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States' Finances: The Day of Reckoning Nears

Mary-Jo Kranacher, MBA, CPA/CFF, CFE

There has been a lot of discussion surrounding the growing national debt, but little conversation about the relatively larger fiscal deficits facing many of the states. The financial condition of many states is becoming increasingly troubling, as they continue to borrow to cover the cost of unemployment benefits, pension funding, and federally or contractually mandated programs. Reductions in services, tax increases, and state employee salary freezes or layoffs are inevitable, even though all these moves would further hamper the already fragile economic recovery.

It's likely that the ongoing financial crisis will continue to wreak havoc with the lifestyles of many Americans in 2011. But, at least in the short term, the fiscal problems at the state and local levels will have greater impact on our day-to-day lives than federal deficits. After all, Uncle Sam has the ability to print money to cover additional spending—state and local governments don't have that luxury.


Although the national unemployment rate fell to 9.4% in December, from a high of 9.9% during 2010, some states—such as Nevada, Michigan, and South Carolina—continue to post double-digit unemployment rates. Many states entered the economic downturn with too little money in their coffers to support unemployment benefit claims during this period. States turned to the federal government to bail them out with loans to cover these deficits. The loans were non–interest bearing for the first two years, but that grace period ended on December 31, 2010, and the first interest payments will come due in September. According to the New York Times, New York owes $115 million in interest on a $3.2 billion loan (www.nytimes.com/2011/01/15/us/politics/15stimulus.html). A tax surcharge will be levied on employers to help cover New York's cost. Some states, such as Texas, are considering floating bonds to raise money to pay the loan interest, while others are searching for alternatives that won't add to their debt load.


Historically, most public pension plans were well-funded because of strong investment returns that controlled the growth rate of annual required contributions. But the latest financial crisis reduced available resources from which to make future payments—lower asset values and investment returns, and less tax revenue—at the same time that demand for retirement benefits (as a result of our aging population) and other government services has risen.

A January 7, 2011, special report by Fitch Ratings, a global ratings agency, states, “There is cause for near-term concern about a number of public sector defined benefit pension plans and [Fitch] recognizes the considerable pressure that these obligations will place on many government budgets in the coming years” (www.ncpers.org/Files/01-07-11_us_st_lcl_gov_pnsns_fitch.pdf). To make matters worse, many public pension funds use an aggressive discount rate (approximately 8%) to keep their annual required contributions low. If this discount rate were adjusted to a more realistic figure, the required contributions would increase for most plans and further exacerbate the states' fiscal problems.

According to a study by a Northwestern University professor, Illinois' pension fund may be depleted as soon as 2018; Connecticut, Indiana, and New Jersey would follow shortly thereafter in 2019; Hawaii, Louisiana, and Oklahoma would likewise run out of money in 2020; and Colorado, Kansas, Kentucky, and New Hampshire would go broke by 2022.

The Good News?

The financial crisis has exposed the cracks in the system and prompted legislators and regulators to take these threats to states' finances seriously. Attempts at reform are currently under way in 19 states to address issues of how retirement benefits are established, funded, and managed. Meanwhile, the Government Accounting Standards Board (GASB) continues to consider proposed changes to pension accounting, including revising the assumptions used to determine pension liabilities.

If efforts to put states' finances back on a sustainable path are unsuccessful, we may find ourselves falling back on what our parents and grandparents did during World War II: “Use it up, wear it out, make it do, or do without.” Let's hope it doesn't get to that point.

As always, I welcome your comments.

Mary-Jo Kranacher, MBA, CPA/CFF, CFE. Editor-in-Chief. ACFE Endowed Professor of Fraud Examination, York College, The City University of New York (CUNY), mkranacher@nysscpa.org.

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