In Texas, Liabilities are Growing in the Background

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DALLAS – As Texas lawmakers struggle to enact a budget based on his reduced revenue estimates for the coming biennium, state Comptroller Glenn Hegar is warning that future legislative sessions face "significant long-term financial challenges."

"As a former legislator, I know too well the difficulties associated with the budgeting process, as lawmakers attempt to reconcile thousands of competing needs," Hegar said. "It is important that Texas continues to take positive steps in each legislative session to address our long-term obligations."

Hegar, in a special report, listed four areas of concern that could affect the state's triple-A credit ratings: state employee pension funding; health care coverage for state retirees and their families; the Texas Guaranteed Tuition Plan; and deferred maintenance projects for state buildings.

"These issues vary in scope, timing and severity," Hegar said, "but they all represent obligations the state will have to address, sooner or later — and later will cost us a lot more."

The Comptroller's report noted that Texas retains triple-A ratings, even though the state Employee Retirement System doesn't meet certain pension standards. With the funding ratio below 80%, Texas' 75% funding level is below what is considered adequate, the report said. Changing demographics, fewer state employees contributing to the system and diminished investment returns are also adding pressure.

"Poor management of the state's long-term debt obligations could cause a downgrade of the state's credit rating, resulting in increased borrowing costs and decreased investor confidence," according to Hegar's special report.

In 2016, Moody's Investors Service introduced a "treading-water" metric that measures whether pension liabilities rose, fell or remained static in a fiscal year. Moody's found Texas was considerably below the treading-water benchmark in 2015.

"In the last few years, most states have enacted some type of pension reform," the report said. "Still, several have seen their credit ratings downgraded due to pension underfunding, including Kentucky, New Jersey, Kansas and Illinois."

"Any change to government pension plans can involve significant challenges and may have unforeseen consequences," the report noted. "Before pursuing any significant change, a cost-benefit analysis should be conducted to fully understand how Texas' pension funds and contributions would be affected."

The state's growing deferred maintenance backlog reflects revenue problems in previous years and the fact that most projects take four to five years while the Legislature meets only every two years. As of Sept. 15, 2016, state agencies reported more than 1,600 deferred maintenance projects to the committee, with a total estimated cost of $487.7 million, the report said.

"When maintenance is postponed, repair and replacement costs become higher in future years due to the accelerated deterioration of known deficiencies, the accumulation of new problems and the rising cost of facility repair and construction," the report said.

The Texas Guaranteed Tuition Plan, approved by voters as a constitutional amendment in 1997, is the "least visible" of the state's long-term debt obligations, according to Hegar's report.

The Texas Prepaid Higher Education Tuition Board invests contract payments and uses the payments and interest earnings to pay college tuition and required fees for enrollees.

The Texas Guaranteed Tuition Plan's contract payments and earnings have failed to keep pace with tuition inflation, the report said. The plan had a projected unfunded liability of $617.2 million as of August 31, 2016, a 15.3% increase from the previous year.

An actuary hired by the Texas Prepaid Higher Education Tuition Board projected that the plan would experience a cash shortfall as early as fiscal 2019. An additional $87.7 million in general revenue funding provided in 2015 pushed the projected shortfall date into fiscal 2020.

"Since the program has a constitutional funding guarantee, any shortfall automatically triggers a draw on general revenue," the report said. "Texas could save as much as $58 million by taking action to fully resolve the Texas Tomorrow Fund's unfunded liability before the end of fiscal 2017."

Although the tuition program does not play a major role in the state's credit rating, "shoring up the program's finances would send a strong message to rating agencies that Texas intends to meet all its obligations."

A day after Hegar's report was released, the Texas Senate Finance Committee unanimously approved a $106.3 billion budget that delays a $2.5 billion payment for transportation funding.

House Speaker Joe Straus called the budget gimmick "cooking the books."

Finance Committee Chairwoman Jane Nelson, R-Flower Mound, said the maneuver allows the Senate to exceed the $104.9 billion that Hegar said is available for 2018 and 2019.

Nelson announced at a hearing Wednesday that Hegar said lawmakers can delay a diversion of sales tax money to highway funding that was originally scheduled for the 2019 budget year until the first month of 2020. While that delays the payments by only a month, the maneuver will reduce widespread cuts across state government, proponents say.

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