Obamacare Is Not a Bailout of State and
Local Governments

By Stephen Eide

True to the iron law of journalist math ("one, two, trend"), when Detroit and Chicago announced plans to use Obamacare to eliminate retirees' health coverage, several stories came out predicting that it would be only a matter of time before other governments followed suit. 

Conservatives pounced, eager to highlight yet another imperfection in what they view as a hopelessly flawed policy. As if Obamacare's subsidies, new taxes, and regulations weren't bad enough, the law may also bail out spendthrift state and local governments.

But while Obamacare may well change state and local governments' approach to health benefits, it's far from clear that "bailout" may serve as an accurate description of how this will all play out. And the term is generally unhelpful, because governments should be encouraged to pursue every possible option, including sending retirees to the federally subsidized Obamacare exchanges, for unburdening themselves of their retiree health-care commitments.

State and local governments collectively owe more than a trillion dollars for retiree health care, a benefit completely unnecessary for the purpose of attracting and retaining a qualified workforce. Only one quarter of all large (200+ employees) employers now offer health benefits to retirees, down from two-thirds in 1988. But 77 percent of state and local governments still provide what is often referred to as "OPEB," for other post-employment benefits.

Costs are soaring. Surveying 20 of California's largest cities, the think tank California Common Sense found that their OPEB costs increased 36 percent on average from 2008 to 2011, with some cities seeing increases of more than 50 percent. Over 60 percent of Detroit's annual health-care bill is for retirees, a sum ($176 million) greater than the size of the fire department's tax-funded budget.

It's important to understand that, as shameful as state and local governments' pension-management record has been, they've been even more irresponsible with regard to retiree health care. States have accumulated over $3 trillion to pay for pension benefits. That may be $1-2 trillion short of what they need, but it's not nothing, which is close to what governments have set aside for retiree health care.

Pension benefits are prepaid out of trust funds whose value has grown through decades of contributions by employer and employee, compounded by investment returns. Governments generally fun OPEB through a "pay-as-you-go" approach, which sounds responsible, but really means that current taxpayers pay for retired workers' benefits. Essentially, taxpayers are compensating retirees for work done decades ago.

Enter Obamacare. The new state-based, federally mandated exchanges are one of the essential mechanisms by which Obamacare intends to expand coverage. They enable anyone without access to employer-sponsored care, or whose employer-sponsored care is too expensive, to purchase care through regulated and subsidized market exchanges.

This will be a "tell" moment for state and local governments, who are normally happy to accept any financial assistance from the federal government. Granted, the exchanges do not exactly offer a free-lunch deal along the lines of stimulus or Community Development Block Grant funds. But if they're motivated, public officials will recognize how Obamacare's subsidized coverage provides a soft landing to retirees that did not exist before.

What would be the motivation not to pursue this option? A manly insistence on taking responsibility for one's own commitments, or pressure from unions and retirees to keep a good thing going?

"Bailout" is a useful term to apply only if the taxpayer winds up getting a bad deal from transferring the burden of funding retiree health care from state and local governments to the federal government. It's easy to imagine scenarios in which the taxpayer comes out ahead. Some governments, such as New York City's, don't require any cost-sharing from employees or retirees for OPEB. From the taxpayer perspective, subsidized care is clearly better than fully-comped care.

Of course, not every government offers benefits as rich as New York's. While red states certainly have OPEB troubles, according to the Pew Center on the States, the 13 states that voted 55 percent for President Obama in the last election collectively owe $340 billion in unfunded OPEB liability. On a per capita basis, that works out to more than twice the OPEB debt total for the 23 states that voted 45 percent or less for Obama.

But, to the extent that pensions in heavily unionized blue states are more generous, fewer of their retirees would qualify for exchange subsidies, because the subsidies are means-tested. A married 60-year-old couple relying on a pension of above $62,000 would not qualify for a subsidy.

And, judging by the experience of pension reform, governments will be more likely to use Obamacare not to dump existing liabilities, a legally complicated maneuver, but to eliminate OPEB on a going-forward basis. Blue-state governments have an obligation to provide public safety to taxpayers but not health care to police and fire personnel who retire 10 to 15 years prior to when Medicare kicks in. Given Obamacare, such retirees, if they do not receive care from their governments, will be able to obtain care by means of the exchanges, whose subsidies are funded, in part, by red-state taxpayers. But that's no reason to think blue-state governments should continue to provide OPEB.

(More generally, conservatives should be careful how far they want to go down the "who is subsidizing whom" route, since it's fairly well-established that red states, which are generally poorer, make out better through federal transfers than wealthy blue states such as New York and California.)

Prior to Obamacare, when a government eliminated OPEB, this was viewed as a bold act of fiscal discipline. Is that somehow no longer true simply because some retirees might end up receiving federal subsidies?

Much uncertainty prevails over how Obamacare will play out, but two points seem clear.

First, state and local governments are spending too much taxpayer money on retiree health care and should be considering every option available to them to get out of the OPEB business. At the very least, they should eliminate benefits going forward and for newer employees far from retirement.

Two, calling Obamacare a bailout is misleading, because it implies the law will encourage irresponsibility among state and local governments at the expense of taxpayers. Not so: Most governments will need to summon substantial political will to use Obamacare to drop retiree health-care coverage -- and most of them will be acting in taxpayers' interests if they do so. We should be encouraging them to pursue this course, not casting aspersions on it.

Stephen Eide is a senior fellow at the Manhattan Institute's Center for State and Local Leadership.

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