Retiree health care debt: Brown and his accounting loophole

A physician flanked by the California flag. (Illustration: Niyazz, via Shutterstock).

Imagine your friend built up $10,000 of debt from buying Christmas presents on credit. When he announces an intention to eliminate that debt, you ask how. He answers that, from now on, he’s going to purchase Christmas presents only with cash. Confused, you ask, “How do you pay off debt by not incurring more debt?” His response: “I don’t know, but my accountant says it works!”

Believe it or not, that is the proposal California Governor Jerry Brown just made to eliminate $72 billion in state retiree health care debt. That debt is the result of promises the state makes to employees to cover their health care costs after retirement. Because no money is being set aside when the promises are made, debt is being created. The cost of meeting that debt is one of the state’s fastest growing expenditures.

Brown’s proposal would require money be set aside when new promises are made. That’s known as “pre-funding,” which means contributing money to an investment fund when the promise is made so that, with investment earnings, there should be enough money in the pot when the promise comes due. That’s a very good idea, and Brown deserves credit for proposing it.

That truth is that the pre-funding of new retiree health care promises does nothing to eliminate existing retiree health care debt.

But his proposal does not eliminate or reduce existing debt. For that to happen, the state would have to do much more. For example, a recent study from Stanford University predicts states could save over $100 billion over ten years from moving employees to the Affordable Care Act.

Why would Brown claim his proposal eliminates existing debt? The answer is that Brown’s accountant told him it works. By prefunding new promises, Brown hopes to gain the benefit of an accounting loophole that allows governments to shrink the reported size of such obligations. In fact, it’s the same loophole that got California into its pension mess.

As with most accounting loopholes, innocent people get hurt when the truth is ultimately revealed. For example, before 2008, accounting rules allowed AIG to understate its debt obligations. When housing prices declined and the obligations were called, their real size was exposed, leading to AIG’s failure and a financial crisis. Similarly, the accounting loophole Brown seeks to use for retiree health care allowed California to report its pension liabilities at less than zero in 1999, but since then the state has had to spend more than $35 billion on pension costs and a $45 billion pension debt remains. In other words, a debt that was magically reported at less than zero 15 years ago has ended up costing taxpayers more than $80 billion.

The good news is that, even though accounting loopholes permit magical outcomes, institutions can still elect to tell the truth. AIG could’ve disclosed its obligations earlier and the Brown administration could disclose the truth regardless of what the loophole permits. That truth is that the pre-funding of new retiree health care promises does nothing to eliminate existing retiree health care debt.

Californians need services, not accounting maneuvers. State revenues are nearly 25 percent above pre-recession levels but many services are being funded below pre-recession levels or at much lower growth rates. That’s because increased spending on entitlements, salaries and retirement benefits, including retiree health care debt, is crowding out those services. Gov. Brown should be applauded for proposing the pre-funding of new retiree health care promises but he should not claim his proposal would eliminate existing retiree health care debt. For that to happen he needs real, not magical, measures.

Ed’s Note: David Crane is a lecturer and research scholar at Stanford University and president of Govern For California. This commentary originally appeared in the San Jose Mercury News.

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