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Illinois Governor Defends Tax Hikes

CHICAGO — As rating agencies and investors digested details of the Illinois General Assembly’s vote increasing state income taxes by two-thirds, Gov. Pat Quinn defended the action Wednesday as being necessary for the state to dig itself out of its fiscal crisis.

Quinn — who vowed to veto any increase in the income tax that exceeded a single percentage point during last fall’s campaign — said Illinois had “to take decisive action” to ease a state “fiscal emergency” that is underscored by a looming $15 billion deficit, a backlog of $8 billion in bills, and $62.4 billion in unfunded pension liabilities.

The individual income-tax hike approved by the legislature amounts to 2 percentage points.

“The next four years are a period of recovery,” Quinn said, adding that a temporary tax hike was needed to “get Illinois back on fiscal sound footing.” The Democrat said at a news conference that he will sign the bill as soon as it reaches his desk.

Without any Republican support, the Illinois House and Senate narrowly voted late Tuesday and early Wednesday to raise the individual income tax rate to 5% from 3% and the corporate rate to 7% from 4.8%. The increases will raise about $6.8 billion annually over the next four years before being rolled back to respective rates of 3.75%, and 5.25%. They would further drop to rates of 3.25% and 4.8% in 2025. The legislation limits spending growth to 2% annually through 2015.

Lawmakers also approved borrowing $3.7 billion to cover pension payments owed in the current fiscal year, which ends June 30. The state sold $3.5 billion to cover its fiscal 2010 payments. Lawmakers rejected a Democratic proposal to issue $8.75 billion of bonds to pay off bills and a $1 increase in the cigarette tax that would have raised $377 million annually.

The pension bonds received some Republican support, but members in both chambers blasted the tax hikes and called for additional spending cuts. The votes came after budget director David Vaught warned that the state faced a drop into junk-bond territory. Illinois’ ratings have suffered several rounds of downgrades, but remain five to six notches within investment-grade territory.

All three major rating agencies said they were reviewing details of the legislation and several planned to release comments in the coming weeks. The state has seen its ratings tumble over the last two years as lawmakers resorted to one-shot revenues to deal with growing budget deficits.

Moody’s Investors Service rates Illinois’ $25 billion of general obligation bonds A1 and Fitch Ratings rates them A, both with negative outlooks. Standard & Poor’s rates the state A-plus, but has it on negative CreditWatch. The outlooks are more long term while CreditWatch is reflects the near term.

Standard & Poor’s issued a statement saying its analysts would consider the state’s legislation, budget gap details, liquidity position, and longer-term financial outlook in their review.

While GOP lawmakers said spending cuts should have accompanied the legislation, analysts likely will look favorably on the tax hike since it’s the first significant step lawmakers have taken to deal with the state’s structural fiscal position. The question remains whether it will be enough to stave off any negative rating action.

“If structural changes are made to the budget and there are near-term prospects for improved performance and liquidity, the rating could be maintained,” Standard & Poor’s wrote.

Fitch said it would conclude its review of how the tax hikes fit into the overall budget picture next week. The agency wrote that its position has been that “enactment of budgetary measures to reduce the operating deficit on an ongoing basis, address the cumulative budget deficit, and reduce the accounts payable balance would be required to stabilize the credit.”

Moody’s said it too was reviewing the legislation but had no initial comment. Illinois in recent years has relied on one-shots and other fiscal gimmicks to deal with its growing budget deficit amid floundering revenues.

The state’s financial and liquidity crisis has captured national attention and some investors won’t buy Illinois bonds. The negative headlines have driven up the cost of borrowing for the state and local issuers here between 50 and 200 basis points and Illinois’ credit default swap has been highest among states.

Municipal investors would like to see further steps taken to address the fiscal woes, but several said the tax increase is clearly represents a positive move.

“It’s no cure-all and it’s still a long road, but they have taken a step toward making things better,” said Matt Fabian, managing director at Municipal Market Advisors. He said rating agencies may take a favorable view of the state’s active management and newfound willingness to right its course.

“The tax increase could help solidify the rating,” he said. “That stabilization is something tangible for investors.”

Fabian said Illinois bonds have weakened by 10 to 15 basis points in initial secondary market trading, but it’s too early to gauge market reaction as that shift could be driven by some investors’ ability to finally shed the debt. Trading levels improved later in the day and the cost for credit default swaps on state debt dropped below 300 basis points, a first in weeks. 

Christopher Mier, head of Loop Capital Markets LLC’s analytical services division, agreed that the tax hikes alone won’t resolve the state’s struggles, but he said the magnitude of their impact shouldn’t be undersold. “It is a substantive step,” he said. “It is the first in many steps needed, but it’s significant.”

Quinn and Democratic leaders have worked feverishly in recent days to raise support for a fiscal bailout ahead of the swearing in Wednesday of a new ­General Assembly with more Republicans, though both chambers still have Democratic ­majorities.

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