Illinois' Credit Rating Downgrades

04/24/2017 02:21 pm ET

Justin Leventhal contributed to this article.

Illinois is quickly proving itself a case study in how not to manage a state’s finances. Its credit rating has been sliding since 2009. In the past two years alone it has seen downgrades from all three major credit agencies. Fitch and S&P currently have Illinois one spot above “speculative” or “junk” status (a ‘BBB’) while Moody’s holds the state’s credit rating two spots above junk (at ‘Baa2’). Each of these ratings firms also have Illinois at a negative outlook.

S&P now says Illinois’ rating could be cut by two more levels if solutions experience continued delays, putting it well into junk status. Some local government debt already qualifies as “junk,” including Chicago Public Schools (CPS).

These downgrades stemming from fiscal mismanagement increase the cost of borrowing money. What went so wrong with Illinois’ finances? And, what can be done to resolve the problem?

The ratings agencies’ statements provide vital information on how Illinois reached this point. S&P cited “long-term irresponsible deficits, growing pension costs and a lack of reforms” as reasons for its downgrade. Fitch cited “the unprecedented failure” of not having a budget for two years and the effects of “spending far in excess of available revenue.” Moody’s reasons are similar for both the state of Illinois and for CPS, namely a “deepening structural deficit.” Ultimately these criticisms can be boiled down to the state having no budget—when it did, that budget was unbalanced for nearly a decade and a half—and pension costs growing unsustainably. Meaningful solutions to Illinois’ financial woes cannot be enacted quickly. According to S&P, if Illinois boosted revenues and ended the two year budget impasse, it would still not see a credit rating upgrade for another two years.

Some continue to blame the state’s credit slide on a lack of tax revenue, but this ignores the fact credit ratings continued to freefall even after increasing the state’s income tax. Legislators continually refuse to align budget priorities with the needs of its citizens. Instead, the legislature too often seeks to fulfill the agenda of public sector union special interests, particularly the American Federation of State, County and Municipal Employees (AFSCME). While numerous other unions have agreed to the need for pension reform, AFSCME has refused. This lack of compromise is threatening insolvency. For perspective, from 2000 to 2015, legislators increased spending on pensions by nearly 586 percent (an increase unseen in any other portion of its spending) and cut higher education funding by 8 percent.

The state is not short on the funds it needs, it is long on promises. First year pension payouts for many state employees exceed career contributions; the average state employee receives $1.6 million over their retirement. And Cadillac health insurance plans for these state employees are often paid completely by the state. Current state workers have enjoyed a 40 percent increase in their salaries from 2005 to 2014. While the rest of the state’s take home pay has remained flat, AFSCME members in Illinois became the highest paid state workers in the nation, when adjusted for cost of living.

Attempts to address these problems through increased taxes led to another systemic problem driving tax revenue down—people and businesses are fleeing the state. Illinois, in its attempts to tax its way out of this problem, encouraged a flood of businesses and people into neighboring states. Former residents and business owners cited high property taxes for their flight. Business owners also noted high worker compensation costs.

Discussing CPS in particular, Moody’s noted the necessity of “revenue growth and/or expenditure reductions” but, “more revenue through higher taxes is not an option.” In other words, broadening the base upon which taxes apply by growing economic output and population is the answer to any alleged revenue shortfalls. Given Illinois’ high tax structure, this advice can be applied to the state as a whole. Between 2015 and 2016, the state’s revenue dropped from $41 billion to $38 billion despite tax rates (some of the highest nationally) remaining constant. Over the same period, the state’s population dropped and businesses moved out of state. Bringing businesses back into Illinois will expand its economy and broaden its tax base, thus increasing revenue and beginning its move back into solvency.

Climbing out of this fiscal hole will be a long term project for Illinois, but S&P suggests several strong ideas. First, legislators should consider moving new state employees into a defined contribution retirement system to make pensions solvent in the long term. The second suggestion is to freeze local property taxes creating a lure to draw people back to Illinois (or at least stem the flow of people out of the state). Lastly, allowing more control by local governments over collective bargaining agreements would further serve to shore up Illinois long term fiscal problems. Short term solutions of increasing taxes will only serve to be counterproductive, pushing more people and business out and driving down state revenue. Legislators need to get the rampant pension growth under control and adjust their spending priorities to serve the needs of all state residents instead of an intransigent union.

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