As a coronavirus-driven cash crunch collides with nearly two decades of unbalanced budgets and exorbitant pension spending, insolvency is on the horizon in Illinois.
The state's Democratic lawmakers have sounded the alarm, telling their federal counterparts that an unavoidable budget shortfall requires a $40 billion bailout. But state Republicans have blanched at the idea of a bailout that does not fix underlying structural issues that they say would guarantee another ask when the next crisis hits.
The dispute has become a headscratcher for members of Congress, who are already negotiating another round of coronavirus relief spending. Democrats, who torpedoed other coronavirus money over state funding, have promised that this latest wave will include provisions to make Illinois and other states whole. Republicans, meanwhile, have been more wary, questioning whether the federal taxpayer should pick up such a large tab without strings attached.
Illinois, which has among the highest tax burdens and worst-funded pension systems in the country, is likely to be used by both sides as a key example in the ensuing back-and-forth. Grappling with the Prairie State's dire straits, however, will also force federal lawmakers to deal with bigger questions: whether to bail out other similarly underfunded states—including Sen. Mitch McConnell's (R.) own state of Kentucky—and what, if any, policy concessions they can reasonably extract in the process.
Many states are feeling the fiscal weight of the coronavirus shutdown. Illinois expects to be particularly hard hit, Illinois Senate president Don Harmon wrote in an April letter to Sen. Dick Durbin (D., Ill.), facing an estimated $14.1 billion revenue shortfall over the coming year. Harmon asked for $15 billion in block grant funding, as well as $10 billion to cover nearly $200 billion in outstanding pension liabilities and $6 billion in unemployment trust fund aid.
Illinois governor J.B. Pritzker (D.) has also called for more money for his and other states, over and above the $4.9 billion the state received specifically to fight the coronavirus under the CARES Act. Harmon and Pritzker's Democratic counterparts in Congress are listening—Speaker of the House Nancy Pelosi (D., Calif.) has repeatedly said that fiscal relief for states will be a major priority in the next round of coronavirus stimulus.
This relief, Democrats argue, is needed because of the fiscal nightmare in front of states. State governments are leading the fight against the novel coronavirus but are simultaneously facing massive budget shortfalls, up to 25 percent in the next fiscal year. Sales tax revenues have dried up while state income taxes have largely been postponed. States also lack the borrowing power of the federal government, resulting in an even bigger cash crunch just as they most need it.
Does that mean that the feds should step in? Illinois state senator Jason Plummer (R.) told the Washington Free Beacon it's not that simple.
"When the Illinois State Senate Democratic Caucus requested all that money, they didn't request that money to bail out the families of Illinois. They requested that money to bail themselves out," Plummer said. "They're just going to take that money and plug some holes. But the things that cause those holes will continue to exist."
That's because the coronavirus is not all that's behind Illinois's current budget shortfall. Adam Schuster, budget and tax research director at the conservative group Illinois Policy, noted that some states have substantial "rainy day funds" that prepare them for the predictable event of a budget shortfall in case of a financial crisis—Arizona, for example, can cover about a 15 percent shortfall. Illinois, however, does not; in fact, Schuster said, it has not had a balanced budget since 2001.
That fiscal irresponsibility is largely driven by the state's pension system: As Schuster described it, "Illinois has virtually become a pension system with a small state government attached to it." State employees routinely retire in their 50s, after which they can expect millions in payouts over the rest of their lives—benefits guaranteed by the state constitution. The state lacks the fiscal capacity to fund these liabilities, which is why just 38 percent of its current obligations are funded—the third least-funded state in the nation.
While the pension system is the "900-pound elephant in the room," Plummer said, it is just the start of the state's fiscal issues. He noted that Illinois has more units of government than any other state, 35 percent more than runner-up Texas. That may be why Illinois taxpayers pay the highest state and local tax rates as a percentage of income in the nation.
The idea of bailing out a situation like Illinois's is part of what has congressional Republicans blanching at the idea of free money for states. Sen. Marco Rubio (R., Fla.), for example, said Wednesday that while essential services need to be backstopped, that did not need to extend to states' self-imposed liabilities.
Those concerns are partially about cost, but they are also about moral hazard—the idea that bailing out irresponsible actors will encourage them to keep making risky bets in the future. At the same time, Illinois—and other states like it—will almost certainly need federal funds, lest it's unable to pay policemen, firefighters, and other essential workers.
How to resolve this conundrum?
A few options have emerged. States could receive a massive infusion of federal funds regardless of their fiscal solvency, likely on the order of $500 billion. That approach appears to be favored by Democratic leadership. Alternately, some Republicans—including McConnell—have floated the idea of allowing states to go bankrupt, which would require a change in federal law but would allow the restructuring of their debts.
The most likely outcome, however, is that Congress will hammer out a deal where states get money either in exchange for another Republican priority—like payroll tax cuts—or with "strings" attached, mandating financial responsibility. Schuster said he'd like to see any state taking federal money to certify that its pension systems are sound, it has truly balanced budgets, and it has built up a "rainy day" fund—all things with which his state will struggle.
Plummer made clear that if his state gets a bailout, it would need to come with major, mandatory changes to the state's fiscal conduct.
"If they want federal money, Washington, D.C., must demand that Illinois and other states lower their skyrocketing costs that are squeezing taxpayers and ruining state economies," he said. "If this doesn't happen, Illinois will soon be back begging for more and there will be no incentive for other states to do things the right way."