Civic Committee Financial Framework
The Financial Framework consists of five elements:
Implement long-term financial planning and increase fiscal transparency;
Eliminate the structural budget deficit and unpaid bills, establish a reserve fund, and implement a new funding plan to pay down the approximately $130 billion in unfunded liabilities of the State’s pension funds;
Scrutinize the entire State budget for spending reductions;
Reform the tax system to reduce Illinois’ negative outlier status and raise revenues, as needed; and
Establish goals and metrics to measure the State’s progress.
The issues facing the State are interconnected, and the elements of the Financial Framework represent a balanced, comprehensive plan that reflects that interconnectedness. The State should adopt all elements of the Framework in order to maximize the effectiveness of reform efforts; piecemeal implementation may do more harm than good.
We believe that it will require $8 billion a year in expenditure cuts and revenue increases over the next five years to put Illinois back on the path to financial stability.
Identifying $8 billion a year will allow the State to fully eliminate the structural budget deficit, pay down the remaining bill backlog, establish an appropriate reserve fund, and properly address the State’s unfunded pension liabilities.
Pursuing these policies, in turn, will lay the groundwork for an upgrade in the State’s credit rating to AA. This is a goal of the Task Force not only because it will reduce the cost of borrowing for the State, but, more fundamentally, because it serves as an indicator recognized throughout the world of the State’s fiscal health and stability.
The Financial Framework does not specifically address a capital budget. Nevertheless, the Task Force recognizes that the State has significant capital needs that should be addressed in the near term. For example, the Regional Transportation Authority (RTA) estimates it will need $38 billion over ten years to bring the mass transit system in the Chicago metropolitan region into a state of good repair.5 In addition, the Illinois Department of Transportation estimates that it will require $1.7 billion each year to maintain existing highway and transit infrastructure.6
We believe that the State should adopt a long-term, transparent capital investment plan that relies on recurring revenue sources and performance-based project funding so that future capital investments are strategic, well thought out, and sustainable. Developing such a plan is critical to bolstering Illinois’ position as a key transportation hub and promoting economic and job growth.
In addition to the Financial Framework described above, the Task Force has identified several additional reforms to improve the jobs climate:
Local Government Consolidation;
P-12 School Funding Reform; and
Workers’ Compensation Reform.
Illinois’ Current Performance
Illinois has many strengths and enjoys a competitive advantage over other states in a number of ways. Despite the State’s numerous advantages, however, Illinois’ economic growth has lagged its peers in recent years and compares unfavorably to other states in several significant ways:
- In a March 2018 poll conducted by the Paul Simon Institute of Public Policy at Southern Illinois University, 84% of respondents said that the State was headed in the wrong direction;7
- Illinois’ credit ratings, which serve as a useful proxy for a state’s fiscal health, are the worst in the nation. Illinois’ S&P credit rating (BBB-) sits one notch above a junk bond rating;8 and
Illinois ranks poorly compared to other states on key economic metrics. For example, Illinois is:9
41st out of the 50 states for year-over-year Gross State Product (GSP) growth (for 2016-2017); and
36th out of the 50 states for year-over-year employment growth (for December 2017-December 2018).
Civic Committee Framework
The State needs to make significant changes in order to right its fiscal ship and reduce uncertainty for job creators.
The elements of the Civic Committee’s Financial Framework identify the changes Illinois needs to make and are based on best practices of other successful states. It is important to note that the policy options described throughout the report assume the current state of affairs; that is, they do not require constitutional changes to implement. We do not rely on policy changes that would require a constitutional amendment, – such as implementing a graduated income tax or adjusting pension benefits for current plan participants – since passing any amendment would be a challenging, multi-year process, and delay will only make the State’s fiscal challenges greater.
I. Implement long-term financial planning and increase fiscal transparency
Compared to other states, Illinois’ financial planning processes are incomplete and opaque. Budget documents tend to focus on the General Funds budget, which includes only about half of the State’s spending. Revenue and expenditure forecasts vary depending on which source they come from (the Governor’s Office of Management and Budget or the Commission on Government Forecasting and Accountability) and rarely include projections beyond three years. In addition, the State frequently uses short-sighted budgetary practices – such as one-time revenues, interfund borrowing, and borrowing to fund current operations – to “balance” the State’s budget.
To identify best practices of other States, we use the Volcker Alliance’s Truth and Integrity in State Budgeting Report (issued in 2017) as a starting point. The report focuses on five key areas (budget forecasting, budget maneuvers, legacy costs, reserve funds, and transparency) and grades states based on their specific policy practices.
The Civic Committee’s recommendations for improving Illinois’ financial planning processes and transparency are consistent with the best practices outlined in the Volcker Alliance report. Our recommendations include:
Establishing clear financial objectives and articulating metrics that will illustrate progress towards those goals in both the short and long term;
Focusing on long-term (at least five year) financial projections for revenues and expenditures;
Scrutinizing all funds under the control of the State during budget negotiations (including General Funds and Other State Funds, as well as revenue-sharing with local governments);
Ensuring that expense forecasts accurately and completely reflect the full expected costs of programs;
Creating consensus revenue forecasts that do not rely on one-time revenues to balance the budget, and focusing on sustained revenue sources;
Producing timely financial statements that report revenues and expenses (as well as assets and liabilities) that are updated at key points of the budget cycle;
Including baseline budgets in budget documents that show projected revenues and expenditures absent major policy changes; and
Publishing the aggregate State pension contribution (from General Funds and Other State Funds) as well as standard pension contribution benchmarks (e.g., the Normal Cost plus Interest payment) so that stakeholders can evaluate the adequacy of the State’s pension contribution and see how current funding compares to that benchmark and impacts the total amount of pension liabilities.
II. Eliminate the budget deficit and unpaid bills, establish a reserve fund, and implement a new funding plan to pay down the State’s $130 billion unfunded pension liability
In order to reach financial stability over the next five years, the State needs to right-size its budget and eliminate the structural budget deficit, pay down the remaining bill backlog, establish a reserve fund, and implement a new pension funding plan.
Since the increase in the personal and corporate income taxes at the beginning of FY18, the structural deficit is much smaller than it was when we published Bringing Illinois Back. Nevertheless, it has not been completely eliminated. As shown in Figure 1 below, the State’s annual structural deficit is projected to be as much as $3.4 billion from FY19-24.
As a result of past budget deficits and the two year-long budget impasse, the State still has unpaid bills that will have to be paid down, which will total approximately $7.8 billion by the end of FY19.10 In addition, the State should follow best practices of other states and establish a reserve fund to cushion against future budgetary shocks, including the potential impact of economic downturns. Depending on the size of the State budget over the next five years (reserve fund requirements are frequently determined as a percentage of revenues or expenditures), a healthy reserve fund would be approximately $4-5 billion.11
Once the State eliminates the bill backlog and establishes an appropriate reserve fund, the State should consider rolling back the recommended tax increases as well as evaluate its top fiscal priorities and allocate these resources as necessary to ensure a balanced budget, adequate spending on education, sufficient pension contributions, and appropriate levels of State services.
In addition, the State should implement a new pension funding plan that will speed up the time frame for getting to a “tread water” contribution level (contributions are sufficient to keep the unfunded liability from growing), is budget sustainable (will not significantly worsen crowding out of all other budget spending imperatives), and will amortize the remaining unfunded liability after the plans reach 90% funded. As is described in the “Pension Reform” section, implementing our “2+2” Plan will require the State to contribute an additional $2 billion a year beginning with the FY20 contribution.
To achieve the goal of eliminating the budget deficit and unpaid bills, establishing a reserve fund, and implementing a new pension funding plan, the State will need to identify approximately $8 billion in spending cuts and/or revenue increases from FY20-FY24, as summarized in Table 2 below.
Figure A below shows several policy options that could be implemented to reach this goal.
The challenges facing Illinois’ public pension systems – massive unfunded liabilities, extremely low funded ratios, and annual contributions that are crowding out other State spending – are significant and well known. Across all five pension systems, unfunded liabilities total roughly $130 billion, and the funded ratio is only 40%.12 In addition, pension contributions currently account for nearly 20% of the General Funds budget,13 a share that will likely increase as the State’s statutorily required pension contributions continue to grow over the next 27 years.
When the State adopted its current pension contribution schedule, it was designed in a way that shifted costs to the future. The schedule has been in place for 23 years, but to date, the State’s pension contributions have not reached a level sufficient to keep the unfunded liabilities from growing. Instead, it relies on higher contributions in the final years of the schedule to amortize the unfunded liabilities; pension contributions will grow at a 3.3% compound annual growth rate until they reach approximately $19.5 billion in FY45 (approximately $10 billion in 2018 dollars).14 Unless the State’s budget growth keeps pace with or exceeds the pension contribution growth, it will become increasingly difficult to make the statutorily required pension contributions without severely cutting services, raising taxes to unreasonable levels, or some combination of both.
The status quo is not sustainable, and the State needs to reform its public pensions. However, options to reduce the unfunded liability are limited due to constitutional constraints and the recent Illinois Supreme Court decision that overturned benefit reforms. Future reforms should expand their focus to include creating a credible plan for paying down the unfunded liabilities of Illinois’ pension systems, while also mitigating the negative impact of pension contributions on the provision of important government services.
Any new funding plan the State pursues should meet the following criteria:
- Structure contributions in a budget sustainable manner that will not significantly worsen crowding out with extremely high, back-end loaded contributions;
- Increase pension contributions up front so that contributions reach the “tread water” level (i.e., the point at which contributions are sufficient to keep the unfunded liability from growing) faster than under the current schedule; and
- Provide a plan to amortize the remaining unfunded liability after the funds reach 90% funded.
The Civic Committee recommends the “2+2” Plan, which meets the above requirements. The “2+2” Plan would restructure the pension contribution schedule so that the State’s baseline contributions would grow at 2% a year, and the State would provide an additional $2 billion in supplemental contributions until the plans are 90% funded. Then, this plan would amortize the remaining unfunded liability over 10 years. Under the “2+2” Plan, the State’s pension plans are projected to reach 93% funded by FY45. The “2+2” Plan also produces total financial benefits of approximately $46 billion. The State’s contributions over time (FY20-FY65) would be about $8.6 billion less in real dollars than under the current status quo contribution schedule. And most importantly, the “2+2” Plan would eliminate the State’s unfunded pension liability projected to be $37.7 billion in FY2065.
Another benefit (as shown in the graph below) is that not only are the State’s pension funds projected to reach the “tread water” level faster, but under the “2+2” Plan, the unfunded liability is projected to peak at a lower level than under the Status Quo pension schedule. It would remain lower than the projected unfunded liability for the Status Quo pension schedule for all years.
Figure A: Unfunded Liability Comparison, Status Quo Contribution Schedule vs. “2+2” Plan
Additionally, the State should consider making changes to pension fund governance to ensure that funds are held to high standards (which may, in turn, lead to higher returns and/or funding levels).15
III. Scrutinize the entire State budget for spending reductions
The State should intensify its focus on identifying opportunities for savings in the State budget. These savings should be generated through improving the efficiency of service provision and ensuring that resources are directed to the State’s highest-priority programs.
General Funds Savings: Group Health Insurance for Active Employees
The State Employees’ Group Insurance Program (SEGIP) provides medical, dental, vision, and life insurance coverage to the following (and their dependents): active State employees, elected State officials, and State university employees. It also provides retiree healthcare benefits for members of the State’s five pension plans (and their dependents) except for retirees eligible for coverage through the Teachers’ Retirement Insurance Program (TRIP) or College Insurance Program (CIP). Total costs for SEGIP in FY18 (excluding interest costs) totaled approximately $2.8 billion, with medical care coverage accounting for approximately 85% of the total.16
As part of recent contract negotiations, reforms were proposed that would require employees to pay a larger share of their healthcare costs in order to reduce the medical care coverage costs to the State for active employees. These reforms would establish a multi-tiered system that offered plans with different combinations of monthly premiums and plan benefits (including out-of-pocket costs such as deductibles and co-pays) that employees could choose from. The tiers range from “bronze” plans that would require no employee premium contribution, but would have higher out-of-pocket costs than current plans; “platinum” plans would require significantly higher employee premium contributions to maintain current plan benefits. This proposal was projected to save the State approximately $470 million for FY19;17 however, contract negotiations have been at a stalemate and are currently the subject of litigation, so the proposal has not been enacted. We support the State reforming and re-designing employee healthcare plans to make benefits for State employees more consistent with the benefits received by private sector employees.
General Funds Savings: Create a New Retiree Healthcare Plan for New Employees
Retiree healthcare under SEGIP provides another avenue of potential savings. Currently, retirees receive a 5% premium subsidy for every year of creditable service (i.e., retirees with 20 years of creditable service receive a 100% premium subsidy). As a result, they tend to pay a very small portion of their healthcare costs. (For FY19, retired SEGIP enrollees are projected to pay only 6.3% of their healthcare costs.) The State has attempted to change the premium subsidy in the past, but the Kanerva v. Weems case held that the State’s subsidies toward the cost of retiree healthcare coverage are constitutionally protected and cannot be diminished or impaired. However, the ruling does not apply to new employees, and the State could create a separate retiree healthcare plan for new employees with a reduced premium subsidy structure that would be applied going forward. It is unclear how much the State could save from reducing the premium subsidy for new employees, but the State should pursue the implementation of a separate retiree healthcare plan for new employees.
Other Expenditure Reduction Opportunities
The State also should expand the frame of the budget beyond the General Funds to include Other State funds. Currently, budget negotiations focus on the General Funds, which ignores nearly half of total State spending. This narrow view of the State budget can be misleading when analyzing total programmatic spending, since several key State programs receive funding from a combination of General Funds, Other State Funds, and federal funds. Looking only at the General Funds portion of spending will give an incomplete picture of programmatic spending. The State should adopt an All Funds budget model that aggregates General Funds and Other State Funds into a smaller number of revenue and spending categories.
Local government revenue sharing also should be scrutinized. Illinois has nearly 7,000 units of local government, by far the most of any state, and many of these governments receive significant funding from the State each year (such as through the Local Government Distributive Fund). The lack of transparency into most local government finances makes it nearly impossible to thoroughly review their revenues and expenditures, which suggests that there are opportunities to improve efficiency and reduce the need for revenue through measures like shared services, joint purchasing, and consolidation. Local government consolidation will have the largest savings impact on local revenue sources (e.g., property taxes), but consolidation could eventually produce savings for the State.
IV. Reform the tax system to reduce Illinois’ negative outlier status and raise revenues, as needed
A state’s tax climate is an important consideration for businesses deciding where to expand or locate and for individuals deciding where to live. It is important that Illinois’ tax structure is carefully designed so that it raises sufficient revenues to pay for critical programs without making the State an outlier.
Despite the many changes to the tax system that occurred when the FY18 budget was enacted, there are still several ways in which Illinois is an outlier compared to other States:
Other states levy taxes that Illinois does not;
Illinois imposes some taxes that other states do not; and
Illinois has burdensome administrative procedures.
The Task Force’s policy recommendations reflect the need to make Illinois less of an outlier compared to other states while raising sufficient revenues to pay for critical State services. Our recommended policy options to reform the tax system and raise sufficient revenues include:
- Increasing the personal income tax to 5.95% would bring in an additional $3.7 billion;18
- Increasing the corporate income tax base rate to 8% would raise an additional $300 million;19
- Ending the exclusion of retirement income from the personal income tax and increasing the value of the 65 and over exemption from $1,000 to $15,000 to protect senior citizens with low and moderate income would raise $1.9 billion;20
Applying the sales tax to a set of consumer services would raise an additional $500 million;
Repealing the capital-based tax portion of the Franchise Tax. Repealing all parts of the Franchise Tax would cost the State $205 million, but keeping the fee-based portion would reduce revenue loss to the State;21
- Eliminating the Estate Tax would cost the State $290 million;22
Amending the Illinois False Claims Act to exclude all tax laws; and
Amending the Uniform Penalty and Interest Act to better align Illinois’ tax penalty structure with other states.
V. Establish financial goals and metrics to measure the State’s progress
The overarching goal of the Task Force is to take a comprehensive approach to improving the State’s finances and business climate. Our Framework provides a blueprint for the policy changes necessary to bring Illinois back to financial solvency as reflected in a AA credit rating; together, our recommendations provide a comprehensive plan that will reduce uncertainty and change the narrative about Illinois’ fiscal health, and lead to improvement in Illinois’ economic and jobs performance.
To measure the State’s progress, the Task Force has identified several short- and long-term goals. The timeline for achieving short-term goals is within the first fiscal year after full implementation of the Framework; long-term goals are to be achieved within five years of full implementation of the Framework.
Implementation of a long-term financial planning process that is transparent, implements best practices, and includes the entire State budget;
Approval of a structurally balanced annual budget and the beginning to amortize the State’s unpaid bills;
Increasing pension funding levels immediately to accelerate the timeframe to stop the growth in the State’s unfunded liabilities;
Implementing meaningful expense reductions based on a comprehensive review of spending across the entire State budget; and
Reforming tax provisions and practices that make Illinois an outlier compared to other states.
Sustained achievement of the median level of performance among the 50 states for employment growth, GSP growth, and unemployment rate;
Achievement of “Top 10” performance among all 50 states for per capita income.
Elimination of the State’s unpaid bills;
Establishment of a reserve fund that equals more than 8% of revenues/expenditures;23
It is also a goal of the Task Force to achieve an upgrade in the S&P credit rating to AA because it serves as a useful proxy for financial health. The S&P credit incorporates several different metrics into one aggregate score, and includes:
Debt and liability metrics (including pension liabilities);
Budgetary performance metrics (including the level of reserves);
Economic indicators (including Gross State Product and income per capita);
Government framework measures (including whether there is a balanced budget amendment); and
Financial management measures (including measures around budget forecasting).
5 Regional Transportation Authority, “2018-2023 Regional Transit Strategic Plan,” p.14.
6 The Civic Federation, “How Will Illinois Fund Its Infrastructure Needs?” January 26, 2018.
7 Southern Illinois University, Paul Simon Public Policy Institute, “Illinois Voters are Not Happy with the Direction of the State: Not Much Influenced by the Recent Tax Cuts,” March 5, 2018. https://paulsimoninstitute.siu.edu/common/documents/opinion-polling/simon-institute-poll/2018/3-5-18-simon-poll-illinois-voters-not-happy-direction-of-the-state.pdf.
8 Commission on Government Forecasting and Accountability, “State of Illinois Budget Summary: Fiscal Year 2019,” August 1, 2018, p.160.
9 Based on Civic Committee calculations. Original Data: Bureau of Economic Analysis, “GDP in Current Dollars: Percent Change from Preceding Period, 2016-2017”; Bureau of Labor Statistics, “Change in total nonfarm employment by state, over-the-month and over-the year, seasonally adjusted,” for December 2017-December 2018.
10 State of Illinois Governor’s Office of Management and Budget, “General Funds Financial Walk Down, FY19-FY24.” November 2018.
11 To get the highest score on the reserve fund component of S&P’s credit rating factors, a state must have a formal budget-based reserve fund that is >8% relative to revenue or spending. S&P looks at the reserve fund as a percentage of general state government funds (including all general and special state funds but not federal funds). In FY19, Illinois’ total appropriated funds revenues totaled $48.3 billion. Assuming a 2.5% growth rate, that will reach $55 billion in five years. Using $56 billion, an 8% reserve fund would be roughly $4.5 billion. However, assuming that part of the State’s solution to covering its deficit and paying off unpaid bills is through revenue increases (which would increase the level of general state government revenues) and that revenues and expenditures will be aligned, we estimate the reserve requirement would be between $4.5-5 billion in 2024. Original Source: Standard & Poor’s, “US State Ratings Methodology,” January 3, 2011.
12 “State of Illinois Pension Projections (TRS, SURS, SERS),” Brian Septon, FSA, The Terry Group. December 1, 2018.
13 Calculated as the Estimated FY19 General Funds contribution (not including savings from the pension buyout plans that were assumed in the enacted FY19 budget) divided by General Funds expenditures from the enacted FY19 budget. Sources: “Illinois State Retirement Systems: Financial Condition as of June 30, 2017,” p.iii; Commission on Government Forecasting and Accountability, “State of Illinois Budget Summary: Fiscal Year 2019,” August 1, 2018, p. 26.
14 “State of Illinois Pension Projections (TRS, SURS, SERS),” December 2018.
15 Tongxuan (Stella) Yang and Olivia S. Mitchell, “Public Pension Governance, Funding, and Performance: A Longitudinal Appraisal,” Pension Research Council at the Wharton School of the University of Pennsylvania, PRC Working Paper 2005-02, pp.18,21. 2005.
16 Commission on Government Forecasting and Accountability, “FY2019 Liabilities of the State Employees’ Group Health Insurance Program,” March 2018, p.15.
17 The proposed reforms aimed to make employees responsible for 40% of costs and the employer responsible for the remaining 60%. Ibid, pp.3,5.
18 Projections provided by Senate Democratic Staff via email on December 3, 2018.
20 Civic Committee calculations. Original data: Illinois Department of Revenue, Final 1040 IIT File, Tax Year 2015. August 2017.
21 Commission on Government Forecasting and Accountability, “3-Year Budget Forecast, FY2019-FY2021,” March 2018, p.11.
22 Ibid, p.11.
23 8% of general state government funds (including General Funds and Other State Funds but not federal funds).