Why Illinois' pension debt outweighs tax policy
Illinois’ rating prospects may depend more on future moves to pay its $133.7 billion pension debt than on how the graduated income tax constitutional amendment fares on next year’s ballot.
Passage "could be good for the state but it really depends on how it plays out,” Moody’s Investors Service's lead Illinois analyst Ted Hampton said last week at the rating agency’s special briefing, “Illinois: What’s Ahead for the State, Local Government, and Infrastructure Credits,” held in Chicago.
“This is potentially positive because it gives the state more policymaking flexibility … but the proof will be in how much revenue they actually raise and what they decide to use it for,” Hampton said. Moody’s affirmed Illinois' Baa3 rating, the lowest investment grade level, and stable outlook soon after lawmakers ended their spring session early this month.
The proposed structure supported by Gov. J.B. Pritzker and Democratic lawmakers would raise about $3.4 billion by increasing the rates on the top 3% of earners — that’s if voters approve the constitutional amendment on the November 2020 ballot allowing the state to scrap the flat income tax rate.
It could end up a “credit neutral" if the state "doesn't really make use” the new revenue to deal with its core problems — led by its pension woes — and props up spending plans instead.
Using the infusion of revenue to help improve the pension funding status would draw the most positive response from Moody’s.
And if voters reject the question? “If voters reject this in and of itself it’s not necessarily credit negative because the pension issue is going to be there the next day in any case,” Hampton said.
That’s good news for existing bondholders worried over the value of their holdings should the tax plan fail.
Either a super majority of three-fifths of those casting a vote on the question or a majority of those voting in the election is needed to approve the constitutional amendment.
Whether the state will heed Moody’s comments is another question. Pritzker has billed the graduated tax as the linchpin to a solution for the state’s long-term structural budget ills. So far he has pledged just $200 million of the $3.4 billion pot annually toward a supplemental pension contribution above payments scheduled under the 50-year plan to reach a 90% funded ratio by 2045. The system, which includes five funds, is collectively funded at just 40%.The state will pay about $9 billion into the system in fiscal 2020, which begins July 1.
Hampton was clear on two points: any action that materially hurts the pension system could draw a downgrade; and an upgrade isn’t likely until the state chips away at its fixed costs that include pensions, retiree healthcare, and debt service.
“Pensions and fixed costs remain very onerous for the state,” Hampton said. “Unless it’s improved it would be hard for us to see the state with a higher rating.”
Those fixed costs consumed 34% of general fund revenue in fiscal 2019, compared with a median for states of 9% in 2017, according to Moody’s data.
The governor’s pension proposals include boosting funding through asset sales and transfers, which is being explored by a special task force that is expected to issue a report this summer. The legislature approved another of his proposals that extends a pension buyout program to six years from three.
A separate task force is examining pension fund consolidation, though the primary beneficiary in the near term for any change on that front are local governments who pay into more than 600 local public safety funds.
After a $1.5 billion revenue windfall in April tax collections, Pritzker dropped plans to issue $2 billion of pension bonds along with his proposal to re-amortize the pension funding schedule. The plan called for extending the schedule by seven years, which would have trimmed more than $1 billion off the 2020 contribution.
The administration faced legislative pushback and market warnings that the move — labeled by critics as a partial pension holiday — could prompt a rating cut.
After the state dropped the pension bond plan, Deputy Gov. Dan Hynes suggested that the state still needs to look at the schedule and could consider some type of future re-amortization as part of a larger plan. “We don’t want to do any one thing in isolation,” Hynes said.
"The big conclusion from the legislative session was that the state had not done anything substantive on the pension front,” Hampton said. They also did not take actions that “notably made things worse,” which was a “distinct possibility” before the re-amortization was dropped.
The lack of progress on pensions and failure to make a material dent in a $6 billion bill backlog overshadowed progress made during the session, which was free of the political feuding that marked former Gov. Bruce Rauner’s tenure.
Pritzker and lawmakers have spent the last month basking in the results. The Democratic majority passed the graduated tax ballot question, a $40 billion general fund budget, a $45 billion capital budget, expanded gambling, and legalized the recreational use of marijuana. Some measures passed with the help of the GOP minority.
“There was some discussion about the positive new sense of harmony in Springfield and the way the budget was enacted in a timely basis and the capital plan,” Hampton said. Given the lack of progress on pensions or the backlog, “we were comfortable keeping the rating where it is.”
In a fireside chat at the Executives Club of Chicago last week, Pritzker defended the decision to act on revenue-raising measures like a cigarette tax hike and expanded gambling to achieve what he says is a budget for 2020 that’s balanced on a cash basis before tackling pensions. He started by rejecting the notion that revenues were his only pursuit in the new budget and insisted stabilizing state finances will take several years.
“Not everything can happen all at once,” Pritzker said. Achieving structural balance requires new revenue, expense management, and growth initiatives. He insisted all can’t be solved in one year after years of structural imbalance. “Now you can't do everything you want to do all at once,” he said of the state's fiscal mess. “It isn't going to be one year or one session that gets us out."