August 15, 2011

The Fiscal Health of U.S. States

Key materials

This paper examines the fiscal health of the 50 U.S. states. Existing work considers important aspects of this issue, but it does not provide a complete picture of current and future state fiscal outlooks. Earlier work has not integrated the assessment of explicit state debts with the assessment of implicit state liabilities for employee pensions.  In addition, earlier work has not sufficiently evaluated whether states face widely varying or substantially similar fiscal outlooks. As this paper shows, accounting for implicit pension liabilities provides a significantly more negative picture than does explicit debt information on its own. And the popular perception that some states are fiscal basket cases while others are models of fiscal rectitude is accurate only in the short term; over a longer horizon, all states are in danger of fiscal meltdown.

This paper offers five conclusions. First, state government finances are not on a stable path; if spending patterns continue to follow those of recent decades, the ratio of state debt to output will increase without bound. Second, the key driver of increasing state and local expenditures is health-care costs, especially Medicaid and subsidies for health-insurance exchanges under the Patient Protection and Affordable Care Act of 2009. Third, states have large implicit debts for unfunded pension liabilities, making their net debt positions substantially worse than official debt statistics indicate. Fourth, if spending trends continue and tax revenues remain near their historical levels relative to output, most states will reach dangerous ratios of debt to GDP within 20 to 30 years. Fifth, states differ in their degrees of fiscal imbalance, but the overriding fact is that all states face fiscal meltdown in the foreseeable future.