Interest Rates have been at historic lows since the start of the recession and now there are rumblings from those on Wall St and other financial gurus that they will start to creep up. But, has anyone thought about the ramifications of an increase in rates on governments at the state & local levels?As investors know, interest rates and prices work inversely; if one goes up, the other goes down. Because of this relationship, when interest rates increase, home prices, historically, have gone down. This creates a significant problem for state and local governments because, according to the Census Bureau, the largest source of revenue for states and local governments is Property Taxes.
If home values decrease due to rates increasing, the unfortunate consequence is less tax revenue for state and local governments. These government entities have few options. They could increase the rates on Property taxes and Sales taxes, and even Income taxes (depending on state), but what will be the ramification be on their local economies?
It really comes down to a roll of the dice. Right now, most state and local governments cannot afford to hit snake eyes since they know there is even a bigger problem on the horizon – Their employees heading to retirement! State & local governments have an obligation to their employees when they retire, in the form of pensions and healthcare benefits, and those obligations are getting bigger by the day.
According to the Pew Research Center, in its June 2012 “Widening the Gap Update”, the reported underfunding of obligations in public sector retirement plans was close to $1.38 TRILLION and growing. Although this problem is reaching a crisis point, it seldom receives any attention even though everyone understands that it exists. It has truly morphed into being the “elephant in the room” which everyone is trying to ignore – regardless of political leanings.
The frustrating part of this problem really isn’t about providing retirement income for employees, as most state and local governments have done a somewhat decent job of funding those obligations. In fact, The Pew Center is reporting that at least 16 states are at 80% or higher when it comes to funding their employee pension plans. Only 2 states, Illinois & Rhode Island, are under 50% funded. All of the remaining 32 states are somewhere between these two numbers and they still have a little bit of time.
The primary reason why the problem is so frustrating is the true cause of the situation, which happens to be the amount required to fund future retiree healthcare costs. In the same report, The Pew Center stated that in 2010 alone, “states should have set aside nearly $51 billion to pay for these promises in the 2010 fiscal year, but they contributed just over $17 billion or about 34 percent of what was annually required”.
The Pew Center went on to conclude that instead of a double digit amount of states properly funding their healthcare obligation, not one was even close to it!! In fact, of all 50 states, not one was even close to being 80% funded and only two are above 50%. Fifteen states are in the single digits, 19 of them were at 0% and one, Nebraska is N/A.
The only “highlight” in 2010 was Arizona, which made a 100% contribution into its fund for that year, yet still remains at only 69% of its fully funded obligation. The only other state to be over 50% is Alaska, and it’s exactly at the 50% level.
With respect to health care obligations for future retirees, the argument being made by the states is that “most pay health care costs or premiums as retirees incur those expenses”. Thus, begging the question as to whether this a recipe for disaster or reasonable justification – Especially if we factor in increasing in interest rates? Most experts would probably agree it’s a recipe for disaster, even if rates stay the same; the reason, very simply, is demographics.
Currently, there are about 76 million Baby Boomers approaching retirement, doing so at a rate of approximately 10,000 per day. Unfortunately, the generation expected to pick up the slack, Generation X, most likely won’t be able to handle the burden due to simple demographics. It’s important to understand that Gen Xers are, unfortunately, a much smaller demographic group than the Boomers. Estimates peg the total at about 60 to 62 million, or 14 to 16 million less than the Boomers.
As a side note, this shortfall just happens to be in line with the number of people who are in the country illegally, to whom Congress would like to grant amnesty too.
So, with a smaller population of Gen Xers to buy homes and simply spend money, who will provide the required state and local government revenue to keep up; especially if/when interest rates tick up? No one can answer this question, likely leaving state and local governments dependent on a handout from the federal government. Then, if this occurs, will the dollars come in the form of a loan with or without strings attached?
As stated previously, the financial gurus and those in the media are all predicting an increase in rates in the near future. However, few of them have really considered the ramifications of this rate increase at the state and local level. As 76 million Boomers head towards retirement, all of them will incur some level of expenses for their health care. Thus, the greatest threat to Boomers in retirement will be healthcare costs…..and all but a handful of financial firms, including Jester Financial, are even discussing this planning topic with them.
What chance do we really have if an industry that makes it’s living on helping people plan for life’s uncertainties, WILL NOT help those same people plan for life’s certainties?