Texas performs relatively well in measures of financial stability by ranking 16th nationwide in fiscal health and 2nd lowest in state debt per capita among the top 10 most populous states. These rankings along with historically high growth rates in economic output and population (see Chart 1) indicate that Texas has remained steadfast in having sound fiscal management. However, a recent TPPF paper shows that there are increasingly troubling signs of fragility in the state’s fiscal position.
Chart 1: Texas’ Economy has Performed Better than Many States in Last Decade
Source: ALEC
These signs of a rising burden of state liabilities (i.e., state debt and public pensions) could cost taxpayers billions of dollars without key reforms.
State debt outstanding, which is just the principal, amounted to $49.8 billion at the end of fiscal year (FY) 2016. While this amount is small compared with the $1.7 trillion economy, it has increased by 52.7 percent per capita since FY 2006 and is up to $1,790 owed per every man, woman, and child in Texas.
Debt outstanding tells only part of the story because the interest owed on this debt is also a taxpayer expense. Total debt service outstanding, which includes the principal and interest owed, is $80.8 billion, meaning every Texan owes roughly $3,000!
If these trends continue, they could jeopardize Texas’ AAA credit ratings by all three major credit rating agencies and raise the debt burden on taxpayers.
To reduce this concern, we recommend increasing debt transparency by requiring the following information on ballot propositions for voter approval of issuances of GO state debt: total debt service required to pay the proposed debt on time and in full and an estimate of the proposed debt’s influence on the average taxpayer’s taxes, as recommended for local debt.
Although state debt is a problem that must be addressed, the elephant in the room is state pensions.
Chart 2 shows the two largest state pension systems, Employees Retirement System (ERS) and Teachers Retirement System (TRS), with their estimated 8 percent annual return and the eight state debts with the highest computed compounded annual growth rates.
Chart 2: Prioritizing Liability Payments by Compounded Annual Growth Rates in 2016 (Thousands of $)
Sources: Texas Bond Review Board and Texas Comptroller and authors’ calculations
Volatile annual rates of return and fewer contributors paying for more beneficiaries are exhausting these defined-benefit (DB) plans. Assuming a less risky average 15-year Treasury rate of 2.3 percent compared with today’s 8 percent assumed return rate, Williams et al. estimate that unfunded liabilities for all of Texas’ state pensions of $360 billion ranks 3rd highest nationwide and of $13,120 per person ranks 14th lowest.
To alleviate this mounting state pension issue, we recommend changing these pension systems from DB plans to defined-contribution (DC) plans, whereby payments would be based on employee contributions and a defined government match with little to no transaction cost and the benefit of sustainability without higher taxes.
Finally, given the low computed compounded growth rates of state debt in Chart 2, we recommend that surpluses of state revenue be used to cut taxes before paying down state liabilities. This could be done by creating a budget-cutting tool called the Sales Tax Reduction (STaR) Fund or eliminating the state’s business margins tax. These tax cuts would help avoid leaving revenue unchanged for future spending.
Implementing ballot box transparency for state debt, converting public pensions to defined-contribution plans, and prioritizing state surpluses to cut taxes will help lower the burden of state liabilities on taxpayers.