Effect of inflation on state finances; a variety of elements are involved

GOVERNMENTS like people have to cope with inflation.

School districts that heat their buildings with fuel oil and run their buses on gasoline have had to pay the doubled and tripled costs just like everyone else. Township road programs have been scuttled as the price of road oil has jumped from 17 cents a gallon to 46 cents a gallon in a year's time. Mental health institutions and prisons have had to pay the increased costs for food just like the housewife in the supermarket. Teachers, administrators, firemen, policemen, professors, prison guards, game wardens, ward workers in institutions, tax collectors, highway maintenance men, secretaries, clerks and the myriad others paid with public money also face higher prices and, like everyone else who works for a living, exert pressure, sometimes subtle, sometimes blatant, for larger pay checks.

What does inflation do to state and local government finances? Do the pressures of increased costs make tax increases inevitable? Or do revenues keep pace leaving government budgets relatively unaffected? Do some kinds of governments gain by inflation, just like some businesses gain, and others lose? Where in the Illinois public sector does inflation hurt the most? Where is the stress most likely to appear?

Before looking at state finances and then moving to the local scene, it may be well to take a brief look at the dimensions of the inflation that has rocked the economy. The recent steep rise in prices came near the beginning of 1973 following two years of price increases at a 3 to 5 per cent annual rate. In 1973 inflation ran between 8 and 10 per cent, rising in 1974 to the 12 to 14 per cent level. The commodities on which prices rose the fastest were foods and petroleum products.

Economic theory would indicate that inflation by itself will not directly hurt general state finances. Revenues, particularly from the sales and income taxes, should keep pace with increased costs. Highway finances are another matter, however, and theory would indicate that severe problems could develop. But the state does not stand alone. It is not fiscally independent. It receives substantial money from the federal government and, in turn, contributes even more money to local governments around the state. If inflation results in federal cutbacks in grants or pressure at the local level for increased state aid or a combination of the two, then the state could be caught in a squeeze between decreased revenues and increased demands.

Sales, income tax yields rise
The revenue side of the picture comes first. Do revenues keep pace with inflation?

The state's general, fund is supported primarily by the sales tax and the individual and corporate income taxes. In fiscal 1974 these three taxes accounted for 78 per cent of all genera! revenue. The sales and income taxes have kept pace with inflation. The sales tax is levied on price, and as prices rise, revenues rise along with them. In an inflationary spiral, wages and profits rise along with prices and income tax revenues.

Almost 50 per cent of the Illinois sales tax comes from the sale of food, automobiles and automotive products including gasoline. As these are the areas that led the inflation, one would expect sales tax revenue increases to have exceeded the rate of inflation, at least until the end of 1974 when car sales slumped badly. This is approximately what happened. Fiscal 1973 sales tax revenues exceeded fiscal

THE STATE'S DOLLAR:
Where It Goes
Based on budget for FY 1975

*Excluding higher education

1972 revenues by 8.2 per cent. Fiscal 1974 revenues climbed another 15.4 per cent, while revenues for the first several months of fiscal 1975 were up better than 12 per cent.

Income tax revenues were up 10.6 per cent in fiscal 1973 over 1972, increased another 13.8 per cent in fiscal 1974, and rose again by more than 12 per cent in the first few months of fiscal 1975.

Revenues from taxes based on quantities rather than prices, like the cigarette and liquor taxes, have not kept pace with inflation, and collections in fiscal 1975 are barely higher than collections in fiscal 1972. Inflation, in fact, may have a negative effect on yields from such taxes, because as prices go up, theory says that the quantities purchased should go down, bringing tax revenues down with them.

In total, the general revenue funds of the state have kept pace with inflation.

Salaries big part of state spending
What about the demands for state expenditures? How have they responded to inflation? About 35 per cent of general revenue goes to operating state government and about 60 per cent is distributed in grants — primarily to schools, other units of local government, and public aid recipients. Of the share that goes to running state government, the largest portion, about 75 per cent, goes to pay salaries and fringe benefits. As salaries go, so go state expenditures.

Historically, salaries, salary increases and cost of living adjustments have been handled by the executive within the Department of Personnel. A pay plan has been worked out and money included in each department's annual appropriation bill. Legislative action has been limited to approving the total money for the department. In fiscal 1973, the cost of living increase granted was 3.7 per cent. In fiscal 1974, the legislature for the first time attempted to legislate a pay increase for state employees, responding to pressures created when the new governor omitted any pay increase in his proposed budget. The General Assembly proposed a 5 per cent increase but went along with a counter proposal by the governor which provided an increase of $300 per year or 3.9 per cent, whichever was greater, for each employee.

In fiscal 1975 the governor proposed in his budget a similar sliding scale cost of living increase which ranged from $300 a year (approximately 7.5 per cent) for the lowest salaried employee to $600 a year (approximately 2 percent) for the highest paid employee with no increases given to those earning more than $30,000 a year. For the average employee the increase was 4.5 per cent. The legislature, however, passed a bill requiring a $100 a month cost of living increase for every employee. The governor reduced the amount $50, but the legislature overrode the reduction and restored the increase to the original $100 per month. To the average state employee this represented a cost of living increase of about 14 per cent.

Salaries keeping pace with inflation
Although there may be some lag, it appears that state employee salaries a keeping pace with inflation. The late pay raise may be attributed, at least part, to the increasing power al militancy of public employee unions. I those unions continue to grow and collective bargaining becomes a reality, upward pressure on salaries can be expected to increase. Continued inflation will be reflected more quickly in salary adjustments. Lags will be shorter.

The other 60 per cent of the general revenue budget is distributed in grants with the largest sums going to schools and public aid recipients. Prior to legislative action in late 1974, public aid recipients had not received a cost of living adjustment in several years and had to absorb all of the recent steep price increases. (However, in switching to a flat grant system in late 1973, the Department ment of Public Aid said that the average public aid grant increased 9 per cent.

For fiscal 1975, the legislature mandated a 10 per cent cost of living crease in public aid grants. The governor reduced the increase to 5 per cent, but again was overridden by the legislature. This pattern can be expected to be repeated. Public aid grants will most likely lag behind any inflation creating no pressure on the state. The current situation is somewhat different because inflation is combined with recession. The squeeze on public dollars is intensified by the recession which has reduced revenues and swollen public aid rolls. It is the swollen public aid rolls and not the inflation causing the problem.

It is difficult to determine precisely what is happening in school finances as a result of inflation. Costs are going up, particularly for fuel transportation. There is a limit on