I would like to address some of the common questions and criticisms we receive about our annual Financial State of the States and Financial State of the Cities reports.
Q. Why do you include unfunded pension obligations as a current liability when the government has a plan to pay them off over time in the future?
Each pay period government employees earn their compensation. Part of the compensation is salaries which are paid each pay period. Another part of this compensation earned is the right to receive a pension. Each year the employees earn a portion of their pensions and the government incurs a related expense and related liability. Most governments choose to fund at least some of the pension benefits earned each year by depositing money into pension plans. A government has an unfunded pension liability to the extent it chooses not to fund all of pension benefits earned. But just because the government has a plan to fund the benefits in the future, doesn’t mean the liability does not exist.
Another way to think about this is to compare it to a credit card. I may charge my purchases to my credit card, but just because I choose to pay them off in the future does not change the fact I have an outstanding credit card balance.
One more way to think about this situation is from the perspective of future taxpayers. When an employee retires, he or she will no longer provide services to the taxpayers. By not funding the entire pension benefits earned, the government is burdening future taxpayers who are paying taxes for the retiree’s pension even though that individual is no longer providing these taxpayers with any services.
Q. The government can change or cancel retiree health care benefits, and we pay these benefits on a pay-as-you-go basis and change them at anytime, so why are you including these as bills in your analysis?
Like pension benefits, employees earn the right to receive retiree health care benefits each year, and the government incurs a related expense and liability. Our analysis includes the amount of unfunded retiree health care benefits due under current law and/or contract as of the date of our analysis. At the time the government decreased the retiree health care benefits promised employees, the related liability would be reduced in our analysis.
Q. Truth in Accounting is giving us a low grade, but the credit rating agencies are giving us a high grade.
Credit ratings focus on bonds, which tend to be of higher priority than most other obligations. In other words, bonds get “paid first.” So as long as the rating agencies believe the government will collect, or can collect, enough taxes to pay the bond payments, the government will have a high credit rating. The credit ratings are mostly concerned about the risk to the bondholders.
Truth in Accounting’s grading system is rooted in our holistic perspective on government finance. Our grade is based upon the government’s overall financial condition. We care about the big picture and the risk to the taxpayers.
Most governments have a balanced budget requirement, which logically means they should not be incurring any non-capital debt and should not be burdening future taxpayers with bills incurred in the past. Therefore we give a government a passing, “C” grade if there is proof the government has been meeting its balanced budget goal. Evidence of this is the government has no “money needed to pay bills and a small Taxpayer Burden. We do give governments a little bit of a break by awarding governments with a Taxpayer Burden of less than $5,000 a “C.”