January 11, 2011
UPDATE: 10:15 a.m. Wednesday
Illinois has many monikers: Land of Lincoln, the Prairie State, home to President Obama, and now this one – budget basket case. At a time when many state governments are struggling to make ends meet, Illinois state officials face one of the worst budget shortfalls of all.
With a self-imposed deadline of midnight Tuesday, Democratic Governor Pat Quinn and the Democrat-controlled state legislature moved swiftly to pass a major tax increase to offset a budget deficit of at least $12 billion, or about 34 percent of the $35 billion general fund budget – plus another $6 billion of debt carried over from the previous year. That debt consists of unpaid bills to public universities, schools, social service agencies, druggists and vendors.
The state’s employee pension fund is woefully underfunded and
its once shining credit rating is dangerously on the skids.
On top of that, the state employee pension fund is woefully underfunded, to the tune of $80 billion to $90 billion, and the state’s once shining credit rating is dangerously on the skids, which means paying high interest rates to borrow money. “It’s the enormity of the deficit,” when compared to the overall budget, that sets Illinois apart from many other states, says Richard F. Dye, of the University of Illinois' Institute of Government and co-author of a study released last week entitled, “Titanic and Sinking: The Illinois Budget Disaster.”
In an interview with The Fiscal Times, Dye said, “If a balanced budget requirement doesn’t bind or is ignored, as is the case here, you’re going to run up against one of two other constraints: either a borrowing constraint because people won’t loan to you, or a cash flow constraint, which is happening now.”
After rank-and-file lawmakers balked during a lame-duck session of the General Assembly at the proposed 75 percent increase in the income tax rate, Democratic legislative leaders rushed to pass a plan that would raise the tax by 66 percent. The 3 percent income tax rate now paid by individuals and families would rise to 5 percent in one of the largest state tax increases in Illinois history, and corporate rates will go up as well. The higher taxes will generate about $6.8 billion a year – a major increase by any measure, and will be coupled with strict 2 percent limits on spending growth. Republicans and other critics said the governor and Democratic state legislative leaders should have tried harder to cut spending before resorting to huge tax increase.
“We opposed the legislation because we need to get our fiscal house in order obviously,” Tom Johnson, president of Taxpayers’ Federation of Illinois, told The Fiscal Times. “Our concern was that the public was expecting some identifiable cuts in programs . . . The public is not going to accept this tax change just with a promise we’re going to cap future growth in spending. They believe there should be specifically identified reductions in program costs. This package doesn’t produce any cuts.”
While Illinois is arguably in the worst shape of any state, scores of others, including California and New Jersey, are grappling with similar problems. The day of reckoning in Illinois comes after years of papering over severe budget problems under a relatively weak balanced budget requirement. Democratic Gov. Pat Quinn planned to sign the tax package before noon Wednesday, when a new state legislature will take over with more Republican members unlikely to go along with big tax increases.
Speaking on Monday after taking the oath of office for a full term, Quinn called for unity. "I'm here today to say that we will pay our bills, we will stabilize our budget, we will strengthen our economy. We will do that very, very soon."
States have used a combination of federal stimulus funding, sharp cuts in government services, and tax and fee increases to close shortfalls totaling $130 billion in their current budgets, according to the Center on Budget and Policy Priorities. But 40 states including Illinois are now facing a combined shortfall of $113 billion in the coming fiscal year.
Making Wall Street Nervous
These huge gaps among states – combined with their longer-term debt and pension problems – have made both Washington and Wall Street nervous about the prospect of some states defaulting. That fear, though, has lessened in recent months. After a couple of years of freefall, revenues have been picking up, or at least stabilizing, in much of the country. But personal income and sales taxes, the main sources of revenue for states, still lag well behind where they were prior to the recession, in real terms – nearly 15 percent and 6 percent less, respectively, according to the Rockefeller Institute of Government.
State revenues aren’t expected to catch up to 2008 levels at least until 2012. So states, which have collectively filled budget shortfalls totaling $230 billion over the past three years, face an additional gap of $175 billion over the next two years. They'll have to fill those holes largely without the help of the federal government. Last year's stimulus package included roughly $135 billion that states could spend as they saw fit, which was mostly to deal with their budget problems. But the stimulus dollars are just about gone.
"The stimulus funding allowed them to delay budget cuts," says David Wyss, chief economist at Standard & Poor's. "The hope was that revenues would come back and they'd never have to make the cuts.” But that hasn’t happened—or not fast enough.
Spending cuts, even in traditionally sacrosanct areas such as K-12 education and public safety, will remain the order of the day. "States certainly have cut spending, but they haven't cut it anywhere near as much as revenue has declined," says Donald J. Boyd, a budget analyst at Rockefeller. "They still don't have enough revenue to support their ongoing spending."
Difficult Choices at the State Level
Some states have addressed this problem more forthrightly than others. Resource-rich states between the Rockies and the Mississippi River have largely been spared the worst effects of the recession. But even states hit especially hard by unemployment, such as Michigan, or by fallout from foreclosures, such as Arizona, have found the will to make some difficult choices.
In May, Arizona voters approved a penny sales tax increase. The state has addressed its problems largely by slashing spending – symbolized by decisions to sell (and then lease back) much of the state capitol complex and, more recently, by denying some organ transplants to Medicaid patients.
Not every state has been willing to go that far. In addition to stimulus dollars, some have relied on temporary taxes, gambling expansions, one-shot accounting gimmicks and a decision to push expenses into the next fiscal year. The result is continuing budget problems. California is looking at a $25 billion shortfall between now and mid-2012.
Compounding the problem are longer-term issues such as the steep rise in both state borrowing and retirement health care costs. The biggest looming crisis is pensions. The gap between promised benefits and the assets states have to pay for them is enormous – at least $1 trillion, or more than $3 trillion, according to one widely-cited academic study out of Illinois. That study has been criticized in some quarters, but there's no question that state pension problems are worsening rapidly, due to questionable accounting practices, overly optimistic investment expectations and demographic pressures.
Some states simply skip pension payments. New Jersey Gov. Chris Christie, hailed as a hero by his Republican peers for balancing his state's budget without raising taxes, pulled that off, in part, by skipping a $3.1 billion payment last year.
The risk that some states could run out of money to pay pensioners within just a few years is one of the red flags prompting concern about default. In September, Meredith Whitney, a prominent Wall Street analyst, predicted that states might soon require the next trillion-dollar federal bailout. Other analysts, meanwhile, have war-gamed the consequences of a potential state default on its bond – something not seen since the 1930s.
"These are very big numbers," Boyd says. "At what points will states exhaust their financial creativity, and when will markets be fed up?"