Wednesday, May 20, 2015

Illinois Whistles Past the Fiscal Graveyard

The state of Illinois is functionally bankrupt from humongous annual pension payments to retired former employees, most of them Democrats.  A recent Illinois Supreme Court decision has just invalidated the Illinois pension reform law, weak as it was, that helped address the financial crisis.  The basis of the court’s decision was a provision in the state constitution, inserted when the document was revised in 1970, that purportedly explicitly protects every state employee’s pension plan as of the day that employee was hired.  Note to self:  vigorously oppose any future effort to rewrite any constitution because of this issue or that, because while everyone is concentrating on the headline issues somewhere in the background insiders will be inserting language that benefits them and shafts the public overall.

Illinois is broke.  Democrats of course want to raise taxes to cover the financial hole, but that’s just been tried and didn’t work.  Illinois just had a portion of a temporary income tax hike expire.  Illinois has a flat income tax, and the increase was from 3% to 5% for individuals, a 66% hike, that ran for three or four years.  Despite bringing in a ton of additional cash, and despite the bulk of that cash going to state pension funds (I have read as much as 90%), at the end of the period of the tax hike I have read that the pension shortfall is greater than it was before the tax hike, meaning that the pension deficit is increasing faster than the additional money raised via the tax hike.  The temporary hike was supposed to make things much better, but it did not. 

The tax rate for individuals has now dropped to 3.75%, which is still higher than the 3% it was a few years ago.  The state is in, as the saying goes, deep doo doo, and of course some local units of government like the City of Chicago and the Chicago Public School System may be in even worse shape. 

Some argue that the problem started with a "rich" and ultimately unaffordable formula for determining the amount of pension, aggravated by a fair amount of Illinois-style corruption such as double and triple dipping, pension spiking, and adding many non-governmental union employees to the pension system.  The unaffordability was hidden for years by financial legerdemain, while some of the money that should have been put to the pension fund was spent elsewhere to make the politicians look better at the moment to their constituencies.  Here's one old clipping I have related to the mess:  "From 1998 through 2008, despite revenue that has gone up by many billions, [Illinois] spending has skyrocketed: per capita state expenditures after inflation have climbed almost 47% while the state population has grown only 4%."  At some point the financial chicanery could not be hidden anymore, even from the accounting firms.

Most state politicians have resisted real reform such as moving government employees off a defined benefit plan to a defined contribution plan, the kind almost all private businesses have today.  For them, "Illinois ain't ready for reform," to borrow a phrase. 

The total state and local tax burden in Illinois is on the high side as states go, and I have read the highest among the surrounding (and competing) states.  Although the income tax may be relatively low (although some states have none), local property taxes and sales taxes are relatively high.

The process some high-tax and functionally-bankrupt states are beginning to experience is conceptually similar to the downward death spiral of an old health insurance plan when, through bad underwriting and pricing, its prices become too high to attract healthy customers and at the same time drive away healthy current enrollees, leaving behind the costly sick ones as an ever increasing percentage of covered lives.  Of course, the implications, intermediate- to long-term, for the municipal bond market are the dark clouds on the horizon.  In some places like Detroit, they have already blown in.

Truly and honestly fixing this problem without changing spending would require a massive tax hike, one that would substantially harm the competitiveness of the state, whose economic growth may already be behind such neighbors as Wisconsin and Indiana, and one that would cause I think most tax-paying retirees and many businesses to flee the state.  One tough alternative so crazy it just might work:  truly and substantially cutting state spending.  But that would mean cutting spending to the core base of the Democrat Party – government workers and welfare recipients, which is not likely to happen. 

So the state slowly slouches toward bankruptcy, while tax-paying retirees and business owners set their sights on Indiana, Tennessee, or Florida.  Many have already left, and many more are sure to follow.  Illinois' financial death spiral may have already begun.

Yeats comes easily to mind:

       Turning and turning in the widening gyre
       The falcon cannot hear the falconer;
       Things fall apart; the centre cannot hold;
       Mere anarchy is loosed upon the world,
       And what rough beast, its hour come round at last,
       Slouches towards Bethlehem to be born?