Tag Archives: Governor Quinn

Governor Quinn’s pension reforms: constitutionally bold, but is it enough?

 

On Friday, Governor Quinn proposed the most drastic pension reforms to date in Illinois. To meet the funding gap in the pension system, which on an actuarial basis is reported at $83 billion, the Governor will offer workers a choice between higher annual contributions to the system or the loss of health care benefits and a reduced pension.

The measures reflect the growing pressure the pension system is placing on general revenues. In FY 2008 Illinois contributed six percent of its revenues to the pension system. In FY 2013, the state must contribute 15 percent of general revenues or $5.2 billion to keep the system afloat.

Employees who accept the terms will contribute 3 percent more to their pensions, have a reduced or delayed COLA upon retirement and in some cases be required to retire at age 67 (up from the current 65). However, any pay increases would continue to count for the purpose of calculating benefits. Employees who refuse the terms and continue under the current plan will lose their health care benefits and their pay increases will not count towards their pension benefit calculation.

Considering the legal framework of Illinois’ pension plan, which constitutionally guarantees workers’ pension benefits, Governor Quinn’s reforms are quite bold. The proposal offers a kind of “constitutional test” to the system and could set a legal precedent in the state for pension reform. It is a sure bet that public unions will take legal action against the measures.

If they are adopted, will Quinn’s new proposal be enough to fill the funding gap? On a market basis, Illinois’ unfunded pension liability is several times larger than reported. We calculate it is closer to $173 billion, so mathematically speaking, no. However, the plan confronts current employee costs and shows a new willingness to tackle the problem. Up until now pension reform in Illinois has only affected new hires.

Proposed changes to Illinois’ pension benefits

Illinois Governor Pat Quinn proposed several changes to the state’s pension plan last week designed to shore up the state’s fund that has one of the nation’s largest unfunded liabilities. The Chicago Tribune summarizes the potential changes:

Illinois’ unfunded pension liability has grown to a huge $83 billion after the state skimped on funding for years. In fiscal 2013, which begins July 1, the state’s payment into the pension system will hit $5.2 billion, or 15 percent of general revenue spending – up substantially from 6 percent in 2008, according to the governor’s office.

Quinn, a Democrat, said his plan would leave the system, which covers state, local school, university and community college employees, 100 percent funded by 2042. Without it, he said Illinois will have expected payments totaling nearly $310 billion between 2012 and 2045, when a $32.7 billion unfunded liability would still remain.

“This plan rescues our pension system and allows public employees who have faithfully contributed to the system to continue to receive pension benefits,” he said.

Under the proposal, workers’ pension contributions would increase by 3 percent, while cost-of-living adjustments would be reduced. A retirement age of 67 would also be phased in.

Governor Quinn says that these changes will save state taxpayers between $65 and $85 billion in the next 30 years. The plan would also take steps to try to reduce abuse of the public sector pension system on the part of union employees that the Tribune exposed this fall.

The reforms are designed to bring the Illinois pension fund in line with the practices that the Governmental Accounting Standards Board advocates. While these reforms are marginal improvements toward putting the pension fund on a sustainable trajectory, they do not address the fundamental problem with the GASB standards. Public pensions are guaranteed benefits, so they should be valued at the risk free discount rate and invested in safe assets like US Treasury bonds. The unfunded liability is, in reality, much larger than what GASB standards suggest because they do not require the use of the risk free discount rate.

Furthermore, the reforms would do nothing to ensure that future politicians do not continue the decades of irresponsible practices that have gotten the state’s fund to where it is today. While the plan says that going forward the state will make the required contributions, we know that current legislators cannot tie the hands of future legislators. Future policymakers could easily return to skipping pension fund payments and painting a rosy picture of the funds assets with accounting gimmicks.

As Eileen and Ben point out in their paper “Illinois’s Fiscal Breaking Points,” the state needs larger institutional reforms to achieve fiscal stability and improve its bond rating. These changes could include a constitutional cap on the unfunded liability, or, better, a transition away from defined benefit public pensions to a defined contribution system.

What Illinois’s Credit Rating Downgrade Really Means

Last week Moody’s Investment Service downgraded Illinois’s credit rating from A2 to A1, thus labeling the state’s debt as the riskiest in the nation. There seems to be some confusion, however, on what this downgrade means for state borrowing, how it will affect taxpayers, and how it will impact the state’s fiscal future.

To put this downgrade into perspective, it’s important to consider that it came just a few days before the state had planned to borrow $800 million to pay for roads, schools, and bridges. Many individuals predicted that this downgrade would make it more expensive for the state to follow through with its planned bonds sale. Illinois Treasure Dan Rutherford estimated that the downgrade would likely cost the state an additional $65 million in order to issue the $800 million in bonds. Bloomberg predicted that Illinois would face borrowing costs more than quadruple the average that it has paid over the past ten years.

But if the rating downgrade was supposed to make borrowing more expensive, how then was Illinois able to secure historically low interest rates in its bond sale this week?

This is precisely the source of much of the confusion and there are a few things that need to be considered. First and foremost, it’s important to point out that a credit downgrade does not necessarily increase the cost of borrowing (as we saw when the cost of borrowing decreased after the U.S treasury was downgraded). A downgrade is just that, a grade. It’s an assessment by a credit rating agency.  A downgrade will generally only change lending terms if it teaches the lenders something new. For example, if lenders (i.e. bond buyers) know that Illinois is flunking math, then they have already built that into their lending habits – the information is “baked into the price.” It’s well known that Illinois is in poor fiscal shape and thus this downgrade did not surprise lenders.

Another thing that needs to be considered is the fact that interest rates on all bonds are currently very low which certainly helped the state obtain the low rate. Additionally, as the Wall Street Journal points out, the relative scarcity of new bonds in the municipal bond market this year aided the reception of Illinois’s $800 million bond sale. And finally, it’s true that Illinois secured historically low rates on its recent bond sale but, more importantly, it’s also true that the state may have secured even lower rates if its credit rating would have been higher. In other words, even though the state was able to borrow at relatively low rates, the borrowing may have been more expensive than it would have otherwise been in the absence of a rating downgrade.

Adding to the confusion, Governor Quinn described the state’s downgrade as an “outlier decision.” It’s difficult to label this downgrade as an outlier, however, considering that Illinois has had its credit rating downgraded nine times in three years.

Not only was the downgrade not an outlier but there is simply no reason to believe that the state’s credit is going to improve in the near future. Given Illinois’s habitual utilization of budgetary gimmicks, its customary practice of issuing debt to avoid making necessary budget cuts and its vastly underfunded pension system – it’s likely that the state’s credit rating will continue to decrease unless Quinn and the state legislature start making serious institutional reform.

Most importantly, this downgrade could mean that Illinois taxpayers will now get less bang for their buck. As legislators continue to push off significant reform, borrowing costs will likely continue to increase and more taxpayer dollars will be going towards interest payments instead of building schools and roads. Paying more money for fewer services is something Illinoisans can simply not afford – especially in the wake of last year’s tax hike which increased the average family’s state tax bill by $1,594.

So to clear up any confusion, what Illinois’s recent credit downgrade really means is that the state’s long run borrowing costs may be higher than they would have otherwise been, Illinois taxpayers are now paying more for less, and Illinois’s fiscal future will suffer if the state continues to hold the riskiest debt in the nation.

More Corporate Tax Deals in Illinois: Was This Really a Win?

Illinois’s fall veto session was a disappointment – little was addressed and even less was achieved. In attempts to make up for their lack of achievement, Illinois lawmakers reconvened early last week to revisit a corporate tax relief package. Specifically, this session was meant to address the recent threats to leave the state coming from some of Illinois’s largest corporations. After a two day session, lawmakers approved a $330 million tax package that will supposedly prevent CME Group Inc. and Sears Holdings from leaving Illinois.

Governor Quinn described this legislative action as a win-win situation by telling reporters that this was a

win for workers and a win for employers in Illinois… what we did here the last two days is a part of making Illinois a good place to do business and a good place to work

But was this a win for Illinois? Not really…

In the case of Sears, it is important to look at the reason the company chose Illinois as a location to do business in the first place. Illinois has been the home of the Sears headquarters for more than 125 years. Interestingly enough, in 1989 Sears had announced plans to abandon its corporate headquarters in Chicago and relocate to another state. Illinois law makers, however, were able to convince the company to stay via the provision of $178 million in state and local subsidies (déjà vu?).

This method of convincing companies to stay in or relocate to a specific state via the provision of large subsidies and tax breaks is often referred to as industrial recruitment. Despite Governor Quinn’s statement, industrial recruitment is one of the least effective ways to make a state a better place to do business.

As Robert Turner makes clear, when utilizing this approach, states generally lack the knowledge regarding how willing a business is to move or stay, how large the subsidy needs to be, and how much tax revenue the relocation will create. This necessarily means that a state cannot conduct an accurate cost-benefit analysis when creating the subsidy and thus, by definition, cannot make an efficient policy decision in this situation.

Ultimately, when states participate in this industrial recruitment method, it results in a prisoner’s dilemma type situation where states overbid for firms that end up bringing fewer jobs and less tax revenue than planned. The industrial recruitment process, therefore, generally ends up being a negative sum game.

It took $178 million to keep Sears the first time around and now Illinois is fronting a portion of the new $330 million tax package to convince the company to stick around for a while longer. Is it not yet clear that this is a fundamentally flawed method of fostering business activity?

A more efficient (not to mention, more equitable) approach would be to create a business climate which fosters all businesses rather than one that picks winners and losers.  Allowing people a measure of economic freedom with low, stable, and non-discriminatory taxation and simple, non-burdensome regulation would be a true win-win.

 

Illinois’ “Goldilocks” budget

This year Illinois’ budget is larger than last year even though the state anticipates a shortfall of  over $9 billion. The Civic Federation notes this is made possible due to overinflated revenue estimates.

The strategy to achieve balance includes a variety of one-shots, including delaying payments to vendors, reports Benjamin Stout of the Illinois Statehouse News.  To cover its huge pension liability the state is making a $4 billion payment into the system. For the past three years that payment was made with bonds. Other strategies: the state will take longer to pay Medicaid, and is banking on higher revenues from newly hiked income taxes. Kurt Erickson at the The Quad-City Times calls it, “The Goldilocks Budget.”

One representative is asking that AFSCME re-open its contracts to find cost-savings. The union is opposed to any contract re-negotiations.

Lawmakers sent Governor Quinn a $33.4 billion budget to sign, but the Governor wants to spend $36 billion. He is constrained as Governor. At this stage in the budget process, he can only line-item veto not add to the legislature’s approved budget. One representative suggests the Governor come back in the fall and ask for more money.

I’ve been having a look at Illnois’ 2012 budget and it is remarkable. Of note are the five strategies the Governor outlined to fix Illinois’ long-running structural deficits. This includes  the “Illinois Now!” initiative, a “jobs-creation program” financed by bonds which claims credit for creating 135,000 jobs. The rest of the strategy includes “strategic borrowing”, federal assitance, higher taxes, and small programmatic reductions.  Structural changes are nowhere apparent, in a state that will run out of assets to pay for pensions in a few short years.

Is Illinois “Greece on Lake Michigan”?

The New York Times reports that Illinois has taken the place of California for the state with the biggest troubles. Downgraded by every ratings agency, Illinois’ pension system is likely to run out of money to pay retirees in the next few years. And the state has hasn’t figured out how to close its $12 billion deficit, representing about half of its budget.

Illinois has avoided program cuts and tax hikes by borrowing. Those bond issues are now another budget line item for interest rate payments. Last year Illinois paid $55.3 million for two short-term borrowings it issued to pay for operating expenses. Former Govenor Rod Blagojevich, pushed the state to issue $10 billion in Pension Obligation Bonds, and Governor Quinn is currently considering issuing more pension bonds to make the state’s payment. The POBs haven’t helped. Today Illinois officially reports $70 to $80 billion in unfunded liabilities, a figure that vastly understates the systems’ true unfunded liability which is likely closer to $219 billion or about one-third of the state’s GDP.