Making Sense of the Illinois Budget Debate

July 3, 2017

Update (7/7/2017): Illinois lawmakers on July 7 completed an override of the governor’s veto, enacting a budget that increases the income tax rate from 3.75 percent to 4.95 percent.

July 1 came and went without Illinois adopting a budget, in what is becoming almost routine. In fact, the state is entering its third consecutive year without a budget—a national record, and not a good one. The state has limped along thus far, but the consequences of inaction are growing more dire as elected officials enter a standoff over proposed permanent tax increases. What’s going on?

If Illinois doesn’t have a budget, why hasn’t the government shut down yet?

Illinois has experience with operating without a budget. Over the past two years, 90 percent of state operations have been funded even without one, due to court orders which mandate that public sector employees get paid, consent decrees which mandate certain services, and governmental obligations that are covered under “continuing appropriations” provisions, along with emergency spending bills covering specific expenditures.

So if Illinois goes another year without a budget, is it just business as usual?

Probably not. All or part of several critical government expenditures, like state aid to public schools, aid to localities, higher education financial aid programs, and some social services, fall outside the scope of existing court orders and continuing appropriations provisions. For the past two years, these have been (mostly) funded through emergency spending bills, which function a little like continuing resolutions at the federal level. Without either a budget or another emergency spending bill, some schools wouldn’t be able to open their doors this fall. Junk bond status is also looming for the state’s debt obligations, which isn’t helped by the current standoff, and has significant ramifications given that Illinois has nearly $15 billion in unpaid bills.

But aren’t states required to balance their budgets?

Technically yes, but in practice, this requirement has a lot of “give.” Forty-nine of the fifty states have balanced budget requirements, Illinois among them, but all states have debt—and that’s fine. It makes sense to amortize the cost of long-term projects like highway construction by issuing bonds, for instance, and any sort of pension fund involves long-term (hopefully funded) obligations.

Unlike the federal government, states can’t print money, which imposes a practical constraint on governing in the red. Illinois, however, is making a go of it: not only is the state’s pension system in crisis (only 40 percent funded as of 2015), but the state actually has a $14.7 billion backlog of unpaid bills, a number that’s likely to keep rising given a $6.2 billion annual deficit. This “unpaid bills” category only exists in Illinois: quite literally, it means that the state has been “balancing” its budget each year—for many years—by not paying its creditors. If Illinois debt gets downgraded to junk bond status, as expected, that will be a key reason why.

What would a credit downgrade do?

It makes future debt a lot more expensive—and for the foreseeable future, Illinois is going to be drowning in debt. The House budget doesn’t appropriate any money for paying off these unpaid bills; instead, it’s widely assumed that the legislature will separately authorize new debt to start paying old bills. The cost of that debt would rise substantially if the state were downgraded, tacking on an additional $5 million to $10 million in debt service costs for every $1 billion borrowed. Illinois would also become the first state rated “junk.”

Under the House’s budget, where does the money come from?

The House would raise the individual income tax from 3.75 percent to 4.95 percent and the corporate income tax from 7.75 percent to 9.5 percent (including the existing “personal property replacement tax” component). The individual income tax increase would raise an estimated $4.3 billion, while the corporate income tax component would yield about $460 million. In May, the Senate backed a very similar tax increase, and Governor Bruce Rauner (R) and Republican legislative leaders have expressed their willingness to raise rates as well.

The proposed budget also eliminates a number of corporate income tax preferences, but restores a research and development tax credit and increases the state earned income tax credit.

Then what are the sticking points?

Permanence and structural reform. Governor Rauner is willing to back a temporary tax increase with the rates which emerged from the House, but only if the increases are temporary and tied to a property tax rate freeze of similar duration. He also wants any tax increases to be paired with other reforms, including pension reform. Legislative Democrats, meanwhile, want the state to revise the school funding formula to increase the share of state money flowing to disadvantaged schools (a proposal Rauner has rejected), and the House budget makes school funding contingent on the implementation of the new formula. They would also make the tax increases permanent, with the stated purpose of enabling the state to make progress on paying down those unpaid bills, though the appropriations bill the House passed doesn’t set aside any money to do so. Given these disagreements, Rauner has pledged to veto the bill.

What’s this about a property tax freeze?

Illinois has some of the highest property tax rates in the country, a fact lamented by Democrats and Republicans alike. Governor Rauner wants a temporary “freeze” during which localities would have to seek voter approval to increase property tax levies. It’s a proposal to which Democrats have been amenable (they previously backed a two-year freeze, while Republicans favored a four-year option), but which is not part of the budget the House adopted.

For Rauner, the property tax freeze and income tax increases would both be temporary and expire simultaneously; Democrats want permanent tax increases and, while open to a property tax freeze, chose to move forward without one for now. The House’s budget also modifies an existing income tax credit for 5 percent of property taxes paid, eliminating it for individuals with income above $250,000 (or household income above $500,000).

Will those unpaid bills get paid?

Time will tell, but a temporary tax increase that raised over $30 billion in additional revenue over several years, for the express purpose of paying down about $10 billion in unpaid bills, expired with unpaid bills totaling about what they didwhen the tax increase began.

Why is the governor insisting on pension reform?

Almost no one thinks that the status quo is sustainable. The obligations are too large, and the funded ratio way too low. In 2013, under a Democratic governor, Illinois adopted pension reforms intended to save $160 billion — that’s billion, with a “b” — over 30 years, but the courts intervened, ruling that the reform impermissibly altered retirees’ pensions. (Illinois has some of the strongest pension protections in the nation.) Rauner is chiefly interested in changing how pensions work going forward, but his proposals have met with significant resistance. Still, with the state’s unfunded liability at $119 billion (2015 figures), the state can only kick the can down the road for so much longer.

Can the legislature override the governor’s veto?

Maybe. The House mustered a 72-45 vote to pass its budget, one vote above the three-fifths required to override a veto. Interestingly, the legislature can pass a budget with a simple majority through May 31, but after that a budget vote requires a three-fifths supermajority: 71 votes in the House and 36 in the Senate. The Senate passed its own tax increase budget in May, but did so with 31 votes. Democrats have the ability to pass the budget along party lines (there are 37 Democratic senators), which would also be enough for a veto override, but they can only afford one defection.

Did I hear that a Senate Republican leader resigned?

Yes, Senate Republican Leader Christine Radogno resigned over the weekend, several days after announcing her intention to do so. The Republican floor leader said that she had been looking for a “natural break” in which to step down, but also expressed frustration with the state’s political stalemate.

What happens next?

The Illinois Senate will take up the revenue and appropriations bills soon, and if they can muster the three-fifths vote to pass them (the higher threshold for budgets adopted after May 31), then they would be in a position to override the promised veto. If not, negotiations will have to begin anew, which could be welcome news to Republican leaders in the House who complained that Democrats broke off negotiations too early.

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