Can Illinois Afford to Allow Current Tax Rates to Expire?

Transcription

1 Can Illinois Afford to Allow Current Tax Rates to Expire? January 30, 2014 David Lloyd Senior Policy Analyst, Fiscal Policy Center Voices for Illinois Children

2 What We ll Cover Very Brief Overview of State Budget Impacts and Origins of the State Fiscal Crisis Where We Stand Now Consequences of End-of-Year Tax Rate Expiration How We Can Invest in Future 2

3 Brief Overview of Budget 3

4 Budget Basics: Gen. Funds Appropriations FY 2013 General Funds Operating Appropriation By Agency State Board of Education 22% Pensions Contributions 17% Dept. of Human Services 11% Dept. of Healcare and Family Services 23% Higher Education 7% Dept. of Corrections 4% Other 7% Dept. of Children and Family Services 2% CMS - Group Health Insurance 4% Dept. of Aging 3% Source: Governor s Office of Management and Budget 4

5 Budget Basics: General Funds Revenue In FY 2013, Income Tax Revenue Made Up 55% of GF Revenue Federal Funds, 12% All Other, 13% Personal Income Tax, 46% Sales Tax, 20% Corporate Income Tax, 9% Source: Commission on Government Forecasting and Accountability 5

6 Illinois Fiscal Crisis 6

7 Billions Fiscal Crisis: Billions in Unpaid Bills Backlog of Unpaid Bills End of Fiscal Year $10.0 $9.0 $8.0 $8.3B $8.8B $7.0 $6.0 $5.0 $4.0 $5.1B $7.0B $6.3B $5.6B $3.0 $2.0 $1.0 $0.0 FY2009 FY2010 FY2011 FY2012 FY2013 FY 2014 Proj. Source: Governor s Office of Management and Budget 7

8 Fiscal Crisis: Percentage Cuts Since FY09\ Many Areas Still Far Below 5 Years Ago 0% Dept. of Children and Family Services Family Case Management Teen REACH Home Visiting Programs* Comprehensive Community-Based Youth Services Early Childhood Block Grant Bilingual Education Developmental Disabilities Community Mental Health Services -10% -14% -16% -20% -22% -24% -21% -26% -25% -30% -38% -40% -50% -51% -60% *Includes non-grf for Parents Too Soon Source: Fiscal Policy Center at Voices for Illinois Children 8

9 How Did This Happen? 9

10 Millions History of Budget Deficits FY 1990 FY 2012 General Funds Balances $2,000 $1,000 $0 $-1,000 $-2,000 $-3,000 $-4,000 $-5,000 $-6,000 $-7,000 Cash Balance June 30th Balance on Budgetary Basis (After Lapse) Note: Illinois law allows agencies to spend annual appropriations over 14 months (formerly 15 months). Lapse spending occurs after the end of the fiscal year in which the funds were appropriated. Source: Commission on Government Forecasting and Accountability, Illinois Office of the Comptroller 10

11 Revenue Hasn t Kept Pace Lagging revenue growth Didn t keep pace with economic growth o State personal income increased 4.2% annually o General Funds revenue from state sources increased 3.3% annually Narrow sales tax base Excludes many goods and all services Economy shifting towards services State discretionary spending growth is not to blame grew at basically same rate as economy. Source: Fiscal Policy Center at Voices for Illinois Children 11

12 Spending Near Middle of Pack Per Capita Government Expenditures in IL Roughly Average 12

13 Revenue Didn t Cover Spending Per Capita Government Taxation in IL Below Average ( ) Source: Bill Testa, Federal Reserve Bank of Chicago 13

14 Spending Through Tax Code Tax Expenditures: $8.4 billion in FY 2012 (23% increase) Many are popular few want to tax all food, or eliminate standard deduction / EITC. Expenditure for drugs, medical appliances, and retirement income likely to continue to increase with aging population. Should all retirement income be exempt even for wealthy? Only 2 other states exempt all retirement income from taxes. 4 Largest Tax Expenditures Revenue Lost Expenditure $1.96 billion Retirement / Social Security Deduction $1.64 billion Food, Drugs, Medical Devices $1.04 billion Standard Deduction $555 million Property Tax Credit Source: Illinois Office of Comptroller 14

15 Millions Inadequate Appropriations for Medicaid Section 25 Medicaid Liabilities High Even Before Recession General Assembly often under-appropriated funds for Medicaid expenses $2,500 $2,000 $1,969 $2,035 Would use one year s appropriations to pay for previous bills Until FY 2013, there was no limit on how much the General Assembly could defer $1,500 $1,000 $500 $0 $681 FY 2000 $747 FY 2001 $965 FY 2002 $1,361 FY 2003 $780 FY 2004 FY 2005 $1,841 $1,815 FY 2006 FY 2007 FY 2008 Source: Illinois Office of Comptroller 15

16 Pensions: Chronic Underfunding Causes of Change in Unfunded Liabilities FY1996 FY2013 (in $ billions)* $40 $35 $30 $36.0 State Underfunding Total Unfunded Liability: $25 $97.4 billion $20 $19.6 $15 $13.8 $10 $8.7 $5.8 $5 $0 -$5 $(2.1) Salary Increases Investment Returns Employer Contributions Benefit Increases Changes in Assumptions Other Factors *Before enactment of pension legislation Source: Commission on Government Forecasting and Accountability 16

17 Pensions: Costs Quadrupled in Six Years General Funds Expenditures for the State Retirement Systems (Millions $) $9,000 $8,000 $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $- 7,643 6,659 1,655 5,742 5,347 1,552 1,607 4,030 1, ,952 5, ,066 5,107 4, ,466 3,680 2,486 1,599 FY 2008 FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 FY 2014 Pension Contributions Pension-Related Debt Service Source: Fiscal Policy Center at Voices for Illinois Children 17

18 Pension Costs Crowding Out Priorities Pension Costs as Percentage of General Funds Revenue from State Sources* 25.0% 20.0% 19.1% 20.7% 23.7% 15.0% 13.1% 10.0% 8.3% 5.0% 0.0% FY 2008 FY 2009 FY 2012 FY 2013 FY 2014 *Includes transfers into General Funds Note: FY 2010 and FY 2011 not included because pension contributions were covered through borrowing. FY 2014 data is projected. Source: Governor s Office of Management and Budget 18

19 Great Recession Caused Huge Revenue Loss General Funds Revenue* FY 2009 $2.1 billion (7.0%) below FY 2008 FY 2010 $2.6 billion (8.6%) below FY 2008 *Excludes short-term borrowing and cash flow transfers Source: Commission on Government Forecasting and Accountability 19

20 Effect of 2011 Tax Increase 20

21 Higher Rates Prevented Freefall Additional Revenue from Higher Income Tax Rates (in $ millions) $25,000 $20,000 $15,000 $7,560 $7,986 $7,668 $10,000 $2,452 $5,000 $9,871 $10,624 $10,413 $11,730 $11,299 $- FY 2010 FY 2011 FY 2012 FY 2013 FY 2014 Est. Base Revenue Revenue Due to Rate Increases Avoided Draconian Cuts / Much Larger Increase in Unpaid Bills After Increase, Rating Agencies Improved Illinois Outlook *Includes revenue from suspension of Net Operating deduction in FY 2012 and FY Source: Commission on Government Forecasting and Accountability 21

22 Stable, But Critical Condition (for now) Additional Revenue Has Allowed State to Make Progress on Unpaid Bills, But Still Large Amount of Accumulated Debt Unpaid bills have been cut by billions of dollars, but still over $5 billion projected to remain by end of fiscal year (June 30) Huge unfunded pension liability has led to ballooning annual costs Growing health insurance costs for retirees Increasing Medicaid costs (despite 2012 cuts) Policymakers trying not to decimate essential programs Even with additional revenue, very difficult to maintain even flat funding for education and human services *Includes revenue from suspension of Net Operating deduction in FY 2012 and FY Source: Commission on Government Forecasting and Accountability 22

23 Impact of Possible Expiration 23

24 Collapsing Revenue Current Personal and Corporate Income Tax Rates Set to Decline January 1, 2015 Personal Rate Corporate Rate Pre % 4.8% % 7% % 5.25% 2025 and beyond 3.25% 4.8% *Includes revenue from suspension of Net Operating deduction in FY 2012 and FY Source: Commission on Government Forecasting and Accountability 24

25 Collapsing Revenue Governor s Office of Management and Budget recently projected huge budget shortfalls due to massive revenue collapse. Source: Governor s Office of Management and Budget 25

26 Cuts Necessary to Close Shortfalls Education and Human Services Would Be Harmed Most Many areas of budget are protected by federal requirements Lawmakers likely to cut unprotected areas first, including education and many human services programs While some programs have been spared cuts by federal maintenance-of-effort requirements, state may decide to forego federal funds because simply can t afford state portion of match A wide swath of budget would need to be cut by 20-25% in FY 2016, the first full year of the rate expiration Source: Fiscal Policy Center at Voices for Illinois Children 26

27 Millions Lost Revenue Quickly Adds Up Ballpark 10-Year Revenue Loss If Current Rates Expire $12,000 $10,000 If Current Rates Maintained $8,000 $6,000 ~$60 billion lost revenue through FY 2024 $4,000 $2,000 $- If Current Rates Decrease Note: CGFA assumes natural rate of income tax revenue growth of 2.3% annually. Data is gross, not net due to uncertainty about Income Tax Refund Fund percentages. Source: Fiscal Policy Center Analysis using CGFA data from April

28 Impact of Pension Legislation 28

29 Small, But Meaningful Impact (if upheld ) However, Doesn t Make Up For Lost Revenue, Most Savings Backloaded Fiscal Year Reduction in Contributions (in $ millions) 2014 $ $ $ 1, $ 1, $ 1, $ 1, $ $ $ $ 1, $ 1,157 *No savings in current fiscal year or in FY 2015, which begins July 1. Savings Through FY 2024 $ 9,689 Savings FY FY 2044 $ 135,201 Source: Governor s Office of Management and Budget 29

30 Credit Ratings 30

31 Repeated Downgrades Since Dec Round of downgrades during Great Recession largely driven by large revenue losses Agencies improved Illinois rating outlook immediately after 2011 tax increase Downgrades started again in January 2012 due in large part to General Assembly s repeated failure to address pensionfunding crisis Low credit ratings increase the state s borrowing costs for needed infrastructure projects, hurt state s reputation State likely to pay approximately $18 million a year for 25 years in higher interest costs for $1.3 billion bond sale last June 31

32 We ve Been Warned S&P Statement on Jan Downgrade [T]he expiration of current personal and corporate income tax rate increases on Jan. 1, 2015, along with other normal budget pressures, could have a profound effect on the state's budgetary performance and liquidity over the two-year outlook horizon. Moody s Statement on June 2013 Downgrade WHAT COULD MAKE THE RATING GO DOWN: Failure to address impending revenue loss from partial sunset of 2011 tax increases. Fitch Statement on June 2013 Downgrade NEED FOR LONG-TERM SOLUTION REMAINS: Temporary increases in both the personal and corporate income taxes, coupled with statutory spending limits, have closed a significant portion of the structural gap in the state's budget through fiscal The state will need to find a more permanent solution to the structural mismatch between spending and revenues.maintenance of the 'A-' rating will require timely action in advance of the expiration of temporary tax increases in fiscal 2015 [T]he tax increases will begin to phase out in 2015; thus, even if the state maintains budget balance to that point, it will once again be faced with a significant budget balancing decision to make permanent the tax increases, makes severe expense reductions, or identify new revenues. S&P Statement After Passage of Pension Legislation (Dec. 2013) In addition to normal budget pressures facing the state, the statutory reduction of current personal and corporate income tax rates on Jan. 1, 2015, highlights a difficult budget climate over the next two years. If pension reform moves forward [is upheld] and the state takes credible action to achieve structural budget balance beginning in fiscal 2015, we believe a higher rating would be warranted. 32

33 Taxes, the Budget, and the Economy 33

34 Lower Taxes = Better Economy? Therese McGuire, Northwestern University economist, reviewed literature at Chicago Fed last spring. She believes: The evidence of a link between the levels of state taxes and state economic growth is weak; too weak for me to believe that cutting taxes with the goal of boosting economic growth is likely to be an effective policy play Center on Budget and Policy Priorities reviewed 20 economic studies since 2000 on connection between taxes and growth: There is simply no consensus whatsoever that cutting taxes is a good strategy to boost state economic growth and create jobs. Many of the studies that find lower taxes are correlated with economic growth hold all else equal But, all else is not equal taxes pay for services, which must be cut if taxes are reduced. 34

35 Strong Evidence for What Does Matter Numerous studies have found that spending on the following are highly correlated with economic growth: Early childhood education K-12 education Higher education, including community colleges Infrastructure roads, public transit, airports Surveys of CEOs and site-selection consultants consistently identify education and infrastructure as key drivers of corporate location decisions. Quality-of-life issues also very important, especially to attract highly educated workers. 35

36 Negative Effects of Uncertainty Baker-Bloom-Davis Uncertainty Index 36

37 Negative Effects of Uncertainty New Research Finds that Uncertainty Undermines Economy Increasing policy uncertainty between 2006 and 2011 nationally led to the loss of 2.3 million jobs and a 3.2% decline in real GDP - Scott Baker and Nicholas Bloom (Stanford), Steven Davis (Univ. of Chicago) A rise in economic policy uncertainty lowers employment and investment, and produces a rapid decline in equipment and software and a slow decline in structure investment. - Troy Davig and Andrew Foerster, the Federal Reserve Bank of Kansas City 37

38 Uncertainty in Illinois Increasing With Looming Tax Expiration Given new research connecting uncertainty to poor economic growth, we need to consider what role it has played in Illinois High uncertainty this year with looming tax expiration If tax rates expire, uncertainty about Illinois ability to fix its finances will worsen 38

39 Getting Back on Right Track Not Possible If We Don t Maintain Stable Revenue We need to: Implement plan to eliminate backlog of unpaid bills Reduce unfunded pension liability by making required contributions under new law Restore funding to education and human services (won t happen overnight) Reform the sales tax to reflect modern economy Eliminate unjustified tax expenditures Increase budget transparency 39

40 Questions? 40