Maine State Senator Peter Mills





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Articles By Peter Mills

A Broader View of Maine's Public Debt

Background

Many legislators and most citizens are completely unaware of the state's major liabilities. If Maine were a private corporation, one wonders how its stock could be traded on any regulated exchange. It is so difficult to find balanced and complete information about the scope of the state's future obligations.

Presentations on debt from the administration and the treasurer are often designed to lull legislators into issuing more bonds to suit their respective interests. Treasurers like debt because it makes the job more important. Governors like it because it allows them to spend money without raising taxes in the current term.

When Maine became a state, the Constitution was adopted without any apparent restrictions on public debt. Thereafter, "In the freewheeling era of the 1830's and 1840's, railroads and canals underwent rapid expansion. Private investment capital was often inadequate, and many states borrowed money to fill the breach, using the public credit. A series of failures of those speculative ventures led to adoption in most states of constititutional limitations on state borrowing, including prohibitions against 'loans of state credit.'" Common Cause v. State of Maine, 455 A2d 1, at 28 (Me. 1983) (Justice Godfrey).

As part of the national reform movement, Maine voters in 1848 adopted a balanced budget amendment to our Constitution prohibiting the state from borrowing large sums of money without passing the measure by a 2/3 vote of the legislature followed by approval from voters. (Article IX, 14.)

Government Facilities Authority

In 1998, on the 150th anniversary of Maine's balanced budget amendment, the legislature borrowed $143 million by majority vote without public approval (See 1997 PL Chapters 643 DD, 752 & 788). This was done by authorizing moral obligation bonds through an entity called the Government Facilities Authority (the "GFA"). In 1998 the money was used to build new prisons and to renovate the State House complex. The record surplus of that year was spent on other things and a separate package of conventional "general obligation" bonds ("GO" bonds) was also passed and sent out to the public.

GFA bonds are technically unenforceable in the sense that no subsequent legislature is legally required to pay them off. Because they are not passed by a 2/3 vote of the legislature and are not approved by voters, they do not carry the "full faith and credit" of the state. Although the GFA statute authorizes the state to grant a mortgage to bondholders on the structures being improved, that form of security is neither needed nor used. (Picture a bank trying to foreclose on Warren Prison or the State Capitol.) It is the market that makes GFA bonds enforceable. If a subsequent legislature ever skipped a payment on one of these bonds, it would destroy the state's credit rating and elevate interest rates to intolerable levels. It is this economic and moral threat that makes GFA bonds saleable. The bond market knows how to take care of its own.

It also makes it possible for any legislature to spend money it doesn't have and pass the debt onto later lawmakers. Because GFA debt is supported only by annual appropriations, it can be incurred by a simple majority of those present and voting on any given day that the legislature has a quorum. With the advent of term limits, present legislators may freely run up bills knowing that it will be their successors who must find a way to pay for them.

While most GO bonds (including highway bonds) are issued for only 10 years, GFA bonds are issued for 20 years. Partly because the payback is so slow, the balance owed by the GFA has grown every year since it was first created. On June 30, 2004, the balance was $198 million. Part S in the present budget proposes to issue $9 million in new GFA bonds for undesignated repairs and improvements.

The GFA gives each legislature the power to make the next ten legislatures pay off the debts that it creates. This is, in fact, how the GFA is used.

The Unfunded Actuarial Liability

The largest state debt of all is the unfunded actuarial liability (the "UAL") owed to the Maine State Retirement System (MSRS). Although MSRS has $6.3 billion in trust to pay pensions for state employees and teachers, another $3 billion is necessary to fund existing promises. Our pension funding ratio is 68%, much lower than most other states. By constitutional amendment (Art. 9, 18-B passed in 1995), this debt must be paid by June 30, 2028, a remaining term of 23 years.

The state's required contribution in FY 2006 for state employee and teacher pensions is $260 million, roughly 10% of the general fund budget. A major portion of this payment, about $160 million, is for the unfunded liability. Although this is much greater than the $120 million we spend annually on GO and GFA bonds, the UAL payment is seldom counted as debt service.

At various times in recent years, the state has contributed more money toward the UAL than is required by the Constitution; but last term the Baldacci administration reverted to the longest allowable amortization schedule, and Part S of the current budget proposes to remain there.

In 1999, the state relinquished its power to diminish accrued pension benefits for state employees and teachers. Changes to the pension system may now be applied only to salaries not yet earned. For state employees in so-called "special plans" (primarily law enforcement officers), pension rights have been significantly increased in recent years.

Retiree health insurance

The second largest state debt, approximately $1.2 billion when last calculated in 2003, is the amount owed to fund health insurance premiums for retired teachers and state employees. Maine pays 100% of the premium for state retirees, 40% for retired teachers and nothing for their family members, although dependents are allowed to participate in the plan at group rates.

In 1999, Governor King created the Retiree Health Insurance Fund to begin chipping away at this unfunded obligation. By early 2004, the fund had a balance of $88 million. During the 2004 session, this entire sum was withdrawn and expended by the Baldacci administration in supplemental budgets.

As the reserve fund was being spent, the Maine State Employees Association persuaded Democrats to insert into a supplemental budget -- without any public notice or hearing -- a measure guaranteeing to vested state workers that the state will continue to pay 100% of the premium for retiree health benefits; and the package itself is guaranteed never to be less than the benefits afforded to active employees. This deprives the state of most of its flexibility to manage these rapidly accruing, unfunded costs. (See 2003 PL Chapter 673, Part DDDD). While most of corporate America is reducing or eliminating health benefits for its retirees, Democrats in the 121st Legislature voted to foreclose such options for the people of Maine. This single measure, buried in a partisan budget, may have had greater financial significance for future Maine taxpayers than the entire value of all outstanding general obligation bonds.

Although money is no longer being set aside toward the 1.2 billion dollar future cost of insuring public retirees, Part X of the Governor's current budget proposes to raise the state's premium contribution for retired teachers from 40% to 45%. Teachers may well deserve such consideration, but there are no funds in the budget to pay for the next 75 years of ensuing premium augmentation. When the teacher contribution was last increased from 35% to 40% on July 1, 2003, the discounted actuarial cost of the increase alone was valued at $44 million. Only the biennial current cost (about $2M) was paid by the legislature that extended the benefit.

On a pay-as-you-go basis, the state contributed about $48 million per year in FY 04 to pay health premiums for retired state employees ($38M) and teachers ($10M). The FY 06 budget projects the total cost at $76 million, $15M for teachers and $61M for retired state employees. If the state's future liability had been funded on an actuarially sound basis in FY 04 and beyond, the total bill would have been $154 million in FY 04. By contributing only the pay-as-you-go amount, the state fell behind by more than $100 million in FY 04 and continues now to fall back by even greater amounts as retiree medical costs continue to rise. This is on top of having dissolved the 88 million dollar reserve fund in 2004.

Workers Compensation

The state pays about $10 million per year in workers compensation losses on a pay-as-you-go basis with no reserves for future benefits. However, since enactment of the 1992 WC reform law, the unfunded liability for comp claims has been steadily dropping and is presently estimated at between $50 million and $60 million, down from $62 million as of June 30, 2003. During the King administration, surpluses were set aside to resolve some of the older and more expensive cases, thus reducing the need for reserves.

Liquor "sale"

In the 2003 biennial budget (Chapter 20, Part LLL), the state's wholesale liquor business was privatized and sold off for $125 million. Although this alleviated the state's budgetary shortfall in the last biennium, we are now losing $26 million to $30 million per year in liquor revenue and will not gain it back again until June 30, 2014, when the liquor lease finally returns to state control.

Lottery factoring

Having sold off ten years' of wholesale liquor business for $125 million, the Governor now proposes to borrow $250 million more in a revenue bond secured by lottery sale proceeds. At 8% interest, with deferred payments on principal, this may deprive the state of up to $40 million per year in lottery revenue for ten years. The Governor proposes to sell the lottery bond to the Maine State Retirement System, but MSRS is unsure whether such self-dealing would jeopardize its tax exempt status. If MSRS can buy the bond, MSRS will have to charge at least 8% to match the minimum return it seeks on other investments. If the state floated the bond in the regular bond market, the rate could be reduced by half but the profits would accrue to the private sector rather than to the MSRS.

Hospital Medicaid payables

Under Medicaid, hospitals are paid a provisional interim payment ("PIP") every week. Because PIP is calculated on the basis of historical usage and cost, PIP payments are usually behind the amount actually owed. Even though the amount owed is calculable within a few months after the close of each hospital's fiscal year, the state simply does not pay the balance until years later.

The accrued balance due to hospitals has been growing steadily in recent years both because more people are covered by Medicaid and because Medicaid beneficiaries are increasing their use of services. The backlog of money owed to hospitals at this time is approximately $200 million in state and federal funds. The state share is about $70 million. Because Maine's federal match rate for Medicaid was reduced in October of 2003 and will be reduced again in October of 2005, our delay in paying the hospitals has cost us, and will cost us again, the loss of federal match. Across the spectrum of Medicaid, the drop in federal match rate in October of 2005 will cost Maine in the coming biennium $80 million which is not yet funded in the Governor's proposed budget.

On top of the ordinary Medicaid settlement money owed to hospitals, there is a lawsuit brought by hospitals against the state for the manner in which Medicaid funds have been paid and administered in past years. The issues involve disproportionate share payments and calculation of third party liability reimbursements. The amount at issue is said to be $180 million of which $60 million is state money.

Outlook

In November of 2002, Standard & Poors changed Maine's bond rating outlook from neutral to negative in response to rapidly dropping revenues. On February 4, 2005, Moody's Investors Service placed Maine's bond rating on a watchlist for possible downgrade. Moody's is concerned that giving up $40 million per year in lottery receipts to reduce property taxes by $250 million in this biennium will deprive the state and its subdivisions of both sources of revenue for years to come, thus badly exacerbating a severe structural gap.

Because interest rates on our non-taxable GO bonds are down around 3%, it is still tempting to borrow money. Unfortunately, both the principal and interest must be paid through future taxes. Bonds are nothing but deferred spending -- plus interest. If the state's entire debt package were put out to referendum, including the factoring of lottery and liquor revenue, the GFA bonds, the deferment of UAL and retiree health payments, and the interest free borrowing from 39 hospitals, would any voter in his right mind vote to approve a new bond? Probably not.

We are often told that our debt payments are only about $120 million per year, or 4% of revenue, a figure that compares favorably with the debt service of other states; yet this figure includes only GO and GFA bonds. It does not include the $160 million minimum payment due for FY 2006 on the UAL. It does not include exponential growth in the unfunded obligation for retiree health insurance for which there are no reserves at all. It does not include $26 million a year for the liquor sale, $40 million proposed for factoring of the lottery, $60 million as the state's share of K-12 school debt financing, nor the rate at which we are falling behind in Medicaid payments to Maine's hospitals. When these and other unpublicized debts are included, Maine's total debt service easily exceeds 20% of annual revenue, five times the amount commonly publicized. 20% of our budget is spent to keep promises that prior legislators failed to pay for.

It may be appropriate to create a bond package this year for voter approval, but we should not do so by camouflaging the true state of debt service. The public and the legislature deserve the truth before they vote.

Peter Mills
February 22, 2005