ILLINOIS FORWARD 2023: ONLY PENSION, BUDGET REFORM CAN SAVE TAXPAYERS WHEN FEDERAL AID ENDS.
By Adam Schuster, Illinois Policy
INTRODUCTION: FEDERAL AID SAVED ILLINOIS FROM COLLAPSE, PRESENTS OPPORTUNITY FOR STRUCTURAL REFORM
Illinois state government’s financial health was the worst in the nation before the COVID-19 pandemic began. An unprecedented flood of federal stimulus and bailouts for state and local governments saved Illinois from collapse, but without long-needed structural financial reforms, the state’s finances will end up in an even worse position when that aid expires in 2024.
Many forecasters predicted the pandemic would lead to widespread state and local revenue losses, mainly from the economic impact of government shutdown orders intended to fight infection rates. A series of spending packages from the federal government worth $5.73 trillion helped support income and consumption levels throughout the economy. State and local government revenue losses ranged from far less than expected to nonexistent.
Still, those federal packages included an $885 billion flood of direct financial support for state and local government budgets that more than patched remaining budget holes, often resulting in surpluses. In fact, total state and local government revenues are 16% above their pre-pandemic trend line. Illinois received a total of roughly $190 billion in support for the public and private sectors, including nearly $33 billion in state and local government aid. The state budget benefit was just over $14 billion.
Recent improvements in the state’s credit rating and balance of unpaid bills are the direct result of this federal assistance. The state has yet to make any of the significant financial reforms needed to eliminate the structural deficit and reduce Illinois’ economically burdensome taxes.
Spending in the state budget actually has increased – significantly – under Gov. J.B. Pritzker relative to baseline expectations in the state budget. Even if lawmakers and the governor make no further increases to spending in the fiscal year 2023 budget, which is unlikely given that Pritzker has proposed spending increases in each February budget address of his term, then total spending during Pritzker’s first term will be up nearly $5 billion, or 3% higher than when he took office.
If anticipated revenue losses had occurred, and absent federal assistance, these spending increases would have further grown the deficit and debt. However, on top of the $14 billion in federal aid for the state budget, Pritzker has signed 24 tax and fee increases worth $5.24 billion in long-term revenue. While many of these tax hikes went to pay for new infrastructure spending, others bolstered general fund revenues.
Tax increases and a massive federal rescue meant revenue grew faster than spending. The federal rescue in particular helped Illinois manage cash flow in the short term, leading to improvements in the state’s backlog of unpaid bills and credit rating. But because state finances remain structurally unbalanced, mostly driven by runaway pension costs, chronic deficits and a growing backlog of unpaid bills will return without major reforms.
Illinois has had a deficit at the end of each fiscal year since 2001.
The state projects deficits each year starting in 2023, with no extra revenue to fill them when federal aid expires in 2024. Illinois Forward 2023 offers a path to balancing the budget with no further tax hikes – eliminating the structural deficit and backlog of unpaid bills for good. The plan relies on common-sense pension reform, diverting wasteful administrative spending to classrooms and rightsizing taxpayer costs for state worker health insurance. Together these reforms can reduce taxpayer costs in the state budget by nearly $3.6 billion the first year.
After eliminating the remaining bill backlog in fiscal year 2023 – the budget year starting July 1, 2022 – the Illinois Forward plan results in surpluses ranging from nearly $2.5 billion to more than $3 billion. Under the status quo, the bill backlog will rise back to a dangerous $6.5 billion within five years, roughly where it hovered before federal aid enabled the state to pay it down.
To spur Illinois’ recovery from COVID-19, these surpluses could be used to finance a reduction in the Illinois income tax of roughly half a percentage point. As the savings grow over time, the income tax could be further reduced. Illinois damaged its economy with an income tax hike in 2011, just after the Great Recession, that cost nearly $56 billion in gross domestic product from 2012 to 2016 and cost at least 9,300 jobs in those four years.
Tax increases along with underinvestment in core government services, resulting from over spending on pension costs and debt, restricted Illinois’ economic growth in the decade after the Great Recession relative to other states and the nation. Illinois lawmakers should learn from this mistake, and cutting income taxes would demonstrate they have.
In fiscal year 2021, 10 states cut personal income tax rates and five reduced corporate income taxes. These pro-growth policy decisions will put these states in a better position to recover from the economic harm of the pandemic and related recession.
If lawmakers do not want to cut income taxes, surpluses could also be used to invest in higher education or programs for the poor and vulnerable. Both have seen cuts during the past 20 years as pensions have eaten up a growing share of the budget.
Federal aid gave Illinois extra breathing room to make needed changes and saved the state from financial collapse. Illinois Forward 2023 offers a way to capitalize on this rescue by finally fixing problems that have plagued taxpayers for decades.
SOLVING ILLINOIS’ PENSION CRISIS SHOULD BE TOP PRIORITY FOR LAWMAKERS
Illinois’ pension crisis is the nation’s worst at nearly $236 billion or 27.3% of GDP in fiscal year 2020, according to Moody’s Investors Service.
Moody’s estimates pension debt using methods in line with expert recommendations for pension accounting that are widely considered more accurate. The state, using much rosier assumptions, most recently estimated the debt at $139.9 billion. Even in this best-case scenario, the funds only have about 40 cents saved for each $1 in promises made.
Pension debt is directly linked to Illinois’ high taxes, reductions in government services, low growth in home values and lagging economic growth. Research shows the pension crisis lowers income growth for the average Illinoisan by $1,417 per person, per year.
Illinois already spends more on pensions as a share of its revenues than any other state: more than double the national average. Still, if the debt burden is as large as Moody’s and other independent experts say, Illinois would need to double its pension spending to 51% of the state budget from about 26% today to pay down the debt.
Financing such an increase in pension spending would require $10 billion in service cuts or a 50% increase in the state income tax, taking $1,800 more from the average Illinois family each year.
Attempts to keep up with this unsustainable debt burden without reform have already caused disinvestment in higher education, public safety, public health programs, and vital services for the poor and vulnerable. Since fiscal year 2000, a 584% increase in inflation-adjusted pension spending was accompanied by a 20% decline in spending on a range of core services.
Simply put, tax hikes alone are not a viable solution to paying down Illinois’ pension debt. Doing nothing endangers the long-term retirement security of Illinois’ public servants, along with investments in core services. The only pension protection that ultimately guarantees a secure retirement for public workers is a sustainable, fully funded pension system.
IMPLEMENT EXISTING OPTIONAL HYBRID PENSION PLAN FOR IMMEDIATE SAVINGS
By offering an optional hybrid retirement plan to Illinois’ teachers, state workers and university employees, the state could save up to $577 million on pension contributions without making any changes to benefits for current workers or retirees.
Virtually all of the debt and financial burden caused by the state’s broken pension system stems from promises made to employees hired before 2011, known as Tier 1 benefits. In fact, Tier 2 employees in the teachers’ pension plan already subsidize the benefits of Tier 1 employees by contributing more as a percentage of salary than is necessary to pay for their own Tier 2 benefits, resulting in a surplus rather than an unfunded liability from their participation.
Under Illinois’ existing pension clause and prevailing case law, changes can only be made to benefits for new workers. The General Assembly created a new pension benefit, Tier 3, as part of the fiscal year 2018 budget process. But they did not include a date by which implementation was required, and none of the state systems have put the new tier into action.
The last mention of the Tier 3 system on the website for the teachers’ pension system was on Sept. 21, 2017. At the time, the pension system estimated “the earliest date” Tier 3 would be ready is July 1, 2019. It has provided no update since.
Lawmakers should fix this oversight by amending the legislation to require implementation no later than July 1, 2022 – the start of the fiscal year 2023 budget.
Once implemented, employees may opt into Tier 3 or opt to take the traditional Tier 2 pension when they begin working. Tier 3 benefits and features are as follows:20
- Employees contribute up to 6.2% of salary towards a defined-benefit pension. They must also contribute at least 4% towards a defined-contribution component.
- Employee contributions vary automatically with the calculated cost of their benefits, so they can fall below 6.2% but cannot rise above that level.
- Employers must contribute at least 2% and up to 6% of salary towards the defined contribution.
- Tier 3 receives the same annual cost-of-living adjustment as Tier 2, equal to one-half of the increase in the consumer price index. The full retirement age is 67, just like Tier 2.
- Costs for Tier 3 pensions are paid directly by the employer, aligning responsibility for setting benefit levels with responsibility for paying them.
Proponents of Tier 3 estimated it would create about $500 million in savings for the state budget, although it was never anticipated to be implemented the first year it passed. The Center for Tax and Budget Accountability – an advocacy group affiliated with government unions and opposed to pension reform – relied on a financial analysis from the State Universities Retirement System to claim the savings would be lower at $300 million annually.
However, the data in that analysis shows Tier 3 would reduce required contributions to university pensions by 5.45% on average. If that analysis is applied to teachers and state employee pensions as well, total savings as of fiscal year 2023 would equal $577 million. Because the state budget and pension costs have grown during the past several years, this estimate is largely in line with proponents’ original expectations. The tax center’s lower estimate may be an error.
Ultimately, lawmakers should conduct a full and publicly released actuarial analysis prior to finalizing any changes to the pension systems. Lack of foresight and cost estimates are a major part of what got Illinois into its pension crisis.23 But all early results point to savings from Tier 3 nearly as large or larger than the entire projected $406 million budget deficit in fiscal year 2023, proving it is a significant reform.
The pension crisis lies at the heart of Illinois’ most severe economic and fiscal challenges. Fixing it is the key to any workable budget solution or plan for long-term financial health. And while no structural Tier 1 reforms can take place without an amendment to the pension clause in the Illinois Constitution, Tier 3 implementation is an incremental step that can be taken now. It can move Illinois in the right direction.
LET THE PEOPLE VOTE ON FIXING THE PENSION CLAUSE
Lawmakers have passed no significant legislation to deal with the state’s pension crisis since a 2013 law to slow the growth in Tier 1 benefits was overturned by the Illinois Supreme Court in 2015. The court’s ruling means no Tier 1 structural reforms can take place without an amendment to the pension clause in the state constitution.
Tier 3 is an important incremental step that offers new options to employees and immediate taxpayer savings. But the most-needed fix remains a constitutional amendment that unlocks reforms of the root causes of the pension crisis.
The Illinois Policy Institute has proposed a “hold harmless” constitutional amendment to allow for reductions in future benefit growth for current workers and retirees. It would still treat benefits earned for work already performed as an inviolable contract, but would clarify that adjustments can be made going forward to ensure pensions are sustainable and affordable.
Recent polling by the institute showed 61% of voters supported such an amendment, with broad bipartisan agreement. That represents enough support to pass at the ballot box.
The General Assembly has so far refused to let the people vote on pension reform. Constitutional amendments require three-fifths approval in both the state House of Representatives and state Senate before being placed on the ballot for voter approval.
Lawmakers should start fixing the pension crisis by letting those who must pay for public pensions decide. Reforms following a constitutional amendment can solve the problem with only modest and reasonable changes to future benefits, while preserving every dollar in retirement benefits already earned.
Benefit reforms modeled closely on the bipartisan 2013 reforms, which were later struck down by the state Supreme Court, could save the state roughly $2.4 billion in the first year and more than $50 billion through 2045.25 That’s achieved while strengthening funding requirements and replacing the artificially low goal of 90% funding with a 100% funding goal that eliminates the debt.
The plan would raise retirement ages for Tier 1 workers younger than 45, replace 3% compounding post-retirement increases with a measure pegged to inflation and cap the maximum pensionable salary for workers hired before 2011. Tier 2 workers hired after 2011 already have a pensionable salary cap. The institute’s reform plan would actually increase the cost-of-living adjustment for younger workers to full inflation from the current one-half of the consumer price index. This cost is more than covered by Tier 1 reforms and reverses the unfairness of Tier 2 workers subsidizing older workers while receiving a less-generous retirement.
Hold harmless pension reform represents the best chance to fix the pension crisis through a principled compromise. It gives consideration to state employees by preserving earned benefits, increasing funding requirements and improving certain benefits for younger workers. It protects taxpayers and vulnerable Illinoisans who rely on government services.
State lawmakers already tried to fix the pension crisis. They should partner with voters to finish the job.
FOCUS RESOURCES ON CLASSROOMS TO SAVE MONEY, BOOST STUDENT OUTCOMES
Consolidation of school districts can enable taxpayer savings while improving education outcomes for students. By using administrative overhead savings to boost local school funding, education spending in the state budget could be set to grow with inflation rather than the static $350 million annually under the current funding policy.
Illinois’ state constitution declares it a “fundamental goal” to provide an education system that allows everyone in the state to reach their full potential. Illinois is failing to deliver on this goal as well as it could because of excessive and wasteful spending on district-level administration.
Illinois spends a lot per pupil on K-12 education, but its student outcomes range from average to worse. Overspending on district administration drives up costs while siphoning dollars away from the classroom, where funds can best help students.
Between 2003 and 2019, Illinois’ per-pupil spending was the highest among neighboring states. Illinois spent between 8% and 25% more per student, only to fall behind every neighboring state on reading assessments, according to the Nation’s Report Card. All but two states, Kentucky and Missouri, outscored Illinois on math assessments. Each neighboring state achieved higher graduation rates.
Among all 50 states, Illinois ranks 15th for spending per pupil but 27th on both math and reading assessments since 2003. There are 15 states that spend less per pupil than Illinois but receive better scores for both math and reading.
High and inefficient education spending also contributes to Illinois’ crushing property tax burden, which is the second highest in the nation. Roughly 62% of all property taxes collected in 2020 went to school districts.
A key reason Illinois spends more than other states yet lags behind in student outcomes is much of the spending never makes it to classrooms, where it can directly benefit students and teachers. Excessive layers of district bureaucracy result in an inefficient allocation of public education dollars and deprive taxpayers of a good return for their money.
Illinois was the only state to spend more than $1 billion on general administration at the district level in 2018. Comparatively, California spent $780.5 million on general administrative costs – one-third less than Illinois to serve three times the students.
Illinois Policy Institute research shows there is a strong statistical link between improved student outcomes and spending on instruction in the classroom, but no such link between student achievement and spending on administration. In other words, spending more than absolutely necessary on administrative costs hurts students because the money could be put to better use on their instruction.
The reason for Illinois’ overspending on district-level costs is clear from the data – Illinois has too many districts serving too few students. If Illinois were to match the national average of districts per student, it would have 220 fewer districts, or a reduction of about 25%. If it were to match the proportions of peer states with similar or larger total student enrollment, it would have between 528 and 800 fewer districts.
If Illinois reduced its general administrative spending to the national average per student, it would save nearly $732 million in unnecessary costs that could be reinvested in the classroom to improve student outcomes or returned to overburdened property taxpayers. A bill currently receiving bipartisan support in the Illinois General Assembly, the Classrooms First Act, presents the best opportunity for Illinois to achieve this goal.
The Classrooms First Act was first introduced by state Rep. Rita Mayfield, D-Waukegan, in 2019. Illinois House of Representatives members unanimously passed it but it never received a full vote in the state Senate.
The Classrooms First Act would create the Efficient School District Commission, tasked with making recommendations for consolidating districts. Each consolidation recommendation would go to local voters for approval. The commission would include representation from all key stakeholders, including teachers unions, organizations representing school boards and superintendents, regional representation from each of the state’s education support districts, and parents. It is tasked with developing specific recommendations for a minimum 25% reduction in bureaucracy, roughly the amount needed to bring Illinois in line with the national average. A larger reduction in districts would likely result in larger benefits.
The bill would require all newly formed districts to be unit districts, meaning they’d serve both high schools and elementary schools. Unit districts spend money more efficiently on average in Illinois, spending $12,704 per student compared to $17,368 for high-school-only districts and $14,001 for elementary-only districts.
Consolidation of districts, particularly among the smallest districts, is a commonsense and proven strategy to reduce the cost of administration while improving student outcomes. Giving Illinois voters the opportunity to exercise that option would yield major benefits for public education while enabling savings for the state.
STATE WORKERS SHOULD PAY A FAIR SHARE OF THEIR OWN HEALTH CARE COSTS
In 2019, Pritzker signed a new contract with the American Federation of State, County and Municipal Employees Council 31, the state’s largest public employee union. It raised compensation and increased the cost of government. The Illinois Policy Institute determined a taxpayer-friendly contract, one that sought to bring government worker compensation in line with what private sector taxpayers can afford, would have cost $3.6 billion less over four years.
One of the most expensive perks offered in that contract was the continuation of a platinum health insurance subsidy that leaves state workers paying only half as much as private sector workers as a share of their own health care costs. In fiscal year 2021, the most recent complete budget year, state workers paid for 22% of their combined premium and out-of-pocket health costs.
By contrast, the typical family pays nearly double what AFSCME pays – 40% for individual coverage and 43% for family coverage – according to the 2020 Milliman Medical Index. AFSCME’s average cost is consistent across family and individual coverage. That means the average taxpayer who funds AFSCME benefits is subsidizing a benefit they almost certainly don’t enjoy at their job.
The state’s final offer to AFSCME before Pritzker’s election would have right-sized group employee health insurance costs by bringing them more in line with the private sector.
The plan would have created three tiers of insurance: one with higher premiums, one with higher out-of-pocket costs and a mixed plan. Each of the plans would have increased the total employee share to 40% on average, with a mix of higher out-of-pocket or higher premium costs, depending on the plan selected.
A bill proposed in the 100th General Assembly, Senate Bill 2680, would have removed health care coverage from the subjects of collective bargaining as long as average employee costs remained below 40% annually. Lawmakers should again pursue similar reforms that better align state workers’ health care costs with affordability for the private sector taxpayers who fund them.
However, a proposed constitutional amendment on the November 2022 ballot would prevent efforts to rein in out-of-control compensation costs in state government. Amendment 1 would grant unions in Illinois more extreme powers than they have in any other state, including the ability to bargain over virtually limitless subjects, the ability to override state law through their contracts, and a guarantee that taxpayers and lawmakers can never reverse course.
Government unions are already Illinois’ most powerful special interest group. And taxpayers are already on the hook for more debt related to union compensation than they can afford. Nearly 80% of Illinois’ debt is from benefits for public employees.
Across all 50 states, the share of government debt owing to government worker benefits has a very strong statistical tie to the overall amount of debt per taxpayer. In other words, when unions are responsible for most of the debt, there tends to be a lot more debt.
The unfair bargaining relationship between unions and the politicians whose campaigns they fund leaves taxpayers with no influence. It also helped public sector wages grow 60% faster than private sector wages from 1998 to 2019.
Amendment 1 must fail at the ballot box for Illinois to have any chance at reining in runaway labor costs
CONCLUSION: SUCCESSFUL ECONOMIC RECOVERY REQUIRES LEARNING FROM PAST MISTAKES
Illinois stands at a crossroads. It can choose structural financial reform that will limit taxpayers’ burdens as much as possible and spur economic growth, or it can choose to continue decades of fiscal irresponsibility that left it on the brink of collapse when COVID-19 hit.
Research and data paint a clear picture of the state’s financial troubles. The worst pension crisis in history drives up taxes at the state and local level, while sucking up resources that could be better spent on core services.
In turn, overly burdensome taxes and poor use of resources reduces economic growth and drives taxpayers to other states, compounding the original problem.
Illinois experienced a “lost decade” of progress after the Great Recession. While many states used the years of economic expansion to shore up government finances and make pro-growth tax changes, Illinois fell farther behind.
It is already starting to happen again. In 2021, Illinois’ unemployment rate remained higher than neighboring states while job creation lagged the national rate.43
It does not have to be this way. Illinois can learn from past mistakes and learn from successes in other states. A federal rescue gave the state time to do so.
Illinois Forward 2023 offers common-sense strategies to limit tax burdens, close deficits, reduce debt and spur economic growth. The path is clear, but leaders must take it.