01/21/2014 02:13 pm ET Updated Mar 24, 2014

Illinois Budget Deficit Will Grow Despite Pension Reform, Study Says

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CHICAGO, Jan 21 (Reuters) - A reform package passed late last year will make improvements to Illinois' woefully underfunded public pension system, but the state's budget gap still will increase to $13 billion by 2025 if current policies remain in place, according to an independent analysis released on Tuesday.

While the pension reforms are expected to save Illinois $160 billion over 30 years, they will reduce the state's structural budget deficit only by $1 billion to $1.5 billion a year over the next decade, according to the report by the Institute of Government and Public Affairs at the University of Illinois' Fiscal Futures Project.

That would leave the state with a projected budget gap of $3 billion in 2015, growing over the next 10 years to $13 billion. The projected shortfall is just $1 billion less than the $14 billion deficit the report projects Illinois would face without pension reform.

"The pension revision law of December 2013 was a huge step in the direction of fiscal stability for Illinois," the report said. "Unfortunately, the state's fiscal problems are so great that much still remains to be done."

The report assumes that the pension changes will take effect in June and that a significant increase in income tax rates, enacted in 2011, will be allowed to partially expire when 2015 begins.

However, state retirees and others have filed class-action lawsuits that seek to stop the law on the grounds that the Illinois constitution prohibits impairment of public worker retirement benefits. The litigation could push back the law's implementation and possibly void it, forcing state lawmakers to find another way to tackle a $100 billion unfunded pension liability.

As for the income tax hikes, the report said lawmakers could vote to make them permanent. If that and implementation of the pension reform law both happen, the state budget deficit in 2025 would come in around $5.5 billion, the report estimated.

The state's own projections disagree with those published in the report. The report foresees a $3 billion deficit in the state's general funds for 2015, while the state budget office projects the $37 billion budget will show only a $1.9 billion deficit.

The comprehensive pension reform law was a critical step to returning Illinois to sound financial footing, said Abdon Pallasch, the state's assistant budget director.

"As the three-year projections posted Jan. 1 show, the state faces a challenge with the expiring revenue to develop a solution that will allow the state to continue to pay down its bills and protect education and public safety services from radical budget cuts," he added.

Under the pension reform law, cost-of-living increases for retirees' pensions will be reduced and suspended, retirement ages will be increased and salaries on which pensions are based will be capped.

The state's failure to tackle its pension funding problems led credit rating agencies to pound Illinois' bond ratings to the lowest levels among states. Meanwhile, Illinois plans to sell its first tax-exempt bonds since passing pension reform. The $1 billion of general obligation bonds are scheduled to be priced through Citibank on Feb. 6.