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 Two decades of fiscal mismanagement left Illinois as one of the
two states least prepared to weather a recession.
Now, with fallout from COVID-19 exposing that mismanagement, Illinois Senate
President Don Harmon wants a federal bailout worth at least $44.2 billion.
Without strict consumer protections against risky bets, insider deals and other
predatory behavior from state lawmakers, a bailout for Illinois or other states
struggling with fiscal crises of their own making would be ineffective and
harmful to residents already suffering under a broken system.
The terms of the deal
In a letter to Illinois members of Congress, Harmon requested:
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$15 billion from an unrestricted block grant
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A $10 billion pension bailout, structured either as a grant
or a low-interest loan
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$6 billion to bolster the state’s unemployment insurance
trust fund
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An increase in the portion of Medicaid paid for by the
federal government to 65%, up from 50.96% in a typical year, worth an
estimated $2.6 billion1
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$1 billion in health care grants to poor and minority
communities
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$9.6 billion in direct aid to municipalities
The first four requests worth $33.6 billion would go directly
to the state budget and together exceed the more than $32.7 billion in revenues
Illinois will raise from state sources for the upcoming budget year. The $10
billion request for pensions almost equals the $10.7 billion the state will
spend in total on pensions next year, including debt service for pension bonds
and pension costs for Chicago teachers. Of the aid requested specifically for
the state budget, only the additional Medicaid funding can be linked to the
public health threat of COVID-19.
So far, federal aid to states and local governments has been appropriately
limited to disaster response efforts to fight the coronavirus pandemic – much as
Congress would do for a hurricane or other natural disaster – or cash flow
assistance through monetary policy.
Under the Coronavirus Aid, Relief and Economic Security (CARES) Act, the state
of Illinois will receive more than $3.5 billion, along with $1.4 billion divided
among Chicago and the five largest Illinois counties. Those grants can only be
used for new costs directly related to COVID-19, not to make up for general
budget holes or lost revenues.
The Federal Reserve has also set up a credit lifeline, essentially offering
two-year loans to state and local governments, which can be used to cover gaps
in operating budgets.
Much of Harmon’s request represents an entirely new category of federal help,
going beyond disaster assistance by bailing Illinois out for mismanagement
unrelated to the current public health crisis. The state’s near-junk credit
rating, which reflects Illinois’ poor overall financial health, is a problem of
its own making. Illinois has the worst pension debt among U.S. states and has
not balanced a budget since fiscal year 2001.
While rejecting Harmon’s pension bailout idea publicly, Illinois Gov. J.B.
Pritzker has called for additional “unencumbered” funding from the federal
government. Without clear restrictions, that money would inevitably flow to the
state’s broken pension systems, including those of politicians who created the
problem in the first place.
Any federal aid for pensions or to cover budget holes should be conditioned on
significant financial reforms, including:
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A requirement that pension systems be built on sound
funding plans with benefit structures that help protect taxpayers from risk,
along with mandatory benefit reform in states where pension systems cannot
be made solvent without increasing taxpayer costs.
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True balanced budget requirements and realistic accounting,
ensuring state lawmakers cannot paper over deficits with accounting gimmicks
or rack up excessive operating debt.
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Restrictions on when lawmakers can make withdrawals from
rainy-day funds and procedures for making automatic deposits during growth
years.
If federal money doesn’t come with consumer protections like
these, Illinois will prove it can waste other states’ money as well as its own.
State lawmakers will be back in the next recession demanding another bailout.
The only way to fix this problem is to demand any aid comes with rules that
prevent dishonest accounting and reckless governance.
Illinois budget troubles stem from a pension crisis that bailouts can’t fix
For nearly two decades, Illinois politicians have spent more than the state
brings in each year.
As a result of 18 consecutive years of unbalanced budgets, Illinois has the
nation’s second worst net debt, measured compared to the size of each state’s
economy. Debt per taxpayer equals $52,600, according to financial watchdog Truth
in Accounting.
Springfield’s overspending has primarily gone to pay for pension benefits and
state worker health insurance, while inflation-adjusted spending on a range of
core government services has actually been reduced in real terms by nearly
one-third. Yet despite the 501% increase in pension spending since fiscal year
2000, the five state pension systems have at least $138.6 billion in pension
debt according to the state’s own estimates.
Illinois pension systems as they exist today are fundamentally
unsustainable because benefits have been set at levels taxpayers cannot afford,
and employee contributions set by state law are insufficient to cover a
substantial enough portion of these benefits.
Career workers in the five state retirement systems, those with at least 30
years of service credit, contribute around 5% of what they receive in lifetime
benefits on average. Among individuals relying solely on public pensions for
retirement, total lifetime payouts range from an average as high as $3.6 million
for career judges to $2.3 million for career teachers and education
administrators. Career state workers receive lower lifetime benefits, a still
generous $1.7 million on average, because more than 96% of them also qualify for
Social Security. Average benefits among all retirees, including
those who worked the minimum number of years required to receive benefits, are
somewhat lower. However, employee contributions still only account for between
4% and 7% of lifetime payouts when employees with fewer years of service are
included. Private sector taxpayers can rarely hope for the
generous benefits they subsidize for public employees in Illinois. The typical
private sector worker would need to have saved $1.6 million in a personal
retirement account by age 60 to receive the same $82,000 base pension as the
average career teacher. According to CNBC, the average 401(k) balance for those
close to retirement, people aged 60 to 69, is just $195,500.
Tier 1 members of the state systems, those hired before January 2011, also
receive 3% compounding post-retirement annual benefit increases, regardless of
the actual rate of inflation or the health of the pension funds’ investments.
Those guaranteed increases double the size of a retiree’s initial pension after
25 years. Such guaranteed increases are not an option for private sector
retirees.
The General Assembly attempted to make modest changes to the future of pension
benefits in 2013, including tying future annual benefit increases to inflation
and slightly raising retirement ages for younger workers. These changes were
struck down by the Illinois Supreme Court in 2015, which determined that even
unearned future pension benefits were part of a contract that cannot be
“diminished or impaired” under the pension clause of the state constitution.
Since the court’s ruling, Illinois’ elected leaders have made no substantive
policy changes to fix the pension crisis, and the cost of pensions has continued
to crowd out core services at the state and local levels. Pension costs have
also contributed to pressures for income tax hikes at the state level and are
the leading cause of local property tax bills being among the highest in the
nation.
Despite tax increases and higher pension spending, public retirees’ benefits are
still at heightened risk of insolvency due to economic fallout from COVID-19.
Moody’s Investors Service estimates the average pension fund will lose 21.1% of
its asset value this year. Given the state’s $96.6 billion in assets, that means
the state could lose $20.4 billion. As the state’s total past and future pension
promises will equal more than $242 billionfor fiscal year 2021, that would drop
the pension funding from about 40% to 31%.
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A stress test commissioned by the Illinois Policy
Institute in fall 2019 found that a recession leading to a 20% loss
of asset value in the pension systems could start a financial death
spiral in the pension systems, with the State Universities
Retirement System the first to run out of money in 2039.
Defenders of the current pension system sometimes claim pensions
have simply been underfunded. But underfunding is a symptom, not a
cause, of Illinois’ pension crisis.
While it’s true that politicians played reckless funding games and
deferred costs into the future, this is the result of politicians
having agreed to benefit levels that were too expensive to be
affordable or sustainable. Because actually making the full payments
would have been budget-busting and required unacceptably high taxes,
both Republicans and Democrats at the state and local levels have
historically sought creative ways to avoid making the full actuarial
pension payments.
While Harmon’s letter claims the state is “on a path to fund the
pension liability in a manner that is actuarially sound,” this is
not true according to the state actuary, a pension watchdog within
the Illinois Auditor General’s Office. Since the position was
created in 2012, each annual report of the state actuary has warned
that state pension funding policies don’t match generally accepted
actuarial standards.
In other words, despite Illinois’ state and local governments
spending the most in the nation on pensions as a percentage of their
revenues, it still is not enough to keep the debt from growing under
currently promised benefit levels.
Illinois’ worst-in-the-nation pension crisis cannot be fixed by
throwing good money after bad. The requested $10 billion in aid for
pensions would merely give Springfield politicians an excuse to put
off needed reforms a little longer. To be effective, aid must come
with structural reforms to make Illinois pension benefits
sustainable and affordable for taxpayers.
If the federal government plays any role in helping Illinois fix its
self-made pension and budget troubles, that role cannot be to simply
prop up state politicians’ fiscal mismanagement, or it will fail to
solve the problem while also wasting money collected from taxpayers
around the nation.
Congress must attach strict consumer protections to any future
financial aid
On top of an overpromised and mismanaged pension system, Illinois is
home to a number of bad budget practices and lacks fiscal
constraints that commonly protect taxpayers in other states. An
Illinois Policy Institute report, “Bad budgeting basics: How
Illinois’ budget process hurts taxpayers,” explains how many of the
state’s budget and accounting practices have enabled or encouraged
fiscal mismanagement in Springfield.
Among the findings in that report are the following:
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Illinois ranked 45th among U.S. states for
rainy-day fund reserves from 2005 to 2018, saving just 0.8% of
its budget compared to an average of 4.6% for all states.
Experts generally recommend states hold 5-10% of annual revenues
in reserve to prevent policymakers from having to rely on severe
service cuts or tax hikes during recessions and disasters.
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From 2003 to 2017 the state budget included
nearly $38 billion in inadvisable budget maneuvers, each year
relying on one-time revenue infusions from borrowing and special
funds transfers to cover operating deficits.
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Illinois is one of just 11 U.S. states which
lacks a “true” balanced budget requirement, in which revenues
and expenditures must actually balance at the end of the fiscal
year rather than just in lawmakers’ projections.
These facts collectively help explain Illinois’
lack of preparedness for the coronavirus downturn.
Many states have spent the past decade of economic growth setting
aside reserves for the next recession. The median rainy day fund
balance among states prior to the pandemic was 8% of general
revenues, according to the Tax Foundation. Unfortunately, Illinois
has continued to overspend and dip into its reserves over the past
two years; it has essentially nothing set aside to cover revenue
losses on its own.
Worse, Illinois actually carries what is essentially a perpetual
operating deficit through its backlog of unpaid bills. As of April
21, Illinois owes more than $8 billion to various vendors for
services already rendered. Under state law, the unpaid bills carry
high interest penalties ranging from 9% to 12%. The state’s weak and
ineffective balanced budget requirement allows the backlog deficit
to be carried from year to year.
The bill backlog more or less amounts to a negative balance in the
rainy day fund, equivalent to an individual who not only has no
savings account but is carrying thousands of dollars in high
interest credit card debt.
So long as these bad budgeting practices remain in place, federal
taxpayers cannot trust Illinois to be an effective steward of
additional tax dollars.
If the federal government is to offer aid to troubled states for
lost revenue or mismanaged pensions, it should impose the following
conditions:
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Sound pensions with taxpayer protections:
Pension funding should be based on actuarial best practices,
with funding plans on track to fully eliminate pension debt over
no more than 25 years. The federal government should require
that annual cost of living adjustments, COLAs, are variable with
either inflation or the rate of return on pension fund
investments. Finally, if any state cannot achieve actuarial
funding in 25 years without increasing taxpayer costs, their
pension liabilities should be reduced to the level taxpayers can
afford through either state-based reforms or a federally managed
process.
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Truly balanced budgets and realistic
accounting: All states receiving federal aid should be required
to maintain end-of-year “true” balanced budgets. A proposal from
the Illinois Policy Institute would require truly balanced
budgets by prohibiting deficits from being carried over, while
also clarifying that the state cannot count one-time budget
gimmicks toward its revenues for the sake of balancing.
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Rainy-day fund protections: To ensure the
federal government will not need to continue bailing out
mismanaged states, each state should be required to set up a
system ensuring it has a sufficient rainy-day fund in the
future. First, states should be required to make automatic
deposits to rainy day funds during growth years, until the
balance equals 10% of annual revenues. States with negative
operating reserves, such as Illinois, should be required to set
aside a portion of annual revenues and create a payment plan to
eliminate their carried deficits. Finally, withdrawals from the
rainy-day fund should be legally permissible only when an
economic downturn or emergency strikes.
Without these changes, a bailout of mismanaged
states would unfairly punish states that have been more fiscally
responsible. Bailouts without reform will also encourage more
mismanagement in other states, since there is little incentive for
fiscal responsibility if Congress can be expected to shield elected
officials from the consequences of their actions. This is a
phenomenon known as “moral hazard.”
Conditioning financial aid on consumer or taxpayer protections is a
common practice to safeguard funds flowing to troubled entities.
Financial rescues in both Greece and Puerto Rico came with
conditions and oversight boards. Corporate assistance under the
CARES Act likewise imposed restrictions, limiting stock buybacks and
executive compensation, among other conditions.
To ensure financial mismanagement does not continue, Congress should
not bail out Illinois or other troubled states without significant
consumer protections and financial reforms.
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