A PERFECT STORM
HOPING FOR A COMEBACK, ILLINOIS WEATHERS A NEW TEMPEST: COVID-19
When Illinois Gov. JB Pritzker delivered his budget address in February, he did so with a distinct note of optimism for a state that showed signs of emerging from the darkness of a two-year budget impasse and a sputtering state economy.
“Last year we began turning our ship of state in the right direction. Today we have the lowest unemployment rate in our history. We gave pay raises to working people. And once again we began attracting more students who want to go to college here, because we made college more affordable,” Pritzker said.
“Our resurgence has been fueled by the very source of our historic resilience: the fundamental strength and goodness of our people, who demonstrate time and again that they can overcome any challenge that comes their way. Never bet against that.”
As it turns out, a surging global pandemic had other ideas.
Less than a month after the governor’s budget address, a deadly novel coronavirus with no cure or vaccine began to spread in Illinois, causing businesses and manufacturers to shut down, restaurants to shutter, large conventions and sporting events to cancel, schools and universities to close, and people to isolate at home.
Now, because of the COVID-19 coronavirus, Illinois faces monumental economic challenges. Although the state shows new signs of life in the fourth phase of a five-phase reopening plan, tremendous economic uncertainty remains, and the worst of Illinois’ fiscal woes could lie ahead.
In the last quarter of fiscal year 2020 — April, May, and June 2020 — state revenues deteriorated, unemployment rolls swelled, and interest rates rose. But Illinois still met its financial obligations after borrowing to significantly draw down the state’s bill backlog.
How the state will meet and pay for its obligations and services in the coming months undoubtedly will be affected.
January 2019 brought with it executive change in Illinois that marked the end of four combative years between the prior administration and the General Assembly.
The rancorous political gridlock and lack of consensus on state spending led to eight combined general obligation bond ratings downgrades by S&P Global, Fitch Ratings, and Moody’s Investors Service between October 2015 and June 2017. The state’s bill backlog reached $14.7 billion by the end of the unprecedented 736-day budget impasse in July 2017, and a record $16.7 billion just four months later.
Gov. Pritzker’s first budget address in February 2019 presented a hopeful plan to put the state on “the road to normal conditions” while addressing fiscal challenges including a $3.2 billion budget deficit, a nearly $8.4 billion bill backlog, a net pension liability of $138.6 billion, and other postemployment benefits liabilities of $54.5 billion. The governor noted Illinois’ systemic fiscal issues would take years to resolve.
Two months later, the state entered the final quarter of the fiscal year with an unexpected $1.5 billion uptick in total base revenues that helped the state balance its fiscal year 2019 budget to within $15 million.
However, Illinois State Comptroller Susana A. Mendoza and other budget leaders cautioned the revenue spike was likely an aberration due to prior tax law changes and should not be counted on each year.
Despite this “April surprise,” another $250 million in interfund borrowing was needed to help address obligations in fiscal year 2019. As of June 30, 2019, $645 million of the $783 million borrowed from other state funds since August 2017 remained outstanding.
Entering fiscal year 2020, the state’s annual spending plan appeared to be balanced even with increases in state support for education, health care, and human service programs. But Comptroller Mendoza cautioned that the state still had between $6 billion and $8 billion in backlogged bills with no dedicated revenue stream to pay them.
Her office utilized budgetary tools to help drive down the bill backlog and continued to do so throughout the fiscal year. This entailed maximizing unused monies to pay more than $600 million in group health insurance bills, thereby stopping the clock on additional late payment interest penalties.
In September 2019, the offices of the Illinois Comptroller and Illinois Treasurer agreed to invest and borrow $400 million of the state’s investment portfolio. Additionally, the Comptroller authorized $150 million in interfund borrowing in November 2019 and another $231 million in January 2020.
When Gov. Pritzker presented his fiscal year 2021 budget address on Feb. 19, only two cases of the COVID-19 coronavirus had been confirmed in Illinois, and the governor’s administration was taking aggressive preventative steps to limit the spread of the virus.
Confirmed cases in Illinois remained in the single digits until the beginning of March. On March 9, the governor issued a disaster proclamation and began hosting daily press briefings about the crisis and the state’s response.
As March progressed, the Pritzker administration continued to monitor the coronavirus crisis and issued directives aimed at combatting new infections. On March 13, the governor ordered schools to close until the end of the month, which later was extended through the rest of the school year.
While restaurants, bars, casinos, and other non-essential businesses were ordered to close throughout April and large gatherings of people were banned, the governor issued another order that deferred collection of state sales taxes from most of these businesses for the next three months.
By the end of March, Illinois officials scrambled to obtain personal protective equipment, or PPE, for frontline health care and safety workers without much direction from the federal government. This led the governor to issue another order directing emergency funding for the Illinois Emergency Management Agency.
In March and April, the Illinois Office of Comptroller tapped into other state funds of $323 million through interfund borrowing to pay for PPE purchases and make direct payments to hospitals and nursing homes that found themselves deep in the battle against the pandemic. At the end of July, state spending related to the COVID-19 pandemic totaled more than $850 million, according to a public online portal hosted at illinoiscomptroller.gov.
Historically, April is when the state tries to catch up on outstanding bills using additional revenues from income tax filers. This year, to be consistent with a change by the federal government, Gov. Pritzker ordered an extension of Illinois’ tax-filing deadline to July 15. This meant an estimated $1 billion or more in revenues to the state was expected to be delayed.
In addition, Illinois experienced a loss of revenue from the state’s payroll tax due to record levels of unemployment and a loss of sales tax revenue due to stay-at-home orders and shuttered business operations.
A loss in revenues was expected, though the extent of the loss on the remainder of the fiscal year was unclear. In April, the Governor’s Office of Management and Budget revised its fiscal year 2020 total state-source revenue estimates from February downward to account for the potential impact of the COVID-19 coronavirus’s effect on state receipts, from more than $36.8 billion to just over $34.2 billion.
The fiscal year officially ended with $34.5 billion in state-source revenues, with the loss concentrated in the final three months. Including federal sources, the fourth quarter of fiscal year 2020 experienced a nearly $2.9 billion decline in total base revenues compared to the fourth quarter of fiscal year 2019.
To help make up for these lost revenues, the state borrowed $1.2 billion through the Federal Reserve Bank’s Municipal Liquidity Facility. This borrowing enabled Illinois to receive $652 million in additional federal reimbursement proceeds (matching funds) in June, which were used to pay $471 million in group health insurance bills.
This plan helped save taxpayers late payment interest penalties on nearly $750 million of interest-generating bills. Without the additional revenue generated by the $1.2 billion short-term borrowing, which is due with interest by June 30, 2021, the fourth quarter shortfall would have been much worse.
Until the pandemic, several positive indicators relative to interest rates, employment levels, and the backlog of bills demonstrated Illinois was headed in the right direction.
However, these indicators eroded in the fourth quarter, raising serious concerns and uncertainty about how Illinois will rebound.
Before the COVID-19 coronavirus outbreak, with the bond market gaining confidence in Illinois’ finances and its leadership in the aftermath of the 2015-2017 budget impasse, Illinois could borrow for short periods of time at interest rates below 1%, resulting in significant savings to taxpayers. Illinois’ longer-term debt was also seen as more favorable by the bond market, and therefore the state was penalized less despite its lower credit rating.
In November 2019, Illinois issued $750 million worth of general obligation bonds as part of the state’s Rebuild Illinois capital construction plan. The debt was well received by the bond market, and the bonds sold at a yield roughly 1.4% over AAA rated bonds. This enthusiasm in the market continued into 2020 as the spread of Illinois’ debt to AAA rated debt dropped to 1.32% by the end of February.
But in April, S&P Global dropped the outlook on Illinois’ general obligation debt from stable to negative, with Moody’s Investors Service following with a similar action. Illinois was just one of the states to suffer lowered outlooks or ratings because of the pandemic. On April 16, Fitch Ratings announced it was downgrading Illinois’ general obligation rating to BBB-, one level above speculative grade.
In the face of the economic uncertainty around the pandemic and negative comments by ratings agencies, the bond market took a more negative view on Illinois bonds. The spread on 10-year Illinois debt climbed to as high as 4.4% over AAA rated debt by the beginning of May.
This continued through May as Illinois sold $800 million in general obligation bonds with spreads that were almost 4% over the AAA benchmark rate. The state obtained a lower sub-4% rate for the $1.2 billion short-term borrowing with the Federal Reserve that was authorized as special borrowing under the federal CARES Act.
Illinois’ employment picture also had improved before the pandemic hit, with all-time low unemployment rates ending December 2019 at 3.7%. This momentum continued into 2020 with unemployment in the state even dipping below the national rate in January 2020 and dropping to 3.4% in February, setting another all-time record.
But starting in mid-March, as the pandemic worsened, the state followed the national trend of spiking unemployment, undoing the previous lows. According to the Illinois Department of Employment Security, the state lost 60,900 jobs in March, followed by another 762,200 jobs in April.
Illinois’ April 2020 not-seasonally-adjusted unemployment rate of 16.8% set a new record since the current methods of calculating unemployment were enacted in 1976. Illinois lost jobs in all major industries in April, with leisure and hospitality down 320,500; professional and business services down 119,800; and trade, transportation, and utilities losing 110,000. This rate declined to 14.7% in May.
A third indicator that demonstrated Illinois was on a path to recovery was an improvement in the state’s bill backlog. For most of the past fiscal year, the state’s backlog was between $6 billion and $7 billion, and $900 million less at the end of calendar year 2019 compared to the year before.
However, in March the backlog rose past $8 billion for the first time since April 2019, and to $8.6 billion in April 2020. The Illinois Office of Comptroller addressed this rising backlog with the $1.2 billion borrowed through the Federal Reserve in June.
Although the backlog stood at $5.4 billion at the end of fiscal year 2020, this multibillion-dollar decline does not include the $2.66 billion in short-term borrowing that has accumulated, portions of which must be repaid in each fiscal year through April 2024.
In May, the Illinois General Assembly adopted a maintenance budget for fiscal year 2021, designed to provide appropriations for elementary and high schools, vocational and higher education, medical programs, payments to the state’s pension systems, and human services and social service programs at funding levels comparable to fiscal year 2020.
Additionally, the budget authorizes $5.5 billion in estimated federal CARES Act funding to several state agencies for COVID-19 response and relief programs. Currently, federal guidance limits this funding for specific purposes and prohibits states from using it to make up for lost state revenues.
In addition to the $3.5 billion originally received by the Illinois Emergency Management Agency, another $2 billion in federal funds is anticipated for programs administered by the Illinois State Board of Education and several state agencies, including the departments of Public Health, Commerce and Economic Opportunity, Aging, Employment Security, Transportation, Human Services, and the Illinois State Board of Elections.
This does not include federal CARES funds that are sent directly to local governments, transit authorities, institutions of higher education, hospitals, or nursing homes.
Revenue assumptions supporting $42.8 billion in general funds appropriations for fiscal year 2021 include as much as $5 billion to $6.5 billion in additional borrowing from various sources, depending on whether the federal government provides direct relief to states for revenue failures as a result of the pandemic.
Options include borrowing up to $5 billion from the Federal Reserve Bank through the CARES Act Municipal Liquidity Facility program, $1.2 billion in general obligation bonds, and $300 million in interfund borrowing.
Although borrowing is not a preferred option, it may be a necessary tool if no federal assistance is provided to states while revenues continue to underperform.
With so much uncertainty surrounding the COVID-19 coronavirus crisis and its effects on Illinois, the Legislature had few options. With the governor’s budget office’s revised revenue estimates declining by an estimated $4.6 billion for fiscal year 2021, lawmakers could not cut their way out of this dilemma.
Debate among representatives in the Illinois House indicated 35% across-the-board cuts would have caused even greater economic hardship in the state, putting more people out of work and closing more businesses. This would have been catastrophic to schools; public safety; and the medical, social, and human service programs upon which the state’s most vulnerable citizens rely.
As Illinois considers the possibility of engaging in additional borrowing, it must be cautioned this is not “free money.” It must be repaid. Adding some $6.5 billion in potential borrowing, especially with interest rates of more than 4%, to the $2.66 billion in short-term borrowing already owed would have consequences on Illinois’ financial outlook for years to come.
The final word on the pandemic has yet to be written with Illinois in Phase 4 of the governor’s five-phase recovery plan, which allows more businesses and other places of employment to reopen with specific public health precautions.
It’s unclear at this time what Illinois, the United States, and the world will look like when or if life returns to normal. No one knows how long the pandemic will last or when there will be a vaccine, nor does anyone know the full impact the pandemic will have on Illinois.
Ending fiscal year 2020 with a bill backlog of $5.4 billion and a 40-day payment cycle for most bills for the first time in several years may give the impression that Illinois’ fiscal condition is not as grim as some observers may claim.
But this current period of relative calm is unlikely to last given that more than $1.6 billion in borrowing will be due this fiscal year, and another $5 billion to $6.5 billion in expenditures will be submitted to the Illinois Office of Comptroller for payment — more than state revenues can support.
This will lead to a growing bill backlog and increased pressure on the Illinois Office of Comptroller’s ability to pay obligations outside of the core payments for debt service, pensions, elementary and high schools, employee payroll, and social and human services.
As the fiscal year evolves, operating with this disparity of authorized expenditures against available revenues, policymakers and analysts will continue to assess state finances, unemployment levels, and the economy.
They also will await the outcome of the November election to see if Illinois voters approve or reject a proposed constitutional amendment to replace the state’s flat income tax rates with graduated rates. If approved, the governor’s budget office estimates about $1.2 billion in additional revenue could be infused into the state treasury in the second half of fiscal year 2021.
But the most immediate question is: what amount of direct relief or borrowing will come from the federal government? The federal government must realize states cannot simply tax or cut their way out of systemic fiscal problems resulting from the COVID-19 coronavirus pandemic.
Important to note is that Illinois is among the so-called “donor states,” like New York, Connecticut, and Massachusetts, whose residents pay far more in taxes to the federal government than they ever receive back for things like federally funded health care and public education. That makes Illinois one of the least federally dependent states. Meanwhile, states like Kentucky, Mississippi, and West Virginia receive far more in federal assistance than they actually send to Washington, D.C.
As Illinois and other states continue to battle this crisis, it is clear federal support will be essential for a pathway to fiscal recovery. ■