For the second time in five years, the state is being warned that its tax collections likely won’t be enough to cover its costs in the years ahead, which may mean tax increases in Hawaii’s future.

That view comes from a consultant called The PFM Group, which has been hired by the state Tax Review Commission to analyze Hawaii’s tax structure. PFM is also supposed to suggest changes that would raise more money and make the tax system less regressive.

In a memo to the commission last week, the consultant reported it had reviewed the obligations of the state, city and counties to fund health benefits for public workers, retirees and their dependents in the decades ahead, and the numbers were not reassuring.

“It is the project team’s conclusion that the current revenue structure is likely inadequate by itself to fund this additional obligation from existing revenue on a year-to-year basis,” wrote PFM Director Randall Bauer.

Tax commission members noted that conclusion echoes a 2012 report when PFM developed a long-range financial model to predict what sort of budget problems may be in store for Hawaii. The research five years ago concluded the state would experience “structural budget deficits based on the current revenue structure and levels of service.”

The Tax Review Commission in 2012 recommended the state establish a panel similar to the federal Simpson-Bowles Commission to develop recommendations on possible spending cuts and tax increases, but that was never done.

State Director of Finance Wesley Machida said he does not disagree with the PFM analysis.

If the unfunded liabilities for the public employees’ pension fund and the public employees’ health system continue to grow as they have in the past, “then it would be very, very difficult because the tax revenues over the last 10 years have not kept pace with the growing liabilities and other commitments,” Machida said.

Machida said Gov. David Ige’s administration has developed a six-year financial plan that covers state government’s obligations without relying on tax increases. That plan assumes state tax collections will grow by 4 percent to 4.5 percent a year through 2023, “but beyond that would be questionable, depending on how much if any tax revenues continue to increase,” he said.

Health care costs

The focus of the PFM analysis presented to the Tax Review Commission this year was the public employees’ health fund, but the public workers’ pension fund also had an unfunded liability of $12.44 billion as of June 30, 2015.

The public workers’ health fund has an unfunded liability calculated to be more than $11.7 billion as of June 30, 2015. The state’s share of that is about $9 billion, and lawmakers who were concerned about that huge obligation passed Act 268 in 2013 to begin setting aside money to cover future public employee and retiree health care costs.

Act 268 set up a schedule of payments that required the state and counties to gradually increase the amounts they contribute annually into the Hawaii Employer-Union Health Benefits Trust Fund until those payments reach a threshold known as the “annual required contribution,” or ARC.

That ARC includes both the health coverage premiums that are paid each year for today’s active and retired public employees and their dependents, and also includes extra money the state will bank and invest to cover health care costs for public workers and retirees in the future.

Assuming the state and counties make those annual required contributions for the next 30 years, experts calculate the unfunded liability will be wiped out. By then, the state and counties would have more than $42 billion set aside to cover health costs, and the required annual contribution would drop dramatically.

The ARC is already sizable, with the latest projections putting the state’s annual required contribution at $744 million for the fiscal year that ended June 30, and at $770 million for this year.

Growing payment

Despite the large ARC amounts, the impact on the state budget hasn’t been noticeable to the public yet because the state and counties haven’t actually been required to pay the entire “required contribution.”

That will soon change. Act 268 requires the state and counties to finally begin paying the entire annual required contribution every year starting July 1, 2018.

By then, the ARC for the state will have reached $811 million, and the combined required contributions for the state and counties will be more than $1.09 billion.

It will continue to grow, with the combined annual required contribution for the state and counties expected to climb to more than $1.35 billion in fiscal year 2025, and to peak at more than $2.33 billion in 2044.

That is troubling to some lawmakers. State Rep. Romy Cachola has repeatedly warned his fellow lawmakers that the state cannot pay the entire ARC year after year unless it raises taxes.

“Unless we do something about it, it will skyrocket like crazy,” said Cachola (D, Sand Island-Kalihi-Airport).

Cachola wants the state and counties to shift to a self-insured model, and set aside several hundred million dollars a year until they have pooled $2 billion in reserves.

He has introduced bills to advance that proposal during the last several sessions of the Legislature, but the idea hasn’t passed. Cachola noted that Act 268 setting out the current schedule of payments “is Gov. Ige’s bill.”

Randall Iwase, who was chairman of the 2012 Tax Review Commission, said Act 268 was an effort to cope with the problem of growth in unfunded liabilities that outpace state and county tax collections.

“The question that’s still left on the table is, will that diminish the government’s ability to fund … all of the programs that are important to our state, and which need funding,” Iwase said. “If the answer is yes, then you confront the question, how do we deal with this?”

The primary options are to raise taxes or cut government spending, he said.

Machida said the state has also taken steps to slow the growth in the unfunded liabilities, including adopting a policy of making an entire year of payments into the health and pension funds at the start of each fiscal year. Those up-front payments allow the pension and health funds to invest that money sooner, which increases their investment earnings.

The administration has also made larger payments into the health fund than were required by Act 268, which also increases investment earnings and reduces the state’s required contributions in the years ahead.

Machida said the cost of health insurance claims for public workers, retirees and their dependents was also less than expected, which reduced the most recent estimates of how much the state will have to pay in the future.