Illinois governor race set with state's fiscal direction at stake

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CHICAGO – The Republican governor of Illinois. Bruce Rauner, and wealthy Democrat J.B. Pritzker won their respective parties' primaries Tuesday and will face off in a November general election where the state’s battered ratings, burdensome pension obligations, and budget pains could become central themes.

In the Democratic primary, Pritzker beat another businessman, Chris Kennedy, nephew of President John F. Kennedy, and Daniel Biss, a state senator.

Rauner narrowly staved off challenger Jeanne Ives, a state representative, for the right to run for a second term as the GOP candidate.

Pritzker spent $70 million of his own money and Rauner spent $50 million.

Two of Illinois’ general obligation ratings are one notch away from a historic cut to a speculative grade while $129 billion of pension obligations straining the general fund. A backlog of bills – while trimmed late last year through $6 billion in state borrowing -- currently stands at $8.3 billion.

Analysts, investors, and fiscal watchdogs, while paying attention, say optimism is in scant supply over the long term. The state faces a $1.5 billion deficit in the current fiscal year and the road to adopting a fiscal 2019 budget is likely to be difficult in an election year.

“The market wants a functional state government, and Illinois hasn’t had one for three and a half years,” said Matt Fabian, partner at Municipal Market Analytics. “Neither party is encouraging with respect to managing long-term costs, but at least a Democratic governor would mean less suspense in the short term.”

In the near term, Rauner’s primary win could mean he pulls right and “makes budget balance difficult again,” but the results, in which right-wing GOP voters backed Ives, could prompt Rauner to track left and “try for an easy, satisfactory budget that deals little pain to state stakeholders,” Fabian said.

The Senate is led by Democrats who hold a three-fifths super majority needed to override vetoes. Democrats hold a simple majority in the House.

Illinois bond spreads have widened after a steady narrowing that followed the July break in the budget impasse that saw a fiscal 2018 budget enacted after two years without one. A handful of Republicans joined Democrats in passing a $36 billion budget with about $5 billion in tax increases and then providing the margin to override Rauner’s vetoes.

The Illinois 10-year GO is trading at a spread of about 208 basis points to the Municipal Market Data AAA benchmark, according to data from MMD municipal strategist Dan Berger. That’s on par with where it was a year ago.

The 208 bp spread is up from 195 bp at the start of March, 178 bp at the start of February, and 177 bp at the start of 2018. It hovered in the 270 bp to 290 bp range last June as the new fiscal year neared and the threat of a cut of junk loomed without a budget.

It spiked briefly at 335 bp on June 8 when the market was spooked by an adverse court ruling on Medicaid payment.

It dropped to the low 200s after the July budget passage and hit a recent low of 168 bp last October.

Several market participants ascribed the higher spread on Illinois paper to concern over ongoing budget turmoil and a greater focus on the grim prospects for tackling the state’s pension quagmire given constitutional protections.

Tom Schuette, partner and co-head of investment research and strategy at Gurtin Municipal Bond Management, thinks investors are most interested in the state’s near-term status.

The question is whether Rauner and lawmakers pass a caretaker budget and leave thorny issues for post-November or the governor aggressively pushes his agenda and potentially pushes the state toward another impasse.
“Even if one of the candidates did offer substantive ideas on pensions and long-term fiscal issues on the campaign trail, I think investors that are avoiding Illinois would need to see something far more concrete than campaign speeches or policy platforms - they would need to see actual evidence that someone can push fiscal measures through the state legislature,” Schuette said.

After Tuesday's primary, Rauner and Pritzker wasted no time in launching fresh attacks in the first advertisements of the general campaign.

Rauner, in keeping with his theme casting blame for the state’s fiscal woes on longtime Democratic House Speaker Michael Madigan, labeled Pritzker as Madigan’s guy. His ad quotes Biss and Kennedy’s warnings that Pritzker was Madigan’s candidate, would serve as the poster child for pay-to-play politics, and protect the status quo.

Rauner blames Madigan for blocking his agenda proposals such as a local property tax freeze, term limits, and worker’s compensation reforms which he says are needed to improve the state’s economic climate. Democrats have labeled most of the proposals as anti-union and harmful to the middle class.

Pritzker countered in his own advertisement that Rauner represents “four years of failure,” highlighting news reports about the state’s low bond ratings and budget impasse and the damage caused to social service agencies by the bill backlog.

Pritzker has offered few details about his fiscal plans including how to tackle the state’s pension quagmire. He is promoting a shift from the state’s flat income tax to a graduated income tax that he is referring to as a “progressive” tax. Voters would need to pass a constitutional amendment.

“It’s a green light to raise taxes on everybody…and will not fix our financial problems,” Rauner said in an interview on National Public Radio affiliate WBEZ Wednesday.

Pritzker has endorsed legalizing marijuana, which could bring in an estimated $500 million in new revenue and said his policies would be aimed at increasing jobs – a similar theme long struck by Rauner although the two diverge own how to accomplish it.

“We cannot solve the financial challenges of the state of the state if we are not growing jobs in this state and that is something that Bruce Rauner has been an abysmal failure at.”

Pritzker said during the radio interview he would “refinance” the $8 billion backlog. The state sold $6 billion of GO debt late last year to bring down the record high $16 billion list of overdue bills.

“Refinancing that bill backlog is the first thing. Of course you want to pay to pay down the backlog but we also need to balance the budget before we can actually pay down that backlog,” Pritzker said. He did not elaborate with additional detail.

Rauner slapped that idea down saying it would raise pressure to lift the income tax because of the need to cover repayment. “We don’t have the money to have a principal payment schedule” based on current finances, Rauner said.

On pensions, Rauner supports Illinois Senate President John Cullerton’s consideration model that would save about $1 billion annually by asking employees to agree to some cuts in exchange for allowing raises to continue to count toward their pensionable salary. Unions have threatened a legal challenge if passed.

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