Outline and discuss two long-term fiscal challenges which states face in the 21st century. 

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Two of the biggest financial challenges facing states in the 21st century stem from the same cause: on average, people are living longer than they ever have before, and the social safety net programs that were set up in the 20th century to prevent older, retired Americans from slipping into poverty, were predicated on the notion that most Americans would not live past the age of 65. 

Social Security, state run pension plans and Medicare were created to provide a base level of income to retired Americans for an average of five years, based on calculations made mostly in 1930s and 1960s, when FDR pushed the New Deal through Congress, and for Medicare, in the mid-1960s, when LBJ pushed through his Great Society legislation. The state run pension plans for teachers, police officers, fire fighters and post office workers, as well as other government employees, are funded only partly by contributions from those workers.

The vast majority of the money for those state run pension plans is supposed to come from state budgets. As a result of higher costs of living, longer life expectancy, lower tax revenues and unbalanced budgets, many states have had to stop or reduce their contributions to these pension plans, leading to what is known as "unfunded liabilities." In essence, government workers in each state have the legal right to collect their pensions, which are part of their compensation packages. Yet many states do not have enough tax revenue coming in to adequately fund these pension plans, or worse, have borrowed money from those pension plans during times of financial duress, in order to fund other essential services.

Now, as baby boomers are beginning to retire en masse, they are taking their pensions and many states are struggling to make good on the promise (legally binding) to pay those pensions. As tens of millions of baby boomers retire over the next decade, they will begin to draw down the funds of both state pensions and Social Security, while relatively fewer young workers are now paying into those systems. This creates a massive structural imbalance in state budgets.

A similar problem is occurring in state run Medicare pools, which were set up to pay out medical expenses for retirees when most only lived on average five to ten years after retirement. Now, however, with retirees often living twenty to thirty years after retirement, the funds for those programs are under stress.  States must pick up a large percentage of Medicare tabs in order to continue to receive money from the federal government.

 

The solution to these problems is mathematically simple but politically treacherous. States could renegotiate pensions, lower benefits, and raise taxes. Some have enacted a mix of all three in order to close the budget gap. Yet each one of those actions has triggered the wrath of various constituencies. Older Americans say there were promised a certain kind of retirement, and threaten to punish politicians who try to change the terms of their pensions. Yet younger people threaten to punish politicians who try to raise income or sales taxes to fund retirement programs. When politicians say that they could instead reduce future pension benefits, that too is unpopular with younger voters, who feel cheated at having to pay in more to the system than they will get out of it later. So, while there are several obvious and simple fixes to these fiscal problems, most politicians are unwilling or unable to pass laws that would shore up the finances of these systems. Several states have managed to pass reforms to fix or substantially improve their fiscal health, but most are still struggling to find a compromise that is palatable to all stakeholders involved. If those states do not manage to find a compromise solution, they may end up in an unprecedented situation of having to declare bankruptcy. The consequences of such an event are virtually unfathomable.