Hidden Expenses In California’s Budget

First in a Series: $2.3 billion Of Undisclosed OPEB Expense

A year ago, Governor Brown listed the state’s Retiree Health liability at $71.8 billion (see page 3 here). This year he lists that liability at $74.1 billion (see page 8 here). How did the state incur $2.3 billion of new debt without disclosure or voter approval? The answer: by not funding some expenses.

Retiree Health (otherwise known as “OPEB,” for “Other Post-Employment Benefits”) is a promise made to state employees to cover their post-retirement health care costs. Like pension promises, OPEB promises are supposed to be funded at the same time employees provide services so that the costs are borne by the citizens who receive the benefit of the services. If not, the costs plus interest are borne by citizens who didn’t get the benefit.

For a sense of how OPEB debt is created, read the State Controller’s OPEB Valuation report here. Unlike General Obligation bond liabilities that must be disclosed and approved by voters, the creation of OPEB liabilities is undisclosed and unapproved. That’s because states like California employ a cash-based form of budgeting that allows them to avoid recording expenses simply by not paying them. Unpaid, the expenses automatically become debt. States could elect to report the unpaid expenses in their budgets but not surprisingly, governors don’t jump at opportunities to add expenses to their budgets. Governor Brown is no exception. That’s how $14 billion* of OPEB debt has quietly been created since he took office in 2011.

At $74 billion, California’s OPEB debt is now nearly equal to the state’s $75 billion of General Obligation Bond debt. Because OPEB debt attracts interest at 4.25%, $74 billion of OPEB debt will translate into the crowd-out of ~$150 billion of services. You can see the progression of OPEB expense on page 128 of Governor Brown’s most recent budget. The ramp up is slow to start but because of the size of the debt and the waterfall nature of California’s budget, the negative consequences for discretionary programs are huge.

Solutions are difficult and made more difficult every day of delay. At a minimum the state budget should disclose costs whether paid or not. That way legislators can see how much money they must save. The state could also look for less expensive ways to provide retiree health care. One option — potentially unavailable if Congress does away with exchanges and credits under the Affordable Care Act — is to move beneficiaries to Obamacare exchanges. Other options include reducing benefits, though state employees didn’t cause this problem and rightfully expect promised benefits to be paid. Either way, legislators should press for truthful budgeting.

*The state had $60 billion of OPEB debt when Brown took office in 2011 (see page 5 of this report). NB: the $74 billion figure is as of June 30, 2015, more than 18 months ago. More OPEB debt has been created since then.

NB: This essay explains how state and local governments are ignoring unpaid OPEB costs in their budgets. State and local governments in California already account for OPEB on their balance sheets. The consequences are very different. Eg, some local governments are already affected by the inclusion of OPEB debt on their balance sheets because the existence of that liability can affect demand for their bonds. On the other hand, the state can largely issue bonds without worry about the growth of its OPEB debt in part because, unlike local governments, states may not declare bankruptcy (that means creditors don’t have to worry about a bankruptcy court discharging or modifying the obligation) and, as explained here, debt service on the state’s General Obligation Bonds is senior in the “waterfall” of revenues. The key point is that in both cases the governments are ignoring the budgetary impact of not paying the full cost of OPEB.