U Of I Projection Says Budget Gap Would Take 10+ Years To Close
New projections show nibbling around the edges of state budget problems won't help Illinois.
The state went for nearly a year and a half without a full budget. But there’s a surprising level of consensus about what must be done if lawmakers and Gov. Bruce Rauner can come to a compromise on the governor’s policy demands and ultimately get down to trying to close the budget gap.
Political leaders, academics, commentators, Democrats and Republicans — even the rivals at the center of the impasse, Rauner and House Speaker Michael Madigan —all recognize that at least two components are needed: new revenues and cuts.
In the past, both Rauner and Madigan have said they would support some form of a tax increase and cuts. Of course, agreeing on a broad concept and voting on legislation are two very different things. Madigan and Rauner have been going back and forth through the media this week over the possibility of a tax vote in the January lame-duck session. Rauner says he would oppose such a move, especially if it was presented without passage of any items on his policy agenda. Meanwhile, Madigan’s spokesman hints that a lame-duck tax hike may have been Rauner’s plan all along.
But if a deal can eventually be reached, what might the solution look like? Perhaps an increase in the state’s income tax rates and a minor cut in discretionary spending could get bipartisan support. It won’t be popular, but it seems like the right prescription of tough medicine to bring Illinois back from fiscal ruin.
Unfortunately, the dosage isn’t nearly high enough. As a new report points out, such a plan wouldn’t come close to closing the budget gap. In fact, in 10 years, it could actually leave the state with a deficit similar to the one it’s in today.
New projections from the Fiscal Futures Project at the University of Illinois’ Institute of Government And Public Affairs (IGPA) make the case that for Illinois to achieve a balanced budget, policymakers would have to agree to increasing the income tax, taxing some retirement income, eliminating tax breaks, applying the sales tax to certain services and making billions in cuts. A little economic growth would also be needed to make this cure viable.
Even under such a politically ambitious plan, it would take a decade for the state to reach solvency.
The two authors of the report, David Merriman and Richard Dye, briefed newly elected lawmakers on their findings yesterday. “Our primary objective was to get them to get some respect for the magnitude of the problem,” Dye says. He says many wanted to discuss the ideas they campaigned on. “We had to, sort of as politely as we could, say, ‘that isn’t even close to the order of the magnitude (of the problem), or it may (have) zero impact based on the evidence that we know,’” he says. “You’ve got to do big things, boldly and quickly.”
If you were looking to describe the way this last week of veto session is playing out, big things being done boldly and quickly is the last phrase you would choose — in terms of the budget, anyway. Madigan and Rauner seem possibly even farther from coming together on a grand bargain than ever before.
The Fiscal Futures Project launched in 2008 with the goal of taking a holistic view of the state’s budget. With Illinois’ hundreds of special funds and history of budget gimmickry, just getting an accurate picture of how spending and revenues change from year to year is no small task. Using data from the comptroller’s office going back to 1998, Fiscal Futures built a computer model of the state budget that can be used to make future projections. At this point, they look bleak. Illinois currently faces:
- A $13 billion deficit for the current year.
- An estimated shortfall of about $14 billion per year for the next five years.
- Unfunded liabilities for retiree pensions and health care of $174 billion.
- A $10 billion stack of unpaid bills for services already rendered by vendors, social service providers and other.
“It is almost certainly not feasible to remedy imbalances of this magnitude by policy changes in a single year,” the report says. “Rather, climbing out of the hole that Illinois is in likely will require hard choices, fiscal discipline and sustained attention over a long period of time.”
Merriman, a professor at IGPA, says solving the budget problem will take political courage and patience. “It’s going to require sustained changes in policy. Probably, it’s not realistic to think that it can be done in under about a decade”.
The report details several of those “hard choices” and the impact they would have on the budget over the next 10 years.
Under the budget cuts scenario, the report looks at a 2 percentage-point reduction each year — not to the current spending levels, but the expected spending growth rate under the Fiscal Futures budget model — to discretionary spending except for K-12 education. The reduction wouldn’t touch debt service, pension payments, or revenue sharing with local governments. It also wouldn’t affect Medicaid. Cuts in that area would require changes in the law, and the state would see a reduction in federal matching funds. Illinois has also entered into legal agreements requiring certain levels of Medicaid spending.
Under this model — and indeed under Illinois law — a lot is off the table. In Fiscal Year 2015, these categories made up over two-thirds of spending. There is no statutory reason Illinois couldn’t cut K-12 spending, but there are obvious political ones.
Dye, a professor emeritus at IGPA, says they aren’t advocating for K-12 spending to be off the table. He says it was left unscathed in the model mostly because it’s the area of the budget that hasn't not been cut or frozen under the impasse. “Even though it is discretionary, it’s sort of first among political choices as things not to cut,” he says.
The areas of state government that suffered under the impasse (social services and higher education would bear most of the pain. The report says the cuts would “undoubtedly result in substantial hardship to vulnerable populations if they were introduced on an across-the-board basis as we simulate here.”
But, unlike the current situation, these areas would at least know how much funding to expect.
This plan would reduce the budget gap by an estimated $900 million in the current fiscal year. Over a decade, it would trim the shortfall by about $7.2 billion. But Illinois would still face a deficit of more than $15 billion in FY 2027.
“The historical rates of growth of spending are greater than the historical rates of growth of revenue. So even if we close the gap or close part of the gap, it’s just going to arise again unless we do something to change that balance,” Merriman says.
Income Tax Increase
Madigan has maintained for some time that a budget fix would require cuts and increased taxes. He has, however, been somewhat vague about what sort of tax increase he would support. “A good place to begin … would be the level we were at before the income tax expired,” Madigan said during an appearance at the City Club of Chicago last year. “And starting there, you can go in whatever direction you want to go.”
The rates Madigan was speaking of were 5 percent for individuals and 7 percent for businesses. The Fiscal Futures model wouldn’t boost the tax rates back to that level, but it would come close. The report looks at the potential outcomes from increasing the personal rate from 3.75 percent to 4.75 percent and the corporate rate from 5.25 percent to 6.65 percent starting on January 1.
This change would take a decent bite out of the deficit in the short run — $2 billion in the current fiscal year and $4.2 billion in the next. But it wouldn’t solve Illinois’ structural deficit over the next decade.
“Because the increase in the tax rate does nothing to change either the rate of growth of revenue or expenditures, revenue in the model would still grow more slowly than expenditures, so that over time the budget gap would begin to grow again,” the report says.
The analysis projects the budget gap would be more than $14 billion by FY 2027, even with this cash infusion.
Expanding The Tax Base
The report also looks at expanding the income tax base by 10 percent. It doesn’t call for specific expansions, but notes eliminating or curbing roughly 40 percent of some popular tax breaks, like the exemption for retirement income and the credit for residential real estate taxes, would get the job done.
The model also assumes a 10 percent increase in the corporate income tax base, achieved by eliminating tax breaks. These changes would reduce the deficit by $1.6 billion in the first year that they're adopted.
The report also looks at expanding the sales tax base by 15 percent by taxing some services. This change would reduce the budget gap by about $2 billion a year.
However, Fiscal Futures predicts spending would ultimately outpace revenue growth under both of these tax-base-expansion scenarios. There are those in the Illinois political sphere who argue the state has a spending problem and those who say it’s a revenue problem. The Fiscal Futures analysis indicates that it’s both.
This hypothetical assumes that unnamed business-friendly policy changes and increased confidence from consumers and businesses would result in a .5 percent growth in projected personal income each year starting in FY 2018. This growth would initially reduce the budget gap by only $100 million, and by the end of the decade would cut it by $1.5 billion.
Dye and Merriman say that growth rate is optimistic. “This is really a nod to those who — importantly — think about the economy of the state, but too optimistically think that that is going to solve the problem,” Dye says. “Growth won’t solve the problem. It is the smallest in its impact of any of the scenarios that we looked at.”
The Whole Shebang
The whole of these policies working in tandem would be greater than the parts. For instance, expanding the income tax base and increasing the rate would mean that the increased rate would be applied to the broadened base. At the same time, one might negatively impact the other. For instance, increased taxes could endanger assumed economic growth. Budget cuts can also end up costing more if they lead to expensive outcomes, like people seeking health care in emergency rooms and ending up in prisons because of untreated mental health problems.
There are also some caveats. The plan doesn’t consider paying down the bill backlog. That would take more money, which could possibly come through some kind of borrowing plan to refinance that debt at a lower interest rate.
Merriman and Dye also warn that their modeling makes some assumptions for the sake of simplicity. “Our analyses should be thought of not as precise forecasts, but as rough but unbiased measures of the order of magnitude of Illinois’ fiscal challenges,” the report says. “Ultimately, the challenges may be smaller, but they may also be larger. What is clear from our analyses is that, even in the best case, Illinois will face a sustained period of extremely difficult fiscal conditions.”
Still, the Fiscal Features model makes the case that implementing all of these changes soon and sticking with them for years would give Illinois a real shot at fiscal stability.
Both Dye and Merriman are quick to acknowledge that combining all the scenarios in their model would mean one of the most politically ambitious and sweeping plans ever proposed. They say they aren’t advocating for any of them specifically, but, instead, set out to capture the scope of what has to be done.
“One of the things about our assumptions that is optimistic is the timeline in which they can be implemented,” Merriman says of the current political situation. “The longer we wait to implement them, of course, the bigger the problem is.”
The Fiscal Futures Project’s report begins with a quote attributed to Will Rogers. “If you find yourself in a hole, stop digging.” But for now, it seems the state’s leaders are clinging even more tightly to their shovels.