Merry Fiscal Christmas!

by John McClaughry 

John McClaughry

The good news is that Vermont still has its AAA bond rating, one of only nine states to be so favored. The bad news, of course, is that the three private agencies that bestow these coveted ratings are the same agencies that cheerfully rated securities backed by toxic mortgages as ultrasafe investments in the run-up to the financial collapse of 2008.

In recent months the three increasingly nervous agencies – S&P, Fitch, and Moody – have begun to be a lot more critical of shoddy financial instruments and unpayable sovereign debt. Last month S&P announced that almost all of the European Union countries have been put on “credit watch”, the first step to a rating downgrade.

That doesn’t suggest that Vermont’s bonds are likely to be downgraded any time soon. It has happily been an article of faith in Vermont from time immemorial, among liberals and conservatives alike, that the first untouchable item in any state budget is funding to cover debt service.

On the other hand, the state’s inability to back off its ever more ambitious spending programs can’t help but raise question about just how sound Vermont’s long term finances are.

The nonpartisan Illinois-based Institute for Truth in Accounting has just come out with a glossy report entitled The Financial Health of the States. It focuses on the assets each state has to cover its obligations, as reported by the states for fiscal year 2009.

For that year, Vermont reported liabilities not related to capital assets of $5.1 billion, of which only $584 million came from state bond issues. But ITA’s researchers identified $2.6 billion in additional liabilities, off the balance sheet. These are largely the result of unfunded pensions and retiree health benefits for the state employee and teacher retirement systems.

The state’s accountants may object to ITA’s methodology, which showed Vermont to be the 18th weakest among the 50 states. But the ITA report does raise troubling questions.

Buried in the state’s 2010 Comprehensive Annual Financial Report is the news that unfunded accrued liabilities for state employee pensions is $294 million, and for teachers, $712 million. Worse yet, the unfunded accrued “Other Post Employment Benefits” (OPEB, mainly health insurance) for state employees is $917 million, and for teachers, $703 million.

The state’s annual contribution for state employee OPEB is running at 39 percent of the Actuarially Required Contribution, the amount needed to pay annual benefits and eliminate the unfunded liability by 2031. There is no annual state contribution to cover those liabilities for retired teachers. Their OPEB benefits are just deducted from their pension fund, which is only 67 percent funded. (The state employee fund is 81% funded.) Not yet a disaster, but not good.

Another eyebrow raising fact is that the state’s actuaries are assuming that the pension funds will earn a 7.9 to 8.1 percent a year long term return on their investments. With 10-year US Treasury bonds yielding 2 percent, one has to wonder just what sort of investments the fund managers will be buying to produce that dazzling yield.

Another troubling consideration is that the Government Accounting Standards Board (GASB), that establishes reporting standards for state and municipal finances, has announced that it will soon require states to report “net pension liability”. This will drag out into the open the extent to which a state has shortchanged its pension and OPEB funds (Vermont: $2.6 billion). The new rule will also force a more realistic assumed rate of interest on pension fund investments, which will increase annual required contributions.

The state faces sizable ($100 million) expenditures for Tropical Storm Irene recovery, plus the ever growing Medicaid budget burden, plus a limping economy, plus a steady aging of the working age population, plus a constant migration of upper income taxpayers to more friendly tax climes.

Vermont may keep its AAA bond rating for several more years, until somebody notices that it has imposed $3 billion in new payroll, income and sales taxes to pay for Gov. Shumlin’s enthusiasm for ever larger government, Green Mountain Care.

Unless those huge new taxes to pay for single payer health care somehow produce an equally huge revenue-producing economic boom – does anybody really believe that? – the Shumlin years may turn out to be, putting it very mildly, a fiscal disappointment.

John McClaughry is vice president of the Ethan Allen Institute (