Pension changes do little to ease budget gap

Pension changes do little to ease budget gap

By Richard F. Dye

Illinois has two very serious fiscal problems: 1) a large and growing gap between sustainable revenues and projected spending levels, and 2) the largest-in-the-nation unfunded pension liability. The December 2013 changes to Illinois pension law — should they survive a constitutional challenge — eliminate the unfunded pension liability problem during the next 25 years.

Unfortunately, the pension law changes do not even come close to solving the structural budget deficit problem.

For the past six years the Fiscal Futures Project at the University of Illinois' Institute of Government and Public Affairs has developed a robust measure of the state's fiscal problems and a technique for projecting the gap between total revenue and total spending into the future. Our measure is broad-based, takes a long-term perspective and focuses on sustainable revenue.

Our analysis of the state's fiscal situation before the recent pension changes projected a $4 billion deficit in FY2015, which would get larger each year and reach nearly $13 billion in 2025. That is a serious budget gap, and one that is impossible for the state to maintain for long. It's like a family spending $5,000 each month when they only have $4,700 in income — and that $300 monthly gap growing to $800 each month in 10 years. Just like for this family, this situation is unsustainable for the state.

While the pension changes were at least implicitly touted as helping deal with this large and growing budget gap, they actually affect it very little in the long term. The new pension law does substantially reduce the fiscal burden to the state of paying for future pension obligations. The savings to the state come mostly from reductions in cost-of-living adjustments for current and future recipients of state pensions.

But for the next 10 years, the state will use most of the savings from the law to address the unfunded liability. The state will only allocate about $1 billion each year to reduce the annual scheduled payments to the pension funds. So with the new pension law in place, the projected deficit goes from $3 billion in FY2015 to $13 billion in 2025 — still a huge shortfall and hardly different than the situation prior to the pension changes.

Could higher taxes fix the deficit? Our projections assume current tax law, with the temporary tax hike from 2011 declining as scheduled starting in 2015. One policy option is to eliminate the phase-out and make the higher income tax rates adopted for 2011-2014 permanent.

We used the Fiscal Futures Model to project the effects of maintaining higher tax rates. Using pre-December 2013 pension law, maintaining higher taxes eliminates roughly half the budget gap. Including the $1 billion annual savings in pension payments under the new law results in a deficit of $1 billion in FY2015, growing to $6 billion in FY2025 — better, but still a significant shortfall.

What is the take-home from this analysis? The work is not over, yet. Now is not the time for complacency from taxpayer-voters or our elected representatives. Illinois' fiscal problems are multi-dimensional and of such magnitude that, even if the recent pension law revisions withstand a constitutional challenge, large and painful tax increases and/or spending cuts will still be needed to get the state back on sound fiscal footing.

If followed for the next couple of decades, the December 2013 pension law changes will deal with one of the major financial problems of the state: the massive unfunded public pension liability. But it fails to make any significant headway on our other major financial problem: we spend too much and/or tax too little. The governor, state legislators and Illinois residents need to face this unresolved problem as soon as possible. The longer we wait, the worse it gets.

Professor Richard F. Dye is an economist and co-director of the Fiscal Futures Project at the University of Illinois Institute of Government and Public Affairs. To read more about the project: igpa.uillinois.edu/fiscalfutures.

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