Who Pays for Public Employee Health Costs?

The cost of healthcare has been rising rapidly, and this is true for both public and private sectors. How have state and local governments dealt with rising employee healthcare costs? In a recent study for the National Bureau of Economic Research, economist Jeffrey Clemens of the University of California, Sandi Diego, and economist David Cutler of Harvard, seek to answer this question. The authors look at several ways that state and local governments could manage rising healthcare costs, which include: reducing employee wages; reducing generous healthcare benefits for employees; reducing other non-labor inputs and quality of public services; or increasing revenue by raising taxes or issuing more debt.

Using data from school districts, the study finds that only a small portion (15 percent) of increases in healthcare costs are offset through reductions in wages. 85 percent of the cost increases go directly to higher total compensation. These increases in employee compensation are financed by transfers from higher levels of government, “from sources subject to significant discretionary reporting”. Also, the relative strength of the teachers’ unions has an influence on how the rising healthcare costs are shared. “Districts with weak unions appear to have offset increases in health care costs much more through reductions in the generosity of benefits”.

Additionally, while it seems counterintuitive, the study finds that employee benefit growth is associated with declines in service quality, measured by increasing dropout rates. In other words, even though public employee unions are able to negotiate better healthcare benefits, they are overcompensated when compared to their counterparts in the public sector. The authors note that the results should be treated with cautions due to data limitations.

These findings have some important implications for the upcoming changes in Other Post Employment Benefits (OPEB) reporting proposed by the Governmental Accounting Standards Board (GASB). The new standards will require that governments report the net OPEB liability at the beginning of their financial statements, along with more extensive disclosures of historical contributions, funded status, and the basis for associated actuarial assumptions. Governments may have to lower the discount rate below the return assumption, depending on their OPEB fund solvency outlook. These changes will likely put more pressure on local and state governments to increase OPEB funding, of which healthcare benefits account for a substantial part.

Governments’ failure to properly fund OPEB liabilities and the aging public employee pensions are placing a great burden on state finances. In 2013, unfunded OPEB liabilities for all the states totaled $529 billion. Only seven states have OPEB funded ratios that are higher than 20 percent. Paying for these generous healthcare benefits will prove difficult for most city and state budgets. Most of this burden will fall on taxpayers, either through increased taxes or reduced quality of public services.