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ERISA Benefits Consulting, Inc. www.erisa-benefits.

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Consequently, Medicaid has replaced education as the largest state spending category. Medicaid
accounted for nearly 24 percent of all state expenditures in 2011, according to the National Association of
State Budget Officers.

Second, state and local governments face large unfunded pension and other post-employment benefit
(OPEB) liabilities. Unfunded liabilities nationwide are estimated to be around $4 trillion, according to the
authors. Creating large demands on revenue, these unfunded retirement benefits are already straining state
and local budgets.

Mark Johnson, Ph.D., J.D.

Consulting services in:

Fiduciary liability
401(k) and ESOPs
Pension benefits
Cash balance conversions
Group life & health plans
Health plan reimbursement
Long term disability benefits
Retiree medical plans
Severance benefits
Survivor benefits
Third party administrators
VEBA plans

State and Local Government Fiscal Sustainability and the
Trend Gap

State and local governments could face several negative
consequencesincluding tax increases, public service reductions
and credit rating downgradesunless a trend gap based on
socioeconomic and other fundamental factors is closed, according to
a recent paper published by the Federal Reserve Bank of Boston
titled Walking a Tightrope: Are U.S. State and Local Governments
on a Fiscally Sustainable Path?

The article, written by two economists, demonstrates that a growing
trend gap results in a lower long-term ability on the part of state and
local governments to raise revenues to meet public service demand
and pay pension obligations.

Municipal Pension and Benefit Obligations Contribute to the
Trend Gap

The fiscal sustainability of state and local governments in the
United States has been a matter of increasing concern for a number
of reasons, two of which are outlined below.

First, the rapid growth in state health care costs has exceeded the
growth of state government revenue in recent decades. The nominal
value of nationwide Medicaid spending grew about 10 percent
annually between 1990 and 2004, while state general revenue grew
only 6 percent.
ERISA Benefits Consulting, Inc. 817-909-0778
Pension and Other Benefit Costs Contribute to 30-Year Growth in Trend Gap

The authors define fiscal sustainability as the long-term ability of state and local governments to provide
public services. They then analyze data from several sources and utilize the trend gap measure to assess
state and local fiscal sustainability as it has evolved over the last 30 years. The trend gap measure takes
into account the actuarially required contributions to pensions as well as other post-employment benefits,
and removes short-term business cycle fluctuations.

The study found that, overall, the nationwide per capita trend gap increased during the past three decades,
even without considering pension or OPEB costs. The trend gap is even larger after adding pension and
OPEB funding requirements.

The nationwide per capita trend gap without pension or OPEB contributions was already above zero
during most of the 2000s, indicating that expenses were outstripping municipal revenue.

The full trend gap, including pension and OPEB obligations, reached over $1,000 per capita in 2010. This
means that the revenue-raising capacity of state and local governments fell short of the amount needed to
meet public service demand and fulfill long-term obligations by that amount.

The trend gap results differ from findings in earlier studies conducted by the Government Accountability
Office (GAO), which showed no clear trend in their measure of operating balance as a percentage of the
Gross Domestic Product (GDP) during the last three decades. The trend gap methodology results in a
different conclusion: the nationwide trend gap as a percentage of GDP increased over time, reaching more
than 2 percent of GDP in 2010.

While social insurance and income maintenance programs have been significant contributors to the
growth of the trend gap, pension and OPEB plans have also become increasingly important in driving up
expenditure levels.

In Summary: Trend Gap May Spur Further Corrective Action

To continue to track the impact of these programs on local and state fiscal sustainability, the authors
recommend that future studies employ the trend gap methodology, contending that utilizing the trend gap
measure provides a more accurate picture than existing measures of the fiscal sustainability of U.S. state
and local governments.

In the meantime, this may serve as yet another warning to state and local government officials that
pension and benefit funding requirements will not go away.

May, 2014

ABOUT THE AUTHOR. Mark Johnson, Ph.D., J.D., is a highly experienced ERISA expert. As a
former ERISA Plan Managing Director and plan fiduciary for a Fortune 500 company, Dr. Johnson has
practical knowledge of plan documents as well as an in-depth understanding of ERISA obligations. He
works as an expert consultant and witness on 401(k), ESOP and pension fiduciary liability; retiree
medical benefit coverage; third party administrator disputes; individual benefit claims; pension benefits in
bankruptcy; long term disability benefits; and cash conversion balances. He can be reached at 817-909-
0778 or

ERISA Benefits Consulting, Inc. by Mark Johnson provides benefit consulting and advisory services and
does not engage in the practice of law.