By JOHN B. CRIHFIELD and J. FRED GIERTZ

Improving economy won't solve
state's budget problems

Tax revenues are strong, but government spending is still high

The state's economy has improved, but continuing fiscal difficulties pose a political dilemma for Gov. Jim Edgar as he heads into a second term.

Tax revenues are keeping pace with inflation. But unfortunately a healthy economy does not promise to solve the state's budget ills. Spending is also increasing, especially in social services and corrections. So, while he has been criticized for his incremental approach to problems, Edgar will again have little flexibility for initiatives during his next four years — unless substantial new revenues are found.

Edgar's first term was marked by austerity, the result of budgetary problems that were not of his own making. The new governor faced a crisis in 1991 that was the result of overspending by the previous administration and by the General Assembly, aggravated by a national recession that began in the summer of 1990. Although state revenues were bolstered by a temporary 20 percent income tax surcharge approved in 1989, the additional income did little to solve Illinois' long-term budget problems. Increases in state expenditures, especially for Medicaid, and greater aid to local governments more than offset the extra revenue from the surcharge. General fund balances were drawn down and payment of the state's bills was extended to finance the deficit. The recession converted a serious situation into a crisis.

Edgar responded immediately with a series of mid-fiscalyear expenditure reductions followed by austere budgets for fiscal years 1992 and 1993. The income tax surcharge, due to expire in 1991, was extended and later made permanent. The state also began relying on a series of new provider taxes levied on hospitals and nursing homes to help finance Medicaid, a joint federal-state program providing medical care for the poor. A recovering economy and previous budget cutbacks allowed modest expansion in the last two Edgar budgets. But there was no room for sweeping changes or new initiatives. Longstanding issues, including education finance and tax reform, were not addressed.

As Edgar enters his second term, unemployment is at a 20-year low and natural revenue growth for fiscal 1996 is expected to exceed $750 million. The governor can expect the strong natural growth of state tax revenues to continue through the rest of fiscal 1995 and into fiscal 1996. Yet, the state's expenses are going up too. For example, the state will share a larger portion of income tax revenues with cities and legislative action in 1994 commits the state to higher levels of public pension funding. Since fiscal 1989, public aid (largely because of Medicaid increases) has grown from 31 percent to 35 percent of the state

12/February 1995/Illinois Issues

budget. Similar increases have occurred in mental health services, children and family services and corrections. Programs in these areas have been driven by expanding case loads and increasing costs. The number of elderly and disabled people covered by Medicaid in nursing homes has grown rapidly. Court edicts, along with a series of highly visible child abuse cases, have spurred increased spending for children and family services. And the prison system has been expanded as politicians have responded to concerns about crime.

We can expect to continue to see ad hoc measures to deal with budget gaps

As a result of spending increases in the social service area, other state activities have been squeezed. State support for education, including higher education, has gone from 37 percent of the budget in 1989 to 35 percent in 1995. Other areas have been affected more severely.

The state faces what is often described as a structural deficit, where expenditure growth, driven by social and demographic factors, tends to outstrip the growth in revenues. Note that the state has experienced steady revenue growth over and above inflation in the last four years, yet our fiscal problems remain. The governor must decide whether this problem is to be addressed by a search for increased revenues or by finding ways to rein in spending growth.

The first problem confronting the new administration is the lingering one of Medicaid finance. As noted, Medicaid has been the largest contributor to the state's fiscal woes. Illinois faces a two-part Medicaid funding problem: how to pay off the backlog of bills (estimated at over $1 billion) and how to control the future growth of Medicaid costs.

The state hopes to address the problem of cost control by moving to a managed care system similar to a Health Maintenance Organization for more than 1 million recipients. The plan is aimed at improving care, as well as controlling costs. Whether it would yield the expected savings remains to be seen. In any event, the federal government has delayed the implementation of the new plan until August 1, while raising the specter of disallowing federal matching funds previously generated by the state's provider taxes. The state also faces the prospect of finding new revenue sources to replace the provider taxes that are set to expire in July 1995.

To deal with the backlog of Medicaid bills, the administration has raised the possibility of restructuring the state's bonded indebtedness to take advantage of lower interest rates. The restructuring would defer repayment for a year or two with the freed-up funds directed at reducing the payment backlog. A similar plan was blocked last year by the Democrat-controlled House. With Republicans in control of both houses, the administration plan might receive a more favorable hearing this year. In addition, the legislature is likely to consider even more sweeping changes in Medicaid, including cutbacks.

School finance reform is a less pressing, but more important long-term problem. Illinois' support of elementary and secondary education has been criticized as being inadequate. A heavy reliance on the local property tax leads to wide disparities among districts.

Democratic gubernatorial candidate Dawn Clark Netsch called for a major increase in the state income tax, with the proceeds to be used for increased aid for public schools, property tax relief and income tax relief for low-income taxpayers. Her defeat does not mark the end of reform efforts, however. Senate President James "Pate" Philip has suggested that the state consider the reduction or even elimination of property tax support for schools. The Illinois Farm Bureau also recently passed a resolution calling for a higher state income tax and lower property taxes. Edgar has advocated a more modest approach. He would designate a significant portion — $200 million extra per year — from the growth of state tax revenues for education over the next five years. Until the Medicaid problem is addressed, however, there may be no excess state revenues available for increased education funding.

A related issue, property tax reform, is also of great interest to Edgar and to Republican legislators. Property taxes have increased substantially in Cook and the collar counties during the last decade. Two approaches have been suggested to alleviate the problem. One calls for replacing at least a portion of the property tax with higher state taxes. This proposal remains problematic because it would require substantially higher state taxes. Replacing half of the local property tax would require doubling the state income tax. There also are difficult questions about how the increased state funds would be channeled to local governments while ensuring that property taxes are actually reduced.

A less thoroughgoing way of providing property tax relief is to constrain growth through caps. Caps that limit the growth of property tax extensions to the lesser of 5 percent or the rate of inflation without approval by referendum have been in effect in the collar counties since 1991. There is now interest in extending caps to Cook County and possibly to downstate counties. This is an attractive alternative for the state, and one that is favored by Edgar because it does not require any state money.

During his re-election campaign, Edgar said that he has no plans to raise state taxes but that he would not rule out the possibility if the need were to arise. Given the conservative shift nationally in the November election, however, the governor is not likely to call for such an increase. As a result, we can expect to see continued reliance on ad hoc measures to deal with budget gaps in a second Edgar administration. *

John B. Crihfield and J. Fred Giertz are economists in the Institute of Government and Public Affairs at the University of Illinois at Urbana- Champaign.