Monday, January 12, 2015

Illinois fiscal hole illustrates future of Fitzwalkerstan

Apparently we are not the only state that’s got exploding fiscal troubles to deal with in the next few months. Our neighbors to the south have perennial budgets problems, but Illinois is looking at a fiscal squeeze that is likely to become much worse starting on July 1 .
Illinois’ new governor, Bruce Rauner, will begin tackling perhaps the biggest fiscal mess in the nation, and the worst his state has seen in decades, when he is sworn in Monday.

The Land of Lincoln is buckling under a chronic structural budget deficit and the lowest credit ratings and worst-funded pension system among the 50 states.

Pension payments are projected to jump to nearly $7.6 billion in fiscal 2016 from $6.8 billion this fiscal year. And outgoing Democrat Governor Pat Quinn's budget office recently estimated Illinois' pile of unpaid bills will climb to $9.8 billion at the end of fiscal 2016, from $4 billion this year.

"In the modern era ... the state has never been in this poor of financial condition," said Laurence Msall, president of the Civic Federation, a Chicago-based government finance watchdog group.
So how did the already-big hole that the FIBs were in get even larger? One of the biggest reasons Illinois’ structural budget deficit was already large was due to the state’s past choices to underfund its pensions in favor of tax cuts and spending in other areas. In later years, those pensions had to be paid for with current-year expenses, and the state almost never raised taxes or reduced other expenses, choosing to delay payments of bills and borrow the money instead. This cycle has continued for decades, and they’ve never seemed to be able to break their way out of it.

Former Governor Pat Quinn finally tried to slow down the spiral by putting in a temporary income tax increase from 3% from 5% in January 2011, and an increase in the corporate income tax, which raised the amount of money coming in, due to an act known as TABSA. As a result, Illinois essentially had a balanced budget in Fiscal Year 2014, and is on track for a relatively minor imbalance of $322 million this fiscal year (less than 1% of all expenses).

However, Quinn and the Dem-run Illinois Legislature reversed those moves in front of the 2014 elections, essentially cutting taxes starting this year, and now the budget hole is exploding again.

This paper from the Chicago-based Center for Tax and Budget Accountability (CTBA) is a good primer on why these 2015 income tax cuts and future mandatory spending means a massive fiscal crunch for the Land of Lincoln starting this summer. We’ll start with the income tax cuts first.
Under TABSA, the personal income tax rate will automatically decline from 5 percent to 3.75 percent, and the corporate income tax rate will automatically drop from 7 percent to 5.25 percent, on January 1, 2015. While those reduced income tax rates resulted in a significant FY2014-FY2015 revenue loss, its impact was somewhat mitigated, because the reduced income tax rates only pertain for six months of FY2015. Things will be worse in FY2016, because those reduced income tax rates will be in effect for the full fiscal year.

Indeed, the recurring revenue loss caused by the phase down of the temporary income tax increases under TABSA will be quite significant. According to the non-partisan Commission on Government Forecasting and Accountability (COGFA), recurring General Fund revenue in FY2015 will be some $2 billion less than it was in the immediately preceding fiscal year, FY2014. In FY2016, however, when the full effect of the reduced income tax rates will be felt, General Fund revenue is projected to be nearly $3 billion less than in FY2015.
The state of Illinois also borrowed $650 million from other state funds to balance its books for this fiscal year, much like how the Wisconsin GOP and Gov Walker are using one-time transfers of hundreds of millions of dollars of General Fund revenue to balance the Transportation Fund’s budget, the difference is that the FIBs are planning to pay back the transferred funds. Illinois will not have that luxury of borrowing from other funds for FY 2016 (or at least is not assumed to do so).

Those two issues explain $3.64 billion of Illinois’ shortfall on the revenue side for FY 2016, but they also have problems on the spending side, particularly involving the pension situation. Gov Quinn and the Legislature tried to cut payments to pensioners to slow down the expenses going into the fund, and recently got a big stiff arm from the courts (the court basically said “a deal is a deal”), which means that money has to go out for the foreseeable future.
In an effort to reduce the debt owed to the pension systems, the General Assembly passed and Governor Quinn signed into law Public Act (PA) 98-599 in December of 2013. That law implemented sweeping changes to Illinois’ state-funded public retirement systems. At its core, PA 98-599 cut pension benefits for current employees and retirees, and those benefit cuts were meant to reduce the state’s required annual contributions to the pension systems, thereby lessening Hard [mandatory] Costs. FY2016 was supposed to be the first fiscal year during which the state’s total pension contribution would be reduced by PA 98-599. However, on November 21, 2014, Sangamon County Circuit Court Judge John Belz ruled that PA 98-599 was unconstitutional, and put a permanentstay on the law’s implementation. While the state will appeal Judge Belz’s ruling to the Illinois Supreme Court, the benefit cuts designed to reduce the state’s pension contributions cannot be implemented for the duration of the stay. Because of Judge Belz’s ruling, the state’s contributions to the pension systems for FY2016 will have to be calculated in accordance with the pension funding laws and benefit levels that existed prior to the passage of PA 98-599.

Moreover, the three largest state pension systems recently reduced their investment rate assumptions. This means the pension systems now project that their assets will generate a lesser return over time than what was previously anticipated. This in turn will cause the annual pension contributions required of the state to increase from what was initially scheduled, to make up for the difference between the higher returns previously projected for the pension systems’ assets, and the new lower growth projection.

As a result of the stay on PA 98-599’s implementation and the reduced investment rate assumptions, the state’s FY2016 General Fund contribution to the pension systems will be some $630 million —or 10 percent — more than in FY2015, rather than declining from year-to-year as previously anticipated.
The underfunding and borrowing for Illinois' pensions fund is a major difference between them and Wisconsin. Wisconsin's pension fund has been fully funded for years, and adjusts payments to retirees in case the markets don't grow as much as needed. You may remember that Gov Walker ordered a study of the Wisconsin Retirement System in 2011, and the report came back in 2012 saying that not only was Wisconsin's pension fund 100% funded, but that you'd have to be crazy to mess with the way it is funded. This got Walker to quickly back off any scheme to funnel money away from the WRS in the short term, but that doesn't mean he might not try in the future.

But I digress- in Illinois, when you combine the need to pay off more debt for all funds in FY 2016, along with the added required pension contributions and having to pay back the $650 million that was borrowed from other funds in this fiscal year, and you now have a one-year increase in mandatory [Hard] costs of $1.93 billion. Add in the revenue shortfall, and here's what you get for the Illinois budget deficit for Fiscal Year 2015-16, (which is on top of the $6.48 billion in unpaid/underpaid bills that they had as of July 1, 2014).

Illinois budget issues, FY 2016
Budget deficit, FY 2015 $322 million
Revenue reduction, FY 2016 $3.64 billion
Mandatory spending increases FY 2016 $1.93 billion

These problems show why Illinois is the prime example of how continually relying on one-time gimmicks of borrowing and underfunding of mandatory payments leads to long-term budget disaster. And now the combination of 2015's tax cuts with increased required spending is making a this year’s 1% deficit explode into a 15.66% deficit for next year.

What’s instructive to note as a Wisconsinite is that this is the same path our state is under with Gov Walker and the WisGOP Legislature. We have also cut taxes in the last couple of years, and the lower revenue is a big culprit in the $2 billion + budget deficit we are facing today. We have also expanded our spending on road projects and raided other funds to do so as a short-term fix. And do not doubt that skipping pension contributions and expanding borrowing further is something the Walker Administration is considering as a means to “balance” this upcoming budget, much as Quinn and other Illinois elected officials did for decades, always hoping to kick the can down the road into another time when it could be fixed with less pain.

What’s funny (or pathetic, depending on how you choose to view it) is that we can expect Gov Walker to drop some line in tomorrow’s State of the State address about “Well, we’re not Illinois.” In fact, the elected officials in charge of things in Wisconsin have acted very similar to FIBs in the last four years, and not just due to the increase in corruption and machine politics. Walker/WisGOP fiscal madness has us well on the road to having our state government and budget be just as screwed up as Illinois’ is today, but unlike our neighbors to the south, with the WisGOP crew, that’s likely a feature of their policies and not just a bad side effect.

1 comment:

  1. Another excellent article Jake.

    You know Wisconsin GOP politicians always seem to point to Illinois as some kind of California without-the-coastline-or-scenery; an unrelieved tax hell run by union bosses; when, of course, nothing could be further from the truth. The tax situation in Illinois is exactly what the Wisconsin GOP salivates over: there is a single flat tax rate, with a low exemption amount. Even the rate, which after the scheduled reduction, will be below all of the four Wisconsin tax brackets. In addition, almost all retirement income, from whatever source, is exempt.
    The result? according to ITEP (2013 figures), in Illinois the lowest 20% of non-elderly taxpayers pay 13.8% of their income in state taxes, while the top 1% pay 5%. Compare that to Wisconsin's 9.6% for lower, and 6.9% for top 1%s.

    The Walkerites would love to copy the Illinois rates, raise sales taxes, and push the costs of government down to the lowest paid people in the state.

    And, of course, the fiscal problems for the borrow-and-spend GOP would shortly follow.

    Dr. Morbius