State of Illinois FY2020 Recommended Operating and Capital Budgets: Analysis and Recommendations

May 16, 2019

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SUMMARY

Amid one of the longest economic expansions in U.S. history, the State of Illinois still faces daunting fiscal challenges. The list includes chronic operating deficits, a multi-billion dollar backlog of unpaid bills, crushing public pension costs and five consecutive years of population loss. Illinois has the lowest credit rating of any state and is ranked as one of the worst prepared states to weather the next recession.

These challenges now confront Governor J.B. Pritzker, who took office in January 2019. A month later, his administration estimated that the Governor’s first budget—for the fiscal year that begins on July 1, 2019 and ends on June 30, 2020—would have to address an operating deficit of $3.2 billion. That gap was $440 million above the deficit projected by the prior administration.

Governor Pritzker’s preferred solution for closing the operating deficit and beginning to resolve the State’s other fiscal problems centers on replacing Illinois’ flat income tax with a graduated rate structure. However, a graduated tax could not be implemented until January 2021 at the earliest because of Illinois’ lengthy constitutional amendment process.[1] The Governor has described his FY2020 budget recommendation as a bridge to financial stability based on a graduated tax.

The Federation is encouraged that Governor Pritzker has moved quickly to address the looming FY2020 budget deficit by introducing specific new revenues and limiting spending growth. The Civic Federation supports the proposed FY2020 budget but still has significant concerns about the reliance on uncertain revenues and the adequacy of the Governor’s long-term plan to deal with the State’s bill backlog and pension obligations.

Initially the Civic Federation would not have been able to support the budget proposal due to its recommended seven-year extension of the statutory pension funding schedule. That plan, which was designed to help close the budget deficit by reducing State contributions, would have continued the State’s practice of pushing costs into the future and further jeopardized the financial condition of Illinois’ severely underfunded retirement systems. However, the Pritzker administration dropped the idea of extending the funding schedule after a surge in income tax collections in April 2019 led to higher revenue projections for the current and upcoming fiscal years. The Civic Federation supports the Governor’s announced intention to use additional revenues in FY2020 for statutorily required pension contributions rather than for new State spending.

Although it is unclear whether the administration will proceed with a plan to issue $2 billion in pension bonds, the Federation opposes that proposal, which would have minimal impact on pension funding while exposing the State to interest rate risk and reducing capacity to borrow for other purposes.

While supporting the dedication of new receipts in FY2020 to pensions, the Federation is concerned that April’s strong revenue performance might not be sustainable. The Federation is also concerned that several of the proposed new revenue sources used to balance the FY2020 budget, including taxes on recreational cannabis and sports betting, may be difficult to implement in a short time frame with adequate attention to social costs and are based on accelerating future revenues.

The Governor’s other plans to address pension obligations are still evolving. The Civic Federation supports the administration’s creation of task forces to consider transferring valuable State assets to the State retirement systems and consolidating pension funds across Illinois. The Federation is also troubled that a proposal to devote only $200 million of additional annual revenue from a potential graduated income tax to the pension funds does not correspond to the scale of the $134 billion problem.

The Civic Federation continues to recommend that the State of Illinois broaden its income tax base by eliminating the tax exclusion for all federally taxable retirement income. This will enhance the State’s fiscal stability by providing access to a faster growing portion of the income tax base, generate FY2020 revenues of over $2.5 billion and bring Illinois in line with other states’ policies. Finally, the extension can be implemented immediately, unlike the Governor’s graduated income tax proposal that requires a constitutional amendment that could be adopted in November 2020 at the earliest.

The Civic Federation is concerned that with pressure to pass an operating budget for FY2020 by the end of the session on May 31, the General Assembly and Governor may not be able to adequately consider sustainable revenue sources or develop a comprehensive project prioritization plan for a capital budget. A better outcome for the State could be passing the Governor’s $3.7 billion maintenance capital budget. Then the Governor and General Assembly should spend the summer identifying sustainable revenues, such as a gas tax increase, and fully vetting a comprehensive prioritization of needs, which will help to justify increased revenues to Illinoisans.

The Civic Federation has the following recommendations to better stabilize the State’s operating budget and establish a balanced financial path out of its ongoing fiscal crisis:

• Limiting agency spending growth to 2.4% annually (the maintenance level identified by the previous administration as reasonable when accounting for existing court orders and other mandated spending requirements) through at least FY2024;
• Consolidating and streamlining government units, including local pension funds;
• Merging the Chicago and State Teachers’ Pension Funds;
• Restructuring Illinois’ public university system to reflect State demographic changes, eliminate duplicative programs and more effectively allocate resources across program and campuses;
• Enacting a constitutional amendment to clarify the pension protection clause to allow reasonable changes to current employee and retiree benefits;
• Implementing reforms designed to lower Illinois’ prison population and generate meaningful cost reductions;
• Examining investment expense and asset allocation in the State’s pension funds;
• Reducing late-payment penalties on overdue State bills;
• Broadening the income tax base by eliminating the exclusion of federally taxed retirement income;
• Expanding the sales tax to include services taxed by the State of Wisconsin;
• Working toward the establishment of a functional rainy day fund to cushion the budget from economic downturns;
• Making supplemental pension payments to its underfunded pension funds to replace debt service on maturing pension obligation bonds;
• Delay implementing a new major capital program until sustainable revenues are identified and a comprehensive prioritization plan is created; and
• Refraining from unwise budgetary practices, including:
  • Relying on illusory savings, accounting gimmicks or one-time revenues;
  • Reducing or extending the pension funding target;
  • Ending level principal debt repayment;
  • Implementing new revenue sources without proper consideration of their reliability and social impact; and
  • Ignoring the State’s essential role in addressing financial condition of Illinois’ local governments.

The Civic Federation offers the following key findings on the Governor’s recommended FY2020 budget:

• The originally proposed FY2020 budget had an operating surplus of $155 million.

• If the $155 million surplus were realized, the budgetary backlog at the end of FY2020 would have been $7.9 billion. This forecast assumed that the State would issue $1.5 billion in backlog bonds during FY2019.

• After accounting for $800 million of unexpected revenue announced in May 2019[2] and the Governor’s cancelation of a plan to extend the pension funding target, the FY2020 budget has an expected surplus of approximately $92 million.
• The $39.7 billion revised revenue estimate for FY2020 represents an increase of $858 million, or 2.2%, from $38.8 billion in FY2019.[3] The increase is composed of four factors:
  • A forecast of strong economic growth leading to a $366 million increase in existing revenues;
  • Policy changes expected to bring in an additional $350 million from existing sources;
  • New revenues of $401 million; and
  • A shift of $259 million in cigarette tax revenues out of the General Funds.
• The total one-time revenue included in the FY2020 budget is $525 million. Of this, $350 million derives from sources new to Illinois: legalized sports wagering and recreational cannabis.
• Under the revised proposal General Funds expenditures increase by $287 million, or 0.7%, to $39.6 billion from $39.3 billion in FY2019.
• Net agency expenditures increase by $211 million, or 0.8% from FY2019, but this increase excludes Medicaid spending that is shifted to a special account outside of General Funds.
• The shift of Medicaid spending includes the cigarette taxes, $65 million from new tobacco-related taxes and $390 million from a new assessment on managed care organizations that goes directly to the other fund, relieving pressure on General Funds.
• If the portion of shifted expenditures traditionally associated with General Funds is included, net agency expenditures grow by 2.0% over FY2019.
• Higher education receives an additional $157 million in FY2020, but average annual funding for the State’s nine public universities over the past five years is still only about 82% of the FY2015 level, due to shortfalls during the budget impasse.
• Agency spending in FY2020 includes $185 million in step increases for members of the American Federation of State, County and Municipal Employees (AFSCME). The State’s largest union is operating under a contract that expired at the end of FY2015, but a court ruled that step increases must continue.
• Under the originally proposed budget, FY2020 pension contributions would have been only $7.1 billion due to a seven-year extension of the statutory funding schedule.
• After the Governor’s cancelation of the partial pension holiday, pension contributions increase by approximately $509 million to $8.0 billion in FY2020 from $7.5 billion in FY2019.
• Incorporating the May 2019 changes, the share of State-source General Funds revenue devoted to pension payments, including debt service on pension bonds, grew from 8.3% in FY2008 to a projected 24.3% in FY2020.
• General Funds debt service on existing backlog bonds will be nearly $800 million in FY2020, bringing total debt service to at least $2.0 billion.
• If it were not for the 2017 backlog borrowing, General Funds debt service expenditures would have declined by nearly $1.1 billion since FY2018 to $1.3 billion in FY2020 due to the final maturity of the 2011 pension bonds.
• The proposed maintenance capital budget contains $3.7 billion of new appropriations. This is close to the average during the years since the FY2010 Illinois Jobs Now! program and represents a maintenance level of appropriation and spending.
• The Governor has announced support for a major new capital program that would exceed the proposal contained in the FY2020 budget, but so far has not provided any detailed plans for funding or spending.