Illinois must navigate pension and economic headwinds to keep up progress

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Illinois needs to gain more ground in putting its fiscal house in order as a burdensome pension tab, population losses, and economic uncertainty threaten progress that has driven a round of positive rating actions.

That’s the assessment offered by the legislature’s non-partisan Commission on Government Forecasting and Accountability in its annual three-year budget forecast.

While the COVID-19 pandemic threw a wrench in fiscal 2020 financials as the income tax filing deadline was pushed several months into fiscal 2021, the state’s fiscal trajectory has brightened since its two-year budget impasse ended in 2017. The gridlock that stemmed from political divisions between then-Gov. Bruce Rauner, a Republican, and the legislature’s Democratic majority, left the state with a peak bill backlog of $16.7 billion and ratings one notch away from junk.

“Since then, the state has ended each fiscal year with the backlog being smaller,” COGFA said. “The state’s fiscal condition and economic environment improved enough that Illinois received upgrades from the rating agencies for the first time in two decades. Despite this good news, the state still has many issues to deal with before its fiscal house is in order.”

The report lays out the strains weighing on the state’s books and offers measures to help ease them, given the revenue surpluses in hand. Without endorsing any specific procedures, the report helps make the case for some pending before lawmakers as they work toward an April 8 adjournment.

The state expects an additional $2.2 billion of revenue, about 5% of general funds, in fiscal 2022 and another $2 billion in fiscal 2023 over levels forecast just a few months ago.

Gov. J. B. Pritzker has proposed funneling $879 million in the current and next fiscal year into the now empty rainy day fund while Comptroller Susan Mendoza has proposed legislation that would strength automatic triggers for rainy day deposits when bills fall below $3 billion.

Pritzker also wants to make $500 million in supplemental pension contributions and to pay down more bills. So far lawmakers have acted on several of Pritzker’s fiscal 2021 changes, including making $300 million in supplemental pension payments and paying off $898 million of overdue employee healthcare bills.

“We have made a lot of progress on Illinois’ finances in the last year. Now is not the time to backslide,” Mendoza said of the rainy day proposals that “would put Illinois on the right path to better budgeting and better credit ratings.”

The state’s $139.9 billion of unfunded pension liabilities “still cast a long shadow over the state’s finances” and the “unemployment rate still lags the country as a whole,” reads the report authored by Benjamin Varner. “While current projections indicate a surplus in FY 2023, it is unknown how long this economic expansion will last and if the state has truly balanced its revenues and spending for the long term. The state must be diligent moving forward to continue to improve its fiscal picture.”

The state recorded strong investment returns last year that helped trim the unfunded tab by a few billion, but its size, a weak 4.24% funded ratio, and statutory funding schedule that falls short of actuarial requirements threatens the state’s outlook, COGFA said, citing the state actuary’s last report.

The current bill backlog, now being referred to as the accounts payable tab, was at $3.4 billion Thursday and has hovered between $3 billion and $4 billion over the past year. At the current levels, Mendoza said the state is paying bills within a more routine cycle of 14 days and the tab is down from $5.2 billion a year ago.

When the backlog hit its peak of $16.7 billion in late 2017. Late payment cost the state $711 million in calendar year 2018, $236 million in 2019, $306 million in 2020, and $201 million in 2021.

“These payments are a threat to the state because any money needed to pay late payment penalties is money that cannot be used for other purposes,” COGFA said.

The state must also tread cautiously to protect its upward trajectory on ratings due to the “increased debt service costs” that would result from any backsliding. Illinois won one-notch upgrades from Moody’s Investors Service and S&P Global Ratings last year, bringing its ratings to Baa2 and BBB, respectively. Fitch Ratings has held the rating at BBB-minus, but it and S&P assign a positive outlook. Moody’s outlook on the state is stable.

“Illinois has had one of the lowest credit ratings among the states for years” after 15 downgrades since 2010, the report notes.

In the near term, the COVID pandemic’s course poses a threat as new strains could drive a surge in cases that dampen economic prospects.

Structural imbalances could drive up the state’s overdue bills and that would drive interest costs up if it’s forced to issue short-term debt or incur state-imposed payment interest penalties to health providers and vendors of 9% and 12%, respectively.

Longer term weak demographics and fiscal instability put the state’s outlook at risk. COGFA cited Moody’s Analytics February report that warned of headwinds due to population losses that weigh on employment gains. Illinois was one of four states or territories that lost residents during the past decade and additional losses are in store, the report warned.

Making progress matching revenues with expenses would go a long way to shore up state finances in the long term, while reducing the late penalties on bills would help reduce interest costs should a recession drive the backlog up. If reduced to 7.5%, the state would save between $15 million and $45 million annually per every $1 billion outstanding.

The state could raise more revenue by expanding its sales tax base to cover services. Making a bigger dent in the state’s fiscal woes would strengthen its economic appeal, luring more business, jobs, and residents, the report said.

Base general funds revenue totaled $44.9 billion in fiscal 2021 up $6.8 billion, or almost 18%, from 2020 due to an infusion of income tax payments held over from 2020 along with a rebounding economy and additional federal support.

The five-year average for tax growth was 8.9% while the 10-year average is 4.8%. The 15-year and 20-year averages are 3.9% and 3.6%, respectively. The personal income tax has averaged growth of 6.4% over the past 20 years, while the corporate income tax grew 9.8%.

The commission forecasts fiscal 2022 base general funds of $47 billion, a 4.8% increase. Adding $1.5 billion of ARPA revenue to make up for COVID-driven lost revenues brings the general fund up to $48.5 billion.

Fiscal 2023 base general funds are forecast at $46.3 billion, a decline of $671 million from fiscal 2022. Revenues are expected to grow $302 million or about 1% to $46.6 in fiscal 2024. Revenue growth is expected to accelerate moderately in fiscal 2025 rising to $47.8 billion, or 2.5%.

“The commission’s revenue outlook reflects current law with a view of moderate economic growth as the country continues to get beyond the COVID-19 pandemic and deals with high inflation and the war in Ukraine,” the report said.

Mendoza reported this week another step in the state’s post-impasse recovery with the repayment of $297 million in short-term internal borrowing tapped as bills had mounted from the impasse. The state borrowed $2.3 billion from other funds through January 2020 that it has not repaid.

The state previously paid off its $3.2 billion of short-term borrowing from two loans through the Federal Reserve’s Municipal Liquidity Facility that helped manage the pandemic’s revenue hits. The $2 billion, three-year loan was repaid nearly two years early.

Mendoza also announced a change in the label assigned to the state’s bills to “accounts payable” from the “bill backlog.” The snapshot of pending bills represents liabilities that are not “backlogged” but rather reflects the ongoing processing of bills which averages around $2.5 billion each month, Mendoza said.

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March 31, 2022 at 03:06PM

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