How Big is California’s “Wall of Debt”?

When California Governor Jerry Brown unveiled his latest state budget, he explained that as the budget begins to generate surpluses, the state will finally begin to dismantle the “Wall of Debt” that has been accumulating. Whether or not Gov. Brown’s budget will generate surpluses, this year or any time soon, is an open question. But just how much debt is there?

The first thing to remember when considering California’s debt is that the only meaningful number is the combination of state and local government debt. Because some states have relatively centralized government functions, and others devolve most government services to the localities. California is one of those states that has a relatively decentralized system of state and local governance, and Gov. Brown’s actions – such as his transferring responsibility for tens of thousands of state prison inmates to County correctional institutions – increase this tendency.

For example, in a recent study released by the California Public Policy Center (CPPC) entitled “The California Budget Crisis – Causes and Recommendations,” there is a chart that amalgamates all state and local government spending (chart 2). This chart shows that in the last fiscal year, only $47.5 billion was retained by the state government for direct expenditures. Everything else flowed through to cities, counties, and local agencies. These local expenditures totaled $242 billion, more than five times as much.

Another vital consideration when calculating debt is to correctly define it. Because the number Brown used, 34.7 billion (ref. California Budget Plan Introduction, Figure 3), only referred to short term borrowing by the state. “Deferred payments to schools,” “Loans from Special Funds,” “Unpaid costs to local governments,” “Borrowing from local government,” “Deferred Medi-Cal Costs,” “Deferral of state payroll costs,” “Deferred payments to CalPERS,” “Borrowing from transportation funds,” etc.

This is not the whole “Wall of Debt.” This is just the short-term payables incurred by the state government. What about bonds? Isn’t that money owed by taxpayers? Again referring to the recent CPPC study, on chart 9 there is a listing of known state and local debt. The primary components are State General Obligation Bonds totaling $80.7 billion, Local General Obligation Bonds totaling $177.6 billion, and Trust Fund Loans of $28 billion. In all, this long-term borrowing adds another $286.3 billion to California’s Wall of Debt.

Further adding to California’s Wall of Debt are the “unfunded” retirement pension and health care liabilities. One may argue that the entire future pension and health care liability is not truly debt, because future revenues will fund future obligations. But by any generally accepted accounting principle, the unfunded portion is debt. This is because to the extent the liability incurred for future pension payments is for work already performed – i.e., to the extent these future pensions have already been earned – there must be sufficient funds invested to cover 100% of the eventual payments due. And using the state’s own numbers (ref. California Budget Plan Introduction, Figure 4), the unfunded pension and health care liability adds another $181.2 billion to California’s Wall of Debt. But it’s likely much more.

First of all, the $181.2 billion of debt recognized in Brown’s budget plan does not include unfunded pension and health care debt incurred by any of California’s cities or counties who do not participate in either CalPERS or CalSTRS. Since these two biggest pension funds only cover about two-thirds of California’s state and local government workers, you have to increase this officially recognized unfunded amount by 50%, which adds another $90 billion to the tab. Next, as exhaustively analyzed in a 2011 study authored by Stanford Professor (and former Assemblymember) Joe Nation, entitled “PENSION MATH: How California’s Retirement Spending is Squeezing the State Budget,” if the rate of return on investment currently used by the major pension funds is dropped from 7.5% to 5.5% or even 4.5%, the size of these unfunded liabilities could increase by another $200 to $300 billion.

To summarize, here a very rough estimate of the real “Wall of Debt” confronting California’s taxpayers:

• $34.7 billion for short-term borrowing by the state
• $30 billion for short-term borrowing by local cities, counties and agencies (very rough estimate, probably conservative)
• $80.7 billion for State General Obligation Bonds
• $177.6 billion for Local General Obligation Bonds
• $28 billion for Trust Fund Loans
• $181.2 billion for unfunded retirement and health care liabilities – CalPERS & CalSTRS participants only
• $90 billion for unfunded retirement and health care liabilities – independent pension plan participants
• $250 billion – impact of lower investment returns on retirement pension funds (quite likely a conservative estimate)

Grand total:   $872 billion, or $23,000 per California resident, or $87,000 per California household.

It is important to emphasize that even using official estimates, about half of the total state and local government debt in California is to fund retirement benefits to government workers. And for anyone who is skeptical that it may be necessary to recognize (and eventually pay) an additional $250 billion in unfunded retirement health care and pension liabilities for California’s state and local government workers, please review the new GASB accounting regulations and the new Moody’s credit rating criteria, both set to take effect in 2014.

When Gov. Jerry Brown suggests that California’s state government is positioning itself to eliminate the so-called “Wall of Debt,” he’d be well advised to consider just how big that wall really is – especially when you remember that the only meaningful calculation of how much California state taxpayers owe must also include the amounts they owe its local governments.