California v Ontario - The Deep Dive

In a previous blog post, I reported some figures showing that California is in significantly better fiscal condition than Canada’s largest province, Ontario. Those findings appeared in a Fraser Institute study published on January 31. In this post, I supplement the Fraser report with a comparison of health, expenditure and pension costs borne by these two systemically important sub-sovereign issuers.

Health and Education Expenditures

In both Ontario and California, health and education are the two largest categories of spending. Health is the largest category in Ontario while education (including post-secondary education) is the largest category in California.

In fiscal 2012, health accounted for 38% of Ontario’s overall spending and 41% of programmatic spending. Over the last 30 years, Ontario health expenditures grew at an annual rate of 7.2% from $5.776 billion in fiscal 1982 to $46.476 billion in fiscal 2012. According to StatCan data, consumer price inflation during this period averaged 2.8% annually while Ontario’s population growth averaged 1.4%. Thus, the province’s long term health expenditure growth cannot be explained exclusively by increasing population and general inflation: real per capita health spending increased 2.9% annually over the 30 year period.

While a number of factors are driving Ontario’s health cost escalation, one contributor is hard for policymakers to address: population aging. Since 1982, the population of those over 65 has increased by 2.7% annually – in contrast to the 1.4% increase for the overall population. Given the aging of the postwar baby boom and today’s relatively low birth rates, Ontario is likely to see a further rise in the proportion of senior citizens. Since this group makes more intensive use of health services, cost pressures on Ontario’s health system are likely to continue.

While California also faces high and rising health costs, it only funds health services for certain categories of residents. Most of the state’s health spending is in the MediCal program – California’s implementation of the federally sponsored Medicaid system. Under Medicaid, California and the federal government share responsibility for the cost of providing care to several groups of economically disadvantaged residents, especially low income mothers and children. Under the 2009 Patient Protection and Affordable Care Act more people will become eligible for Medicaid. Also, some moderate income individuals without employer health insurance will become eligible for state and federal insurance subsidies when purchasing coverage on a new state administered health insurance exchange. Finally, MediCal pays for nursing home care once seniors exhaust most of their assets. It is only this last category of MediCal spending that is substantially exposed to population aging.

In the US, most government health expenditures benefiting senior citizens are directly incurred at the federal level through the nation’s Medicare program. While there is wide agreement that this program is fiscally unsustainable, it does not directly affect the budget of California or any other US state. That said, states do provide medical coverage to their retired employees. But this cost burden is limited by two factors: (1) state workers only account for 0.9% of the population and (2) these workers are also eligible for Medicare. The impact of the second point is complex. Since most state workers can retire prior to becoming eligible for Medicare, the state is wholly responsible for their healthcare costs in the years immediately following their retirement. Further, since state retirees are eligible for a better benefit package than that provided under Medicare, the state still has to pay for insurance that provides incremental coverage to its Medicare-eligible retirees. Finally, it is worth noting that Ontario also pays for supplemental retiree health benefits, including dental and supplementary hospital costs.

Despite these advantages relative to Ontario, California also has a serious disadvantage: it is burdened by the high rate of US health cost inflation. Over the last 30 fiscal years, Canadian health care CPI has risen 3.2% annually while US medical CPI has grown 5.2% per year. Overall consumer price inflation has been quite similar in the two countries – 2.8% in Canada versus 2.9% in the US.

The sum of California’s MediCal and state retiree health costs rose from $5.419 billion in 1982 to an estimated $46.673 billion in 2012, representing an annualized increase of 7.4%. Real per capita cost rose 2.9%, similar to Ontario’s cost trend. However, because California’s health care responsibilities are less comprehensive than Ontario’s, health expenditures comprise a lower proportion of its overall spending – roughly 24% in fiscal 2012.

In fiscal 2012, education, post-secondary education and training accounted for 25% of Ontario’s overall spending and 27% of programmatic spending. Over the last 30 years, Ontario expenditures in these categories grew at an annual rate of 6.5% from $4.715 billion in fiscal 1982 to $30.709 billion in fiscal 2012. By contrast, education spending in California rose at an annual rate of only 4.7%.

The difference appears to arise from California’s balanced budget requirement. When state revenues fall during recession years, the governor and legislature cut education spending. These cuts have been especially noticeable at the post-secondary level, where state colleges and universities have imposed tuition increases to offset reduced state funding. The overall effect has been a long term shift in the revenue mix away from taxpayer support and toward student funding. This trend has also been evident in Ontario, but to much more limited extent.

For example, in the University of California (2011a, 2012b) system, average annual in-state undergraduate tuition has risen from $938 in the 1981-1982 academic year to $12,192 in 2011-2012, representing an 8.9% annual rate of increase. By contrast, StatCan figures show that annual tuition in Ontario for domestic, undergraduates increased from $936 in 1981-1982 to $6815 in 2011-2012 – an annual increase of 6.8%. According to the University of California (2012) budget, “All tuition and fee increases since 1990-91 have been a direct result of inadequate and volatile State support (p. 101).” Historical data from the California Legislative Analyst Office (2012) show reductions in state aid to the University following the 1991-1992, 2001 and 2007-2009 recessions.

Pension Obligations

Pension provision is one area in which Ontario outperforms California.

As shown the accompanying table, four of the five funds to which the Province contributes are fully funded. By contrast, California’s Public Employees Retirement Fund was only 80% funded as of 2010, and the California State Teachers’ Defined Benefit Fund was just 72% funded at that time. But the difference in these ratios understates the real discrepancy. California’s largest pension funds base their funding ratios on more aggressive return assumptions. CalPERS (the California Public Employee Retirement System) and CalSTRS (the California State Teachers’ Retirement System) use 7.75% return assumptions while Ontario’s provincially supported funds use assumptions ranging from 5.40% to 6.75%. If California funds used similar assumptions to their Ontario counterparts, their funding ratios would be significantly lower. According to calculations published by Nation (2011), CalPERS and CalSTRS funding ratios would each fall by about 15% if they used a 6.2% return assumption rather than the current 7.75% rate.

During recessions, California politicians are often tempted to meet balanced budget requirements by skipping or reducing actuarially required or even statutorily required pension contributions. On the other hand, public employee unions and the courts apply pressure to maintain funding and meet legal commitments. For example, in 2003 the state withheld a required a $500 million payment to CalSTRS. The pension plan sued, and a Superior Court judge compelled the state to make the contribution (CalSTRS, 2005).

The state’s two biggest pension obligations – payable to CalSTRS and CalPERS – are both subject to important limitations. In the case of CalPERS, only about three in ten of the system’s members are state employees; local governments in California are responsible for the remaining obligations. In the case of CalSTRS, primary responsibility rests with local school districts; the state’s contribution is a fixed percentage of covered payroll. By contrast, the provincial government makes the vast majority of Ontario Teacher’s Pension Plan employer contributions.

Although Ontario has done a superior job of funding its pensions relative to California, it is worth noting that the province also has a greater obligation due to its higher rate of public sector supported employment. According to StatCan data (series 183-0002), Ontario had 87,851 general government and 238,905 health and social service public employees in March 2012, which works out to 24.1 provincially supported workers per 1000 residents. In California, total state government employment was 343,767 for fiscal 2011-2012, or 9.1 state workers per 1000 residents (California, 2012). Both of these calculations exclude teachers.

Sources

California (1983). Governor’s Budget, 1983-84. http://archive.org/details/governorsbudget1983cali.

California (2012). Governor’s Budget, 2012-13, Schedule 6. http://www.ebudget.ca.gov/pdf/BudgetSummary/BS_SCH6.pdf.

California Legislative Analyst Office (2012). Historical Data. http://www.lao.ca.gov/laoapp/LAOMenus/lao_menu_economics.aspx.

California Public Employees Retirement System (2012). Comprehensive Annual Financial Report for the Year Ended June 30, 2011. http://www.calpers.ca.gov/eip-docs/about/pubs/comprehensive-annual-fina-report-2011.pdf.

California State Controller’s Office (2011). Comprehensive Annual Financial Report, 2011. http://www.sco.ca.gov/ard_state_cafr.html.

California State Teachers’ Retirement System (2005). Text of the Judgment in TEACHERS' RETIREMENT BOARD, ET AL. v. CAMPBELL, ET AL. Attachment to Agenda Item 15 for the Teacher Retirement Board Meeting of June 2, 2005. http://www.calstrs.com/About%20CalSTRS/Teachers%20Retirement%20Board/AGENDAS/BOD0605PDF/Regular0602/rm0615%20SBMA.pdf.

California State Teachers’ Retirement System (2011). Comprehensive Annual Financial Report for the Fiscal Year Ended June 30, 2011. http://www.calstrs.com/help/forms_publications/printed/CurrentCAFR/cafr_2011.pdf.

Canada Department of Finance (2012). Fiscal Reference Tables. http://www.fin.gc.ca/pub/frt-trf/index-eng.asp.

Canadian Taxpayers Association (2004). Ontario Superior Court Filing No. 04-CV-269781 CM1. http://taxpayer.com/sites/default/files/downloadable/73.pdf.

Nation, J. (2011). Pension Math: How California’s Retirement Spending is Squeezing the State Budget. Stanford Institute for Economic Policy Research. http://siepr.stanford.edu/system/files/shared/Nation%20Statewide%20Report%20v081.pdf.

Ontario Ministry of Finance (1982). Public Accounts 1982.

Ontario Ministry of Finance (2012). Public Accounts 2012. Retrieved from http://www.fin.gov.on.ca/en/budget/paccts/2012/.

Ontario Pension Board (2012). 2011 Annual Report. http://www.opb.ca/portal/ShowBinary?nodePath=/OPBPublicRepository/OPB/Publications/Investments/AnnualReports/en/Annual%20Report%202011.

Ontario Teachers’ Pension Plan (2012). Annual Report 2011. http://docs.otpp.com/annual_report/PDF2012/AnnualReport2011.pdf.

OPSEU Pension Trust (2012). Delivering Sustainability: Annual Report 2011. http://www.optrust.com/AnnualReports/AR2011/OPTrust_AR_2011.pdf.

University of California (2011a). Historical Fee Levels 1975 - Present. http://budget.ucop.edu/fees/documents/history_fees.pdf.

University of California (2011b). 2011-12 Tuition and Fee Levels as Approved by the Regents. http://budget.ucop.edu/fees/201112/documents/2011-12rev.pdf.

University of California (2012). Budget for Current Operations: Summary and Detail, 2012-13. http://budget.universityofcalifornia.edu/files/2011/11/2012-13_budget.pdf.

University of California Retirement System (2011). Annual Financial Report 10/11. http://www.universityofcalifornia.edu/finreports/index.php?file=ucrp/ar11ucrp.pdf.