CHICAGO — Analysts and market observers say the immediate significance of Illinois Gov. Bruce Rauner's cuts-only budget proposal lies in the tone it sets rather than in its specific details, which are subject to what's expected to be tense negotiations with legislative opponents.
"Governor Rauner promised that we'd get a fresh approach to government and he delivered on that," said Richard Ciccarone, president of Merritt Research Services LLC.
The analysts and other municipal bond experts describe Rauner's proposed fiscal 2016 budget — which would balance the state budget with cuts and no new revenue — as an opening shot in a long game with an uncertain outcome ahead.
All said they will be closely watching how the legislative process plays out in the coming months as the rookie Republican governor butts head with the Democrats who hold veto-proof majorities in the legislature, who have made clear they favor more revenue to avoid what they consider dire cuts.
"From a credit standpoint this is an extremely pivotal point for the state and its rating," said John Sugden of Standard & Poor's. "They are facing challenges with a $1.6 billion deficit for this year before they even start dealing with the $6 billion shortfall for next year."
The rating agency likes Rauner's proposal to enact consensus revenue forecasting and to build reserves, but the plan to deal with the state's structural budget imbalance relies on deep cuts "in a state not known for delivering" on such reductions.
"The governor's proposal deals with a lot of the key issues, but some have serious implementation risks," Sugden said.
Rauner's nearly $32 billion general fund budget closes what his administration estimates is a $6.6 billion gap by cutting $1.5 billion in Medicaid funding, slicing $634 million in local government income tax aid, and trimming higher education spending by $400 million and local transit by $200 million.
Additional cuts, along with $2.2 billion budgeted from pension reform savings and $700 million in employee healthcare savings, complete Rauner's plan to eliminate the deficit without new tax revenue.
"It's a first step in the process. We are looking for the state to address its serious fiscal challenges in a sustainable way and I think the budget starts this process," said Fitch analyst Eric Kim.
Moody's Investors Service declined to comment on the budget proposal as a matter of policy given how early it is in the legislative process.
Illinois has the lowest ratings of any state at the A-minus level across the board, with negative outlooks, due to budget and pension pressures.
Two attention-getting features of the budget are its plan to slice the amount of income tax revenue distributed to local governments to 4% from 8% and its reliance on pension reform savings.
The pension reforms, if passed, would face an immediate legal challenge.
Rauner defended the local government cuts in his budget address by saying they would amount to just 3% of local government budgets and that locals are sitting on reserves of more than $15 billion to soften the blow.
Municipal officials counter that the cut could have a dramatic impact on some local budgets, especially in smaller communities or those without a big business base, forcing cuts of 20%.
Ciccarone describes the potential impact of local governments as creating "light to severe turbulence" with the potential to impact credit quality. Rauner also wants to impose local property tax freezes which, if accomplished, could severely limit the fiscal flexibility of some municipalities.
Ciccarone said his database on 131 municipalities shows a median fund balance of 34.5% in 2013.
"Most government can handle the cut. They will complain and they will feel the pain but it won't crush them," Ciccarone said. "But for those that are already on the margins they are going to have real problems managing."
Local governments across the state already must absorb a spike in public safety pension payments under a prior state mandate so the hit would come a difficult time.
Molly Shellhorn, senior research analyst at Nuveen Investment Inc. echoed worries over the impact. "We see that could be really problematic for local governments already fiscally stressed," Shellhorn said.
Shellhorn said the budget's reliance on pension savings raises questions given that the state's 2013 pension overhaul was overturned in court on state constitutional ground in a case that is now in front of the Illinois Supreme Court after the state appealed.
"We are viewing this as the opening bid," Shellhorn cautioned. "This is not the finished product. What is the important takeaway for us is that all of the dramatic cuts being proposed reflect that this is the result of years of structural imbalance it doesn't matter who the governor is. At some point Illinois was going to have to confront reality and there is just no easy way out of it."
While market participants warn of the credit pressures cuts could pose on local governments, academic researcher and financial consultant Martin Luby highlighted the positive impact on local borrowing costs should the state stabilize its fiscal foundation.
"My thinking is that if the state can get its fiscal house in order, the Illinois effect should be mitigated a little," said Luby, an assistant professor in the School of Public Service at DePaul University and a visiting senior fellow at the University of Illinois' Institute for Government and Public Affairs.
Luby authored a study on the so-called Illinois "effect" or "penalty" imposed on state paper due to the state's reputational risks but most Illinois-based issuers pay some interest rate penalty for the link.
Luby serves as Chicago's independent registered municipal advisor so cautioned his comments don't involve Chicago directly. Chicago stands to lose about $125 million in annual income taxes under Rauner's plan.
