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 Illinois’ pension crisis eats more than a quarter of the state
budget, drives up property tax bills and is the No. 1 reason Illinois has the
worst credit rating in the nation.
But the state’s overly generous and severely indebted pension system has
another, hidden cost: it lowers income growth by roughly $1,417 – per person,
per year on average.
By causing desperately needed public investments to decrease, a rising share of
government expenditures to shore up unsustainable pension systems severely
damages the state economy. It is workers who miss out on tens of thousands of
dollars in take-home pay during their careers simply because they live and work
in Illinois, where public pensions take priority. Every dollar spent on pensions
is a dollar diverted away from services that most Illinoisans benefit from such
as education, infrastructure and even direct government transfers to low-income
families.
Not only has the pension crisis helped foster an environment where economic
racial gaps are wider than the national average, the current economic downturn
has disproportionately affected minority Illinoisans, even when compared to
peers in other states. Employment of Black Illinoisans has declined by 15%,
while 4.5% of the state’s working mothers have left the labor force entirely.
Amid the worst economic downturn in Illinois since the Great Depression, pension
reform would relieve pressure on the state’s budget, boost the state’s economic
prospects and help foster a more robust and equitable economic recovery.
Removing the hidden pension tax would even do more for Illinoisans over the long
run than the additional $1,400 federal stimulus check that’s part of the Biden
administration’s current plan.
How pension costs hit Illinois paychecks
Measuring outcomes in all 50 states, research from the Illinois Policy Institute
shows per capita personal income grows faster in states that spend less of their
budget on pensions (see appendix). Illinois’ tremendous growth in pension
expenditures during the past 30 years has cost each Illinoisan an estimated
$1,417 in additional income every year since 1991, the second-highest cost in
the nation.
The only state where pensions cost its residents more than Illinois is New
Jersey, which is also severely indebted and faces massive unfunded pension
liabilities. Following Illinois at No. 3 on the list is Connecticut, which is
the only state in the past 30 years to switch from a flat to a progressive
income tax structure. Since passing the progressive tax, Connecticut’s finances
have continued to deteriorate and lawmakers have hiked taxes on all taxpayers
including the state’s median earners – the middle class. Luckily for
Illinoisans, voters in November thoroughly rejected Gov. J.B. Pritzker’s call
for higher taxation via a progressive income tax hike. Although, newly elected
House Speaker Emanuel “Chris” Welch has suggested lawmakers pursue another
progressive income tax explicitly for pensions in the future.
When lost economic activity is combined with the tax dollars devoted to
pensions, Illinois’ total pension costs have soared to nearly $28 billion
annually.
Despite the record increase in pension expenditures in the past several decades,
Illinois’ pension system remains the nation’s worst by multiple measures.
According to Moody’s Investors Service, Illinois’ pension debt was equal to 500%
of the state’s revenues in fiscal year 2018 and almost 30% of the entire state
economy, both the highest rates in the nation. At the same time, Illinois’
credit rating has been in precipitous decline and now sits at the lowest credit
rating in the nation.
As pension debt continues to increase, so do required pension contributions.
Pension contributions now consume 26.5% of the state’s general funds budget, up
from less than 4% during the years 1990 through 1997.
The state has increased pension spending by more than 500% during the past 20
years, adjusting for inflation. Health insurance spending has gone up 127%.
To put that into perspective, most state leaders say education is their
priority. However, education spending has gone up only 21% during that time. All
other spending, adjusted for inflation, including social spending for the
disadvantaged, has dropped 32% since 2000. In the most recent budget, spending
on education was cut in real terms because the budget was not adjusted for
inflation.
Amid the severe economic contraction induced by COVID-19 and associated
state-mandated lockdowns, Pritzker signed the state’s 20th consecutive deficit
budget. At the time, the $43 billion spending plan was out of balance by nearly
$6 billion as economic fallout from COVID-19 blew a large hole in expected
revenue collections for the coming fiscal year.
In April, Pritzker’s own Office of Management and Budget predicted revenues
would drop by more than $4.6 billion for fiscal year 2021. A stress test
conducted by Moody’s Analytics projected an even steeper drop in total revenue
of between $5.2 billion and $6.9 billion, depending on the severity of the
economic contraction. Illinois had neither cash reserves nor a plan to handle
the crisis, outside of hoping for a federal rescue or raising taxes while
cutting services in the midst of a severe recession. Luckily, revenue declines
were not as severe as initially feared, with more recent revenue projections
revised upwards by $2.3 billion for the current fiscal year 2021, which “closes”
this year’s $3.9 billion deficit if December’s $2 billion in borrowing from the
federal reserve is counted as revenue.
That same month, Illinois Senate President Don Harmon asked the federal
government for a $44 billion bailout, of which at least $10 billion would go
toward the state’s pension debt. Meanwhile, Pritzker has continually advocated
for tax increases, first in the form of the $3.4 billion progressive income tax
hike that voters rejected and removing small business tax relief passed in
Congress, and now by advocating the closure of “loopholes” for businesses which
were put in place to incentivize job creation. Even more recently, newly elected
House Speaker Welch has suggested lawmakers pursue another progressive income
tax explicitly for pensions in the future.
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Instead of those measures, a state constitutional
amendment that allows for modest pension reform, such as replacing
guaranteed 3% compounding annual benefit increases with a true
cost-of-living adjustment tied to inflation, could free up state
resources and provide a boost for Illinois’ economic recovery.
By cutting investments in education, cash
assistance to the poor and other services to preserve unaffordable
pension benefits, Pritzker and lawmakers are sending a clear and
disturbing signal to taxpayers about what they value most.
Quantifying the hidden cost of Illinois pensions
Most economists agree how governments spend taxpayer dollars matters
for economic growth. It is difficult for a highly indebted
government to boost growth, especially during an economic slowdown,
through additional spending. Instead, a more effective approach
would be to change the composition of its expenditures.
Using data from the Bureau of Economic Analysis and the U.S. Census
Bureau, the Illinois Policy Institute found that in U.S. states,
economic growth is negatively associated with the share of
government funds spent on pensions. The massive increase in
Illinois’ pension system has resulted in an estimated $1,417 hidden
tax on each Illinoisan annually. That’s because research shows
higher pension-related expenditures lower the growth rate of per
capita personal income. Each year Illinois government increases
pension spending, Illinoisans experience less growth in their
incomes.
States that on average spent a larger share of their budgets on
pensions grew less than other states during the past two decades,
the evidence suggests (see appendix). The negative relationship
between pension contributions and per capita income growth is
statistically significant even after controlling for the initial
level of income, levels of government spending, population growth
and other factors specific to each state.
According to economic research, pension reform can improve economic
growth by increasing labor supply and household consumption. The
most important contributor to growth is an increase in the
retirement age. Encouraging longer working lives with higher earned
income increases household spending during working years. In
addition, delayed retirement leads to lower pension costs.
Lastly, research published in the Journal of Macroeconomics shows
population aging leads to a higher pension-to-gross-domestic-product
ratio at the expense of public education. While this is true in most
jurisdictions, the state of Illinois, with a voter population that
is similar to the rest of the nation, is clearly an outlier.
Illinois prioritizes pensions over classrooms despite having a
population similar in age to the nation. Pension spending has
increased by more than 500% when compared to just a 21% increase for
education in the past 20 years. The shift in spending priorities
toward pensions at the expense of educating youngsters and other
services is associated with persistently lower economic growth.
This is unfortunate because a number of studies have found a
positive correlation between economic growth and the share of
government expenditures on primary and secondary education. In
Pritzker’s current budget, education spending was cut, and pension
spending increased. The same thing is planned for his proposed
fiscal year 2022 budget. Meanwhile, as millions of Illinoisans were
applying for unemployment, government workers were given pay raises,
which ultimately will raise future pension costs and make finding a
job harderfor private sector workers.
Turning it around
Government spending not only reveals politicians’ true priorities,
but it also has consequences for residents beyond what they see in
their tax bills. Illinois’ outsized pension spending has lowered
Illinoisans’ incomes by an average $1,417 each year.
Making matters worse, even though voters thoroughly rejected
Pritzker’s $3.7 billion income tax hike, Welch has suggested
lawmakers pursue another progressive income tax explicitly for
pensions. This approach has been tried before to no avail, and a tax
hike during a nationwide economic slowdown could be disastrous.
Instead of enacting modest pension reforms, lawmakers have pursued
massive tax hikes that have largely gone to finance additional
pension spending. Despite the large, rapid increase in state pension
spending, state pension debt has ballooned to $261 million,
according to Moody’s Investors Service.
In order to allow for a robust economic expansion, Illinois must
avoid more disastrous tax hikes, which have failed and will fail to
make a dent in Illinois’ pension debt. They should pursue pension
reform.
In the short run, pension reform would help to fix the state’s
finances by freeing up resources to ensure core public services are
not cut and provide desperately needed stimulus to help the majority
of Illinoisans weather the current economic storm. In the long run,
pension reform would provide a path to pay down state debt, free up
funds for desperately needed new investments that raise economic
growth and reduce the tax burden.
Until the state addresses the problem through constitutional pension
reform that preserves earned benefits while curbing the growth in
future liabilities, contributions to its five pension systems will
continue to burden Illinois taxpayers and crowd out spending for
core government services on which Illinoisans depend. It will also
take that extra $1,417 from their pockets each year, even though
they will never see it.
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