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Is Fiscal Stabilization On The Horizon For Illinois?

The Proposed Fiscal 2022 Budget Calls For A Small Surplus

S&P Global Ratings acknowledges that this is only a budget proposal and there is uncertainty about the pace of economic recovery and prospects for additional federal stimulus. Future credit direction will be evaluated as greater clarity is available on these key issues. Currently, we rate Illinois 'BBB-' with a negative outlook. The $41.7 billion general fund budget is slightly smaller than the initial $42 billion budget proposed last year before the pandemic began, and $1.8 billion or 4.2% less than the estimated final spend in fiscal 2021. The introduced budget is designed to generate a $120 million surplus. The state expects to close fiscal 2021 with a small $77 million surplus as well, even after accelerating a municipal liquidity facility (MLF) payment due in fiscal 2022 into fiscal 2021 and filing a supplemental fiscal 2021 spending bill late in the fiscal year. The supplemental bill has minimal effect on the general fund budget and primarily allocates money outside the general fund and federal stimulus money to the appropriate agency, with $2.25 billion from the Elementary and Secondary School Emergency Relief Fund but also allocates $60 million to support employment-security measures.

Potential Risks Of The Illinois State Governor's 2022 Budget Proposal
Federal uncertainty The budget does not rely on additional federal aid, but educational enhancements and further efforts to retire MLF borrowing obligations early could be aided by further stimulus. Should additional aid materialize, the state could adjust budget expectations.
Pensions remain a high fixed cost Included in the budget is $9.4 billion for general fund contributions to the state’s various pension systems. This is a $739 million increase over the previous budget contribution. The statutory contributions are forecast to continue to increase, but the state projects its share of the budget will remain at about 25% of expenditures through 2045.
Challenge in changing tax structure The fiscal 2022 budget relies on changing business tax provisions to generate an estimated $932 million in additional revenues. Legislative scrutiny of the tax-structure proposal could limit change and revenue projections.
Prolonged economic disruption Outside the timing of vaccine distributions, any long-term permanent changes in business, travel, or consumer patterns in and around Chicago will likely have a material effect on the state’s economic recovery.

Closing The Gap Depends On Improved Revenues And Making Spending Adjustments

The initial projected fiscal 2022 budget deficit was almost $5.5 billion or 13.2% of proposed general fund expenditures before gap-closing measures and improved revenue forecasts. To close the gap, and introduce a budget showing a small surplus, the governor proposed the following changes:

  • Improved revenue forecasted from state and federal sources of $1.88 billion;
  • Instituting budgetary adjustments and position freezes of $1.269 billion;
  • Closing business tax provisions of $932 million;
  • Prepaying the MLF payment of $690 million, due in fiscal 2022, in fiscal 2021;
  • Redirecting existing revenue of $565 million from other sources to the general fund; and
  • Eliminating a 48-month deadline to repay internal borrowings to allow payment in fiscal 2023 of $276 million, should funds not be sufficient for an earlier repayment.

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Reducing The Bill Backlog Is A Step Toward Improved Fiscal Footing

All of these proposed changes would lead to a projected budgetary surplus of $120 million and do not include additional federal funds being discussed in the $1.9 trillion stimulus package currently under review by Congress. Although we consider most of these actions reasonable and likely achievable, there are some items of note. The closing of the corporate tax loopholes will require legislative action and is being opposed by some because it would raise taxes on businesses during an economic downturn. The redirecting of revenues includes a change in dedication from the capital program to the general fund, which the administration does expect will need to be offset with debt. And, although the move to push the internal borrowing into a later fiscal year is good cash management, it is generally seen as a credit weakness. However, given the amount and the fact this is happening during a downturn, we do not believe it is likely to be a significant credit factor if it is a one-time event.

The budget does not assume any individual income tax rate changes. The Fair Tax amendment failed at the November 2020 ballot, and the once-expected $1.4 billion in additional revenue cannot be collected. Although allowed in law, the administration in this proposal did not adjust the existing flat income tax amount of 4.95%. The fiscal 2022 budget assumes individual income taxes will increase by about 2% when the second payments attributable to the shifting of the tax payment dates early in the pandemic are allocated back to fiscal 2020 collections.

The budget does assume that the enhanced federal medical assistance percentage (eFMAP) increase of 6.2 percentage points will extend through calendar 2021, providing additional reimbursement amounts for the first half of fiscal 2022. At present, the eFMAP extension is only through June 30, and so the additional amounts are assumed but not guaranteed to materialize. The Biden administration has sent a letter to governors indicating it intends to make this change.

Illinois entered the recession as one of the few states with no reserves. During the long slow economic recovery from the Great Recession, many states were able to establish and increase rainy-day funds to help offset pressures during a subsequent downturn. Illinois faced an extended budget impasse that contributed to a bill backlog that limited any reserve buildup. The bill backlog remains at approximately $5.0 billion, but that is about $2.0 billion less than at this time last year. We expect the state's focus will remain on paying the past-due obligations (although most are now less than 45 days delinquent), before shifting to establishing a reserve for future recessions.

Pensions And Other Postemployment Benefits Liabilities Remain Credit Risks

The fixed costs in the budget related to pensions continue to increase as expected. The fiscal 2022 total annual contributions of $9.4 billion represent 22% of general fund expenditures, a $739 million increase over the fiscal 2021 contribution. The 39.0% funded ratio of all plans combined as of June 30, 2020, makes Illinois the lowest-funded state pension system in the country. Although it represents a significant increase in funding, a third-party actuary does not recommend the statutorily set funding plan, and the goal to attain 90% funding set by the state does not meet levels set in our guidance document "Assessing U.S. Public Finance Pension And Other Postemployment Obligations For GO Debt, Local Government GO Ratings, And State Ratings," published Oct. 7, 2019, on RatingsDirect. Although the budget is still viewed as structurally imbalanced, in our opinion, this increased contribution and meeting the statutorily set amount during the pandemic-induced recession is a positive step.

The mounting of unfunded pension liabilities to $137.2 billion, as of June 30, 2019, represents a per-capita liability of more than $10,750, which we consider high. The ongoing lower-for-longer economic expansion with a lower investment rate of return has resulted in negative cash flows for state pension plans, given that annual benefit payments exceed incoming contributions. Furthermore, with just under a 40% average funded ratio, the state pension system plans are more dependent on favorable investment returns and are exposed to market volatility.

The other postemployment benefit liability is also a credit risk, with an unfunded liability of $56.9 billion, as of June 30, 2019, or a per-capita liability of approximately $4,500, which we also consider high.

The State's Capital Program Holds Additional Debt

We view Illinois' general obligation (GO) debt burden positively. With more than 75% of GO debt retired in 10 years and the state in the third year of a long-term $45 billion Rebuild Illinois capital improvement plan, it is expected to maintain debt ratios at similar levels. As of Feb. 1, 2021, the state has $27.2 billion of fixed-rate GO debt outstanding and $2.845 billion of GO MLF debt, equating to debt per capita of about $2,375, which we consider moderate. The fiscal 2022 plan includes $4.3 billion in new capital appropriations, with the majority ($3.6 billion) allocated to the Department of Transportation, and the remainder to the Illinois Environmental Protection Agency ($652.5 million) and the Department of Natural Resources ($43.1 million). The state might issue more GO debt in fiscal 2021 and has about $2.5 billion of issuance in fiscal 2022 in the capital program. We expect total debt outstanding will hold relatively steady at about $30 billion through fiscal 2023.

This report does not constitute a rating action.

Primary Credit Analyst:Geoffrey E Buswick, Boston + 1 (617) 530 8311;
geoffrey.buswick@spglobal.com
Secondary Contacts:Blake E Yocom, Chicago + 1 (312) 233 7056;
blake.yocom@spglobal.com
David G Hitchcock, New York + 1 (212) 438 2022;
david.hitchcock@spglobal.com

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