(Editor's note: This article was published first at Illinois Policy Institute).
Illinois Gov. J.B. Pritzker is reportedly pushing for further upgrades in the state’s credit rating despite pension debt growing to record levels and persistent budget deficits during his term.
The governor traveled to New York to make his case to the three major ratings agencies, according to Rich Miller’s Aug. 6 report in the subscriber-only edition of the Capitol Fax blog.
Moody’s Investors Service’s upgrade on June 29 – from one notch above non-investment grade or “junk” status to two notches above – was the state’s first improvement in more than 20 years. S&P Global Ratings followed with an identical upgrade on July 8. In June, the third major ratings agency, Fitch Ratings, opted to keep Illinois just one notch above junk status, but upgraded the state’s outlook to positive from negative.
Illinois’ credit rating remains the lowest of all 50 states.
Pritzker called the upgrades “a giant step forward to true fiscal stability” and said his fiscal policies were the cause. But judging by the state’s own financial projections and reporting, he is wrong. The state basically stumbled into a small, temporary improvement thanks to cash gifts from Uncle Sam.
Illinois’ most daunting fiscal challenges – its worst-in-the-nation pension debt and multibillion-dollar annual structural budget deficits – are both worse than when Pritzker took office. The Pritzker administration and the Illinois General Assembly have yet to adopt anything close to the significant reforms necessary to repair the state’s bleak fiscal condition.
And while the state’s backlog of unpaid bills currently sits lower than it has in recent years – at $4.18 billion as of Aug. 16 – Illinois Policy Institute analysis of official state forecasts shows Illinois’ short-term debt burden is on track to reach a record $22 billion in three years. Short-term debt includes the bill backlog, bonds sold to cover the backlog, interfund borrowing and borrowing from the Federal Reserve.
That $22 billion of short-term debt will surpass the prior $16.7 billion record reached during the budget impasse in 2017.
With Illinois’ deteriorating fiscal condition in mind, Pritzker’s request for additional ratings upgrades should not be granted.
So why was Illinois’ credit upgraded in the first place? In short, thanks to a flood of federal aid worth more than $190 billion, which propped up state revenues and improved the state’s ability to manage cash flow in the short-term.
Credit ratings are intended to reflect the risk to investors, or the likelihood that government bondholders will be repaid. From that perspective, an infusion of federal aid to support Illinois’ spending might justify the recent upgrades from Moody’s and S&P.
But while bondholders can feel more secure in their Illinois investments during the short term, that does not translate to an improvement in the state’s long-term financial outlook. Most importantly, Illinois residents will not receive relief from the high tax burdens and economic stagnation perpetuated by the state’s fiscal mismanagement until the underlying causes are addressed.
Federal aid propping up Illinois’ finances runs out in 2024
Shortly after the start of the COVID-19 pandemic, researchers for the Institute of Government and Public Affairs at the University of Illinois predicted revenue losses as high as $28.4 billion during three budget years. According to those projections, even a short downturn followed by a strong and fast economic recovery would result in more than $14 billion of losses under a severe pandemic lasting two years.
But significant revenue losses never occurred in Illinois. In fact, state and local government revenue losses around the country have ranged from far less than expected to nonexistent. Governing magazine recently reported 29 states, including Illinois, saw higher revenue collections in the 12 months after the pandemic began than in the 12 months prior.
Moody’s Analytics, an economic forecasting firm separate from the ratings agency, predicted in April 2020 the combined impact of revenue losses and increased pressure on Medicaid would cause a nationwide “fiscal shock” to states of $300 billion through fiscal year 2022. The agency said federal support of at least that amount would be required to prevent economically harmful spending cuts and tax hikes in state budgets to cover the shortfall.
But federal spending to support state and local governments has far exceeded what Moody’s Analytics said was needed.
The CARES Act provided $150 billion in state and local grants to cover economic and public health costs related to the pandemic, and the American Rescue Plan added another $350 billion in flexible financial aid that could be used to cover general budget holes. Additionally, Congress increased the federal Medicaid matching rate by 6.2%, which will provide just over $100 billion in additional federal funds to state budgets. The federal government spent billions more on direct support for education, transit, election security, and other state and local government functions that reduced the fiscal shock.
In addition to this direct government aid, unprecedented levels of federal support for private sector incomes and consumption – through direct stimulus checks, enhanced unemployment benefits, the Paycheck Protection Program and much more – meant collections from sales and income taxes remained strong. Illinois was the fifth-largest recipient of loans under the Paycheck Protection Program at more than $38 billion.
As a result of federal spending, state and local tax revenues nationwide have performed much better than many feared. Data from the St. Louis Federal Reserve shows state and local revenues dropped by 3% in the second quarter of 2020 but fully recovered by the third quarter and exceeded pre-pandemic collections thereafter.
Total federal aid allocated to Illinois across the public and private sectors is roughly $190 billion. Direct aid to state and local governments equals more than $31 billion.
Despite this unprecedented federal spending, the budget signed by Pritzker still included $655 million in tax hikes and failed to achieve balance. Pritzker has not advocated for and the General Assembly has not passed pension reform or the other significant financial reforms necessary to stabilize the state’s long-term financial outlook or close its 21-year budget deficit.
Still, the flood of federal money has made it easier for the state to pay its debts right now, which is what credit rating agencies are ultimately concerned with.
S&P noted in its report on the credit upgrade the fiscal year 2022 budget uses $2.8 billion of the $8.1 billion Illinois received from the American Rescue Plan. Initially, the governor had wanted to use federal aid to repay nearly $2.8 billion in short-term borrowing, including borrowing from the Federal Reserve’s Municipal Liquidity Facility.
When federal rules were issued stating the aid could not be used to repay debt, the governor switched to spend the money on infrastructure and economic relief. However, that freed up state revenues that otherwise would have gone to those purposes, meaning the federal aid still indirectly financed the borrowing repayment. The practical effect is the same: The $5.3 billion in remaining funds is precisely the amount of aid Illinois would have left over had the funds been used for direct repayment of the debt.
U.S. Sen. Dick Durbin acknowledged the connection between federal aid and the credit upgrades in a statement reported in the Center Square. “The governor announced and I was happy to hear it that our credit rating as a state has improved dramatically for the first time in a long time,” Durbin said. “Part of the reason is we are sending $8 billion dollars [in federal taxpayer funds] to the state of Illinois.”
But while the aid is helping keep Illinois afloat in the short term, it’s temporary. CARES Act funds expire at the end of 2021 and American Rescue Plan funds must be used for expenses incurred by the end of 2024.
That’s important, because as the state’s own reports show, the underlying problems of runaway debt and deficits have seen no improvement under Pritzker. Unless that changes, Illinois will find itself in an even worse position when federal aid expires.
Record short-term debt around the corner demonstrates lack of progress
Pritzker has consistently pointed to a reduction in the state’s backlog of unpaid bills to claim he has responsibly managed state finances. Indeed, both S&P and Moody’s mentioned the lower bill backlog when issuing their upgrades. The backlog, representing how much money Illinois owes for services it’s already received but hasn’t paid for, stood at $2.9 billion as of July 7 but had grown to $4.2 billion as of Aug. 17.
While this is still between $1 billion and $2 billion less than where the backlog has stood in recent years – and good news for vendors who won’t have to wait as long for the state to meet its obligations – it is not a meaningful sign of improvement in the state’s finances for three reasons.
First, much of the debt that used to belong in the state’s bill backlog has simply been transferred to other forms of short-term debt. Other forms of short-term debt include bonds sold to cover operating costs and monies borrowed from the Federal Reserve or other state accounts. The state sold $6 billion in bonds in 2017 which were directly used to pay down the backlog, which is essentially paying off one credit card with another.
Second, the reduction in the bill backlog appears to be entirely the result of federal aid supporting state cashflows. In fact, the structural deficit that causes Illinois’ bill backlog has deepened since Pritzker took office. In 2019, the governor’s budget office estimated a structural deficit for fiscal year 2024 of $3.24 billion. That deficit was most recently projected at $4.83 billion by the governor’s budget team last November, and other more recent projections show even faster growth. The General Assembly’s fiscal forecasters said the structural budget deficit will grow to more than $5 billion by 2024 if spending grows at the five-year average of 2.7%.
Third, because the structural deficit has grown, the state’s own projections say the drop in the bill backlog will be short lived, followed by growth to record highs. In November 2020, prior to the most recent round of federal aid, Pritzker’s own budget office projected the backlog would skyrocket to $24.5 billion by 2024.
Additional federal spending and higher than expected revenues helped lower that number. In March 2021, the General Assembly’s fiscal forecasters estimated the bill backlog would grow beyond $19 billion if spending grew at the state’s five-year average and would reach $20.5 billion under the 10-year average.
The final fiscal year 2022 budget spent less than the governor’s proposed budget in February, which was used as the basis for that forecast. But even when accounting for slightly lower spending and a therefore lower starting backlog this year, short-term debt will reach $16.9 billion by June 2023. That would exceed the prior $16.7 billion record reached during the two years in which Illinois operated without a budget.
By the end of fiscal year 2024, short-term debt stands to reach a staggering $22 billion under baseline conditions.
This projection includes the bill backlog and other forms of short-term debt such as bonds used to pay down the backlog, Federal Reserve borrowing for operating costs and interfund borrowing from other state accounts.
These numbers prove Illinois’ underlying financial condition has not improved despite more than 20 tax increases enacted during Pritzker’s three years as governor.
Meaningful improvement in state credit requires meaningful policy change
Pritzker claims to have balanced Illinois’ budget despite persistent deficits during his watch. He has mischaracterized what the reduction in the bill backlog means, what is responsible for the reduction and what it says about the future of the state’s finances. Pension debt this year reached a record-high $144.2 billion, and shows little sign of slowing down.
State Senate Republican Leader Dan McConchie recently offered the governor some valuable advice: “Instead of doing a victory lap pretending the financial problems have disappeared, we need to take these federal dollars and put them to good use by doing our job of producing long-term solutions to Illinois’ very complex financial problems.”
Long-term solutions were presented in a recent five-year budget plan by the Illinois Policy Institute. The most important fix is letting the people vote on pension reform through a “hold harmless” amendment that preserves earned benefits while allowing for reductions in future benefit growth to make state retirement systems sustainable and affordable. Hold harmless pension reform can save the state roughly $2.4 billion the first year and more than $50 billion through 2045, while fully funding all five state pension plans.
If Pritzker wants to see further credit upgrades, he should focus on solving the pension and budget crises that have worsened on his watch, rather than pretending they are already disappearing.