Local Govt. Debt $7.3 trillion

The Debt Bomb That Taxpayers Won't See Coming State and local governments owe $7.3 trillion in promises they've made that were never approved by taxpayers.

By STEVEN MALANGA

Earlier this month, the Securities and Exchange Commission charged Illinois officials with making misleading statements to bond investors about the state's pension system. The agency detailed a long list of deceptive practices including failure to tell investors that the system was so underfunded that it risked bankruptcy. Illinois taxpayers, as well as the holders of its debt, will ultimately bear the burden of the officials' misdeeds. But there is nothing unique about the Prairie State. For years, elected officials in states and municipalities across the country have been imprudently piling up obligations that are imposing serious strains on budgets, prompting higher taxes and cutbacks in services.

In January, city officials in Sacramento, California's capital, reported the results of a study they had commissioned on all the debt that the municipality had incurred. At a City Council meeting that the Sacramento Bee reported as "sobering," the city manager explained that Sacramento had racked up some $2 billion in obligations (mostly pensions and retiree health care). All this for a municipality of 477,000 residents with an annual general fund budget of just $366 million. Sacramento finances are already stretched—the city has cut some 1,200 workers, or 20% of its workforce, in the past several years. Servicing its debt in years to come will only add more woe, especially given the intractability of public unions. The budget report noted that "While reducing staff is clearly not the preferred method for reducing costs, the city has a very limited ability to reduce the cost of labor absent cooperation from the city's employee groups."

According to studies by the Pew Center on the States, states and the biggest cities have made nearly three-quarters of a trillion dollars in promises to pay for retiree health-care insurance. Yet governments have set aside only about 5% of the money they'll need to pay for these promises.

This year a Chicago city commission reported that retiree health-care expenditures would soar from $109 million in this year's budget to $541 million in a decade. After concluding that the expenditures were unaffordable, one member of the commission proposed that retirees be required to sign on to the Illinois Health Insurance Exchange being created under President Obama's Affordable Care Act. Health insurance would be cheaper if it is subsidized by the federal government. A December report by the States Project, a joint venture of Harvard's Institute of Politics and the University of Pennsylvania's Fels Institute of Government, estimated that state and local governments now owe in sum a staggering $7.3 trillion. Incredibly, the vast majority of this debt has never been approved by taxpayers, who are often unaware of the extent of their obligations. Most state constitutions and many municipal charters limit borrowing and mandate voter approval. No matter. Politicians evade the limits, issuing billions of dollars in municipal offerings never approved by voters, sometimes with disastrous consequences. Courts have rubber-stamped many of these schemes.

The debt incurred by New Jersey for school projects is a case in point. In 2001, legislators in Trenton hatched a scheme to borrow a shocking $8.6 billion for refurbishing school buildings. The reaction to their plan in the press and among taxpayer groups was so negative that the politicians knew that voters would never approve it. So the legislature created an independent borrowing authority.

Since it, and not taxpayers, would take on the debt, politicians claimed that there was no need for voters' consent. Taxpayer groups challenged the maneuver. The state Supreme Court brushed aside their objections, arguing that there was already precedent for such borrowing. New Jersey's Schools Construction Corp. quickly squandered half of the money on patronage and inefficient construction practices, so in 2005 the state borrowed another $3.9 billion. All of the debt is being repaid by taxpayers. The authority, which was dissolved several years ago, had no revenues of its own.

Next door, in New York, a scant 5% of the Empire State's $63 billion in outstanding debt has ever been authorized by voters, according to the state comptroller. The rest has been engineered through independent authorities such as the Transitional Finance Authority. These authorities are designed to circumvent voters. Of the seven bond offerings that have gone before New York voters in the past 25 years, four have been defeated. But thanks to unsanctioned debt, New Yorkers bear the second-highest per capita debt burden in the nation, $3,258, according to a January report by the state comptroller. New Jersey is No. 1, at $3,964.

To prevent the pile-up of hidden debt, taxpayers need to spearhead a revolt that will narrow the ability of officials to mortgage their future. Any such revolt will first of all seek an end to government sponsored defined-benefit pension plans, through which politicians promise benefits years hence to current employees in a manner that potentially leaves taxpayers on the hook for unlimited liabilities. Simpler, defined-contribution plans featuring individual retirement accounts would make government pension systems less expensive and their accounting more transparent. Similarly, reformers will have to rein in borrowing by independent authorities and other government entities created to circumvent current debt limits. No state or municipality should be allowed to issue any debt for which taxpayers are ultimately liable without voter approval. Without such reforms, many states risk becoming like Illinois, where a $7 billion tax increase in 2011 was largely gobbled up by rising pension costs, leaving the state with a $9 billion backlog of unpaid bills and the prospect of new taxes to pay off its $271 billion in debt.

This is a future in which rising taxes don't provide citizens new services but merely go to pay off hidden debts.

Source: Wall Street Journal, March 29, 2013, 6:28 p.m. ET Mr. Malanga is a senior fellow at the Manhattan Institute. This column is adapted from a forthcoming issue of City Journal, where he is a senior editor. A version of this article appeared March 30, 2013, on page A11 in the U.S. edition of The Wall Street Journal, with the headline: The Debt Bomb That Taxpayers Won't See Coming. http://online.wsj.com/article/SB10001424127887324077704578362101467799948.html?mod=WSJ_hp_mostpop_read