Why Is Illinois Ranked as the Least Fiscally Healthy State?
This year Illinois falls to last place in our annual Ranking the States by Fiscal Condition report, coming after Kentucky (46th), Massachusetts (47th), New Jersey (48th), and Connecticut (49th). Illinois’s ranking shouldn’t come as a surprise to anyone following state fiscal news. Last year the state made history by finally passing a budget to close out a two-year budget gap. The state passed a budget on time this year but is nowhere near addressing its $7.1 billion backlog of unpaid bills and ongoing budget issues.
Illinois performs poorly on just about every metric that goes into calculating its overall rank. It is 49th in cash solvency. The state only has between 0.55 and 1.13 times the cash needed to cover short-term obligations, far short of the average in the states.
Illinois’s experienced a shortfall in fiscal year 2016, with revenues only covering 92 percent of expenses. The state ranked as 46th in the budget solvency area and its net position moved in a negative direction, showing a deficit of $450 per capita. This is not a unique occurrence for Illinois, which has experienced a shortfall in every year that we looked at except in 2006 and in 2013. Illinois’s structural deficits are a result of expense growth (about two percent per year) outpacing revenue growth (about one percent per year).
Long-term liabilities are over three times larger than assets, leaving Illinois in a vulnerable, almost impossible position to cushion against shocks or long-term fiscal risks. This explains Illinois’s long-run solvency rank of 49th. Long-term liabilities are a persistent issue for many states, but Illinois’s liability growth is especially worrisome. Most states have experienced an annual 11 percent growth rate in their long-term liabilities per capita since 2006. Illinois’s long-term liabilities per capita, by contrast, have grown at about 19 percent per year. The state’s pension obligations are driving this growth in long-term liabilities. Illinois’s unfunded pension obligations amount to $445.79 billion and are only 21 percent funded when measured on a market basis. These liabilities take up 67 percent of state personal income, explaining its 46th rank in trust fund solvency.
To really drive home how severe Illinois’s situation is, a recent study by J. P. Morgan finds that Illinois would need to make pension payments that would amount to 50 percent of state revenues in order to fully meet unfunded obligations over time. Illinois stands out in the study as one of the states—along with New Jersey—with the most deteriorated pension finances. Looking at three different potential solution areas, the J. P. Morgan study also finds that Illinois would have to increase tax revenues by 25 percent, increase worker contributions by 689 percent, or hope for pension investment returns to increase to 11.5 percent. The unlikelihood of achieving any of these options means that Illinois’s recovery may be a long time coming.
How Did Illinois Get Here?
Illinois’s fiscal crisis is the result of many years of poor financial decisions and budget gimmicks. It is not the result of any one politician or specific administration’s momentary misdirection or misjudgment. The Illinois Policy Institute documents the ongoing and structural nature of Illinois’s poor financial decisions and diagnoses them as a result of the political tendency to kick the can down the road. Even in years in which the state has experienced infusions of revenues, like the one that resulted from the drastic 2011 income tax hike, policymakers end up spending the money irresponsibly. The state has increased pension benefits very generously over the years without making regular payments to keep up with benefit growth. All the while, Illinois residents have been leaving at a much faster rate than residents of any other Midwestern state, and Illinois consistently loses more residents than any other state.
Another issue making pension reform especially difficult is the way in which the state constitution has tied the hands of lawmakers. Pension and health-care liabilities have been carved into constitutional stone. Only seven other states put pressure on their finances by explicitly guaranteeing the payment of public employee pensions through their constitutions. Mercatus Senior Affiliated Scholar David M. Primo has described this as a conflation of the purposes of the legislative and the judicial arms of the state. Additionally, there are ways to protect the benefits that beneficiaries have already earned while not condemning future residents to financial distress.
The reality, however, is that Illinois’s constitutional work has already been done, and has the most stringent forms of pension protections of the states as a result. The Illinois State Supreme Court has reinforced the strictness of the pension-related clause of their constitution and interprets it as protecting both benefits that have already been earned by current employees as well as protecting the future benefits not yet earned by future employees.
This is why Illinois’s latest attempts at reform have relied on the voluntary participation of plan beneficiaries. In the latest budget, policymakers offered two buyout options where beneficiaries could receive payments now in lieu of their complete retirement benefits in the future. When buyouts are properly structured, they balance the competing priorities of fulfilling benefit promises as well as dealing with past policy mistakes. As I’ve written at The Bridge previously, Illinois’s buyout options don’t balance these priorities well.
Illinois finds itself in a deep hole with no fully reliable ladder to climb out. Some even think that the only solution to their mess is to file for bankruptcy and ask the Federal government to bail them out, an event with no legal precedent. There is not one panacea solution for the state to move forward. Their recent attempt to reform pensions through offering buyouts signals that they’re thinking beyond short-term fixes like tax increases, but more work needs to be done in this direction. Illinois needs long-term solutions that will involve regulatory, tax, and pension reform.
Illinois’s and the other bottom states’ positions are especially concerning considering the current state of the national economy. We are experiencing one of the longest bull runs in history: the S&P 500 has quadrupled from its 2009 low. Granted, the way that plays out in tangible terms varies by state and not every state experiences the same growth rate. Illinois has been one of the slowest-growing states in the nation. Even so, with the state still unable to stabilize its finances 10 years after the recession and still only experiencing a 0.7 percent annual growth rate in personal income compared to the national average of 1.6 percent, there is cause to worry about how the state would respond to another crisis.
Other states can learn from Illinois’s situation by not falling into the rut of making consistently poor financial decisions. Although their situations are not exactly the same, policymakers in New Jersey and Connecticut have exhibited similar patterns in their behavior and are highlighted in our study as being consistent underperformers. I will discuss what can be learned from them as well as from the consistently high performing states in more detail in the next essay of this series.