CHICAGO — A new Illinois pension-reform proposal calls for making permanent its temporary income tax hike and directing those revenues along with higher employee contributions to stabilize the pension system and stave off further credit deterioration.

Reforms designed to rein in soaring annual payments and chip away at $95 billion of unfunded liabilities have been stuck in political gridlock over the last year as the state’s credit rating tumbled and investors demanded greater interest rate penalties.

The plan state Rep. Lou Lang, D-Skokie, proposed Wednesday would raise employees’ retirement age and require them to contribute an additional 3% of their salaries towards their pensions.

The plan makes permanent the state’s 2011 income tax hike, a portion of which is set to expire in fiscal 2015. While Gov. Pat Quinn’s administration has warned of a dramatic drop in revenue that looms, it has steered clear of calling to make the tax permanent, focusing instead on pension reform. Lang is the first state lawmaker this year to broach the controversial subject.

Lang’s plan also relies on new funding of about $1 billion annually once pension-related debt is paid off in 2020. He portrayed his plan as the only one so far that can pass the state constitution’s ban against diminishing or impairing promised pension benefits. He believes all other proposals so far fail that test.

“This unfunded liability is affecting our ability to do our budgets, affecting our ability to fund services, affecting our bond rating,” Lang said. “We need a pension plan that will work on day one …. I think it’s a constitutional and credible way to fix the problem.”

It would shift to a new 50-year schedule aimed at reaching an 80% funded ratio. Like some of the plans previously floated, it would shift the cost of funding suburban and downstate teacher pensions from the state to local districts, but it stretches out the shift over a longer period of time than other proposals.

The plan requires Illinois to make its annual payment and if any of the revenues dedicated to pension payments exceed what’s needed, taxpayers would receive a rebate. The reforms apply to all five of the state’s pension funds. Lang offered estimates on potential savings and new revenue projections, but they have not been reviewed by actuaries.

The Democratic governor has endorsed a Senate plan which includes provisions in a House plan that cuts benefits and increases employee contributions. The legislation includes a backup that asks employees to voluntarily elect to accept the changes in exchange for maintaining their state-subsidized retiree health care benefits should the first plan be ruled unconstitutional.

The governor said Wednesday that he remains behind the Senate proposal as a “vehicle” for a reform plan that can be refined to win passage. When asked about Lang’s plan, Quinn said pension reform must be “comprehensive” and not rely solely on an infusion of revenue.

The state’s massive pension obligations, the looming tax expiration and a bill backlog of $9 billion are the key strains on the state’s credit. Standard & Poor’s rates the state A-minus with a negative outlook. Fitch Ratings has Illinois’ A rating on negative watch and Moody’s Investors Service is A2 with a negative outlook.

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