CHICAGO – Illinois Gov. Pat Quinn chided state lawmakers Wednesday for failing to tackle pension reform as he unveiled a $35.6 billion general fund budget for fiscal 2014 that cuts spending on some core priorities “to the bone” due to rising pension payments.

Quinn warned that rising pension costs will consume new revenue growth anticipated in the fiscal year beginning July 1, leaving little for state programs and services or to pay down billions in overdue bills.

“This is the most difficult budget Illinois has ever faced,” the Democratic governor said in his address before the General Assembly. “And it is only a preview of the pain that is to come if this General Assembly does not act decisively on comprehensive pension reform.

“There are too many priorities that have been cut to the bone due to inaction on pension reform,” he said. “The people of Illinois need your immediate action.”

Republicans agreed that action is overdue but they blamed Quinn and his fellow Democrats who control the General Assembly. “Most of the activity has come out of the General Assembly especially from the House,” said Senate Republican Minority Leader Christine Radogno. “The governor is the one that has been woefully absent.”

Republicans had a long list of complaints. They argued that further cost cuts were needed to stabilize state finances and paying down bills should be prioritized with the goal of letting a 2011 income tax increase expire on time. They believe the education cuts are aimed directly at pressuring all lawmakers to act on pension reform but Republican leaders avoided criticizing that strategy. 

The state’s pension payment will rise by about $900 million, to $6 billion, in the next budget, consuming 19% of the general fund compared to the 8% it took up in 2008, budget documents show. 

Pension reform emerged as a theme Quinn returned to throughout his speech. The crisis, illustrated by $95 billion of unfunded liabilities in a system that is just 40.4% funded, and cash-flow problems that have resulted in a massive bill backlog of $9 billion, are cited by rating agencies as the two core strains on Illinois finances.

The state’s fiscal woes have driven a series of downgrades. That has raised state borrowing costs. The state pays between 50 basis points to 200 basis points over the triple-A MMD scale. The impact has trickled down to local governments, schools, and other borrowers who investors demand penalties from due to state exposure. Further state credit deterioration is expected this year absent the adoption of pension reforms.

Disagreements over specific reforms and how best to craft a package that could withstand a legal challenge given strong legal protections public pension benefits enjoy have prevented action to date.

Quinn proposed suspending a series of corporate tax loopholes that could generate more than $445 million in new revenue annually to pay down the backlog. The plan is “good for our vendors and good for our economy,” he said.

The budget anticipates closing out the current fiscal year with $7.5 billion in unpaid bills. That’s down from $8.7 billion in fiscal 2012. The number drops to $6.8 billion in fiscal 2014.

Quinn also wants to better match appropriations with costs to end the practice of carrying over bills into the new fiscal year in several targeted areas. Quinn aides said there is no plan to renew a previous push to borrow to pay down bills.

The spending plan laid out by Quinn is up by 3% over current year spending. The overall budget rises to $62.4 billion when federal revenues, other funds, and capital spending are added to the general fund. Revenues are expected to increase by about $800 million. No new taxes or fees are proposed. The state faces a drop in tax revenues beginning in fiscal 2015 due to partial expiration of the 2011 income tax hike – a pressure also cited by rating agencies -- but Quinn aides deflected questions on the subject of whether he would push to make the tax permanent or extend it. Instead they said the governor is focused squarely on pension reform.

As part of the budget the state will review all automatic fund transfers. That proposal has raised concerns among local governments that their share of income taxes could be cut.

The state will allocate $13.2 billion to education, up from $12.7 billion this year. The budget actually cuts $400 million in aid to lower and higher education. Quinn said higher teacher pension payments are driving the increased spending and drop in actual aid. Grants for low-income college students and early education would escape cuts.

“Our pension obligations have squeezed out funding for core services.  And every day that passes without pension reform, the problem gets worse,” Quinn said.

The budget proposal now heads to the General Assembly where it faces scrutiny from both Democrats and Republicans. The House recently adopted a resolution setting revenue available for the next fiscal year at about $35.1 billion and it’s expected to stick with that figure.

The budget funds raises – with a price tag of about $200 million over three years and $140 million in back raises – as part of a new collective bargaining agreement. The proposed contract shaves $900 million off the state’s bill for retiree healthcare over the three years. Quinn called the agreement a “landmark” one and the healthcare changes “unprecedented.”

The changes were sought under legislation aimed at reducing the state’s unfunded other post-employment benefits liabilities. The state will spend about $877 million this year to subsidize retiree healthcare. As of June 30, 2011, the state carried a $33.3 billion unfunded OPEB liability.

Under the new plan, retirees will pay a greater share of the premium costs based on their income. The unions negotiated the changes with the state but continue to wage a legal battle against the legislation.

The budget touts the state’s ongoing investment in infrastructure. The spending is included in the state’s ongoing $31 billion capital plan, a $12 billion tollway capital program, and a $1 billion clean water initiative. State general obligation and sales tax backed bonds support the capital program, the state toll authority will sell as much as $1 billion of toll-backed bonds this year for its plan, and the Illinois Finance Authority anticipates issuing state revolving fund bonds to fund clean water projects.

In his speech, Quinn outlined provisions he wants in pension reform. They include suspending cost-of-living adjustments, increased employee contributions, dedicating the $1 billion that now goes to pay off pension notes once they are retired in 2020 to pensions, and guaranteeing annual pension payments.

Negative action on the state’s credit prompted it to pull a $500 million competitive GO sale earlier this year as early indications suggested bids would come in higher than anticipated.

Fitch Ratings has the state’s A rating on $26.2 billion of GO debt on negative watch. Standard & Poor’s earlier this year downgraded the state to A-minus and assigned a negative outlook. Moody’s Investors Service assigns a negative outlook to Illinois’ A2 GO rating.

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