CHICAGO—Illinois Gov. Bruce Rauner is poised to reveal his plan to erase billions of red ink, with analysts, investors, and budget watchdogs warning that cuts alone aren't likely to solve the state's long-term structural woes.
The newly elected governor releases his first budget Wednesday, and is expected to provide more details about the structural changes he has promised to shore up the state's shaky fiscal foundation.
Market participants say a real solution will take years to accomplish and is hard to foresee without a mix of both new tax revenue and spending cuts.
"The state can't solve its challenges in one year," said Municipal Market Analytics partner Matt Fabian. "A long term plan has to be in place."
That's what the market is expecting from Rauner, Fabian said.
"Gov. Rauner has been working with members of his administration to craft a budget that is fair and protects taxpayers while helping grow the economy. He will release the details of the budget on Wednesday at his budget address," spokeswoman Catherine Kelly said, declining to address any specific proposals or suggestions.
Illinois faces a $1.4 billion shortfall in its current $35 billion general fund budget. The already structurally unbalanced budget must also incorporate the loss of $3 billion in income tax revenue in the fiscal 2016 budget following the partial expiration Jan. 1 of a 2011 income tax hike. The fiscal year begins July 1.
Rates fell to 3.75% for individuals from 5% and to 5.25% for corporations from 7%. Before the 2011 hike they were at 3% and 4.8%, respectively.
Rauner has not said whether he will ask lawmakers to extend the rates, but many see his hiring of Donna Arduin as a top fiscal aide as a signal that deep cuts await, given track record in past Republican administrations in other states.
House Speaker Michael Madigan, D-Chicago, said recently he believed the governor was inclined to leave income tax rates at their current level based on recent conversations. The governor has indicated that one option for raising new revenue could be a broadening of the sales tax to cover some services.
The Civic Federation of Chicago's Institute for Illinois' Fiscal Sustainability on Thursday offered ideas on stabilizing the state's fiscal underpinnings in a five-year plan it says would shore up the operating budget and eliminate a $6 billion backlog of bills.
The state has typically artificially balanced its books by pushing off bills owed to the next fiscal year, one of the central factors rating analysts consider in their assessments.
"The incomplete fiscal year 2015 budget resulted in a greater deterioration of Illinois' finances and made the necessary actions to fix this crisis even more painful," said Laurence Msall, president of the Civic Federation. "Illinois cannot afford such a steep rollback of its tax rates without eliminating entire areas of state services or completely restructuring the government."
The federation proposes a retroactive increase in the income tax rates to 4.25% for individuals and 6% for corporations from their current rates of 3% and 5%, respectively, with a drop to 4% and 5.6% occurring in 2018. The income tax would be broadened to cover some retirement income from individuals with a total income of more than $50,000. Illinois is one of only three of the 41 states with an income tax that does not tax any pension income. The federation also endorsed expanding the sales tax base to include 32 services, as proposed by Rauner.
On the expenditure side, the Civic Federation plan recommends restricting discretionary spending growth to 2%. That's lower than the 2.7% level used in the state's recent three-year budget projections. The reduction would reduce spending by $1.3 billion over five years.
Other recommended actions include a temporary elimination of the sales tax exemptions for food and non-prescription drugs to provide a near-term infusion of new revenue. The exemption would be restored in fiscal 2020.
The various tax proposals would also help raise additional revenue for local governments; the federation suggested they should be allowed to impose municipal taxes on services, food and non-prescription drugs.
The plan would put the state on course to generate surpluses by the end of fiscal 2020. The federation proposes the funds go into a reserve with strict limits on access.
The plan gambles on the state's 2013 pension overhaul being upheld by the Illinois Supreme Court. The pension legislation was aimed at shaving $144 billion off state payments in the coming decades. A lower state court judge found the changes violated constitutional protections of pension benefits and a state appeal is pending.
If the law does not survive, the state could not make much of a dent in its bill backlog. "The impact on Illinois' credit rating and operating costs would also be significant," the federation warned.
Illinois is the lowest-rated state at the A-minus level with negative outlooks across the board due to budget stress, billions in unpaid bills, and pension pressures from $111 million of unfunded obligations. The state pays steep interest rates to borrow.
Several other research and academic groups have also recently warned new revenue is needed to offset too deep cuts that could harm state services and hinder its economic recovery.
The Republican governor also faces a stark political reality in that his budget must clear a General Assembly where Democrats enjoy a veto-proof majority.
The market is looking at both the state's short- and long-term solutions. "We remain focused on how the state will address the expiration of the temporary income tax increase and the budget gap in the current year and continue to look for how the state will balance its general fund budget" in a more structurally sound manner that doesn't heavily rely on non-recurring revenues, said Fitch Ratings analyst Karen Krop. "It remains to be seen how the state will do that."
The rating agency doesn't weight in on how the state should accomplish that goal, but Krop said given the size of the budget hole "it would be hard to cut that much."
Fabian said that Rauner is potentially well positioned to accomplish the task as a political novice with few embedded allegiances who tapped his own wealth to fund much of his campaign.