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February 2017

THE SKY IS NOT FALLING

WHAT’S HAPPENIING?

There is a lot of hand wringing in Dover that state government may end this fiscal year (FY 17, ends June 30, 2017) with a deficit of anywhere from $250 million to $500 million.

The “my dog ate the homework” excuse currently being put forward by state legislators is that “Delaware has faced budget problems for years because spending keeps automatically growing faster than income from taxes and other revenues sources.”

This excuse would have citizens believe that the Governor and the legislature have no control over state spending.

This is false. The sources of the runaway spending are obvious and can easily be fixed. The state can then stop taxing the Delaware economy into the dog house.

WHY IS IT HAPPENING?

The sources of “runaway” state spending are clearly identified in the Final Report of the Delaware Expenditure Review Committee. Commissioned by Governor Markell, the report was released in January of 2016.

The two top FY 17 cost drivers identified by the Committee were employee/retiree health (49% of total increased costs) and debt service (12%).

The report goes on to detail state spending on employee and retiree benefits. Between FY 09 and FY 15, employee salaries rose at a compound annual rate of 1.5% and general fringe benefits rose at 1.0%. Meanwhile, employee health care benefits jumped 4.3% per annum, retiree health care 3.6%, and pension outlays by 6.1%.

On average the 122,000 current and former state employees and their family members who are covered by the state program pay 8.6% of their health premiums on average.

Despite some minor reforms, Aon, the state’s health and benefit consultant projects total state spending on employee and retiree health care to rise to just over $1.2 billion by 2022. The Expenditure Committee believes that these increases are not sustainable. A current conservative estimate of the unfunded health liability to state retirees is $5.7 billion.

The state pension funds are generous. They are the old fashioned defined benefit (guaranteed payout) and opposed to the common defined contribution. The average employee contribution rate is 3%. Again, despite some modest reforms, both the Pew Trust and Mercatus Center, estimate the state of Delaware’s unfunded pension liability to be almost $10 billion.

According to analysis by the Delaware Public Policy Institute, state employees receive a benefits package that is approximately 53 to 102% more generous than is received by most private sector workers.

THE IMPLICATIONS FOR BUSINESS?

Following the 2007-08 recession, state of Delaware elected officials opted to raise taxes rather than cut spending. The top personal income tax rate and every business tax rate were increased. The estate tax was rebooted. And, as a topper, the state gave $500 million to Bloom Energy courtesy of Delmarva Power rate payers.

The result was to take the wind out of the sails of the Delaware economy.

Delaware businesses and households need to keep an eye on the proposed “solution” to the state government’s FY 17 deficit crisis. If the predominant short-term solution is to raise taxes, then state economic growth will slow even more. If the issue of generous state employee and retiree benefits is not addressed, there remains a structural spending problem that will continue well into the future.

Dr. John E. Stapleford

ECON First uses economics to strengthen Delaware business. This is accomplished by providing accurate, objective, and relevant analysis of the economy, coupled with best practice recommendations that deliver new customers. The detailed analysis for the Indicators above is found in the ECON First quarterly Delaware Economic Review (www.econfirst.com).

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