CHICAGO – Action that could end two years of Illinois budget gridlock and avert a looming downgrade to junk moves to the state Senate Monday.

After beginning a third fiscal year on Saturday without a budget in place, the House passed a $36 billion fiscal 2018 spending plan and $5 billion tax hike package on Sunday with the help of Republicans who broke with Gov. Bruce Rauner.

Fitch Ratings on Monday published a commentary calling the developments "concrete progress on reaching an agreement to break the two-year long budget impasse." The report cites both spending cuts and revenue hikes and acknowledges a threatened veto.

Fitch said it would "continue to monitor the developments" and that "failure to enact a balanced budget for fiscal 2018 would result in a further downgrade," while enacting a budget that puts the state on a more stable path could stabilize its rating. The rating agency has said it plans to resolve the state's February placement on Rating Watch Negative of its BBB rating, two notches above junk, by the end of July.

Pressure on lawmakers to resolve the budget quagmire intensified late Friday when U.S. District Court Judge Joan Lefkow ordered the state to begin paying $586 million a month toward Medicaid-related bills to bring the state into compliance with existing consent decrees. About half would come from federal funds. The state also must pay down over the course of fiscal 2018 several billion in delinquent bills now on the rolls.

“As if the governor and legislators needed any more reason to compromise and settle on a comprehensive budget plan immediately, Friday’s ruling … takes the state’s finances from horrific to catastrophic,” state comptroller Susana Mendoza said in a statement.

“Payments to the state’s pension funds; state payroll including legislator pay; General State Aid to schools and payments to local governments – in some combination – will likely have to be cut. Payments to the state’s bond-holders will continue uninterrupted,” she added.

The state’s “core” priority payments total $1.85 billion. Before the ruling, Mendoza said that the state in August will fall $185 million short of what’s needed just to meet those obligations.

The House’s budget doesn’t yet include a plan to pay down the state’s $15 billion backlog of bills including $3 of Medicaid-related vouchers, but it does fund state services, schools, transportation projects and raises about $5 billion in new annual revenue. Negotiations are continuing on a cash flow borrowing with proposals ranging from $4 billion to $7 billion.

The budget bills now go before the Senate where a prior vote on tax hikes passed with only a simple majority. Gov. Bruce Rauner threatened a swift veto so it will need to pass the Senate with a super three-fifths majority of 36. House Republicans who helped reach the 71-vote super-majority needed in that chamber for an override to succeed will have to hold steadfast in their decision to break with Rauner.

Illinois Gov. Bruce Rauner warns that the House approved budget falls short of the reforms he's demanded to win his signature.

“I will veto Mike Madigan’s permanent 32% tax hike,” the first-term Republican governor said in a statement. "The legislature could have passed a no-reform budget like this one two years ago. Instead, they allowed Mike Madigan to play his political games, passed phony budgets, racked up our debt and inflicted pain on the most vulnerable.”

The governor has focused much of his attacks on House Speaker Michael Madigan, D-Chicago, for his resistance to Rauner’s demands that governance and policy reforms be included in any budget that relies on tax hikes.

COURT RULING

Rating agencies and investors have been watching closely how the court would resolve its finding that Illinois had violated consent decrees by allowing bills to pile up which has threatened recipients continued access to care.

The judge’s findings earlier this month and decision to send the state and lawyers for Medicaid recipients into negotiations rocked the market, sending the state’s spreads the following day up between 50 and 100 basis points.

They later recovered but it underscored just how precarious the state’s cash flow has become and how investors are worried a shift in payment obligation alone could drive a downgrade.

“Other than the state’s debt service obligations which must be met in order to avoid default, a consequence that all parties and the court agree should be avoided, defendants have not demonstrated a basis in law or fact for the choices they have made,” the Friday ruling read.

As requested by the plaintiffs, the state must now begin paying $586 million monthly on vouchers submitted after June 30 on behalf of providers of services in the Medicaid-funded programs involved in the cases, including managed care organizations. The state had offered to raise current payments by $150 million, about 16% more than it currently pays.

In addition, the comptroller must pay down $2 billion of the $3 billion in overdue fiscal 2017 bills owed to MCOs. The judge gave the state some breathing room there as the plantiffs had sought the pay down of the $2 billion over four months. The Illinois Attorney General's office is reviewing the order and couldn't immediately say if it was considering an appeal.

BUDGET

The Senate’s session resumes at noon Monday. Tensions ran high during weekend deliberations. Madigan called for an initial vote to amend the Senate Democrats’ budget on Friday and that passed in a bipartisan 90-25 vote to applause. Madigan then sent letters to the three rating agencies asking them to hold off on any negative action as work continued on efforts to end the impasse.

The momentum stalled on Saturday and at first Madigan said there would be no budget votes over the weekend. Minority Leader Jim Durkin, R-Western Springs, fired back that action was needed. Madigan later abruptly announced there would be a vote on Sunday.

Durkin then questioned the move as he said there was still no deal on non-budget items like a local property tax freeze and worker’s compensation changes being sought by Rauner and accused Democrats of backing away from negotiations.

The state must resolve its budget mess soon or it risks a downgrade by at least S&P Global Ratings to junk, a first ever event for a sovereign state. Moody’s assigns a negative outlook to the state’s Baa3 rating and Fitch Ratings expects to act on the state’s BBB rating by the end of July, based on its watch placement.

Democrats hold 67 seats and Republicans hold 51 in the House. Senate Bill 9, the tax bill, cleared in a 72-45 vote, with one vote more than needed. The tally for the bill included 15 GOP votes while 10 Democrats voted against it. The vote on the budget appropriations Senate Bill 6 followed and passed with a higher margin in an 81-34 vote.

The tax package primarily relies on raising the personal income tax rate to 4.95% from 3.75% and the corporate rate to 7% from 5.25%. Democrats scaled their original plan back by about $400 million for a final size of $36 billion. The state currently spends about $39 billion while collecting just $32 billion to $33 billion.

Republicans who broke ranks gave impassioned speeches saying it was time to end the pain.

“I was not elected as a state legislator to help preside over the financial destruction of this great state,” said David Harris, R-Arlington Heights.

Democrats included an amendment requires the distribution of school district aid based on “evidence-based model,” which is included in a school funding overhaul that Rauner has threatened to veto because he believes it’s too favorable to Chicago Public Schools.

Rauner and many Republicans opposed the budget vote without a deal on worker’s compensation changes and a four year local property tax freeze in the form demanded by the GOP. Rauner also wanted to cap the income tax hike to four years, but the approved budget makes them permanent.

Durkin warned that the House vote alone might not stave off action this week.

“I don't know how much value the bond houses put into legislation that is facing a veto from the governor,” Durkin said.

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