Illinois Can’t Balance It’s Budget by Taxing Retirement Income

Back in December, the Northwest Herald ran a story about a proposal to make retirement income subject to Illinois income tax. On December 2, Rep. Dave McSweeney sponsored House Resolution 890, which states that:

“We state our belief that the Illinois Income Tax Act should not be amended to permit taxing retirement income.”

I wrote about this back in October after the first whiff of the proposal hit the Chicago Tribune. At that time I said that to tax retirement income is nothing more than piling more bad tax policy onto an already broken system.

But this post isn’t about a call for more and more revenue, it’s an attempt to make sense out of why the State’s budget is so out of balance.

There’s a simple, one-word answer: pensions. As I pointed out several days ago, in the next fiscal year, Illinois’ required pension contribution will amount to a full 24% of the state’s general revenue budget. Continue reading

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Choosing Among Bad Options to Fix Our Pension Mess

Good Choice Bad ChoiceSo now we know that next year the State of Illinois will have to shell out 24% of its state budget just to pay pensions, and we strongly suspect that we’re having smoke blown at us if we believe the underfunding of the state’s 5 pension plans is “only” $111 billion.

What’s to do about it? Since states cannot file for bankruptcy, perhaps all we have left is an old saying attributed to “Reefs and Shoals” a handbook for cadets at the U.S. Naval Academy dating from the 1920’s that goes: “When in danger or in doubt, run in circles, scream and shout.”

But this is a serious issue, and deserves a serious response. For years, Illinois’ politicians have in effect borrowed money from the pension plans by not making required contributions or by overstating the expected rate of return on the portfolio so as to lower the amount of such contributions as have been made. While enactment of the Tier II pension system for new employees is supposed to stop the continued increase in pension accruals, the question remains: How do we pay off the $111 billion or $300 billion or whatever amount by which the funds are short?

In a 2010 article from the Chicago Tribune, economists Robert Novy-Marx and Joshua Rauh listed what few options the state has:

  • Taxpayers pay for it all in higher taxes and reduced public services. But it is hard to see us finding an extra $200 billion anytime soon. State and local government tax revenues in Illinois are around $55 billion annually, and budget shortfalls are colossal.
  • Continue to borrow to fund pensions. This tactic restructures the debt to employees so that it becomes debt to investors. Unfortunately, future generations of taxpayers would shoulder the burden. Illinois has already made $13 billion of pension bond issues, which are expensive as they enjoy no tax subsidies. The silver lining is that to keep borrowing, Illinois will soon need to credibly show capital markets a reform of its entire budgetary process.
  • Increase retirement ages for existing employees to 67 and eliminate openhanded early retirement deals. The Illinois Constitution states that public employee pension benefits may not be diminished or impaired. But if we are putting all options on the table, this one also has to be there, even if it involves changing the constitution.
  • We could do nothing and end up like Greece. If so, Illinois will eventually default on some of its $26 billion of outstanding general obligation and pension bond debt. The depletion of the state’s pension funds, which is quite likely within the next 10 years, will provide a catalyst. Illinois will then end up at the federal government’s doorstep, hat in hand. This should be avoided at all costs. Markets already are charging more for insurance on Illinois bonds than for bonds issued by Spain, Portugal or California.

Continue reading

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Is the Underfunding of Our Pensions 3 Times More Than Advertised?

Half Empty GlassAs I pointed out in the previous post, the required contributions to Illinois’ 5 pension funds will increase by $291 million in the next fiscal year, and will comprise fully 24% of the state’s general revenue outlays. That’s being done to satisfy the requirements of the Illinois pension law that requires all 5 funds to achieve a funding level of 90% by 2045.

That’s based on an assumption that the plans are underfunded by the $111 billion as stated in the November, 2015 report issued by the Commission on Government Forecasting and Accountability (COGFA). But what happens if the underfunding is 2 or 3 times greater than is reported?

Contributions for the past 3 years have increased dramatically from the previous years. From Doug Finke’s Springfield Journal-Register article:

“Dan Long, the commission’s executive director, said a reason is that the pension systems lowered their expected rates of return on investments last year, resulting in the state having to make a somewhat larger contribution. That lowered rates of return are now built into projections for state contributions.” (Emphasis mine)

I want to concentrate on Dan Long’s comment above about how lowered expected rates of return resulted in larger annual contributions. That’s going to require a bit of math.

Simply put, to achieve a particular return on an investment, the greater the investment return you demand, the less you’re willing to pay for it. Conversely, the lower the investment return you will accept, the more you have to pay for it. That’s because investors aren’t willing to pay a higher return-adjusted price for an investment than they could get if they put their money into a risk-free investment, which is generally defined as the rate on U.S. government securities. (Now, that wasn’t so bad, was it?)

According to the 2013 Illinois State Actuary’s Report:

“The interest rate assumption (also called the investment return or discount rate) is the most impactful assumption affecting the required State contribution amount. This assumption is used to value liabilities for funding purposes.”

This goes to the very heart of the discussion as to how underfunded Illinois’ pension funds truly are. According to the COGFA report, the plans are underfunded to the tune of $111 billion. That number is derived by using a lower assumed investment rate of return than had been used in previous years. This chart shows the reduction in investment returns for the 5 funds over the past several years:

Continue reading

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19% of Illinois’ Budget Goes to Pensions, and That Number is Going UP

Upward ArrowBack in June I wrote a post pointing out that in fiscal year 2016, a full 19% of the Illinois’ budget was allocated to contributions to its 5 pension plans. That was then.

This is now. A new report from the Commission on Government Forecasting and Accountability (COGFA) released in November states that the pension contribution for fiscal year 2017 will increase by $291 million from the current year, and will consume 24% of Illinois’ general revenue budget.

Doug Finke of the Springfield Journal Register reports:

“The increase is substantially less than the $681 million increase in pension contributions that were required this year. It is also substantially lower than the nearly $1 billion annual increases seen in 2013 and 2014.”

To read Doug’s article, you would think that a mere $291 million increase is something to celebrate. After all, it’s only a fraction of the billion dollar increases seen in 2013 and 2014. But reading further brings the bad news:

“But while the increase for next year isn’t as steep, the total contribution is still a concern…The issue is the state contribution is about 24 percent of the general fund (outlays),” [COGFA Executive Director Dan] Long said.”

Does anybody think that if the state didn’t have to pay 20% of its total budget outlays to its pensions, it would have anywhere near the budget crisis it has today?

Things aren’t going to get better any time soon, either. As required by Public Act 94-0004, in determining the required State contribution under State law, the State’s actuary must determine what level of future contributions is needed to make a projection of the System’s funded status in 2045 be at 90%. According to the COGFA report, the State’s contribution to the 5 state pension plans (based on the funds’ 2015 valuation) will increase from $7.9 billion in fiscal 2017 to $17.3 billion in 2045.

Consider that last sentence. The state’s contribution to the pension plan 30 years hence, based on what we know now, is 220% higher than this year’s contribution, which takes up 24% of the state’s general revenue budget. Even if this projection does nothing more than track inflation, the state will ultimately become nothing more than a giant pension plan that performs incidental state services. I don’t know about you, but to project beyond the next election is a fool’s game, let alone 30 years down the road.

And what if the pension plans aren’t underfunded by $111 billion, as COGFA states in its report? What if the underfunding is 2 or even 3 times that amount, as some economists are saying? We’ll discuss that in the next post.

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Taxing Retirement Income: Adding a Second Story to a House with a Crumbling Foundation

ILEXPATThe Chicago Tribune recently reported (behind its paywall):

“[Republican Senate Leader Christine]Radogno said lawmakers likely will consider hiking the state income tax or taxing retirement income, rather than increasing the state sales tax or instituting a tax on services.”

If this is what passes for thoughtful consideration of tax policy in this state, we’re doomed. There could not be a single more compelling reason to accelerate the exodus of citizens from Illinois than to add to the tax burden of those who are already leaving in droves.

The Illinois Policy Institute points out:

“Illinois lost 81,000 residents and $4.1 billion of annual taxable income during the 2013 tax year, according to an Internal Revenue Service report. That’s one resident and $50,000 of income every 6.5 minutes. That’s a record.”

Simply adding another level of taxpayers onto a broken tax system is no different than adding a second story onto a house with a crumbling foundation. It’s going to collapse even sooner.

Illinois’ tax system was devised for the day when it was a manufacturing powerhouse. Those days are gone, yet our corporate income tax rate is the fourth-highest in the nation. However, only about one-third of corporations pay the tax. Most corporations have adapted and have structured themselves as “pass through” entities, which means that the shareholders pay taxes on their net income at individual rates. Yet, what company that is traditionally structured and subject to Illinois’ corporate income tax will want to stay or locate here?

Hoping to increase revenue by keeping the current tax system and then taxing more sources of income within that system is a recipe for disaster. Taxpayers are already overburdened by high property taxes and fees, and to tax retirement income would encourage more citizens to vote with their feet.

This pretty much sums up the problem:

“If you were to get all of the nation’s state tax experts in one room and ask them what good policy is, the answer you’d get from 9 out of 10 of them is four words: Broad Bases, Low Rates. In many ways, Illinois does precisely the opposite. The state sales tax is one of the narrowest in the country—exempting many goods and services—but the rate is among the highest. Property taxes are high. And the corporate income tax rate is among the highest in the world. Faced with this uncompetitive rate, companies take and seek the incentives to reduce their tax costs.” (Joseph Henchman “Sensibly Reforming the Tax Structure and Tax Incentive Policies of Illinois” The Tax Foundation, January 17, 2014)

It’s long past time to stop trying to find new oxen to gore. Illinois needs to restructure its tax system so as to generate revenue from those sources that provide the most opportunity for sustainable growth. Once those sources have been identified, then the system needs to be built around a broad base with few exemptions and low rates.

Illinois is like the man who’s fallen out of a 40-story building, he’s 39 stories down and thinks: “well, nothing bad has happened yet.”

h/t: McHenry County Blog

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