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By MICHAEL D. KLEMENS
The morass in state government's Gov. Jim Edgar's term has been a 14-month financial crisis. The governor has taken Illinois through one minor and two major sets of budget cuts, to mixed reviews. On January 8, Edgar told lawmakers assembled in the Illinois House for his financial emergency address, "We simply must resist going back to our taxpayers again and again." Republicans rose and applauded; the poor who filled the House galleries booed and chided: "Edgar Scissorhands!" Even after three rounds of budget cuts in a year, Edgar has made little progress in moving Illinois out of the financial hole. On January 31, Comptroller Dawn Clark Netsch estimated that the state was holding $939 million in bills that it lacked the cash to pay. No one expects the state to be out of the fiscal hole any time soon. Edgar first blamed past financial practices, then the recession, for the state's budget mess. Democratic lawmakers blamed Republicans — President Bush, Edgar and Gov. James R. Thompson in that order. Blame cannot be that simply affixed. The state's problems are in the general funds. The general funds include the General Revenue Fund, the all-purpose checking account from which anything can be paid; the Common School Fund, from which school aid payments to elementary and secondary schools are made; and the Education Assistance Fund, the fund into which education's share of the 1989 income tax increase is paid and from which some elementary and secondary and some higher education spending is made. The general funds revenue base can be viewed as a three-legged stool. (See table 5.) Approximately one-third comes from income taxes, one-third comes from sales taxes, and the remaining third comes from other sources, the largest of which is federal aid. Revenues from income and sales taxes grow with the economy and inflation, while the other sources tend to remain level.
Three significant factors contribute to the current general funds problems. Illinois' budget problem has its roots in the state's tax base and its revenue structure. Overspending by the outgoing administration of Gov. Thompson aggravated the problem. In turn, Edgar's gubernatorial campaign pledge not to raise taxes limits his options for dealing with the cash shortfall. First, general funds revenues grow slowly, even in good times. General funds revenues increased from $3,090 million in fiscal year 1971 to $13,261 million in fiscal year 1991, a 329 percent increase. When adjusted for inflation, the increase was a much more modest 21 percent, and most of the increase came in the early part of the 20-year period. In fact, the all-time high for general funds revenues in inflation-adjusted dollars was reached in 1979. (See table 1.) A 1987 study by the General Assembly's revenue forecasting unit, the Illinois Economic and Fiscal Commission (IEFC), identified the tax base problem. The IEFC found that from 1971 until 1979 general funds revenues had grown faster than inflation but since 1979 had grown slower than inflation. "There is little evidence to indicate that total general funds revenue will increase fast enough to avoid a long-term deterioration in the state's purchasing power," the IEFC reported. The prediction has proven true. From 1981 to 1991 constant 10/March 1992/Illinois Issues dollar revenues decreased five years and increased five years. Revenues would have been down for the period except for the large jump in the 1984 tax-increase fiscal year. Revenues tending to increase more slowly than inflation is clearly a trend. Barring a miraculous economic reversal, revenue growth will not carry Illinois out of its fiscal dilemma. Slow growth in revenue is something that state government has inflicted upon itself. When times were better, a number of tax breaks were granted. When any tax base is narrowed, however, the revenue produced depends on the remaining taxpayers. Those tax breaks have undermined general funds revenue growth and contributed to the decline in inflation-adjusted general funds revenues. The greatest damage from tax breaks has been done to the sales tax base. All told the erosion to the sales tax base costs the state around $1.2 billion per year. Beginning in fiscal year 1979, a number of exemptions were made, eliminating the sales tax on machinery and equipment used in manufacturing, agriculture, graphic arts, oil fields and coal mining. Gasohol sales are also taxed at a reduced rate. For fiscal year 1991 the IEFC estimated the revenue loss at $166 million from the sales tax because of the business exemptions. The biggest loss to the sales tax base came from eliminating the tax on food and drugs. In a series of steps begun in fiscal year 1980 and completed in fiscal year 1984, the state removed its sales tax from groceries and medicine. The IEFC estimated that revenue loss at $826 million in fiscal year 1991. The exemption reduced the stability of the sales tax base by removing essentials that citizens purchase in good times and bad. Without those essentials in its base, the sales tax as a revenue source is more volatile, relying more on consumer spending for nonessentials. Gov. Thompson tried unsuccessfully as part of his fiscal year 1988 "revenue positive tax reform" to put nonprescription drugs back into the sales tax base and to include some services in the sales tax base. Thompson's base broadening proposals got no serious consideration from lawmakers. The sales tax base has suffered other losses. The Build Illinois program is funded with 5.55 percent of sales tax revenue. In fiscal year 1990 the diversion took $222 million out of general funds spending. Lawmakers also changed the public utility tax to one based on units of energy used instead of on price, and they eliminated the state inheritance tax. New sources of revenue have been pumped into the general funds, offsetting sales tax losses. Lottery profits annually transferred to the general funds increased from $69 million to $580 million, or 740 percent, between 1981 and 1991. The most spectacular of that growth, however, came in the first five years; since 1986 lottery transfers have been flat. (See table 2.) New taxes and higher tax rates have helped prop up general funds. The major ones include: • Temporary increases in income tax rates (from 2.5 percent to 3.0 percent for individuals and from 4.0 percent to 4.8 percent for corporations), first for 18 months beginning January 1, 1983; again for two years beginning July 1, 1989; and again last year. The latest increase generated about $550 million for the state general funds in fiscal year 1991.
• Increases in cigarette taxes from 12 cents per pack to 20 cents per pack in fiscal year 1986 and to 30 cents per pack in fiscal year 1990. The two increases accounted for about $190 million of the fiscal year 1991 cigarette tax revenue. Without the one billion-plus generated by these tax increases and the half billion from the lottery's phenomenal early 1980s growth, general funds revenue would have experienced much more modest growth. Without these sources, the average annual percentage increase in revenues would have been 3.8 percent from 1981 until 1991; with them, general revenues increased 5.1 percent per year. The second significant factor is Edgar's promise to forswear the tax increases that Gov. Thompson used regularly to sustain spending. Without Thompson's tax increases, spending would have grown much more slowly; with March 1992/Illinois Issues/11 the increases, it grew more slowly than many wanted, particularly spending for education and human services. The state has never fully funded the 1985 school reform package. Decreased state support to public universities prompted tuition increases. Staffing levels at mental hospitals remained far below what almost everyone considered acceptable. State school aid declined relative to local taxes. And caseloads in human service agencies remained unmanageably large.
For Edgar, that means having to fulfill an appetite for spending increases that has grown on average more than 5 percent annually with a revenue base that grows at less than 4 percent per year. That leaves Edgar short of normal spending growth by $150 million to $200 million each year. By the time of the next gubernatorial election, if he keeps his word, the difference between what Edgar can spend and normal spending increases would be pushed to $1 billion. When Edgar took office he knew about the weakened tax base, and he had put the "no-tax" handcuffs on himself during his campaign. What he did not realize was the size of the fiscal hole he would find in the budget. While Edgar was campaigning in early 1990, the fiscal year 1990 budget was unraveling. General funds revenues rose $708 million because of the temporary tax increase at the same time general funds spending increased $1,271 million. The gap was closed by drawing down reserves and by pushing off millions of dollars in spending until after the 12-month fiscal year ended June 30, 1990. The third significant factor is overspending that was covered up by a variety of cash management techniques. The fiscal year 1991 budget that Edgar took over in midyear had $600 million in spending obligations that the state had to honor but had not appropriated. Even without the appropriations spending exceeded revenues by $300 million. Another $200 million in spending was postponed to be paid off with fiscal year 1992 revenues. To understand the severity of the problems Edgar inherited, some definitions are in order. First, during the three months immediately after the state's fiscal year ends, money can be spent from the previous year's appropriation. Spending during this July-August-September "lapse period" inflates the June 30 bank balance, however. In theory Illinois should have enough in the bank on June 30 to cover this lapse-period spending. Only twice in the last decade has that occurred. (See table 4.) Second, the budgetary balance (June 30 balance minus lapse-period spending) is one measure of whether the budget is balanced. To the extent that the budgetary balance is negative, the state is using one year's revenues to pay the previous year's bills. The budgetary balance in the fiscal year 1991 budget that Edgar took over was the largest negative balance in the history of the general funds. The 1991 negative balance was nearly twice as high as the previous record, and the balance in the fiscal year 1992 budget is only slightly better. (See table 4.) The magnitude of the negative budgetary balances for fiscal years 1991 and 1992 is one of the clearest indicators of the seriousness of the current financial situation. During Edgar's first days as governor in January 1991 he implemented plans to cut general funds spending by $46 million. Later in the spring he and lawmakers would wrestle with a $1.5 billion deficit, the amount all agreed was needed to continue existing programs. In March Edgar presented his first budget as governor, pushing for deep spending cuts and proposing a budget based on a general funds spending level of $14,178 million. Democrats would deny him some cuts in programs that serve the poor, while forcing him to accept a series of one-time revenue increases. In July Edgar signed a budget with spending at $14,425 million. Edgar won some of his cuts. Trimmed was the General Assistance welfare program for single adults. Also trimmed was pharmaceutical assistance for low-income elderly. State-funded energy assistance for the poor was terminated. Most state agencies saw reduced budgets. Workers were laid off. An early retirement program was approved, and those vacancies may not all be filled.
12/March 1992/Illinois Issues Edgar also signed on to a lot of one-time revenue fixes in his first budget. Accelerated collection of sales taxes was to generate $111 million. There was $135 million in transfers from other funds into the general funds. Edgar successfully grabbed half the local government share of the 1989 surcharge, but must give half of his half ($78 million) back to locals in fiscal 1993. And lawmakers postponed a $177 million school aid payment from June into July, increasing lapse-period spending. Finally, the budget that Edgar and lawmakers agreed upon was premised upon economic recovery. The recovery never happened. The governor's Bureau of the Budget (BOB), which had premised its budget on recovery from national recession early in calendar year 1991, first pushed the date into mid-1991, then to late spring of 1992. The legislature's IEFC, whose revenue estimates had been less optimistic than BOB'S to start with, held to its pessimistic view of the economy for the rest of fiscal year 1992. In its February update of revenues, the IEFC found evidence that Illinois had lagged behind the nation moving into the recession and could be expected to lag in recovering from it. The IEFC said that the loss of 238,000 jobs, seasonally adjusted, since February 1990 has contributed to Illinois' economic problems. The recession hit Illinois with a vengeance. Revenues fell $231 million short of BOB'S projections for the first six months of fiscal year 1992. In December Edgar announced that spending cuts would have to be made. The size went from "tens of millions" to $350 million overnight. The midyear fiscal problems have resulted in another series of budget cuts, in many respects the deepest to date. Having already used gimmicks like postponing the school aid payment and accelerating revenues to balance the original budget, lawmakers and Edgar had few options but to cut spending in January. They hammered out the Emergency Budget Act of Fiscal Year 1992 with a combination of budget cuts and revenue increases that balanced at $350 million. New revenues came from $45 million in new transfers to the general funds and from the suspension, for the rest of fiscal year 1992, of the transfer of 1.7 percent of sales tax collections to the Road Fund. The suspension will save $29 million for the general funds. Cuts also came in the form of establishing an amount (reserve) that agencies cannot spend from their fiscal year 1992 appropriation. The reserve totalled about $260 million. Democrats won reductions in the size of Edgar's original proposed cuts to elementary and secondary education and to the Department of Public Aid. When the budget cutting process was done, both the governor's and the legislature's revenue forecasters produced new estimates for fiscal year 1992 revenues. Since summer IEFC's 1992 revenue estimate had been about $300 million below BOB'S. In January the BOB'S revised total moved $28 million below IEFC's, a difference of less than 0.2 percent. The BOB'S revenue revision cut its total revenue estimate for fiscal 1992 general funds by $336 million, even after adding $45 million worth of new transfers to the general funds that were part of the Emergency Budget Act. That translates to a 2.6 percent drop in its original revenue estimate. Major reductions were made in revenues from sales taxes, individual income taxes and corporate income taxes. (See table 5.)
In January BOB also reduced its estimate of the cash balance to be available on June 30. Edgar had fought throughout the spring session and into July to build the year-end balance from $100 million on June 30, 1991, to $200 million on June 30, 1992. At the time Edgar said that he planned to increase the balance further, to $400 million, by the end of fiscal year 1993. In its January quarterly report BOB projects that the balance will rise to only $110 million by June 30, 1992. (See table 6.) The midyear budget adjustments for fiscal 1992 will make the fiscal year 1993 budget all the more difficult to construct. The revenue platform upon which the fiscal year 1993 spending plan will be built has been lowered. Edgar will propose the fiscal year 1993 budget in April, and lawmakers will debate it through June. With the fiscal year 1992 ending balance reduced by $90 million, Illinois will begin fiscal year 1993 with the same kind of cash flow problems it experienced in fiscal 1992. The state will have $110 million in the bank, and the current estimate for lapse-period spending is $767 million. (See table 4.) That means that $657 million of fiscal year 1993 revenues will pay fiscal year 1992 bills. The fiscal year 1993 budget will depend in large measure upon where the economy goes. The IEFC in February issued its preliminary estimate of fiscal year 1993 revenues, and the news was not heartening. The IEFC pegged revenues at $14,405 million, which is $4 million below its estimate for the current year. The IEFC reduced revenue growth by $630 million in one-time revenue sources it could identify for fiscal year 1992. Major one-time sources are $185 million in short-term borrowing; $154 million from local governments' share of the state income tax surcharge; $111 million in sales tax acceleration; $85 million from Build Illinois reserves; and $85 million in transfers from
March 1992/Illinois Issues/13
other state funds. The IEFC's revenue estimate is also based on Illinois moving out of the recession in the fall of 1993. It projects sluggish growth for July through December and moderate growth for the remainder of the year. Overall, when one-time 1992 revenues are excluded, the IEFC projected 4.6 percent revenue growth for fiscal year 1993. "This is not a pessimistic forecast. This is a moderately optimistic forecast," says William G. Hall, IEFC executive director. If the IEFC estimate proves accurate, there will be no increase in total spending, but money that was spent for a one-time purpose in fiscal year 1992 will be available for other spending in fiscal year 1993. The BOB had matched one-time spending to one-time revenues in its original budget for Edgar, and the BOB projected the total at about $500 million in that fiscal year 1992 budget. There are already a number of claims for that money in fiscal year 1993, including: state employees group health insurance that is underfunded by $130 million; a contract settlement with unionized state workers that will cost $80 million; repayment of $40 million borrowed from the Road Fund in fiscal 1991; and $20 million to open prisons and work camps newly built but still vacant. Then there are structural issues to which no one is committed but should be. Money should be spent to reduce lapse-period spending from the $767 million level, otherwise cash flow problems will continue. Edgar had also talked about building up the balance to $400 million. Just getting it back up to $200 million will cost him $90 million. The payment cycle for Medicaid services will be no better than 60 days; bringing it down to 30 days would cost $200 million. And to begin to deal with the shortfall in state pension funding would cost hundreds of millions of dollars more. Add up the resources, and there is about $500 million to spend. Add up the obligations, and they will consume all of the resources and then some. What the situation adds up to is more of the same.
One obvious solution would be a tax increase. That will not come this spring for three reasons. First, Edgar has said he will oppose a tax increase. He has said that over and over. Second, lawmakers are loathe to pursue a tax increase that will likely be vetoed by the governor. That is particularly true this year when lawmakers are preparing to run for election in new legislative districts and are reluctant to rile new constituents. Third, taxpayers are wary of tax increases and should be, given recent Illinois history. Illinois began fiscal year 1990 with more than $500 million in the bank, and with that record-high balance lawmakers and the governor raised income taxes 20 percent. The large ending balance and the tax increase precipitated the spending orgy that plunged the state into its current financial crisis. Still, there is talk of higher taxes. James D. Nowlan, president of the Taxpayers' Federation of Illinois, sees for fiscal year 1993 continued conflict between a revenue structure that grows at less than the rate of inflation and is strained by double digit demands for increased health care spending: "Illinois can't grow its way out of this revenue problem even if the economy picks up." Nowlan thinks that state leaders will have to choose within the next year or two between further cuts to education and social services, a dramatic narrowing of the focus of state government and/or increased taxes. Gov. Edgar's financial crisis is at 14 months — and counting. He took office to find himself in a billion dollar budget hole. The way out is not easy when the state has a tax base that produces revenue growth that trails inflation and the governor has taken the no-tax pledge. Nevertheless, there are only two options: Higher revenues, read tax increase, or reduced spending, read more painful spending cuts than have been inflicted to date. The choice is clear, if not easy.• 14/March 1992/Illinois Issues |
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