Fiscal Condition Critical:The Budget Crisis in Illinois

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Late in 2009, the Pew Center on theStates released a national study which

found that Illinois ranked among the top10 states facing the worst fiscal problems,and warned that “some of the same factorsdriving California toward the brink ofinsolvency also are hurting an array ofstates.”1 Starting from the basic question,“What went wrong in California?” Pewresearchers identified six indicators thathad played a significant role either in cre-ating California’s fiscal crisis or preventingit from being fixed. They then scored allstates on each of the indicators, findingthese same conditions in many places.While Illinois fared better than some statesin terms of its ability to weather the hous-ing market meltdown and the collapse ofspecific industries, the magnitude of itsbudget shortfall and its unfunded pensionliability are among the worst in the nation.The Pew study noted that, “what putsIllinois squarely in the company ofCalifornia is its lack of fiscal discipline tobalance its state budget … the legislaturepassed a budget significantly out of bal-ance, leaving it to the governor to makethe cuts. The state also has a history ofdeferring its bills, including payments tocover its public-sector pension liabilities;this year, Illinois borrowed money to payfor its annual pension contribution.”2

Certainly, the national economy is affectedby the degree to which states are able torecover from the “Great Recession,” andmany states are not recovering. In the fol-lowing sections we outline the national sit-uation, describe the current situation inIllinois, and discuss possible long-termsolutions. We then present the first resultsof our economic forecasting model, theFiscal Futures project, a new Institute ofGovernment and Public Affairs initiativedeveloped in the past year. We conclude

that Illinois, like many states, faces somevery hard budget choices in the bleakyears ahead.

Short-Run and Long-Run Crises in Illinoisand Other States

The current recession appears likely to bethe worst since the Great Depression. Realgross domestic product fell by about 3.8percent between the fourth quarter of 2007and the second quarter of 2009, a full per-centage point greater than the decline inthe severe 1981-83 recession. Nationally,the unemployment rate peaked at 10.2 per-cent in October 2009, while Illinois washigher than average at 11.0 percent.Current national unemployment rates arelower than the peak of 10.8 percent duringthe 1981-83 recession but are otherwisehigher than any time since the GreatDepression. The Federal Reserve reportsthat 86 percent of the nation’s industrieshave cut back on production since therecession began – the largest figure in the42 years that the statistic has been kept –while every state reported an increase inunemployment since December 2008.Having begun at the end of 2007 and onlynow showing signs of ending, this reces-sion is turning out to be even worse thanthe 1981-83 decline.

Illinois is among the states whose budgetswere already in poor condition before therecession began. In a case of remarkably badtiming, the state government’s contributionto the state pension systemwas scheduledto increase markedly in 2010 as a way topartially make up for decades of underfund-ing. The underfunding of pension obliga-tions is a form of “implicit debt” and amajor way that Illinois has been able to meetthe letter of its balanced budget requirementin past years.3 The accumulated implicit

Fiscal Condition Critical: the Budget Crisis in IllinoisBy Richard F. Dye, Nancy Hudspeth, andDaniel P. McMillen

1 Pew Center on theStates. 2009.Beyond California:States in Fiscal Peril(November 2009).http://www.pewcenteronthestates.org/report_detail.aspx?id=56044(Accessed 11-12-09).

2 Pew Center on theStates. 2009.Beyond California:States in Fiscal Peril(November 2009),pp7&47.http://www.pewcenteronthestates.org/report_detail.aspx?id=56044(Accessed 11-12-09).

3 Giertz, J. Fred. 2006.The Illinois StateBudget andPensions, in TheState of the State ofIllinois, Institute ofGovernment andPublic Affairs,University ofIllinois: 16-27.

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The Illinois Report 2010

4 NationalAssociation of StateBudget Officers(NASBO). 2009. TheFiscal Survey ofStates (June 2009)http://www.nasbo.org/ (Accessed 10-12-09).

debt from underfunded budgets during thegood economic years before the currentrecession has increased the strain on thecurrent budget situation and contributes tothe deficit going forward. The state reliesheavily on a sales tax with a relatively nar-row base. Much of the gasoline tax is leviedon a per-gallon basis, which means revenuecan actually fall as the price of gas rises.While recessions never come at a goodtime, Illinois needed a much longer stretchof growth to offset its underlying deficit.

A National Perspective

Illinois is far from alone in its currentbudget situation. ANational Association ofState Budget Officers (NASBO) publica-tion, “Fiscal Survey of the States,” paints agrim picture.4 During the 2009 fiscal year,42 states have together been forced toreduce their budgets by a combined $31.6billion. Though some states have managedto maintain balanced budgets by cuttingexpenditures, 41 states reported budgetgaps during the 2009 fiscal year and 37states expect to face gaps for 2010.According to the NASBO, more than 40percent of the states have enacted across-the-board spending cuts. Targeted cuts,rainy day funds, furloughs, layoffs, and

reduction in local aid have also been usedto reduce spending in response to budgetshortages.

The budget declines are large by historicalstandards, particularly because budgetsincrease in most years. Figure 1 shows theannual percentage change in the totalbudgets across all states from 1979 to 2009.Budgets declined only three fiscal yearsacross this 30-year period, in fiscal year1983 and now during the two most recentfiscal years. The 2.5 percent decline pro-jected for fiscal year 2010 is the largestdecline during this 30 year period, withthe 2.2 percent for fiscal year 2009 a closesecond.

These reductions in revenue have led tosignificant decreases in expenditures.Twenty-six states cut spending on K-12education in 2009, while 31 states reducedspending for higher education.Expenditures were also cut for publicassistance (22 states), Medicaid (25 states),corrections (25 states), transportation (15states), and personnel (25 states). Illinois isone of only 12 states that did not makemajor program cuts in fiscal year 2009.

Several states – not Illinois – have man-aged to set aside rainy day funds or otherreserves to help stabilize their budgetsduring economic downturns. According toNASBO, an informal rule of thumb is thata budget reserve of at least 5 percent oftotal expenditures is an adequate cushion.Illinois’ budget reserve balance was 1.5percent of expenditures in fiscal 2008 and1.4 percent in 2009. In contrast, thenational average was 9.1 percent, and isestimated to have declined to 5.5 percentin fiscal 2009. States have been reluctant todraw from their reserves because the reces-sion is only now showing signs of ending,and state fiscal conditions often take a longtime to improve after a downturn.

Some states have been helped by theAmerican Recovery and Reinvestment Act

Figure 1Annual Budget Increases Across All States

-5

0

5

10

15

20

79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09

Fiscal Year

Budg

etIn

crea

se(%

)

Source: National Association of State Budget Officers

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(ARRA), popularly known as the “stimulusplan.” More than $135 billion of the $787billion in stimulus money was allocated tothe states to help reduce budget shortfalls.Most of that money, $87 billion, is forMedicaid. On average, ARRA funds havesucceeded in closing 30-40 percent of thebudget gaps. However, when this tempo-rary source of federal aid goes away, stateslike Illinois with structural budget problemson top of cyclical problems will still be introuble.

Structural Deficits

The severity of the current recession hasexposed systemic weaknesses in the designof many states’ revenue systems and theirspending obligations, which raises concernabout structural deficits. If a state consis-tently experiences conditions in whichcosts are projected to increase faster thanrevenue, even in non-recession years, thisis considered a “structural deficit.” In astructural deficit, crisis conditions becomethe new normal, and structural deficits arebecoming common. A 1998 study foundstructural deficits in 39 states and a similarstudy in 2002 found structural deficits in 44states.5 By not funding the current value offuture obligations for pensions and retireehealth care, states like Illinois haveincreased future spending obligations andadded to their structural deficits.

Among the causes of structural deficits are:the shift of the economy from goods toservices; outdated sales tax systems; ero-sion of state corporate taxes; over-relianceon and erosion of state income taxes;growth of interstate sales (due to Internettransactions); the aging of the population(more retirees, fewer workers); states’ fail-ure to maintain a mix of taxes that cangrow with costs; political adoption of taxand spending limitations and supermajor-ity requirements; federal policies thataffect state revenue (federal pre-emption ofstates’ taxing authority); and interstate taxcompetition (fears that raising taxes will

harm states in competition with theirneighbors).6 Dealing with structuraldeficits requires fundamental reforms ofboth state revenue systems and spendingobligations – with health care costs beingthe overarching consideration in everybudget examination.

Illinois Budget Problems Are Nothing New

Illinois has had periodic cyclical deficits, inwhich a downturn in the economy causesrevenue to decline, leading to a scramble tobalance the budget, and a long-recognizedstructural deficit. A 1996 study by J. FredGiertz, Therese McGuire, and JamesNowlan of the Institute of Government andPublic Affairs found that expenditures wereprojected to grow at a rate of 2 percentabove inflation for the next decade, whilerevenue was projected to grow at half thatrate. Thirteen years ago, they wrote:

“A look at how Illinois has coped withthe structural deficits in the past (suchas increased income tax rates, under-funding the state’s pension systems,and delaying payments to health careproviders) indicates that the state hasbeen using short-term coping strategiesto deal with a long-term, persistentproblem. Illinois can continue toincrease the efficiency of state govern-ment; however, because state operationstake up less than one-quarter of generalfunds spending it is unlikely that futureoperating reductions alone can erase theprojected structural deficit.”7

Unfortunately, the warnings in 1996 didnot lead to fiscal reform. In The IllinoisReport 2007, Giertz presented estimates ofIllinois’ structural deficit growing yearafter year, showing (again) that revenue isprojected to grow at a slower rate thanexpenses, concluding that, “[s]oon, thestate must face the prospect of either mak-ing large and painful cuts in major pro-grams or finding additional permanentsources of revenue.”8

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5,6 Lav, Iris J.,Elizabeth McNicholand RobertZahradnik. 2005.Faulty Foundations:State StructuralBudget Problemsand How to FixThem. Center onBudget and PolicyPriorities.http://centeronbudget.org/files/5-17-05sfp.pdf(Accessed 10-12-09).

7 Giertz, J. Fred,Therese J. McGuire,and James D.Nowlan. 1996. TheIllinois StructuralBudget Dilemma:The Gap BetweenExpectations andRevenue Realities.State Tax Notes (10)727 (March 4,1996).

8 Giertz, J. Fred. 2007.The Illinois StateBudget, in TheIllinois Report 2007,Institute ofGovernment andPublic Affairs,University ofIllinois: 7-12.http://igpa.uillinois.edu/system/files/TheIllinoisReport2007.pdf (Accessed11-12-09).

In our contribution to The Illinois Report2009,we wrote that, “the state has takenno…action and may have made thingsworse.”9 At that time, we noted that theCommission on Government Forecastingand Accountability (COGFA) had issuedan “early warning” of fiscal trouble inNovember 2008, predicting a $1.3 billionrevenue shortfall for fiscal year 2009, andfeared that even worse was yet to come.Unfortunately, we were proven correct.Seven months later, the actual FY 2009deficit reported in last July’s Comptroller’sQuarterlywas more than twice as bad: $2.9billion.10 Determining the actual amountsof the 2009 and 2010 budget shortfalls islike attempting to pin down a moving tar-get, but concluding that they are large andproblematic is easy.

Two Really BadYears in a Row: the 2009 and2010 Budgets

As noted earlier, Illinois and other statesfaced a severe budget shortfall in fiscalyears 2009 and 2010 due to the nationalrecession and the hangover from pastbudget decisions. Soon after Governor PatQuinn assumed office from the impeachedand removed Rod Blagojevich in lateJanuary 2009, numerous budget reportsand briefings were issued by governmentofficials, advocates, and experts. While allagreed that there would be a seriousbudget shortfall, and that Illinois needs tomake some drastic fiscal changes, therewas no agreement about the actual amountof the current and near-future deficit or thespecific solutions proposed.

During the latter half of FY 2009, analystspredicted revenue shortfalls ranging from$1 billion to $4 billion. In February 2009,the Comptroller’s Transitional Report esti-mated that Illinois’ general funds deficitwas $8.9 billion, by combining preliminaryestimates for 2010 with one for the 2009shortfall that would be carried into 2010.11Just one month later, the Governor’s Officeproposal for FY 2010 upped the ante with

an estimate of the 2009 carryover plus the2010 deficit “without reform and cuts” of$11.6 billion.12 Other estimates from othersources or from these same sources at dif-ferent times vary considerably, but they areall very large.

Governor Quinn proposed a substantialincrease in the personal income tax to helpbalance the FY 2010 budget, but wasunable to get support from the legislatureto pass it into law. Instead, on July 15,2009, the legislature passed and the gover-nor signed a budget without a tax increasethat included:• $3.5 billion in borrowing to cover pen-sion payments to be paid back over fiveyears

• $1.8 billion in federal stimulus money• $0.4 billion in “fund sweeps,” or trans-fers from special fund balances

• $2.1 billion in spending cuts• another $1.1 billion in spending cuts tobe made later in the year.13

Pension borrowing helps in this year, butmakes the next five years worse. The fed-eral stimulus money is a non-recurringrevenue source, as are the fund sweeps. Itseems at this writing that revenue is com-ing in at a slower rate than budgeted andthat budget year 2010 will have a sizabledeficit without future tax increases orspending cuts or both. Moreover, the 2011budget will start in a deeper hole due tothe non-recurring revenue sources and thedelay in spending cuts.

Long-Term Solutions

Major revenue options: In The Illinois Report2008, David Merriman outlined Illinois’fiscal situation and possible revenue solu-tions:

“[O]ver the long term Illinois will haveto make hard choices in order to pay forits normal operating expenses, pensionobligations and Medicaid programs.Minor tinkering with the tax system,18

The Illinois Report 20109 Dye, Richard F. andDaniel P. McMillen.2009. Illinois’ FiscalFuture and theState’s Economy, inThe Illinois Report2009, Institute ofGovernment andPublic Affairs,University ofIllinois: 14-22.http://igpa.uillinois.edu/system/files/IR09/text/ch2fiscal.pdf (Accessed 11-12-09).

10 Illinois Office ofthe Comptroller.2009a. FY 2009Revenues Fall 9%,Payment BacklogUnprecedented.Comptroller’sQuarterly (July2009). http://www.ioc.state.il.us/common/getLocalFile.cfm?fileName=CQ_Jul_09.pdf(Accessed 10-12-09).

11 Illinois Office ofthe Comptroller.2009b. TransitionalFiscal Report/FY2010 BudgetaryOutlook http://www.ioc.state.il.us/ioc-pdf/dwhreportFeb2009.pdf(Accessed 10-12-09).

12 Governor’s Officeof Managementand Budget(GOMB). Fiscal Year2010 Budget,March 18, 2009, p11. http://budget.illinois.gov/documents/FY10BudgetPowerpointFINAL.pdf (Accessed 10-12-09).

13 Center for Tax andBudgetAccountability,2009. The BudgetThat Just Passed,Weekly Review, July20, 2009.http://www.ctbaonline.org/Weekly%20Review/2009/7-20-2009%20Weekly%20Review.htm (Accessed 11-12-09).

user charges and one-time revenue fixessimply will not provide enough moneyfor Illinois to continue business asusual. There is a long list of revenue-raising options, which includesincreases in sales, corporate or incometax rates or elimination of exemptions;means testing for tax credits; changingthe base of the personal income tax tothe federal income tax liability; expand-ing the sales tax to include consumerservices; increasing the gasoline tax;value-added tax; and others.”14

Merriman evaluated several major optionsand expressed his own preference for onethat would change the base of the Illinoispersonal income tax to the federal incometax liability, making Illinois’ personalincome tax into a surcharge on the federalincome tax. This would be easy for thestate to administer and would make theIllinois’ income tax more progressive. Italso would broaden Illinois’ tax base bytaxing pension and Social Security income.Merriman argued that this change “wouldallow Illinois’ revenue to grow more rap-idly in the future if the current trendtoward disproportionate growth of highincomes continues. This change could helpstabilize Illinois’ fiscal climate for manyyears into the future.”15

Sales tax base broadening. Expanding thesales tax base to cover consumer serviceshas recently been studied by theCommission on Government Forecastingand Accountability (COGFA). They esti-mate that taxing a broad array of con-sumer services could raise approximately$3.6 billion in additional state revenue peryear.16 Taxing services may make sense inIllinois because, compared to its GreatLakes neighbors, Illinois’ economy is moreheavily concentrated in the services sectordue to the predominance of finance, insur-ance, and professional services.Broadening the sales tax base to includeservices would “increase economic effi-ciency and modernize the sales tax system

so that revenues would grow more rapidlyas the economy expands,” Merrimanwrote.17

Income tax rate increases. Governor Quinn’sunsuccessful budget proposal for 2010would have increased the personal incometax rate from its current 3.0 percent to 4.5percent. To soften the impact on low- andmoderate-income families, the proposalwould also have tripled the personalexemption from $2,000 to $6,000 per person.

Multi-part revenue proposals. In the spring of2009, a tax reform bill introduced by stateSenator James Meeks (SB 750) and revisedby State Representative David Miller (HB174) was proposed as a way to help bal-ance the 2010 budget. The proposal had sixcomponents:• Raise the personal income tax rate from3 percent to 5 percent

• Increase the per person exemption from$2,000 to $3,000 per person

• Triple the state’s Earned Income TaxCredit

• Double the residential property taxcredit from 5 percent to 10 percent

• Increase the corporate income tax ratefrom 4.8 percent to 5.0 percent

• Expand the sales tax base to cover 39different consumer services.

The first element would be a very largeincrease in the personal income tax. Thenext three would have reduced thatincrease in ways that are targeted to alltaxpayers, low-income families, and home-owners respectively. The fifth componentwas a modest increase in business taxes.The final plank was a very modest broad-ening of the sales tax base. The bill passedthe Senate but was not called to a vote inthe House.

Spending cuts. Substantial cuts in statespending will also have to be part of anylong-term plan to balance the state’sbudget. There are a number of proposalsbeing circulated and available online, some

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14 Merriman, David.2008. Illinois’ FiscalFuture: Fundamen-tal Issues FacingIllinois, in TheIllinois Report 2008,Institute ofGovernment andPublic Affairs,University ofIllinois: pp 9-14.http://igpa.uillinois.edu/system/files/03-ILRept08-FiscalPg8-17.pdf (Accessed11-12-09).

15 Merriman, David.2008. Illinois’ FiscalFuture: Fundamen-tal Issues FacingIllinois, in TheIllinois Report 2008,Institute ofGovernment andPublic Affairs,University ofIllinois: p 17.http://igpa.uillinois.edu/system/files/03-ILRept08-FiscalPg8-17.pdf (Accessed11-12-09).

16 Commission onGovernmentForecasting andAccountability(COGFA). 2009.Service Taxes: 2009Update (August,2009).http://www.ilga.gov/commission/cgfa2006/Upload/2009-JULY%20SERVICE%20TAXES%20Update%20REPORT.pdf (Accessed 11-12-09).

17 Merriman, David.2008. Illinois’ FiscalFuture: Fundamen-tal Issues FacingIllinois, in TheIllinois Report 2008,Institute ofGovernment andPublic Affairs,University ofIllinois: pp 16-17.http://igpa.uillinois.edu/system/files/03-ILRept08-FiscalPg8-17.pdf (Accessed11-12-09).

listing multiple options. Noteworthy arean analysis of the state budget by the CivicFederation18 and the report of the TaxpayerAction Board,19 a citizen’s commissionempanelled by Governor Quinn. Someadvocate across the board cuts in all gov-ernment programs. Some offer long lists ofsmaller programmatic cuts. The major can-didates for reforms that would cut spend-ing are:• Medicaid: Past spending increases inexcess of income and revenue growthhave been the major source of statebudget problems for decades.Nationally, Medicaid has experiencedcost inflation as have all health careservices, so the biggest chance for“bending the cost curve” on healthspending comes from federal actionsbeyond the control of any one state.Reductions in Illinois’ total Medicaidspending would not entirely be creditedto the state’s budget, because federalreimbursements currently cover themajority of the state’s Medicaid bills. In

Illinois, the federal match rate has his-torically been 50 percent, meaning thatthe federal government would reim-burse the state for half its Medicaidcosts, but in April 2009 the federal stim-ulus plan temporarily increased thematch rate to 61.88 percent.20 So, forexample, a $2 billion reduction in thestate’s overall Medicaid expenditureswould result in less than $1 billion insavings of Illinois’ own dollars. The factthat Illinois’ federal match rate of 50percent was the lowest possible – states’reimbursement rates range from 50 per-cent to 83 percent – has been controver-sial for many years, and proposals topermanently increase Illinois’ matchrate have been advanced since the pro-gram’s inception. Some of the cost-sav-ing recommendations for actions by theState of Illinois include continuing toreduce Medicaid patients’ in-patienthospital and emergency-room use byexpanding the Illinois Healthy Connectprogram, which has reported substan-tial cost savings since its inception in2007 and provides case-managed andpreventative care, often in an outpatientclinic, similar to a HMO. Managed-care-type programs in other states have beencost-effective for Medicaid patients withdisabilities or mental illness; the vastmajority of these persons in Illinoishave no “medical home.”21 The CivicFederation notes that “Illinois lagsbehind other states in developing alter-natives to institutional care for the eld-erly and disabled. Of particular concernare the hundreds of millions of dollarsthat Illinois spends annually on institu-tional care that is not eligible for federalreimbursement.”22

• Pensions and retiree health care: Thebiggest problems with both pensionsand retiree health care programs are dueto the decisions to not fully fund thepromises that were made to state work-ers over the past several decades. Goingforward, there are some opportunitiesfor more modest savings in pensions,

The Illinois Report 2010

Someadvocateacross theboard cuts inall governmentprograms.Some offerlong lists ofsmallerprogrammaticcuts.

18 Civic Federation. 2009a. A Fiscal Roadmapfor Creating a Sustainable State Budget:Actionable Recommendations for GovernorPat Quinn and the General Assembly (March9, 2009) http://civicfed.org/sites/default/files/civicfed_292.pdf (Accessed 10-12-09).

19 Taxpayer Action Board (TAB). 2009. Reportof the Taxpayer Action Board, June 2009.http://www2.illinois.gov/budget/Documents/TABreport.pdf (Accessed 10-12-09).

20 Illinois Department of Health Care andFamily Services website “Highlights of theAmerican Recovery and Reinvestment Act of2009: Enhanced Federal Medicaid MatchingFunds (Updated November 12, 2009)” http://www.hfs.illinois.gov/recovery/ (Accessed 11-12-09).

21 Taxpayer Action Board (TAB). 2009. Reportof the Taxpayer Action Board, June 2009.http://www2.illinois.gov/budget/Documents/TABreport.pdf (Accessed 10-12-09).

22 Civic Federation. 2009b. The IllinoisMedicaid Program: An Issue Brief (May 22,2009). http://civicfed.org/sites/default/files/civicfed_295.pdf (Accessed 11-10-09).

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which include increasing employee con-tributions from current state workers,increasing the retirement age, and atwo-tier system with lesser benefits fornew employees.23 Cost savings may alsobe realized by consolidating the pensionsystems’ administration and serviceproviders. Recently enacted legislationto reform the management of the statepension programs calls for increasedoversight and regulation.24 Similar topensions, retiree health care has becomea huge, unfunded liability that the stateneeds to address. Reforms in this areacould include increasing employee con-tributions and providing less costly ben-efit packages.

• Human services: Recommendationsinclude consolidating services – adopt-ing an integrated service deliverymodel – and streamlining theDepartment of Health and FamilyServices’ approach to service delivery.Illinois human services agencies cur-rently operate more than 300 locations;it may be possible to consolidate thesemany small offices and provide severalservices in one place. Currently, thestate is implementing a pilot programfor streamlining service delivery sys-tems via the Internet; a similar programin Florida is reportedly saving $83 mil-lion annually.25

• K-12 Education: According to theTaxpayer Action Board, administrativeefficiency and cost savings might beattained by consolidating school dis-tricts, of which there are 870 in Illinois.About 200 districts have only oneschool.

• Public Safety: The Taxpayer ActionBoard recommends reviewing the casefiles of low-risk inmates for early paroleand release. Nearly 20 percent of thosewho are incarcerated committed rela-tively minor Class 3 and Class 4 feloniesand it costs the State of Illinois morethan $250 million per year to keep themin prison.

Illinois’Fiscal Future Is Bleak

Two clear implications from our examina-tion of fiscal years 2009 and 2010 are thatcyclical revenue problems will persist forat least another year and that the hangoverfrom some of the temporizing choices –like the five-year repayment of the borrow-ing that papered over part of the 2010deficit – will persist for a number of years.The near-term fiscal future of the state ofIllinois is bleak. There is also new evidenceon the structural deficit from which weconclude that, absent some major changes,the long-term fiscal future of the state issimilarly bleak.

The Fiscal Futures Project

In The Illinois Report 2009,we introduced anew IGPA initiative, the Fiscal FuturesProject. In this edition, we outline a year’sprogress on that project and some of theresulting estimates of future budgets.

Illinois budget data for prior years. In order toknow where you are going, you first needto understand where you have been, soconsiderable effort has gone into gathering,

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23 Governor’s PensionReform websitehttp://www.illinois.gov/gov/pensionreform/

24 Mayer Brown,2009. GovernmentRelations Update:Sweeping IllinoisPension ReformLegislation AffectsRetirementSystems andPension Funds andtheir Advisers,Managers andConsultants.http://www.mayerbrown.com/publications/article.asp?id=6537(Accessed 10-10-09).

25 Taxpayer ActionBoard (TAB). 2009.Report of theTaxpayer ActionBoard, June 2009.http://www2.illinois.gov/budget/Documents/TABreport.pdf(Accessed 10-12-09).

Figure 2Spending Components of Consolidated Budget In FY 2008

Medicaid

Other

Debt Service

Human Services

State EmployeeHealth Care

Pensions

Transportation(including Tollway)

Higher Education

Elementary andSecondary Education

Revenue TransferLocal

15%10%4%

3%3%

7%

8%

7%

21%

22%

Source: IGPA Fiscal Futures Model 20 October 2009

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studying and reconciling 13 years ofIllinois state budget data and grouping itinto major revenue and expenditure cate-gories. We use a broad concept of theIllinois budget, which we call theConsolidated Budget. For fiscal year 2008,our consolidated budget for the State ofIllinois is $59.5 billion, while the lessinclusive but more commonly reportedGeneral Funds budget totals only $34.6 bil-lion. Figure 2 and Figure 3 show FY2008amounts for the 10 expenditure categoriesand 12 cash receipts categories in the fiscalfutures model.

Economic and demographic data: actual forprior years, forecasts for future. The RegionalEconomics Applications Laboratory(REAL) at the University of Illinois

The Illinois Report 2010

In most reporting and discussion of the Illinois statebudget, the concept of General Funds is used. We use amore inclusive concept, which we call ConsolidatedFunds, because we believe that it better represents thetotal burdens and benefits of state government to tax-payers and residents. If analysis was limited to the fourGeneral Funds, it would largely exclude several impor-tant categories of revenue and expenditures:

• Only a small amount of the transportation budgetcomes from the General Funds, because motor fueltaxes are deposited in the special road fund. Weinclude transportation revenue and expenditures,including the Illinois State Tollway Authority, in theconsolidated budget.

• Debt service expenditures do not come directly fromthe General Fund, but rather from special debt serv-ice. Debt service is incorporated in the consolidatedbudget in a way that avoids double counting.

• Most transfers of revenue back to local governmentsdonot come from the General Funds but are in our con-solidated budget. These include: the PersonalProperty Replacement Tax levied on corporations andutilities; the 1.25 percent of the general sales tax thatis passed back to local governments (out of the 6.25percent total); the one-tenth of the state income tax

that is transferred to local governments; and the por-tion of motor-fuel taxes that goes to local govern-ments. The consolidated budget includes these taxes,because they are levied statewide at a common rateand with a burden on taxpayers throughout the state.Also, the distribution to local governments is bystatutory formula, which could be changed. (Notethat purely local-option taxes levied by specific localgovernments with the state just acting as collectionagent are not included in our consolidated budget.)

• Health care providers’ taxes and fees are a key compo-nent of the total Medicaid budget, but they are typi-cally deposited into specially designated funds, notthe General Funds. With care to avoid double count-ing, this revenue source and associated expendi-tures are included in our consolidated budget.

• Many federal grants for a designated purpose gointo specially designated non-general funds. Theseare important sources of revenue for transportation,Medicaid, education, and human services, and areaccordingly included in our consolidated budget

Adding those and smaller adjustments increases thetotal state budget by over two-thirds in fiscal year2008 – from $35 billion for general funds alone to $60billion for the consolidated funds.

The General Funds Represent Only Part of the State Budget

Figure 3Revenue Components of Consolidated Budget In FY 2008

Personal Income Tax(Inc. Local Share)20%

Corp. Income Tax6% (+CPP Rep. Tax)

General Sales Tax(Inc. Local Share)

18%

24%

Federal Funds

Gambling(Lottery + Other)

Motor Fuel/Veh./Operator

(Inc. Local Share)

Public Utility Tax(+PUPP Rep. Tax)

Excise Tax (Other)

Healthcare ProviderTaxes

Bond Issue Proceeds 0%

Short-Term Borrowings Other

11%

4%4%

2%3%5%

3%

Source: IGPA Fiscal Futures Model 20 October 2009

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supplied detailed historical and forecastdata from its model of the Illinois econ-omy. Additional economic, fiscal, anddemographic data for both the state andthe nation has also been obtained. In par-ticular, the model described below makesuse of past and forecast data for Illinoispersonal income, consumption, consump-tion of services, total population, and pop-ulation in various age groups as “drivers”of different budget categories.

Demonstration model.We have completed apreliminary version of the fiscal futuresmodel. For some of the budget compo-nents – pensions and debt service – officialschedules of future payments are used. Foreach of the other designated revenue andexpenditure categories we have created a“projection module.” The modules esti-mate the historical relationship betweenthe budget variable and one or more “dri-ver” variables, such as total income orpopulation, and use forecasts of the drivervariables to create projections for thebudget component. Most of the attentionto date has been given to the largest rev-enue and spending categories: personalincome and general sales taxes, Medicaid,and K-12 education spending.

The default module simply relates pastgrowth in the budget measure to pastgrowth in state personal income; for somecomponents, additional drivers are used,such as growth in: population, school-agepopulation, college-age population, orhealth-sector output. Two revenue sources,gambling and motor fuel, showed zerogrowth in recent years so we assumed zerogrowth in the future.

Figures 4 and 5 (on page 24) show thegrowth rates for each of the revenue andexpenditure components generated fromthis data and the estimates that lead to theassumed relationships with the drivervariables. The growth rates predicted bythe model fluctuate somewhat in the initialyears, and then converge on a fairly con-

stant rate, so the figures show the annualaverage for the 2020 to 2030 time period.The first two bars in both figures give, forreference, the rate of growth for personalincome and the rate of inflation in theConsumer Price Index.

The growth rates in revenue componentsare shown in Figure 4. Referring to Figure3, we see that the three largest revenuesources are the personal income tax, thegeneral sales tax, and federal funds. Thegrowth rate in personal income tax collec-tions is projected to be 4 percent per year,slightly above the growth in statewideincome. The general sales tax is projectedto grow at only 1.7 percent per year, whichis less than the rate of inflation. Projectedgrowth in federal aid of 6.1 percent peryear is a statistically educated guess basedon the growth rate between 1998 and 2008.Whether or not this actually happensdepends upon the future actions ofCongress. The projections for all types ofrevenue indicate total growth of 4.4 per-cent per year.

The growth rate projections for the spend-ing categories are shown in Figure 5. Thelargest spending components are elemen-tary and secondary education andMedicaid, both of which have high pro-jected growth rates, 5.2 and 7.8 percent,respectively. Transportation spending alsohas a high projected growth rate, as doesthe payment schedule for state contribu-tions to state and local public employeepensions. The growth projections for alltypes of spending total 5.3 percent peryear. This may not seem like much morethan the 4.4 percent projection for revenuegrowth, but note that the difference will becompounded over many, many years.

The demonstration model has two basicpurposes. First, the model can be used toproject a “baseline” into future years ofrevenue and spending under current lawand current projections of economic anddemographic trends. The difference

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The growthprojections forall types ofspending total5.3 percent peryear. Thismaynot seem likemuchmorethan the 4.4percentprojection forrevenuegrowth, butnote that thedifferencewillbecompoundedovermany,many years.

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Figure 4Projected Growth Rates for Income, Prices and Revenue Components(Annual Average for 2020 to 2030)

0 1 2 3 4 5 6 7 8 9Percent Per Year

Total Revenue

Other Revenue

Excise Taxes (Other)

Public Utility Tax

Motor Fuel/Vehicle/Operator

Gambling

Federal Funds

General Sales Tax

Corporate Income Tax

Personal Income Tax

Consumer Prices

Personal Income

Source: IGPA Fiscal Futures Model 20 October 2009

Figure 5Projected Growth Rates for Income, Prices, and Spending Components(Annual Average for 2020 to 2030)

0 1 2 3 4 5 6 7 8 9

Total Expenditure

Other Expenditure

Transfer to Local

Human Services

Transportation

Higher Education

Pensions

Employee Health

Medicaid

K12 Education

Consumer Prices

Personal Income

Percent Per Year

Source: IGPA Fiscal Futures Model 20 October 2009

between total would-be spending and totalwould-be revenue in a future year can becalled an estimate of the “structuraldeficit.” Second, with the right data, themodel can also simulate budgets underalternative policy scenarios or using differ-ent economic and demographic variables.These “what if” estimates, or out-year pro-jections of policy alternatives, might becalled the “scorekeeping” function of themodel. For example, the personal incometax module has been constructed in a waythat allows for changes in policy parame-ters like the tax rate or the amount of thepersonal exemption.

Total budget estimates. Figure 6 shows theactual and projected paths for total stateexpenditures and total state revenue overtime in real (inflation-adjusted) dollars.The first part of the figure shows actualvalues for the consolidated budget con-cepts for the historical 1998 to 2008 period.The amount by which spending exceedsrevenue is called a deficit, and the amountby which revenue exceeds spending iscalled a surplus. The surge in revenue infiscal year 2003 is a cash surplus resultingfrom a new issue of “pension obligationbonds” and a related jump in pensionspending shows up in the next year. Theprojected values for 2012 to 2030 comefrom the model described above. As noted,the model compounds any differencesbetween spending growth rates and rev-enue growth rates over the years, so thehigher growth for spending leads to anever larger deficit projection. The modelprojects that the deficit will grow to theorder of $15 billion (real 2008 dollars) by2020 and to $29 billion by 2030. Thisunderlying mismatch between the level ofrevenue that existing rules can sustain andthe level of spending that caseload driversproject is sometimes called a “structuraldeficit.”

Policy simulations. The model can also beused to make hypothetical projections offuture budgets with alternative policies.

For example, we could use the model tocompute projected revenue under theMerriman proposal to piggyback on thefederal income tax, the Quinn proposal toincrease the income tax rate and personalexemption, the COGFA option to expandthe sales tax base to include a wide range ofconsumer services, or a hybrid proposal likeMeeks-Miller to make multiple changes.

The important qualitative result from ourtax simulations is that there is no percepti-ble impact on the growth rate of revenue infuture years. Except possibly for theexpansion of the sales tax base to includeservices, none of the proposed changeswill increase the growth rate of revenue,only the baseline amount. So even if a pol-icy is successful in closing the gap in oneyear, it will do little or nothing to changethe fact that spending will grow faster thanrevenue, so the structural deficit will soonre-emerge.

Notes on interpreting the model. This articleis being written in budget year 2010, butthe model is based on available data thatstops in fiscal year 2008. Even though weknow that, due to the severity of the reces-sion, budget years 2009 and 2010 are muchworse than the model projects, we base

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The importantqualitativeresult fromourtax simulationsis that there isno perceptibleimpact on thegrowth rate ofrevenue infuture years.

Figure 6Illinois' Structural Deficit Difference Between Expenditureand Revenue: Actual FY 1997-2008, Projected 2012-2030

40

50

60

70

80

90

100

110

120

97 00 03 06 09 12 15 18 21 24 27 30

Billi

ons

of20

08D

olla

rs

Total Expenditure

Total Revenue

Source: IGPA Fiscal Futures Model 20 October 2009

our later-year projections in Figure 6 start-ing from the rather “optimistic” 2008 base-line. (This is why we choose not to evenshow the near-term projections of themodel.)

Data lags are not the only thing to noteabout the model. The fiscal futures modelmeasures underlying, long-run tendenciesand makes projections, not predictions orforecasts, so the model is not a substitutefor existing short-term budget forecastingtechniques. Future policy makers will beforced by balanced-budget requirementsor cash-flow constraints to raise revenue,

cut spending, or increase the amount ofexplicit or implicit debt to avoid thewould-be deficits. In the words of econo-mist and sage Herb Stein, “If somethingcannot go on forever, it will stop.” We arecontinuing to refine our model and areseeking support to expand its capabilities.

Regrettable Choices in the Past, ToughChoices in the Future

Illinois has both a cyclical and structuraldeficit. We have outlined some of the rea-sons for the current budget crisis. The cur-rent recession has contributed significantly

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The Illinois Report 2010

Future policymakerswill beforced bybalanced-budgetrequirementsto raiserevenue, cutspending, orincrease theamount ofexplicit orimplicit debt toavoid thewould-bedeficits.

Richard F. Dye has been on theIGPA faculty since 1990. Hisresearch and public service activi-ties have focused on state andlocal government finance as itrelates to economic development.Professor Dye initiated IGPA’s studyof the impact of property tax capson the Illinois collar counties since1991 and a study of the impact oftax increment financing on localeconomic development in Illinois.He has written on the impact ofproperty tax classification on busi-ness activity, voter preferences forthe equalization of school propertytaxes, earmarking revenue for spe-cific public expenditures, thegrowth and stability of differentstate revenue sources, and theimpact of stadiums and professionalsports on local development.

Daniel P. McMillen is a professorof economics at the University ofIllinois at Urbana-Champaign. Hehas held an appointment at IGPAsince 2002. Professor McMillen’sresearch interests are urban eco-nomics, real estate, and appliedeconometrics. He is editor of thejournal Regional and UrbanEconomics, and has served on theeditorial boards of the Journal ofUrban Economics, the Journal ofEconomic Geography, Growth andChange, the Journal of Real EstateLiterature, and the Journal ofHousing Economics. In 1998 and1999, he served as the chair of theDepartment of Economics atTulane University, where he hadbeen a professor since 1994. In1998, he was a research fellow forthe Center for Urban Real Estateand Land Economics at theUniversity of British Columbia.

to the state's problems, but if the recessionwent away tomorrow the state’s budgetproblems would not. The current problemand its projection into the future have beenexacerbated by the avoidance of toughchoices in the past. The most significantchoice made repeatedly was to not makecurrent contributions to cover the cost offuture pension obligations. These are notjust pensions of state employees; the stateis also responsible for covering the cost ofpension promises made to local govern-ment employees. This “implicit debt” hasgrown and the obligation has been passedto future taxpayers. Eventually, the

unfunded promises for pensions andretiree medical costs will become due andpayable. Other avoidance mechanisms inthe past include: borrowing against or sell-ing future revenue streams and spendingthe proceeds on current operations; rollingunpaid bills into the next budget year; andcommitting temporary, cyclical surges inrevenue to new or expanded programs. Allthis temporizing has put Illinois in a verydeep hole. Worse, the differential growthrates driving existing revenue streams andprogram caseloads make for a structuraldeficit. Even if we restored balance nextyear, the state would face deficits severalyears down the road.

It is inescapable that Illinois faces very,very tough choices. There almost certainlywill have to be major cuts in spending pro-grams and major increases in revenue.

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The currentproblemandits projectioninto the futurehave beenexacerbated bythe avoidanceof toughchoices in thepast.

Nancy Hudspeth is a Resource &Policy Analyst for the Institute ofGovernment and Public Affairs’Fiscal Futures project, and a PhDCandidate in Urban Planning andPublic Policy at the University ofIllinois at Chicago. She has a MA inUrban Planning and Policy fromthe University of Illinois at Chicagoand a BA from the University ofIllinois at Urbana Champaign. Herresearch interests include state andmunicipal finance, local economicdevelopment, and the effects ofmarket dynamics and failure uponlow-income neighborhoods. Priorto joining IGPA, Hudspeth workedfor six years at UIC’s Nathalie P.Voorhees Center for Neighborhoodand Community Improvement,where she co-authored a numberof studies on housing and eco-nomic development.