY 2015.

The importance of rainy day fund vigilance is confirmed through recent research published by the Mercatus Center at George Mason University. David Mitchell and Dean Stansel find that state fiscal crises aren’t caused by economic factors like unemployment or market crashes, but by poor planning and “boom-time” spending by politicians. Robust rainy day funds and spending caution during expansions mean less fiscal stress in state budgets during the inevitable market fluctuations that can take a bite out of tax collections. As long as West Virginia sticks with the same discipline it’s shown since establishing the rainy day fund in 1994, the state is more likely to ride out fluctuating energy markets.

On pension liabilities the news is more sobering, requiring better budgeting and more accurate accounting. Unlike some states, West Virginia has shown discipline in confronting deeply underfunded public sector pension plans by making regular payments rather than skipping them. The three largest plans for public employees (PERS), teachers (TRS) and the State Police Death and Disability Fund (SPDDRS) report funding levels of 77.6 percent, 53 percent and 72 percent respectively — an improvement from 13 years ago, when TRS and SPDDRS were treading water at only 19 percent and 21.9 percent funded.

Unfortunately, these self-reported numbers place the state in the most favorable light possible, and don’t reflect reality. Due to flawed accounting standards affecting all U.S. public sector pensions, West Virginia’s pension liabilities are actually three times larger than current government estimates. According to my forthcoming research, West Virginia’s total unfunded pension liability is $19 billion. That’s about 35 percent of West Virginians’ total personal income.

While the switch to a defined contribution plan for teachers proved unpopular in 1990s, the state might reconsider it. Give employees an option for their retirement savings and protect the taxpayers from growing long-term liabilities. The first step toward stabilizing workers’ retirement benefits is for policymakers and the public to have a look at the real numbers. Value the pensions as though they are guaranteed to be paid (like a bond), and then determine the level of contributions needed to meet these obligations.

West Virginia has a good track record of tackling hard fiscal truths — from economic shocks and budget gaps to health care liabilities. And that needs to continue. An underfunded pension system can quickly become a major problem during economic downturns. To avoid the fate of other states West Virginia has a chance to become a leader in pension reform and an example of how fiscal discipline is the best preparation against economic uncertainty.