Illinois governor's State of State low on fiscal details
Illinois’ persistent fiscal ills took a backseat in Gov. J.B. Pritzker’s State of the State address Wednesday to calls for ethics reforms and a recap of last year’s bipartisan passage of a budget and an infrastructure program.
“Just look at what a difference a year can make,” said Pritzker, the Democrat who ousted Republican Bruce Rauner in 2018, ending four years of bitter partisan feuds with the Democratic legislative majorities.
“We passed a bipartisan, truly balanced budget on time, with renewed investments in job creation, cradle to career education, and physical and mental healthcare,” Pritzker said. “Even the credit rating agencies and financial analysts described a ‘distinct improvement’ in our fiscal stability, and investors took notice and lowered our state’s borrowing rate.”
Fitch Ratings did move the state’s outlook to stable from negative on its BBB-minus rating after passage of a budget that benefited from a more than $1 billion April tax windfall but rating agencies have warned that the stability is shaky.
“The recent gains, however, are somewhat tenuous and their sustainability hinges on the state's actions over the next several years, particularly around the November 2020 ballot initiative on the graduated individual income tax,” Fitch said at the time.
Rating agencies have warned the state of the need to move toward structural balance and any material hike in the bill backlog that is now at $6.6 billion or any effort to push off pension contributions could trigger downgrades. The state has two ratings at the lowest investment grade, with thethird only one notch higher.
While market participants generally see the state’s credit as holding steady for now actions this year stand to influence that perception at a time when the state intends to ramp up borrowing to finance the six-year, $45 billion capital program approved last year. Analysts and the buy side are watching closely to see how the progressive income tax referendum fares and how the state manages either a win or loss.
Pritzker’s only mention of the referendum was a reference to the longstanding support for it by the new Senate President, Don Harmon, D-Oak Park. Harmon replaced John Cullerton, a Chicago Democrat, who has retired.
Market participants looking for fiscal signals from the speech may be disappointed.
“The address was designed to emphasis the new productive, collegial tone in Springfield, address the ‘naysayers and cynics,’ and to reassure voters that reforms to contain corruption and cronyism were in the works,” Christopher Mier, head of analytical services division at Loop Capital Markets LLC, said in a special commentary. “The address was geared for voters with a populist tone” and “bondholders will be underwhelmed by the lack of priority given the State’s financial challenges in the address.”
The state’s fiscal forecast projects it — without spending or revenue changes — could see its deficit swell to more than $3 billion in five years, driving its unpaid bill backlog up to a record $19 billion.
Pritzker wants to impose graduated income tax rates, with higher income earners paying more, the cornerstone of his plans to stabilize state finances. If voters approve the constitutional amendment the new tax structure is estimated to raise about $3.5 billion annually.
One-shot maneuvers or resurrecting the previously pitched re-amortization of the existing pension funding schedule in the event the tax referendum fails are viewed as threats to the state’s stability as is a big spending spree in the event of victory.
The state last raised tax rates in 2017 as part of a budget vote that ended the state’s two-year impasse and staved off a cut to junk. The individual rate rose to 4.95% and the corporate rate to 7%. Critics of the potential change to a progressive structure say it will open the door to hikes on the middle class.
The state is operating on a $40 billion general fund budget and Pritzker will unveil the 2021 budget proposal Feb. 19.
While the state’s secondary bond market spreads have steadily narrowed since the end of the budget impasse and they are helped by the stable rating outlooks, Illinois has also reaped benefits from market conditions.
The 10-year spread to the Municipal Market Data’s AAA benchmark is 147 basis points, compared to 155 bps at the start of the year, 161 bps in the fall, and 175 bps over the summer, according to MMD state yield curve data.
The 10-year bond landed at a 140 bp spread on the state’s last primary offering in November but the competitive sale results were influenced by banks offering favorable bids to gain favor on future negotiated deals.
“Spreads across the board have diminished as there’s been a quest for high yield in this low rate environment,” said Daniel Berger, senior market strategist at MMD-Refinitiv. “It’s more demonstrable for the more challenged, higher yielding” issuers like Chicago and Illinois.
Along with the supply-demand mismatch, investment reallocations from equities to tax-exempt paper may also be a factor, Berger said.
Questions remain over what, if any, action might be sought on pensions in the new session as Pritzker reflected only on recent action.
“In addition to expanding our state pension buyout program, in the fall veto session we accomplished something that eluded governors and General Assemblies for almost 75 years by consolidating 650 downstate and suburban first responder pension systems,” Pritzker said.
The state's five fund system is collectively funded at just 40.3%. Unfunded liabilities rose to $137.2 billion in fiscal 2019 from $134 billion. State contributions will rise in the current fiscal year to $9.8 billion from $9.2 billion in fiscal 2020.
The governor is still awaiting a report from a task force he named last year to review potential state asset sales and transfers to bolster the pension system.
The administration last year laid out a series of pension proposals. It dropped several pieces including a pension obligation bond offering and a seven-year re-amortization of the funding schedule after a more than $1 billion April tax windfall. A buyout plan that was part of the package also continues but so far its results have been lackluster.
Chicago Mayor Lori Lightfoot will be pressing lawmakers to overhaul the tax structure for the Chicago-based casino authorized in last year’s gambling expansion package. Pritzker has said he supports tax changes aimed at easing the initial impact on a potential developer/operator in order to attract private interest.
The state has incentive to go along with the changes that fell flat during the annual fall veto session because the capital plan relies on revenue from a Chicago casino.
Lightfoot will also push for changes to the city’s property transfer tax that would allow it to implement graduated rates. Several Democrats opposed the plan during the veto session in an attempt to pressure Lightfoot to bolster affordable housing funds.
The administration is banking on the eventual flow of an additional $200 million from the casino to fund police and firefighters pension contributions and $100 million from the property transfer tax. Both are cornerstones of the city’s 2022 target to achieve structural balance. The city has some breathing room in the 2021 budget after achieving an additional $100 million in near-term savings on its $1.5 billion refinancing earlier this month.
Pritzker listed passage of property tax relief and reforms and clean energy legislation as priorities for the session. Republicans said property tax relief is a top priority for them and while wanting to work with the governor some said they were disappointed more concrete solutions were not laid out.
House Minority Leader Jim Durkin, R-Western Springs, praised the governor’s bipartisan efforts but said Democratic lawmakers needed to abide by that effort and called for stiff ethics measures “to get the trust of the public back.”
Federal probes of corruption scandals that ensnared several Democratic lawmakers cast a cloud over the session. Former Sen. Martin Sandoval entered a guilty plea to bribery charges this week and is cooperating with prosecutors. Another former lawmaker is expected to be arraigned next week on corruption charges.
It’s no longer enough to sit idle while under-the-table deals, extortion, or bribery persist, Pritzker said. “Protecting that culture or tolerating it is no longer acceptable. We must take urgent action to restore the public’s trust in our government. That’s why we need to pass real, lasting ethics reform this legislative session.”