Summary: The Illinois Budget Crisis

I. Introduction

Throughout the spring and summer of 2017, numerous articles appeared in local and national media outlets describing the escalating financial crisis in the State of Illinois. The main proximate cause of the looming budget disaster and its accompanying media attention was the high likelihood that the Republican Governor, Bruce Rauner, and the Democratically-controlled Illinois State Legislature, led by House Speaker Mike Madigan, would not reach an agreement on a state budget by the 30 June deadline for a third consecutive fiscal year . The immediate consequences of failing to enact a budget were far-reaching and included continuing detrimental impacts to social services, the state’s inability to pay its bills even to lottery

winners, accruing more debt due to late fees, and the possibility of some public universities closing their doors (Dabrowski and Klingner).
Perhaps the most significant impact of failing to pass a budget was the real possibility that Illinois’ investment grade credit rating would be further downgraded to “junk” status by Standard & Poor’s (S&P) Global Ratings and Moody’s Investors Service due to its nearly $15 billion in unpaid bills, $7 billion budget deficit, and $251 billion in unfunded pension liabilities. The ongoing political dysfunction involved in the budgeting process, due to the government’s overall unwillingness to make difficult decisions regarding spending and taxation to assuage the state’s rapidly deteriorating financial situation, was likewise a key factor. Fortunately for the citizens of Illinois, the state legislature, by overriding Governor Rauner’s veto, was finally able to pass a budget after the new fiscal year began in early July, thus ending an impasse that had lasted more than two years. The state narrowly averted the catastrophe effects to its long-run solvency by avoiding being the first U.S. state to earn the dubious distinction of having its credit rating downgraded to “junk.”
Nevertheless, the State of Illinois remains mired in debt and represents a cautionary tale on how government finances at any level can go horribly wrong. The media attention surrounding the budget stalemate in 2017 simply spotlighted Illinois’ chronic and extensive financial problems for all audiences. The ultimate causes of Illinois’ fiscal situation are significantly more complex, can be traced back several decades, and illustrate a lack of adherence to numerous principles commonly associated with sound public finance and budgeting. Lessons for both fiscal administrators and public servants, in general, abound in analyzing how the State of Illinois delayed fiscal Armageddon and hopefully escaped this fate if its government can finally begin to make tough choices that will effectively balance revenues and expenditures for the long-term. Before proceeding to the lessons learned portion of this analysis, Illinois’ financial history must be briefly explored to place the events of 2017 in their proper context.
II. Historical Background on Illinois’ Financial Management
The most fundamental themes discerned from Illinois’ financial history is that the state has consistently been unable to keep tax revenues and expenditures (particularly adequate pension funding) in relative equilibrium, and has proverbially “kicked the can down the road” in dealing with this glaring imbalance.

To illustrate these tendencies, several macro-level trends and events in Illinois’ recent history warrant brief discussion. First, Thomas Walstrum, a business economist from the Federal Reserve Bank of Chicago, published a striking analysis in 2016 concerning Illinois’ fiscal situation that succinctly illustrated how the state’s current fiscal trajectory essentially began in the late 1980s. In his article, “The Illinois Budget Crisis in Context: A History of Poor Fiscal Performance,” he posits that the state could have been categorized as a low-expenditure, low-revenue state prior to the 1990s (Walstrum). Starting in the mid-1990s, however, his analysis shows that the state began consistently spending more than it took in in revenues, significantly outpacing the national average (see figs. 1-3). From the years 1994 to 2010, Illinois’s spending averaged 115.9% of its revenues compared with 105.7% for the typical U.S. state (see fig. 4). The main source of this increased spending was pension-related and since revenues continued to remain low, the state began accruing debt to cover these liabilities (Walstrum). This imbalance between revenues and expenditures indicates that Illinois’ budget has not really been balanced since this period in the 90s. In his analysis, Walstrum also treats the yearly change in pension liabilities as an expenditure, treating future payments as if they were being made right now. In doing so, he demonstrates that Illinois was actually a much higher expenditure state than commonly believed since it was merely deferring those expenditures in the form of pension fund payments well into the future

(Moser).
Nonetheless, Illinois’ political leaders were acutely aware of the impending pension-related crisis. A second critical event occurred in 1994 when policymakers under the leadership of former Republican Governor Jim Edgar enacted a 50-year plan to restore solvency to the state’s pension systems. Known as the “Edgar Ramp,” the plan called for escalating investments into the pension accounts to achieve 90% funding over time. Tax revenues required in the short-term were minimal with the vast majority of contributions required starting in 2010 and accelerating until completion in 2045 (as history would have it, the Great Recession struck precisely when the “jump” in contributions was supposed to occur) (see fig. 5). In retrospect, this attempt at reform has been the subject of intense criticism from both Democrats and Republicans legislators as well from financial regulatory entities (Zorn). While this analysis will delve more deeply into the Edgar Ramp in the succeeding section, it is noteworthy that this was, in the end, a bipartisan agreement that supposedly sought to mitigate the future effects of underfunded pensions.
To make matters worse, Illinois’ revenues were significantly impacted, along with the rest of the nation, by the Great Recession of 2007 - 2009. This third critical event merely exacerbated Illinois’ financial woes at a time when the state faced increasing pension liabilities. The collapse of the housing bubble caused revenues from property taxes to decline drastically with detrimental impacts on pension liabilities when viewed as government expenditures (Moser). Illinois also lost a considerable number of private-sector jobs, which placed strains on unemployment insurance and other social programs, therefore contributing to a significant drop in annual revenues from 2007 to 2010 (Ramos).
Fourth, the Illinois legislature approved personal and income tax rates in 2011 to grapple with the state’s widening budget deficits. With a programmed sunset of 1 January 2015, these tax hikes constituted a 66 % change in personal income rates from 3% to 5% and roughly a 45 % change in corporate rates from 4.8 % to 7.0%. With respect to incomes taxes specifically, the revenue generated was almost doubled from 2010 to 2014 (Ramos). Despite the much-needed increase in revenues, the tax hikes were allowed to expire in 2015.
A fifth set of events during this same period (2009 to 2017) concerned the state’s long-term creditworthiness. Illinois’ investment grade rating suffered multiple downgrades from each of the three major rating agencies as a result of increasing debt and budgetary mismanagement (see fig. 6). By the time the 2017 budget impasse was in full swing, Illinois had the lowest possible investment grade without being categorized as “junk” (see fig. 7). Bond ratings are essentially long-term assessments of risk. A higher degree of risk causes interest rates to increase for the borrowing government to ensure lenders are adequately compensated (Mikesell 654-655). Therefore, these repeated demotions in investment grade ratings theoretically made borrowing and refinancing existing debt more expensive for the state in the long-run.
To summarize, the confluence of all of these events and trends in Illinois’ recent fiscal history culminated in the 2017 budget stalemate that nearly sent the state into what Fox News at the time termed a “financial death spiral” (Singman). Merely recounting the main events along the path of Illinois’ near financial ruin is insufficient and does not fully reveal the full complexity of the issues. As such, this paper will now review and provide a more in-depth examination of some of the key principles and lessons for public servants.