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A Fiscal Rehab Plan for Illinois

CHICAGO — Gov. Pat Quinn’s effort to build support for an income tax hike to help dig Illinois out of a $12.8 billion budget hole and liquidity crisis was helped along this week by a local government watchdog group that endorsed tax increases if accompanied by $2.5 billion in spending cuts and pension reforms.

The report from the Civic Federation of Chicago comes as the state is ready today to formally launch its fiscal 2011 budget process with the posting online of state budget figures that will serve as the basis for Quinn’s next budget proposal.

“The Quinn administration is eager to hear from everyday people and get their views on the state’s budget,” said budget office spokeswoman Kelly Kraft.

The federation’s plan, “A Fiscal Rehabilitation Plan for the State of Illinois,” offers the governor and General Assembly recommendations for a fiscally reasonable path out of the state’s budget crisis based on sound financial principles, said federation president Laurence Msall.

In addition to the budget’s red ink, the state faces a backlog of $5 billion of overdue bills, a $62.4 billion unfunded pension liability, and a rating that has fallen into the single-A category, with warnings of further negative action.

Lawmakers put off dealing with falling revenue and growing bills until after the state primary election earlier this month, but political attention is now focused on tackling the fiscal crisis ahead of Quinn’s scheduled release of a fiscal 2011 budget in mid-March.

The Civic Federation believes the state needs the mix of pension reforms, spending cuts, and revenue increases to solve its fiscal problems, but it supports the latter only after the first two issues are addressed.

Before any tax increases, the federation said the state should roll back spending levels to fiscal 2007 levels, with the exception of Medicaid and general aid to public schools.

The federation would then recommend an increase in the individual income tax to 5% from 3% and the business income tax to 6.4% from 4.8%. Combined, the increases would raise $6 billion in new revenue. Illinois could raise another $1.6 billion by repealing the income tax exemption for federally taxed portions of retirement and Social Security income.

The report also recommends increasing employee contributions to pension and health insurance, which, with other changes, would save the state $400 million. In addition, business tax changes and a $1 increase in the tax on a pack of cigarettes could raise additional funds.

If adopted as proposed, the 106-page plan — available at civicfed.org/sites/default/files/IllinoisFiscalRehabilitationPlan.pdf — would leave the state with just a $2.1 billion gap in the form of unpaid bills that could be addressed in fiscal 2012 by holding spending again steady at fiscal 2007 levels. The additional revenue generated by the tax increases would then go to fund escalating pension payments beginning in fiscal 2013.

“Illinois’ fiscal crisis has been many years in the making. It was caused by more than 30 years of pension underfunding and many years of spending unfettered by the state’s shrinking revenue resources,” Msall said. “The Civic Federation does not enjoy advocating a significant tax increase in the middle of a difficult recession. However, continuing to do nothing would be, by far, a worse option.”

The pension reforms such as trimming benefits for new employees are needed to deal with the growing effect of the state’s mammoth unfunded liability on its operating budget.

With just a 54% funded ratio, Illinois ranks last among states in the amount it has set aside for its pensions, according to the Pew Center on the States’ national report released last week.

That report, however, looked at figures from fiscal 2008, when the state carried a $54.4 billion unfunded liability. The latest figures show the funds have deteriorated. The state closed out fiscal 2009 with a $62.4 billion unfunded liability, with an increase of $8 billion for a funded ratio of just 51%.

That increase was calculated based on a smoothing of the valuation of assets. The state last year shifted to the smoothing method — one in which market losses and gains are recognized in equal amounts over five years — from the fair-market valuation previously used.

If not for the shift, the actual increase in the liability during fiscal 2009 due to market losses would have amounted to $23.5 billion, for a 39% funded ratio, according to a supplemental digest posted to the state auditor general’s recent audits of the retirement systems.

Illinois faces steep increases in annual payments when its annual required contributions and debt service on its $10 billion pension bond issue from 2003 are combined, with $4.5 billion due this year, $5 billion in fiscal 2011, and $5.5 billion in 2012. The contribution rises to $21.4 billion in fiscal 2045 to bring the systems to a 90% ratio, as required by state law, by 2045.

The Civic Federation noted the state’s debt levels as a contributing factor to its current crisis. Illinois has about $25.4 billion of outstanding long-term debt, an increase of $17 billion or 200.9% from fiscal 2001, due largely to the state’s 2003 issue.

Total debt service next year is estimated at $2.7 billion, up 162% since 2001. Between fiscal 2010 and fiscal 2033, the state is expected to pay a total of $22.7 billion in debt service on outstanding pension obligation bonds.

The Democrat Quinn last year pushed for an income tax increase that would have pushed the state’s 3% flat rate on individuals to 4.5%, but lawmakers balked.

 In response to the federation’s report, the governor’s office issued a statement calling the report “a positive step forward in the ongoing dialogue necessary to address our state’s fiscal crisis.”

Quinn has proposed some limited pension reforms, but any could prove a hard sell given union opposition and the pending general election. Republicans oppose a tax increase. Both of the General Assembly’s chambers are controlled by Democrats.

Both Chicago Mayor Richard Daley and Senate President John Cullerton, D-Chicago, when asked about the report, endorsed the federation’s proposals to cut spending and raise taxes. Cullerton said he could support some limited pension reforms.

Fitch Ratings rates the state’s general obligation debt A and has the credit on negative watch. Moody’s Investors Service rates it A2 and Standard & Poor’s rates it A-plus, both with negative outlooks. The state’s fiscal 2010 budget totaled $59 billion.

Though its borrowing costs have risen with lower ratings, Illinois has found eager buyers for its paper in a series of deals over the last few months amid the negative fiscal news.

It received orders totaling about $2.5 billion on its sale last week of $1.4 billion of refunding GOs. The state ended up insuring about $500 million of the transaction with Assured Guaranty Municipal Corp. at a cost of about 10 basis points, market participants said.

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