Healthcare, social services to take up 38% of state, local budgets by 2025

The share of state and local government budgets dedicated to healthcare is expected to balloon by 2025 as healthcare inflation continues its upward trajectory, according to a new report from Fitch Ratings.

Fitch analysts forecast that ongoing inflation will drive the proportion of budgets dedicated to healthcare and social services to 38.3% in 2025, a bump from 30.7% in 2015. As a result, other priorities like education, transportation and public safety are expected to shrink under the weight of healthcare, social services and other areas less likely to be cut.

That's not going to come at a good time. Baseline government revenue is expected to grow at a slower rate in the coming years, and federal transfer payments are threatened by rising entitlement program strains, Fitch's report said.

Healthcare was the largest driver of state and local expense growth between 2005 and 2015, according to the report. State and local governments spent $929 billion on healthcare and social services combined in 2015, up from $586 billion a decade earlier. By 2025, Fitch expects healthcare and social service spending will reach $1.6 trillion, assuming no significant policy action is taken in the meantime.

Healthcare, social services, debt service and pension expenses are considered to be more fixed than other spending categories, and thus less likely to be cut, the report said. Fitch projects the share of state and local spending on pensions will rise to 5.1% by 2025, up from 4.4% in 2015, which the agency described as "slightly higher but still manageable."

In the coming years, fixed expenses like healthcare and social services will make up a larger proportion of budgets in states with lower credit ratings than they will in highly rated states, Fitch wrote. The report highlighted seven states Fitch currently rates at AA- or below: California, Connecticut, Illinois, Kentucky, Louisiana, New Jersey and Pennsylvania, and said they will be more vulnerable to marginal decreases in population, incomes and investment returns going forward compared with higher-rated states.

In 2015, aggregate state and local budgets in states with Fitch's AAA rating reported below-average spending on those less flexible items: 36.2%, compared with 40.8% in states rated AA- and below. By 2025, Fitch expects less flexible expenses will constitute 41.1% of budgets in AAA rated states, compared with 46.5% in states rated AA- and below.

Raising taxes to solve the coming challenges is tough in any state, but Fitch predicted it will be especially difficult for states with property, corporate and income tax rates that are already above national averages.

A new PricewaterhouseCoopers study on employer-sponsored healthcare projects that medical costs will grow at 6% in 2019, on par with the past five years, but that higher costs haven't yielded healthier or more productive consumers.

An edited version of this story can also be found in Modern Healthcare's June 18 print edition.