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* Summary…

Moody’s has issued a short report concerning the ongoing budget stalemate in Illinois (rated A3/negative outlook). Illinois has had budget delays before and the weak governance is already factored into the state’s rating. However, the nature of the eventual agreement will matter far more to the state’s fiscal situation than the long delay that has already occurred. The report’s highlights are:

* Pension funding pressures are growing, and the state cannot reduce liabilities through benefit cuts. Costs of constitutionally protected pension benefits are rising and funding pressure will be compounded by retiree healthcare benefit costs, which are rising by about 6.5% a year.

* Illinois still has options to address its current-year deficit. An approximately $5 billion projected deficit can be offset with a combination of spending cuts and revenue increases including reinstating higher income tax rates.

* The current impasse underscores the state’s governance weaknesses. Illinois has had late budgets before. This time, the Republican governor’s struggles to reach agreement with the legislature’s strong Democrat majorities have not yet strained the state’s finances, but that will change if an accord is not reached soon.

The press release is below and the report is attached. If you have any questions or wish to speak to anyone at Moody’s, please contact me. Thanks

David Jacobson

AVP, Communications Strategist - Public Finance Group

Moody’s Investors Service

* Press release…

Moody’s: Illinois’ budget impasse secondary to intensifying pension and revenue problems

The State of Illinois’ (A3 negative) current budget stalemate underscores the weak governance already incorporated into its rating, and is symptomatic of the state’s severe fiscal challenges, Moody’s Investors Service says in “State of Illinois: Late Budget Matters Less than Solving Pension and Revenue Problems.”

“Illinois projects its income and other taxes to generate $32 billion this fiscal year, or $5.4 billion less than expenditures without cuts,” author of the report and Moody’s Vice President – Sr Credit Officer Ted Hampton says. “While the state still has options to address its current-year deficit, continued political gridlock and the inability to reach an agreement by late September will greatly increase the likelihood of the deficit moving from projected to actual.”

The state also faces intensifying pressure to fund retiree benefits, which account for roughly 24% of its current general fund expenditures. The pension funding situation is compounded by retiree healthcare benefits costs, which are growing at about 6.5% a year.

“The state’s ability to manage these pressures will be a primary determinant of future rating actions. Given the state’s ironclad protection of benefits for current workers and retirees, Illinois requires a long-term plan to ensure it can at least comply with statutory funding requirements,” Hampton says.

Moody’s says the state has been deficient for many years in meeting the standardized annual required contribution (ARC) requirements to its pensions, and has been legally blocked from reducing its accrued liabilities via pension benefit cuts.

In the absence of a budget, Illinois will eventually have insufficient revenues to fund likely expenses, even as the pace of spending has slowed from last year. Some expenses have been paid because they do not require appropriation, have been mandated by court orders, or are allowed under limited appropriation measures.

Like other states, Illinois has had budget delays before, most recently in FY 2010. Moody’s believes it is unlikely Illinois can significantly reduce expenses without having a full budget in place, especially with services like healthcare that continue to be provided.

* The full analysis (click here) includes a possible road map…

Illinois has the economic capacity to absorb higher income tax rates. It is one of only eight states that levy a flat individual income tax. Among those states, Illinois’ current rate is comparatively low: the average among these states is 4.4%, compared with 3.75% in Illinois. Unlike excise taxes, income taxes can be implemented retroactively, although the political feasibility of applying higher income taxes retroactive to July 1 has diminished, given that a quarter of the state’s fiscal year likely will have elapsed before new policies can be implemented.

Raising the individual rate to 4.75% from 3.75% and the corporate rate to 6.75% from 5.25% for the second half of this fiscal year would generate approximately $2.4 billion of additional revenue, leaving about $2.2 billion of the deficit to be addressed by other measures. The state could probably impose $1.7 billion of expenditure cuts, less than half the $3.7 billion of savings in the governor’s proposed budget that were not related to employee benefit reductions. This would leave $500 million to be addressed by additional new revenue, or non-recurring measures.

As time has elapsed, the difficulty of realizing such savings has increased; imposing these spending cuts in a shortened period may prove politically challenging. The cuts would reduce monthly outflows by about 9%, twice the monthly reduction that would have been required if such cuts had been put in place for the full year.