How do state and local governments raise revenue?

They raise revenue primarily through 'own sources' like property, sales, and individual income taxes (around $2.2 trillion annually), and also receive about $0.6 trillion in transfers from the federal government, along with fees for services.

Can state and local governments run deficits indefinitely?

No, deficits cannot be run forever. Eventually, increasing interest expenses consume a larger budget portion, making it unsustainable. Governments must raise taxes or cut spending to manage debt.

What is a defined benefit pension plan?

A defined benefit pension plan is an arrangement where the employer promises the employee a fixed monthly payment upon retirement, continuing after employment ends. This is common for government workers but rare in the private sector now.

Why are defined benefit pensions a hidden cost?

They are a hidden cost because governments often don't set aside enough money to cover these future promises. This means current taxpayers may end up paying for both present services and past employees' pensions.

How do companies handle retirement plans differently than governments?

Companies often use defined contribution plans (like 401ks), where the employer's obligation ends with their contribution. This contrasts with government defined benefit plans, creating continuing liabilities for the employer.

What is the role of actuaries in government budgeting?

Actuaries are mathematical experts hired to calculate the costs of future pension obligations. However, they may apply flexible standards, and governments have discretion in deciding what constitutes an 'adequate' contribution towards these promises.

Why might actuaries present optimistic financial outlooks?

Some actuarial firms may make aggressive assumptions to align with government preferences, essentially providing funding plans that are more palatable, even if less realistic, to avoid immediate financial strain.

Are State and Local Government Budgets Balanced? (Lessons from the Hoover Policy Boot Camp) | Ch 1

Hoover Institution

Education3 min read23 min video

Mar 5, 2020|62,019 views|56|4

Pensions Public Pensions Hoover Institution Hoover Institute Josh Rauh Underfunded Pensions State and Local Governments State Pensions Local Pensions

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Key Moments

TL;DR

State and local governments may appear to have balanced budgets, but hidden pension debts create significant financial shortfalls.

Key Insights

State and local governments generate roughly $3 trillion annually from taxes and fees, supplemented by federal transfers.

Core services provided by state and local governments include education, public welfare, higher education, and public safety.

A balanced budget, where revenues equal expenditures, is legally required in 49 states, but this doesn't account for all financial obligations.

Defined benefit pensions promised to public employees represent a significant future liability not always reflected in current budgets.

State and local governments manage approximately $4 trillion in assets for pension funds, but their adequacy is questionable.

Actuaries determine contribution levels for pension funds, but they often use optimistic assumptions and face pressure from governments to provide favorable opinions.

THE ROLE AND REVENUE OF STATE AND LOCAL GOVERNMENTS

State and local governments are responsible for a wide array of public services not directly handled by the federal government. These essential services include elementary and secondary education, public welfare, higher education, healthcare, police, corrections, and highway maintenance. To fund these operations, they collect approximately $3 trillion annually. Revenue streams primarily consist of 'own sources,' such as property, sales, and income taxes, accounting for about $2.2 trillion. An additional $0.6 trillion comes from federal transfers, highlighting the significant financial responsibilities and revenue-generating capacities of these governmental levels.

THE APPEARANCE VERSUS REALITY OF BALANCED BUDGETS

On the surface, state and local government budgets often appear balanced, with revenues closely tracking expenditures. This perception is reinforced by the fact that 49 states have legal requirements to operate on a balanced budget annually. However, this traditional view of a balanced budget, where current income meets current expenses, fails to account for significant long-term liabilities. This oversight can create a misleading picture of fiscal health, masking potential future financial crises.

THE SIGNIFICANT OBLIGATION OF PENSION DEBT

A major hidden liability stems from defined benefit pension plans promised to public employees. Unlike defined contribution plans (like 401(k)s) common in the private sector, these plans guarantee a specific monthly income in retirement. These promises, which can amount to tens of thousands of dollars annually for a full-career employee, represent a substantial financial commitment. When governments do not adequately set aside funds to cover these future payments, current taxpayers may end up supporting both present services and the pensions of past workers, essentially paying double.

UNDERFUNDING AND OPTIMISTIC ASSUMPTIONS

While state and local governments hold around $4 trillion in assets designated for pension funds, the adequacy of these funds to meet future obligations is frequently questioned. Governments have discretion in determining their contribution levels and can set their own funding rules, often hiring actuaries to assess these needs. However, there's a documented tendency for actuarial firms to make overly optimistic assumptions about investment returns and life expectancies. Some firms face pressure to provide favorable opinions, leading to underfunded plans and potentially jeopardizing the ability to pay promised benefits.

THE CONSEQUENCES OF UNMANAGED DEBT

The failure to adequately budget for pension obligations can lead to severe consequences, mirroring the financial downfall of households with excessive debt. If governments cannot meet their long-term commitments, they are typically forced to either raise taxes significantly or cut essential public services. Examples like the bankruptcy of Detroit, where public safety response times dramatically increased due to underfunding, illustrate the tangible impact of fiscal mismanagement. This hidden debt thus poses a risk to both taxpayers and the beneficiaries of public services.

IMPLICATIONS FOR TAXPAYERS AND PUBLIC SERVICES

The complexity of state and local government budgeting goes beyond simple revenue and expenditure analysis. Deferred promises, such as pensions, must be factored into the true financial picture. When these long-term liabilities are ignored or underestimated, future generations of taxpayers bear the burden. This situation can create a scenario where current taxpayers are effectively funding multiple generations of public employees' benefits, highlighting the critical need for transparent and realistic financial planning to ensure the continued provision of vital public services.

Mentioned in This Episode

●Software & Apps

●Companies

●Organizations

●People Referenced

Annual Pension Promises for Public Employees

Data extracted from this episode

Job/Description	Annual Pension Amount
Construction worker (general)	$19,000
New York City Teacher average (includes part-time)	$43,071
California Highway Patrol full career average	$88,101
California retiree (tens of thousands promised)	> $100,000

Pension Fund Assets Comparison (Trillions USD)

Data extracted from this episode

Category	Assets
State and Local Government Defined Benefit Pension Funds	~$4.0
Old-line Company Defined Benefit Plans	~$3.0
401k Plans (newer firms)	~$5.0+
Nonprofit Sector Defined Contribution Plans	~$1.0

Common Questions

State and local governments provide essential public services not directly handled by the federal government, such as elementary and secondary education, public welfare, higher education, health and hospitals, police and corrections, and highway construction.

Topics

State Government Local Government Balanced Budget Government Finance Defined Benefit Plan Actuarial Science Government Debt Public Services

Mentioned in this video

organizationCalifornia Highway Patrol

Mentioned as an example where a full-career officer can expect an average pension of $88,101 per year.

companyLansur

Mentioned as one of the old-line companies with defined benefit pension plans.

locationSacramento

Shown as a picture of the California Capitol building, illustrating where state authorities direct tax revenue.

organizationUrban Institute

Source of a graph showing expenditures and revenues by state and local governments from 2002 to 2016.

legislationTenth Amendment

Specifies that all powers not granted to the federal government are reserved for the states and the people, outlining the basis for state and local government responsibilities.

organizationNew York City teachers union

Stated that they report New York City teachers receive an average of $43,071 annually in retirement.

companyStudebaker Corporation

A defunct car manufacturer that promised pensions to employees but did not prepare for them, leading to employees receiving nothing when the company went bankrupt.

software401k

A type of defined contribution retirement savings plan, contrasted with defined benefit pensions, where employers and employees contribute to an individual account.

software403B

Mentioned as a type of defined contribution retirement plan, similar to a 401k, typically for non-profit organizations.

personJohn Cogan

Mentioned as someone who will discuss federal government budgets the following day.

locationVermont

Mentioned as the only state that does not have a de-facto balanced budget requirement, characterized by high taxes and high spending.

toolNevada

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