Illinois on the Fiscal Brink

Illinois—a state that has long embraced progressive fiscal policies—has moved one step closer to the financial abyss. Last week, Moody’s Investors Service issued the jarring announcement that it was downgrading Illinois’s general obligations bonds to Baa2 from Baa1, which is just two levels above junk bond status. The next day, Standard & Poor’s followed suit by lowering its rating to BBB+, or three levels above junk bond status. In one important sense, this is really not news at all, since Illinois had thirteen bond downgrades under its previous governor, Patrick Quinn, even though it passed a temporary tax increase that collected an additional $31 billion in revenues between 2011 and 2015, 90 percent of which was funneled into pension payments for public employees.

The reason Illinois’s credit ratings have declined is that the state has been unable to live within its means. Even with its tax increases, Illinois has not had a balanced budget since 2001, though one is required under its Constitution. The latest credit downgrade stemmed from the inability of key players in the state to agree on any budget at all for the coming year. It is therefore no surprise that Moody’s observes: “The rating downgrade reflects continuing budget imbalance due to political gridlock that for more than a year has kept Illinois from addressing revenue lost due to income tax cuts that took effect in January 2015.” This remark reflects the bias of rating agencies to worry more about the condition of government balance sheets than the overall health of the state economy. Reduced expenditures are another, superior way to bring a budget into balance, which is necessary, for—as Moody’s ruefully notes—Illinois is running a structural budget gap of about 15 percent of its general fund expenditures.

The backstory is somewhat more complicated. In January 2015, when Bruce Rauner, who had amassed a tidy fortune in private equity, was elected governor, the temporary Illinois tax increase to a flat 5 percent reverted to its former rate of 3.75 percent. Many Democrats, led by the formidable Michael Madigan—Speaker of the Illinois House of Representatives for 31 of the last 33 years—wanted to reverse those tax cuts and replace the Illinois constitutionally mandated flat tax with a progressive tax in order to cut the deficit. Without any deliberation, the Illinois House passed an unbalanced budget with revenues under $33 billion and expenditures at close to $40 billion—a $7 billion deficit. Rauner did not have to exercise his veto threat because the budget was rejected by the Illinois Senate, even with its large Democratic majority. But a few days ago, Rauner did exercise his veto of a stop-gap educational measure that would appropriate $4 billion for education and human services, which he chastised as an “unfunded, empty promise.”

This clash of wills is no surprise, because Rauner’s worldview is the opposite of Madigan’s. The governor has been steadfast in his belief that raising taxes is throwing money down a sinkhole, unless and until someone introduces structural reforms to pull Illinois back from the brink, most notably in labor markets. The state is known for the extensive benefits that it lavishes on public employees, most of whom are unionized. It has generous workers’ compensation laws, high property taxes, a devastating public pension shortfall for retirees, and no right-to-work law, which all make the cost of doing business in Illinois among the highest in the nation. Madigan wants to postpone the reform discussions until the budget is passed. Rauner knows that if he allows that to happen, he will lose all leverage on his reform.

Full article: Illinois on the Fiscal Brink (Hoover Institution)

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