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As debt crisis looms at state level, Illinois identified as a ‘sinkhole’

NEW YORK NY - AUGUST 12:  Traders work floor New York Stock Exchange (NYSE) just before closing bell August

NEW YORK, NY - AUGUST 12: Traders work on the floor of the New York Stock Exchange (NYSE) just before the closing bell on August 12, 2011 in New York City. Global markets have continued to rise and fall throughout the week as conflicting news emerges about the health of the global economy. Stocks were up nearly 126 points at the end of the trading day trading on the NYSE. (Photo by Spencer Platt/Getty Images)

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Updated: May 3, 2013 12:15PM



U.S. debt has been downgraded, and a budget deal is left to a “supercommittee.” The world holds its breath to see if Greece, Italy, Spain or Portugal will default and destroy the Euro. China is letting its currency rise, making exports more expensive. Americans have lost confidence in the economy amidst bankruptcies and foreclosures.

What else could there be to worry about in the world of money and finance? Well, there’s one more catastrophe waiting to happen.

The disaster revolves around the overwhelming, and mostly hidden, financial woes of many states.

Since states don’t have the option of “printing money” — an option that gives some breathing room to the United States and the European community — state budgets are coming to grips with huge shortfalls. This, despite the fact that 49 of the 50 states have balanced budget amendments.

According to a new report just released at TruthinAccounting.org, the states have used accounting trickery to conceal a total of $1 trillion of outstanding bills. The report identifies five “Sinkhole” states and five “Sunshine” states. Truth in Accounting is a national, non-profit advocacy group dedicated to “promoting honest, accurate and transparent accounting.”

Truth in accounting

This new report charges: “State officials permit themselves the use of antiquated accounting principles — and almost no rules with regard to budgets. The institute’s study found balanced state budgets are largely a myth. This fantasy accounting, along with the political math necessary to claim state budgets have been ‘balanced,’ is why states with balanced budget requirements are accumulating very large debts and deferred liabilities.”

Sheila Weinberg, founder and CEO of the institute, says: “State officials say their budgets are balanced, but do not include employee pension and health care obligations in their calculations.”

Eventually, these obligations will fall on taxpayers. So instead of comparing states by overall debt, or just comparing the amount of unfunded pension liability, this report compares states by the “taxpayer burden.”

On that basis, the report identifies Connecticut, New Jersey, Illinois, Hawaii, and Kentucky as top debtors — each with more than $23,000 in debt per taxpayer. On the positive side, Wyoming, North Dakota, Nebraska, Utah and South Dakota are considered “Sunshine States” — because they have either a surplus or minimal taxpayer burden.

Illinois among the worst

The report explains that Illinois has $55 billion worth of assets (defined as both financial assets, and also including state parks, for example), but less than $19.6 billion is available to pay $130.2 billion of bills as they come due. Each taxpayer’s financial burden is $26,800.

How do they get away with it? In addition to not including pension obligations tied to current compensation in the annual budget, the report condemns Illinois because, according to the report: “Illinois habitually delays issuing its year-end financial report until after the next fiscal year’s budget process has been completed. That prevents citizens and public officials from having important information, leading to less-than-optimal public policy decisions.”

How will those gaps be filled? States have already tried raising income taxes, sales taxes, corporate taxes, property taxes, lotteries and, more recently, even legalizing gambling. But one way or another it will come out of the pockets of workers and employers.

Accounting legerdemain

States are getting away with this financial legerdemain, despite their balanced budget amendments. Here’s how the report explains it:

“To put an end to budget shenanigans, the institute has developed a budgeting system called ‘Full Accrual Calculations and Techniques’. FACT based budgeting would require governors and legislatures to recognize expenses when incurred regardless of when they are paid. We believe that if FACT based budgeting had been used by state governments over the past 50 years, the states would not be in the financially high risk conditions they are now in.”

Or to put it in non-accounting language we can all understand: A debt is a debt. Whether it is required to be paid now or in the future, you still owe the money. And you must acknowledge that.

To do otherwise is to think that your $5,000 Visa bill is not your debt, because your current required payment is only $37. It all depends on what you count!

Making the move

This report is certain to be picked at by doubters. For example, the burden of public aid in states like Wyoming and North and South Dakota is certainly lower than in states with major metropolitan areas like Illinois and New Jersey. Where do you want to live?

Ironically, many of the states with the largest debt burden already have relatively high tax structures — meaning it will be even more difficult to fill the gap. But they will try. And eventually you could find the most productive people moving out of high-tax states to those with lower rates.

Most famously, economist Arthur Laffer (of the Laffer curve, which explained why higher tax rates eventually bring in lower revenues) actually moved his family and business from high-tax California to no-state-tax Tennessee! That’s actual proof that higher taxes do have consequences — for those individuals and businesses flexible enough to move.

This report pulls back the covers on state debt burdens. Hiding state budget deficits will only make the problem worse. We’re going to pay — one way or another, and one day or another. And that’s The Savage Truth.

Terry Savage is a registered investment adviser.



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