Accounting, Texas-Style

Accounting, Texas-Style
By E.J. MCMAHON

Retiree health benefits amount to an exceptionally cushy deal for America's public-sector workers. Texas, for example, not untypically pays 100% of health insurance premiums for state employees who can retire in their early 50s. Unlike pensions, these other retiree benefits generally are financed on a pay-as-you-go basis.

These benefits impose huge and growing future liabilities on taxpayers—liabilities that states and localities have long hidden from public view, deceiving citizens about the true costs. And the nation's second largest state is now poised to perpetuate the deceit. Last week the Texas Senate completed passage of a bill that would allow the state and its local governments to avoid funding long-term obligations for retiree health insurance and other non-pension benefits. If Gov. Rick Perry signs the measure, Texas will simply defy a key provision of established government accounting standards. This would be stunning setback for efforts to improve transparency and accountability in government finances around the country.

Three years ago, the Government Accounting Standards Board (GASB) promulgated a new requirement for state and local governments to begin calculating and reporting the net present value of their retiree benefit promises. GASB 45 is based on the sensible premise that future retiree benefits, like pensions, are essentially a form of deferred compensation that should be recognized as their costs accrue. The rule becomes effective in fiscal 2007-08 financial reports for the largest government employers.

Why is this a big deal? Because the total unfunded liability for state and local retiree benefits (other than pensions) has been estimated at $2 trillion ($50 billion for Texas governments alone). The numbers are so daunting that opponents of funding the liabilities—especially public employee unions—have predicted governments would face a stark choice between starving basic services and entirely eliminating retiree benefits.

That's baloney. While unfunded liabilities will be reported in notes to financial statements, the number of immediate concern to legislators and taxpayers will be the "annual required contribution," which amortizes the amount over 30 years. For example, a city with a total unfunded liability of $1 billion might initially have an annual required contribution of $35 million. If it pays the whole amount, there is no impact on the balance sheet. If it chooses to pay only $20 million, the result is a net liability of $15 million. The required contribution will grow rapidly if it is ignored or under-funded—so governments that choose to ignore the number will risk seeing their credit ratings suffer. Getting the jump on the GASB timetable, New York's Mayor Michael Bloomberg has already made what amounts to a $2 billion down-payment on his city's required contribution.

What isn't baloney—and what opponents of the GASB 45 do understand—is that financial transparency about costs may help apply some braking mechanism to the otherwise natural tendency of governments to engage in runaway promise-making to their employees.

Even so, state and local officials do have some breathing room to explore strategies for reducing their required contributions. Options include streamlining insurance plans, eliminating overlaps with Medicare, revising eligibility standards, requiring co-pays and creating trust funds supported at least in part by employee contributions.

While there are clearly many ways of skinning this cat, some government officials would rather pretend the animal doesn't exist—even while they continue to feed it under the table. The pretense became official in Texas earlier this year, when Comptroller Susan Combs circulated a letter to the standards board claiming the rule simply shouldn't apply in her state. Texas doesn't allow its public employees to form unions; therefore, she said, retiree health benefits are not contractual obligations but bi-annual appropriations "changeable at the will of a legislative body."

Yet the comptroller and her legislative allies also have made it clear that they have no intention of changing anything, because they do, in fact, view employee benefits as an obligation. If GASB 45 is implemented, Comptroller Combs wrote, "the worst of all possible worlds will occur—a non-existent future liability will result in a loss of benefits now." Huh? If the liability is "non-existent," what is being lost?

The Texas bill requires disclosure of long-term retiree benefit liabilities "for information and planning purposes only." This simply isn't good enough: Unless some of the liability hits the balance sheet under consistent rules that politicians can't manipulate, there will be no incentive to effectively manage retiree benefit costs. Ms. Combs and Texas lawmakers apparently are gambling that the state is simply too big an issuer for credit raters to downgrade. But smaller, more vulnerable governments can't be quite so cavalier—which perhaps explains why Houston and other cities have already indicated they won't opt out of GASB 45.

Ironically, both Comptroller Combs and Gov. Perry have been national leaders in expanding the public's access to detailed government expenditure data. But their stance on honest accounting only serves the interests of disclosure-averse elected officials and public-sector union bosses from coast to coast. This is truly a Texas-sized bad example.

E.J. McMahon is a senior fellow at the Manhattan Institute and a member of GASB's Derivatives and Hedging Task Force.



©2007 The Wall Street Journal