Illinois lawmakers return to tackle taxes, budget, and pensions

Illinois lawmakers return to work next week to take up Gov. J.B. Pritzker’s crowded fiscal agenda in a five-week homestretch with the state’s weak ratings and spread penalties at stake.

The session resumes Tuesday with big votes looming and a new distraction that provides rival Republicans fresh fodder in their opposition to key pieces of the first-year Democratic governor’s tax proposals.

Jay Robert "JB" Pritzker, partner and founder of New World Ventures, speaks during a Bloomberg Television interview at the annual Milken Institute Global Conference in Beverly Hills, California on April 29, 2013.
JB Pritzker during an interview with Bloomberg TV at the annual Milken Institute Global Conference in Beverly Hills, California, U.S., on Monday, April 29, 2013. The Global Conference convenes chief executive officers, senior government officials and leading figures in the global capital markets to explore solutions to today's most pressing challenges in business, health, government and education. Photographer: Patrick T. Fallon/Bloomberg *** Local Caption ***

WBEZ radio reported Wednesday that federal authorities are conducting a criminal probe of Pritzker for a residential property tax appeal that resulted in $330,000 in savings after toilets were removed from his Gold Coast home leaving the home to be labeled as uninhabitable.

A Cook County inspector general’s report concluded that false representations were made and it raised questions over potential federal conspiracy and mail fraud violations. Former Gov. Bruce Rauner highlighted the questionable appeal in a commercial featuring toilets. He labeled his rival the “porcelain prince of tax avoidance.”

The allegations create some cognitive dissonance with Pritzker's top fiscal priority: changing the state constitution to permit graduated income tax rates under the argument that wealthy people like Pritzker — scion of a billionaire family — can and should pay more.

Votes also loom on Pritzker's $39 billion general fund budget plan, which is supposed to serve as a “bridge” to the adoption of a graduated tax, which can't be put to the state's voters until 2020. It's part of an overall $77 billion spending package that banks on the eventual income tax shift. Proposals that generate new revenue from sports betting and the legalization of recreational cannabis and a cut in pension funding also lay ahead.

Several local market participants and legislative aides said they don’t believe the toilet allegations will sidetrack Pritzker's agenda.

“The fact is the governor’s agenda was well-received by the legislature’s majority and I think it reflects the Democrats’ agenda, so I don’t think this report has the ability to derail it,” said Richard Ciccarone, president of Merritt Research Services LLC. “Elements might be taken off the table but I think the majority of it will be approved.”

The graduated tax legislation and any new borrowing — including Pritzker’s $2 billion of pension obligation bonds and a $1.5 billion deal to lower the state's backlog of unpaid bills — requires a three-fifths supermajority. Democrats hold those supermajorities in both chambers.

Richard Ciccarone speaks at the Bloomberg Link State and Municipal Finance Briefing held at Lighthouse International in New York, U.S., on Tuesday, March 22, 2011.
Richard Ciccarone, managing director and chief research officer at McDonnell Investment Management, LLC, speaks at the Bloomberg Link State and Municipal Finance Briefing forum held at the Lighthouse International in New York, U.S., on Tuesday, March 22, 2011. Photographer: Jin Lee/Bloomberg *** Richard Ciccarone

Brian Battle, head of trading at Chicago-based Performance Trust Capital Partners, offered a similar assessment.

The Democratic majority “is going to get everything done at lightning speed,” Battle said. “The state needs the money desperately and it’s the Democratic Party not just the governor that wants it. The bigger question is will it improve the state’s fiscal status?"

To achieve that, Battle said the state needs action on pensions, and Pritzker's budget doesn’t accomplish that and could even worsen the system’s health in the near-term.

A legislative aid close to leaders agreed but said politics could delay some measures.

“For many Democrats, these issues are on their agenda, not the governor’s,” said the aid. “My general sense is the members have more invested in these issues than the governor, even though parts of his budget rely on them.”

The aide cautioned that at the state capital, nothing is a sure bet. “Gambling expansion, sports betting, etc. — they are always on the verge of passing…the fair tax amendment was on the verge of a big vote a year or two ago, and then it wasn’t.”

Pritzker, who later paid the taxes, said he was not concerned about the outcome of any review. “Let me be clear that I’m very confident that any review of this matter will show that all the rules were followed,” Pritzker said, adding of his agenda: “All of these things will pass.”

RATINGS AND SPREADS
The state’s secondary general obligation trading levels have been holding steady. The two-year is trading at a 120 basis point spread to the Municipal Market Data AAA benchmark, the 10-year is trading at a 178 bp spread and the 25-year is trading at a 168 bp spread, according to MMD data. The state’s recent refunding carried a final nine-year bond on the tax-exempt side. That maturity landed at a 175 bp spread.

Illinois carries a BBB rating and negative outlook from Fitch Ratings, a Baa3 from Moody’s Investors Service and a BBB-minus from S&P Global Ratings. The latter two assign a stable outlook. Analysts have warned of potential credit deterioration if the state’s pension woes worsen or red ink materially drives up the bill backlog that stood at $7.3 billion Thursday.

Fiscal pressures could worsen if some of the governor’s revenue measures don’t come to fruition and he in turn refuses to cut spending to deal with a more than $3 billion deficit or backs down from his pension re-amortization.

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Pritzker's makeover of the current funding schedule would shave $1.1 billion off the $9.2 billion scheduled 2020 contribution. The state has nearly $134 billion of unfunded pension liabilities with a 40% funded ratio.

If Pritzker's proposals all pass, analysts may give Illinois time to see how adoption of a graduated tax, if voters approve it, impacts the state’s fiscal ills. But that’s a gamble.

“Given its tenuous fiscal position, near-term progress toward resolving its ongoing structural imbalance is critical to maintaining our investment-grade rating. If Illinois is unwilling or unable to pass a revenue increase within the next two years, absent significant expenditures cuts, we would likely lower the rating,” S&P said in a recent report.

Fitch, the only agency holding Illinois two notches above junk, has indicated it will downgrade Illinois if it returns to a pattern of deferring payments for near-term budget balance, saying “elements of the governor's proposal…appear to do that without a clear path toward long-term balance.”

Moody’s is reserving judgment until a final budget is passed. Factors that could drive a downgrade to junk include renewed growth in payment backlog that reverses progress and a reduction in pension contributions for fiscal relief.

GRADUATED TAX
A Senate vote is expected soon on the graduated tax amendment. A Senate committee advanced SB SJRCA0001 to the full floor in early April. If approved, it would then go to the House.

Pritzker has proposed a rate schedule that would raise an estimated $3.4 billion in new revenue annually. It would increase the current 4.95% flat rate on only the top 3% of the state’s earners and lowers it for those on the other end of the earnings scale, but those rates are subject to negotiation. The corporate rate would rise to 7.95% from 7%.

The constitutional amendment would not set tax rates, but the administration has said it won’t go to voters without first setting a rate structure. Pritzker has dodged questions over how he would proceeds if he the graduated tax fails.

The GOP is opposed to the constitutional amendment, arguing that it would make future tax increases easier to enact. Ciccarone warns that more revenue will likely be needed down the line without cost cuts now “as shortfalls occur especially during economic downturns.”

PENSIONS
Amid pushback from various factions, Pritzker has in recent days defended his pension proposals as a balancing act on spending.

“I want to make sure we are doing everything we can do to simultaneously pay the pensions that are owed…and at the same time we need to balance the budget of the state,” Pritzker said.

His five-piece pension package would provide upfront budget relief by extending the current amortization target date to reach a 90% funded ratio by seven years to 2052 and extending a pension buyout program. That would trim contributions by $1.1 billion in fiscal 2020 with relief seen in future years too. The administration has not released information on the actuarial impact on the funding schedule and funded ratios.

It also calls for pension obligation bonds, funneling $200 million in future graduated tax revenue to bolster contributions, and selling assets or transferring them to the pension system to bolster the its funded ratio.

Pritzker recently signed legislation to move forward with the long-stalled sale of the state’s downtown Chicago headquarters which could generate an estimated $250 million to $300 million for the pension system.

The Teachers’ Retirement System Board of Trustees, the largest of the state’s five funds, slammed the re-amortization.

“The system is at a growing risk of insolvency in the event of an economic downturn,” TRS said. “This danger is the direct result of eight decades of state contributions that always have fallen far short of actuarially based funding” and the governor’s proposal would only exacerbate the problem.”

Pritzker has named a task force to explore pension fund consolidation for the state and local governments but a report is not due until the summer.

The state has not passed a major infrastructure bill since 2009 but there appears to be momentum to change that. Hearings have been ongoing over the need for transit, transportation, and school projects, but legislation with a funding mechanism has yet to be filed. Pritzker initially said he opposed a motor fuel tax hike but has recently said that’s on the table.

The proposed budget relies on $1.1 billion of fresh revenue from a new tax on plastic bags, license fees from legalized cannabis and sports betting, closing a corporate tax loophole, taxing e-cigarettes, raising the existing cigarette tax, assessing a tax on Medicaid, changing the existing tax structure on video gambling and capping a retailers' discount.

Some proposals have seen committee votes, but remain subject to change, and most have not gone to the Senate or House floors and in some cases legislation has not yet been filed.

Expansion of gambling has proven difficult and recreational cannabis has seen pushback from critics who want the process slowed to consider the impact on workplace rules, impaired driving, and social and law enforcement costs. Proponents say it could raise between $350 million to $700 million in revenue, but market participants have warned it’s no fiscal panacea.

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