Can Illinois Afford to Allow Current
Tax Rates to Expire?
January 30, 2014
David Lloyd
Senior Policy Analyst, Fiscal Policy Center
Voices for Illinois Children
www.voices4kids.org
dlloyd@voices4kids.org
What We’ll Cover
 Very Brief Overview of State Budget
 Impacts and Origins of the State Fiscal Crisis
 Where We Stand Now
 Consequences of End-of-Year Tax Rate Expiration
 How We Can Invest in Future
2
Brief Overview of Budget
3
Budget Basics: Gen. Funds Appropriations
FY 2013 General Funds Operating Appropriation By Agency
State Board of
Education
22%
Pensions
Contributions
17%
Dept. of Human
Services
11%
Higher Education
7%
Dept. of Healcare
and Family
Services
23%
Dept. of
Corrections
4%
Other
7%
Dept. of Children
and Family
Services
2%
CMS - Group
Health Insurance
4%
Dept. of Aging
3%
Source: Governor’s Office of Management and Budget
4
Budget Basics: General Funds Revenue
In FY 2013, Income Tax Revenue Made Up 55% of GF Revenue
Federal
Funds, 12%
All Other,
13%
Personal
Income Tax,
46%
Sales Tax,
20%
Corporate
Income Tax,
9%
Source: Commission on Government Forecasting and Accountability
5
Illinois’ Fiscal Crisis
6
Fiscal Crisis: Billions in Unpaid Bills
Backlog of Unpaid Bills – End of Fiscal Year
$10.0
$9.0
$8.8B
$8.0
$8.3B
$7.0
$7.0B
Billions
$6.0
$5.0
$6.3B
$5.6B
$5.1B
$4.0
$3.0
$2.0
$1.0
$0.0
FY2009
FY2010
FY2011
FY2012
FY2013
FY 2014
Proj.
Source: Governor’s Office of Management and Budget
7
Fiscal Crisis: Percentage Cuts Since FY09\
Many Areas Still Far Below 5 Years Ago
Dept. of Children
and
Family Services
Family Case
Management
Teen
REACH
Home Visiting
Programs*
Comprehensive
Community-Based Early Childhood
Block Grant
Youth Services
Bilingual
Education
Developmental
Disabilities
Community
Mental Health
Services
0%
-10%
-20%
-14%
-22%
-16%
-21%
-24%
-26%
-25%
-30%
-38%
-40%
-50%
-51%
-60%
*Includes non-GRF for Parents Too Soon
Source: Fiscal Policy Center at Voices for Illinois Children
8
How Did This Happen?
9
History of Budget Deficits
FY 1990 – FY 2012 General Funds Balances
$2,000
$1,000
$0
Millions
$-1,000
$-2,000
$-3,000
$-4,000
$-5,000
$-6,000
$-7,000
Cash Balance June 30th
Balance on Budgetary Basis (After Lapse)
Note: Illinois law allows agencies to spend annual appropriations over 14 months
(formerly 15 months). “Lapse” spending occurs after the end of the fiscal year in which
the funds were appropriated.
Source: Commission on Government Forecasting and Accountability , Illinois Office of
the Comptroller
10
Revenue Hasn’t Kept Pace
 Lagging revenue growth — Didn’t keep pace with economic
growth
 2000 - 2008
o State personal income increased 4.2% annually
o General Funds revenue from state sources increased 3.3%
annually
 Narrow sales tax base — Excludes many goods and all services
 Economy shifting towards services
 State discretionary spending growth is not to blame – grew at
basically same rate as economy.
Source: Fiscal Policy Center at Voices for Illinois Children
11
Spending Near Middle of Pack
Per Capita Government Expenditures in IL Roughly Average
12
Revenue Didn’t Cover Spending
Per Capita Government Taxation in IL Below Average (1995-2010)
Source: Bill Testa, Federal Reserve Bank of Chicago
13
Spending Through Tax Code
Tax Expenditures: $8.4 billion in FY 2012 (23% increase)
 Many are popular — few want
to tax all food, or eliminate
standard deduction / EITC.
 Expenditure for drugs, medical
appliances, and retirement
income likely to continue to
increase with aging population.
 Should all retirement income
be exempt – even for wealthy?
Only 2 other states exempt all
retirement income from taxes.
4 Largest Tax Expenditures
Revenue Lost
Expenditure
$1.96 billion
Retirement /
Social Security
Deduction
$1.64 billion
Food, Drugs,
Medical Devices
$1.04 billion
Standard
Deduction
$555 million
Property Tax
Credit
Source: Illinois Office of Comptroller
14
Inadequate Appropriations for Medicaid
“Section 25” Medicaid Liabilities High Even Before Recession
 General Assembly often
under-appropriated funds
for Medicaid expenses
 Until FY 2013, there was
no limit on how much the
General Assembly could
defer
$2,035
$1,969
$2,000
$1,841
$1,361
$1,500
Millions
 Would use one year’s
appropriations to pay for
previous bills
$2,500
$1,815
$965
$1,000
$681
$747
$780
$500
$0
FY
2000
FY
2001
FY
2002
FY
2003
FY
2004
Source: Illinois Office of Comptroller
FY
2005
FY
2006
FY
2007
FY
2008
15
Pensions: Chronic Underfunding
Causes of Change in Unfunded Liabilities FY1996 – FY2013 (in $ billions)*
$40
$36.0
$35
Total
Unfunded
Liability:
State
Underfunding
$30
$97.4 billion
$25
$19.6
$20
$13.8
$15
$8.7
$10
$5.8
$5
$0
-$5
$(2.1)
Salary Increases
Investment
Returns
Employer
Contributions
Benefit Increases
Changes in
Assumptions
Other Factors
*Before enactment of pension legislation
Source: Commission on Government Forecasting and Accountability
16
Pensions: Costs Quadrupled in Six Years
General Funds Expenditures for the State Retirement Systems (Millions $)
$9,000
7,643
$8,000
6,659
$7,000
5,742
$6,000
5,347
$5,000
$4,000
$3,000
$2,000
$1,000
1,667
4,030
2,066
467
2,952
466
1,655
1,552
1,607
564
5,988
5,107
3,466
3,680
FY 2010
FY 2011
4,135
2,486
1,599
$FY 2008
FY 2009
Pension Contributions
FY 2012
FY 2013
FY 2014
Pension-Related Debt Service
Source: Fiscal Policy Center at Voices for Illinois Children
17
Pension Costs Crowding Out Priorities
Pension Costs as Percentage of General Funds Revenue from State Sources*
23.7%
25.0%
19.1%
20.0%
15.0%
10.0%
20.7%
13.1%
8.3%
5.0%
0.0%
FY 2008
FY 2009
FY 2012
FY 2013
FY 2014
*Includes transfers into General Funds
Note: FY 2010 and FY 2011 not included because pension contributions
were covered through borrowing. FY 2014 data is projected.
Source: Governor’s Office of Management and Budget
18
Great Recession Caused Huge Revenue Loss
General Funds Revenue*
FY 2009
• $2.1 billion (7.0%) below FY 2008
FY 2010
• $2.6 billion (8.6%) below FY 2008
*Excludes short-term borrowing and cash flow transfers
Source: Commission on Government Forecasting and Accountability
19
Effect of 2011 Tax Increase
20
Higher Rates Prevented Freefall
Additional Revenue from Higher Income Tax Rates (in $ millions)
$25,000
$20,000
$15,000
$7,986
$7,668
$11,730
$11,299
FY 2013
FY 2014 Est.
$7,560
$2,452
$10,000
$5,000
$9,871
$10,624
$10,413
FY 2010
FY 2011
FY 2012
$Base Revenue
Revenue Due to Rate Increases
 Avoided Draconian Cuts / Much Larger Increase in Unpaid Bills
 After Increase, Rating Agencies Improved Illinois’ Outlook
*Includes revenue from suspension of Net Operating deduction in FY
2012 and FY 2013.
Source: Commission on Government Forecasting and Accountability
21
Stable, But Critical Condition (for now)
Additional Revenue Has Allowed State to Make Progress on Unpaid Bills,
But Still Large Amount of Accumulated Debt
 Unpaid bills have been cut by billions of dollars, but still over $5
billion projected to remain by end of fiscal year (June 30)
 Huge unfunded pension liability has led to ballooning annual costs
 Growing health insurance costs for retirees
 Increasing Medicaid costs (despite 2012 cuts)
 Policymakers trying not to decimate essential programs
 Even with additional revenue, very difficult to maintain even
flat funding for education and human services
*Includes revenue from suspension of Net Operating deduction in FY
2012 and FY 2013.
Source: Commission on Government Forecasting and Accountability
22
Impact of Possible Expiration
23
Collapsing Revenue
Current Personal and Corporate Income Tax Rates
Set to Decline January 1, 2015
Personal Rate
Corporate Rate
Pre-2011
3%
4.8%
2011 – 2014
5%
7%
2015 – 2024
3.75%
5.25%
2025 and beyond
3.25%
4.8%
*Includes revenue from suspension of Net Operating deduction in FY
2012 and FY 2013.
Source: Commission on Government Forecasting and Accountability
24
Collapsing Revenue
Governor’s Office of Management and Budget recently projected
huge budget shortfalls due to massive revenue collapse.
Source: Governor’s Office of Management and Budget
25
Cuts Necessary to Close Shortfalls
Education and Human Services Would Be Harmed Most
 Many areas of budget are “protected” by federal
requirements
 Lawmakers likely to cut unprotected areas first,
including education and many human services programs
 While some programs have been spared cuts by
federal maintenance-of-effort requirements, state may
decide to forego federal funds because simply can’t
afford state portion of match
 A wide swath of budget would need to be cut by
20-25% in FY 2016, the first full year of the rate
expiration
Source: Fiscal Policy Center at Voices for Illinois Children
26
Lost Revenue Quickly Adds Up
Ballpark 10-Year Revenue Loss If Current Rates Expire
$12,000
$10,000
Millions
$8,000
$6,000
If Current Rates
Maintained
~$60 billion
lost revenue
through FY 2024
$4,000
$2,000
If Current Rates
Decrease
$-
Note: CGFA assumes natural rate of income tax revenue growth of 2.3%
annually. Data is gross, not net due to uncertainty about Income Tax
Refund Fund percentages.
Source: Fiscal Policy Center Analysis using CGFA data from April 2013
27
Impact of Pension Legislation
28
Small, But Meaningful Impact (if upheld…)
However, Doesn’t Make Up For Lost Revenue, Most Savings Backloaded
Fiscal Year
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
Savings Through
FY 2024
Savings FY 2025 FY 2044
Reduction in
Contributions
(in $ millions)
$
$
$
$
$
$
$
$
$
$
$
1,182
1,266
1,386
1,176
716
824
932
1,050
1,157
$
9,689
$
135,201
*No savings in
current fiscal
year or in FY
2015, which
begins July 1.
Source: Governor’s Office of Management and Budget
29
Credit Ratings
30
Repeated Downgrades Since Dec. 2008
 Round of downgrades during Great Recession – largely
driven by large revenue losses
 Agencies improved Illinois’ rating outlook immediately after
2011 tax increase
 Downgrades started again in January 2012 due in large part
to General Assembly’s repeated failure to address pensionfunding crisis
 Low credit ratings increase the state’s borrowing costs
for needed infrastructure projects, hurt state’s
reputation
 State likely to pay approximately $18 million a year for
25 years in higher interest costs for $1.3 billion bond
sale last June
31
We’ve Been Warned…
S&P Statement on Jan. 2013 Downgrade –
[T]he expiration of current personal and corporate income tax rate increases on Jan. 1, 2015, along with other
normal budget pressures, could have a profound effect on the state's budgetary performance and liquidity over the
two-year outlook horizon.
Moody’s Statement on June 2013 Downgrade –
WHAT COULD MAKE THE RATING GO DOWN: Failure to address impending revenue loss from partial sunset of
2011 tax increases.
Fitch Statement on June 2013 Downgrade –
NEED FOR LONG-TERM SOLUTION REMAINS: Temporary increases in both the personal and corporate
income taxes, coupled with statutory spending limits, have closed a significant portion of the structural
gap in the state's budget through fiscal 2014. The state will need to find a more permanent solution to the
structural mismatch between spending and revenues….Maintenance of the 'A-' rating will require timely action in
advance of the expiration of temporary tax increases in fiscal 2015…[T]he tax increases will begin to phase out in
2015; thus, even if the state maintains budget balance to that point, it will once again be faced with a significant
budget balancing decision to make permanent the tax increases, makes severe expense reductions, or identify new
revenues.
S&P Statement After Passage of Pension Legislation (Dec. 2013) –
In addition to normal budget pressures facing the state, the statutory reduction of current personal and corporate
income tax rates on Jan. 1, 2015, highlights a difficult budget climate over the next two years. If pension reform
moves forward [is upheld] and the state takes credible action to achieve structural budget balance beginning in
fiscal 2015, we believe a higher rating would be warranted.
32
Taxes, the Budget, and the Economy
33
Lower Taxes = Better Economy?
 Therese McGuire, Northwestern University economist, reviewed
literature at Chicago Fed last spring. She believes:

“The evidence of a link between the levels of state taxes and state economic
growth is weak; too weak for me to believe that cutting taxes with the goal of
boosting economic growth is likely to be an effective policy play”
 Center on Budget and Policy Priorities reviewed 20 economic studies
since 2000 on connection between taxes and growth:

“There is simply no consensus whatsoever that cutting taxes is a good strategy to
boost state economic growth and create jobs.”
 Many of the studies that find lower taxes are correlated with
economic growth hold all else equal
 But, all else is not equal – taxes pay for services, which must be cut if
taxes are reduced.
34
Strong Evidence for What Does Matter
 Numerous studies have found that spending on the following are
highly correlated with economic growth:
 Early childhood education
 K-12 education
 Higher education, including community colleges
 Infrastructure – roads, public transit, airports
 Surveys of CEOs and site-selection consultants consistently
identify education and infrastructure as key drivers of corporate
location decisions.
 Quality-of-life issues also very important, especially to attract
highly educated workers.
35
Negative Effects of Uncertainty
Baker-Bloom-Davis Uncertainty Index
36
Negative Effects of Uncertainty
New Research Finds that Uncertainty Undermines Economy
 Increasing policy uncertainty between 2006 and
2011 nationally led to the loss of 2.3 million jobs and
a 3.2% decline in real GDP
- Scott Baker and Nicholas Bloom (Stanford), Steven Davis (Univ.
of Chicago)
 “A rise in economic policy uncertainty lowers
employment and investment, and produces a rapid
decline in equipment and software and a slow
decline in structure investment.”
- Troy Davig and Andrew Foerster, the Federal Reserve Bank of
Kansas City
37
Uncertainty in Illinois
Increasing With Looming Tax Expiration
 Given new research connecting uncertainty to poor
economic growth, we need to consider what role it has
played in Illinois
 High uncertainty this year with looming tax expiration
 If tax rates expire, uncertainty about Illinois’ ability to fix its
finances will worsen
38
Getting Back on Right Track
Not Possible If We Don’t Maintain Stable Revenue
We need to:
 Implement plan to eliminate backlog of unpaid
bills
 Reduce unfunded pension liability by making
required contributions under new law
 Restore funding to education and human
services (won’t happen overnight)
 Reform the sales tax to reflect modern
economy
 Eliminate unjustified tax expenditures
 Increase budget transparency
39
Questions?
40