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Peering Over Illinois’ Fiscal Cliff: New Projections from IGPA’s Fiscal Futures Model

Peering Over Illinois’ Fiscal Cliff: New Projections from IGPA’s Fiscal Futures Model

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Published by Reboot Illinois
The Fiscal Futures Project of the University of Illinois' Institute for Government and Public Affairs examines Illinois state government's finances and the state economy in this three-part study. Part 1 says that Illinois is not in a mere financial "crisis." It's suffering from a chronic financial ailment that will get worse even if the state extends the income tax increase that is scheduled to expire in 2015.
The Fiscal Futures Project of the University of Illinois' Institute for Government and Public Affairs examines Illinois state government's finances and the state economy in this three-part study. Part 1 says that Illinois is not in a mere financial "crisis." It's suffering from a chronic financial ailment that will get worse even if the state extends the income tax increase that is scheduled to expire in 2015.

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Published by: Reboot Illinois on Oct 29, 2013
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 THE FISCAL FUTURES PROJECT
igpa.uillinois.edu/scalfutures
Peering Over Illinois’ Fiscal Cli:New Projections rom IGPAs Fiscal Futures Model
FISCAL PROJECTIONS
Richard Dye, Nancy Hudspeth and David Merriman
ARE WE LOOKING AT A CRISIS OR A CHRONIC CONDITION?
Illinois’ scal situation has been precarious for at least a decade—and much longer if pension liabilities are considered.From FY 2003 to 2008, which were good years for economic activity and revenue collection, the General Assembly andgovernor approved budgets with spending well in excess of revenues. From that shaky starting point, the Great Recessionof 2008 triggered several years of scal crisis for the state. It is reasonable to ask whether the situation can still be denedas a crisis, “an unstable condition…involving an impending abrupt or decisive change,”
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but that would miss a moreimportant point. It is clear that Illinois is still mired in a chronic condition which predates the recession, and constrainsgovernment’s ability to implement and administer policies. Illinois’ scal condition contributes to economic and policyuncertainty for citizens, businesses, nonprot organizations, and local government.After the recession tipped the state from chronic shortfall to crisis, Illinois muddled through several years by takingon more debt, using one-time sources of revenue, paying bills late, and with substantial scal help from the federalgovernment. By late 2010 it had become clear that major adjustments would be necessary to operate in a scallyresponsible manner. Faced with intense pressure to take some corrective action, the Illinois legislature and governoragreed on a package of scal policies in January 2011. The policies included temporary increases in the personal andcorporate income tax rates and limits to General Funds spending.
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In terms of revenue, the most important changes werethe increase in the personal and corporate income tax rates. The income tax rates scheduled in the January 2011 law are:
Calendar YearPre-20112011-142015-24Post-2024
Personal Rate3.0%5.0%3.75%3.25%Corporate Rate4.8%7.0%5.25%4.8%Since January 2011, Illinois has faced continued severe scal problems but has navigated annual budget challenges bymaking use of borrowing, one-time revenue, fund balance reductions, inter-fund transfers, and other short-term xes.
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On some maers, in some years, the legislature has given the governor increased discretion to make budget cuts. Mostgovernment functions have continued to operate, there has been limited public outcry, and political leaders have, for themost part, retained their positions.Despite the appearance of normalcy, Illinois’ scal diculties have had important and tangible negative impacts. Perhapsthe most visible impact has been the large backlog of unpaid bills (discussed below) that has greatly inconvenienced (ordriven out of business) many vendors that supply the state government with goods and services.
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The Free Dictionary hp://www.thefreedictionary.com/crisis
2
More detail on legislative actions are given at hp://igpa.uillinois.edu/IR12/pdfs/ILReport2012Ch4budgetW.pdf.
3
See hp://igpa.uillinois.edu/IR13/chap02.php for more details.
OCTOBER 2013
 
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Another important eect has been a steady deterioration inthe state’s credit rating. Illinois now has the lowest creditrating and highest borrowing costs of the 50 states. The“Illinois eect” on borrowing costs
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has also aected localgovernments. Illinois’ state workforce has shrunk andmany government tasks are performed more slowly, or lesscompletely, than in the past.In parallel with its chronic and nagging structuralimbalance, the long-term challenges that Illinois facesdue to its unfunded liabilities
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—particularly liabilities forpensions promised to teachers and state workers—havereceived heightened public and legislative aention.Largely due to many years of scheduled underfunding,Illinois’ has accumulated unfunded pension obligations onthe order of $100 billion. Pension payments are scheduledto rise rapidly over the next several years, exacerbatingan already dicult state nancial situation. Even theseescalating pension contributions are too small to keepIllinois’ unfunded pension liabilities from growing over thenext decade. The enactment of a two-tiered system withhigher contributions from and lower benets to employeeshired starting in 2011 was a huge step, but is alreadyfactored into these projections. Despite major legislativeand gubernatorial eorts to further reduce unfundedliability and state contributions, there has been no action asof October 2013.Since 2008, the Fiscal Futures Project has carefullytracked the state of Illinois’ revenue and expendituresand developed an empirical model of the state budget.
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Using this historical budget data, information about pasteconomic performance, projections of future economicactivity, and well-documented standard analyticaltechniques, we are able to calculate measures of Illinois’past scal health and are able to project its future scalperformance under a variety of policy choices andeconomic conditions. We believe that it is crucial that publicleaders and the general public understand the implicationsof the scal policy choices currently being discussed inIllinois, and in this paper we use our model to analyzesome of them. In particular, we calculate the baseline scalsituation under current Illinois law—if the temporary taxincreases expire as scheduled—and an alternative scenariowhich assumes that the higher rates are made permanent.
OUR LOOKING GLASS: THE STRUCTURAL GAP IN THECONSOLIDATED FUNDS BUDGET
Assessments of Illinois’ scal condition and changes inthat condition can vary greatly depending on the frame ofreference used to do the analyses, as we have documented
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See: Luby and Moldogaziev, “The Scarlet Leer in the MunicipalBond Market: ‘Unpacking’ the Risk Premium on State of Illinois’Debt.” Forthcoming.
5
For more details see
Report of the State Budget Crisis Task Force:Illinois Report
. 2012. hp://www.statebudgetcrisis.org/wpcms/wp-content/images/2012-10-12-Illinois-Report-Final-2.pdf.
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For more details see hp://igpa.uillinois.edu/scalfutures.
elsewhere.
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In our analyses we use a carefully chosenand consistent frame of reference that provides a realisticassessment of Illinois’ scal situation. In particular,our Fiscal Futures Model uses a budget concept we callConsolidated Funds, which is much broader than the morecommonly reported General Funds. The rationale is thatwith the broader measure, accounting changes or transfers between funds will not be confused with a real change inthe state’s revenues or expenditures.
Structural Budget Gap.
The Illinois Constitution limitsappropriations for the upcoming budget year to “fundsestimated to be available,” which is interpreted to includepre-existing account balances or new borrowing, inaddition to projected tax collections, federal grants, andvarious fees. Our preferred measure of the state’s scalcondition is:
Structural Budget Gap =Total Revenue - Total Spending
where “total revenue” includes the annual ow of taxes,grants and fees but
not the one-time use of asset balances ornew borrowing
. This measure focuses on sustainable revenueand thus the underlying or structural scal situation.Note that the gap can be either positive, zero or negative.A positive gap (revenue > spending) is called a structuralsurplus; a zero gap is called a structurally balanced budget; and a negative gap (revenue < spending) is called astructural decit.
Baseline Projections o Illinois’ structural budget gap.
Figure 1 presents projections of the structural gap in theconsolidated funds budget from the most recent version
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For more information, please see work by The Fiscal FuturesProject on transparency in budgeting: hp://igpa.uillinois.edu/system/les/Fiscal%20Futures%20Budget%20Transparency%20Report.pdf
Figure 1:
Illinois Consolidated Funds StructuralBudget Gap FY 2005 to 2025
-16-14-12-10-8-6-4-202200720252010201320162019 2022
   B  u   d  g  e   t   G  a  p  =   T  o   t  a   l   R  e  v  e  n  u  e  -   T  o   t  a   l   S  p  e  n   d   i  n  g   (   b   i   l   l   i  o  n  s  o   f   d  o   l   l  a  r  s   )
Fiscal Year
 
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of the Fiscal Futures Model.
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Illinois had a structural gapof about -$2 billion (a decit of $2 billion) in FY 2005 to2008. With the nationwide crisis in nancial, housing,and employment markets, the structural decit grewto $8 billion in FY 2010. The state’s budget gap was lessnegative—the decit was smaller—in FY 2011 and 2013.Preliminary gures for 2013 suggest a small positive gapor surplus in the Consolidated Funds budget (which, as isexplained later, was used to reduce the backlog of unpaid bills from previous years).Starting from an estimated decit of roughly $1 billion inFY 2014 (i.e. a gap of -$1 billion, Figure 1), the state’s scalsituation is projected—under current law and estimatedrates of growth in revenue and spending—to deterioratesteadily and reach a structural decit of $14 billion in FY2025. Each year growth in revenue that is less than growthin spending adds $1 billion or so to the decit and thescheduled decline in tax rates makes the declines from2014-2016 and 2024-2025 even larger.
The Consolidated Funds budget gap does notcapture the ull extent o the state’s fscal problems.
The baseline Fiscal Futures Model (Figure 1) projects anegative structural budget gap for each year from 2015to 2025. These are projections of “would be” decits with“current trends” or “current policy” which do not accountfor how a decit in one year could aect the budget infollowing years. A decit can be
avoided
with tax increasesor spending cuts; or a decit has to be
 funded
withdecreases in asset holdings or increases in liabilities (suchas new debt).
8
Please see
Fiscal Futures Project Documentation
(October2013), hp://igpa.uillinois.edu/system/les/scal_futures_documentation_21oct13.pdf for details on the model and citationof sources of data.
Avoiding or funding a decit aects the scal situation infuture years. Higher taxes diminish the public’s ability topay in the future. Lower spending now could increase theneed for services later. Decreases in nancial asset holdingsdiminish investment income and reserves in the future.Failure to keep up with depreciation of infrastructureand government buildings means higher costs or lowerservices in the future. Explicit borrowing backed by bondsmeans a greater claim on future government revenue topay contractual debt service; it also means higher interestrates. Borrowing by delaying payment to vendors raisescosts to the state in the future as some suppliers are drivenout of business, and others become reluctant to do businesswith the state. Increases in unfunded pension or retireehealth care liabilities are implicit forms of borrowing thatrepresent a greater claim on future government revenue,thus crowding out the ability to pay for other things.An ideal measure of the scal situation would combinethe ow of current revenue and spending with changesin assets and changes in liabilities. Assets would include both nancial accounts or holdings and physical assetsproperly adjusted to include depreciation or deterioration.Liabilities would include explicit borrowing and alsoimplicit borrowing like the increases in unfunded pensionpromises that have contributed so much to the state’scurrent situation.
ON THE FISCAL CLIFF LOOKING AT THE SUNSET OFHIGHER TAX RATES
The phase-out of the higher income tax rates is scheduledto begin January 1, 2015, which aects half of FY 2015.Figure 2 presents projections of the Fiscal Futures Modelfor 2014-2025 with two scenarios. The blue line repeatsthe baseline—current tax law—projections alreadypresented in Figure 1. The red line presents an alternativescenario where the law is changed to keep the higher ratespermanent (personal income tax rates remain at 5.0 percentand corporate tax rates remain at 7.0 percent).Figure 2 illustrates that tax collections at the higher ratewould be about $5 billion more—the decit would be about$5 billion lower—each year for the FY 2016 to 2024 period.Maintaining the higher rates would also avoid anotherdecline in revenue in FY 2025. Note, however, that even ifthe higher tax rates were made permanent, the budget gapwill continue to worsen—going from -$1 billion in 2014 to-$7 billion in 2025. Higher tax rates alone will not solve thestate’s structural scal problems.
UNFUNDED PENSION LIABILITIES: LOOKING BAD ANDGETTING WORSE
The state of Illinois has unfunded pension liabilities on theorder of $100 billion. Many people in the state have becomeaware of that fact, but fewer may know that under currentlaw those unfunded liabilities are scheduled to grow eachyear for the next decade or so. Since the 2010 enactment
   B  u   d  g  e   t   G  a  p  =   T  o   t  a   l   R  e  v  e  n  u  e  -   T  o   t  a   l   S  p  e  n   d   i  n  g   (   b   i   l   l   i  o  n  s  o   f   d  o   l   l  a  r  s   )
Figure 2:
Illinois Consolidated Funds StructuralBudget Gap Projections to FY 2025 With and WithoutPhase-Out o Higher Income Tax Rates ater 2014and 2024
-16-14-12-10-8-6-4-2022015 20252017 2019 2021 2023
Fiscal YearBaseline: Tax rates dropped as scheduledAlternative: Tax rates kept up

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