Part 1: Illinois is the Nation's Extreme Outlier
Illinois’ General Assembly has refused to solve the state’s ever-growing retirement crisis for more than three decades. And for three decades, Illinois’ finances have steadily decayed. Debts have grown by billions year after year despite assurances by lawmakers that budgets were balanced and actions had been taken to bring the crisis under control. Illinois is now a national outlier, and in many cases, an extreme outlier – on almost every financial, economic and demographic metric that matters.
Pensions aren’t Illinois’ only problem, but because their costs dominate government budgets, their impact is felt everywhere. There’s no fixing Illinois without changing the current system and dramatically reducing the state’s retirement shortfalls.
The costs of retirement debts are overwhelming every constituency in Illinois. Retirement security for most government workers has collapsed in tandem with falling funded ratios. Spending on Illinois’ most vulnerable is being crowded out as retirement costs have grown to consume more than a quarter of the state’s budget; no other state spends nearly as much on retirements. And ordinary residents who pay for the costs of their public servants are being crushed by the country’s highest property taxes and one of the nation’s highest combined state and local tax burdens.
The evidence of the state’s decay can be captured in just two metrics: the state’s credit rating and domestic out-migration.
No state has ever been rated junk before, but today Illinois is rated just one notch above junk with a negative outlook. The rating embodies not just the state’s fiscal failures, but also the continued failed governance of the General Assembly. It’s not as if lawmakers weren’t warned of the consequences of their mismanagement. The big three rating agencies have downgraded Illinois 22 times since 2009.
Illinoisans have fled the state’s growing problems in record numbers. No other state lost more people over the last decade than Illinois. What was revered as the country’s destination state just 60 years ago is now a state with a shrinking population and the nation’s second largest rate of domestic out-migration.
This first part of Wirepoints’ four-part series lays out how Illinois is the nation’s extreme outlier and the negative impact that status has on people’s lives and livelihoods.
Illinois’ worst-in-nation crisis
Illinois is a national outlier when it comes to the financial well-being of the state and its residents.
Illinois has the nation’s largest pension shortfalls, both in amount and on a per capita basis. Total retirement debts consume more of Illinois’ budget than they do in any other state in the country, by far. And retirement costs have helped drive Illinois’ overall tax burden to one of the highest in the nation.
All of that has created a crisis of confidence in Illinois. The state has the nation’s lowest credit rating, sitting at just one notch above junk.
And since 2010, Illinois’ population has shrunk by more than any other state as residents have left in record numbers. That’s contributed to a fall in real property values and a vicious downward spiral for the state.
Moody’s Investors Service puts the pension shortfall for Illinois’ five state-run pension funds at $241 billion. Illinois’ debts dwarf those of its neighbors as well as those of the largest states in the country by population. Illinois is the extreme outlier nationally.
The same can be said when debts are measured on a per capita basis. At nearly $19,000 per person ($50,000 per household), Illinoisans’ pension debt burden is six times larger than the national average. Compared to residents in neighboring Wisconsin and Iowa, Illinoisans’ burden is 10-12 times larger.
That burden is overwhelming the state’s economy, with state level-debts alone now equivalent to 28 percent of the state’s annual GDP. In most of Illinois’ neighboring states, the debt is just 3 to 6 percent of the economy.
State-level retiree health insurance liabilities add to Illinois’ debt load. According to Moody’s, as of 2018 each Illinois household was on the hook for more than $11,700 in official unfunded retiree health insurance benefits, the nation’s 6th-most. That amount is more than double the national average and six times what Kentuckians owe.
And it’s many times more than what households in states like Wisconsin and Indiana are burdened with. The combined cost of those retirement debts already consumes more than a quarter of Illinois’ state budget – the most of any state nationally.
That has crowded out new spending on other core priorities such as education. Billions of state appropriations for K-12 and higher education dollars are being spent on pension costs instead of students in the classroom.
And it’s still not enough. Illinois’ retirement crisis continues to grow because the state can’t afford to pay what it really should to get its retirement costs under control. J.P. Morgan’s Michael Cembalest calculates that more than half of the state’s budget is needed to make pensions and retiree health insurance actuarially sound.
That’s the largest share of any state budget, by far. Yet again, Illinois is the nation’s extreme outlier.
The problem of crowd out is not going to go away. The Commission on Government Forecasting and Accountability projects that the state’s statutory pension costs alone will consume a quarter or more of the budget for the next 25 years. And that’s the official, rosy estimate. Additional revisions to the pension funds’ assumed investment rates of return and other actuarial assumptions will likely cause official pension costs to consume even more of the budget over the next two decades.
Illinois simply can’t compete with its neighbors on services and tax levels when over a quarter of its budget is perpetually consumed by pensions. The extreme cost of Illinois’ retirement debts has also pushed residents’ overall tax burdens to punitive levels.
As pension costs have grown to consume nearly half of what the state appropriates on K-12 spending, local school districts have raised local property taxes to pay for Illinois’ bloated educational bureaucracy. Add to that the costs of Illinois’ local public safety pension crisis and that’s helped drive the state’s property tax rates to the highest in the nation – more than double what residents in Missouri, Indiana and Kentucky pay.
That statewide average doesn’t do justice to how destructive property taxes have become for some homeowners. In many Illinois communities, particularly in Chicago’s southland area, effective property tax rates have reached confiscatory levels of 5 percent or more.
According to Cook County Treasurer Maria Pappas, more than 57,000 Cook County property owners were delinquent on their taxes in 2019. Many are at risk of losing their homes.
But while property taxes impose the most public and painful burden in Illinois, they are only a part of the state’s overall tax structure. Illinois’ overall state-local tax burden is one of the nation’s highest. Kiplinger and Wallethub both rank Illinois’ tax burden as the highest/worst of any state, with Kiplinger calling Illinois the “Least Tax-Friendly State” in the nation. The Tax Foundation says Illinoisans are burdened by the 5th-highest taxes in the nation.
Federal Reserve Bank of Chicago economist Leslie McGranahan goes further, saying Illinois’ combined tax burden has been high for decades. McGranahan says Illinois has consistently ranked near the top of all states for state and local tax revenues per capita – tracking closely with the 80th percentile (the country’s top 10 states). Illinoisans have been paying more in total taxes than residents in most other states for the last 60 years.
A crisis of confidence
Illinois’ damaging budget crowd out and taxes – and the expectations for even more of both – have created a crisis of confidence in Illinois.
The state’s credit rating is arguably the most comprehensive indicator of Illinois’ financial health. It has collapsed after 22 downgrades from the nation’s three major ratings agencies over the past 11 years.
Moody’s Investors Service, S&P Global Ratings and Fitch Ratings have each downgraded Illinois to just one notch above junk, the lowest rating of any state. All three have also assigned a negative outlook to Illinois, warning of future downgrades. No state has ever been rated junk.
The City of Chicago is already rated one notch into junk by Moody’s, while Chicago Public Schools is four notches into junk. Cook County continues to be investment grade, with an A2 rating, but its rating is stuck between New Jersey and Connecticut, the nation’s two worst-rated states excluding Illinois.
The state’s low rating has resulted in punitive borrowing costs. Illinois pays interest rates on its debts that are multiple times higher than other states. At over 5.5 percent as of May 2020, Illinois’ rate is now five times the 1.1 percent rate it costs AAA-rated states to borrow.
The lack of confidence is costing Illinois jobs and investments as businesses stay out of the state. For example, Warren Buffett says he wouldn’t relocate a business to a place like Illinois:
“In the public sector, you know, it’s a disaster…If I were relocating into some state that had a huge unfunded pension plan, I’m walking into liabilities…And those are big numbers, really big numbers…And when you see what they would have to do – I say to myself, ‘Why do I want to build a plant there that has to sit there for 30 or 40 years?’”
Illinoisans have expressed their own lack of confidence in Illinois by voting with their feet. U.S. Census data show that a net of 1.6 million Illinoisans have moved out of this state since 2000. Only New York and California lost more people. In all, domestic out-migration from Illinois resulted in a net loss of almost 13 percent of the state’s population as of 2000.
Those losses aren’t normal, even for a cold weather state in the Rust Belt. Neighboring states like Indiana, Wisconsin and Iowa have seen far smaller out-migration losses both in nominal and percentage terms.
And as residents have left, they’ve hurt Illinois’ tax base. According to domestic migration data from the Internal Revenue Service, Illinois has lost an average of 62,000 tax filers and their dependents to other states every year since 2000. On average, Illinois lost $2.8 billion in adjusted gross income (AGI) due to out-migration annually.
Those numbers have ramped up in recent years as Illinois’ crisis has deepened. Net annual losses of residents have exceeded 80,000 while AGI losses have topped $5 billion.
The impact of losing those residents and their income is even bigger than it first appears. One year’s worth of losses don’t just affect the tax base the year they leave, but also all subsequent years. The losses build on each other, year after year. Add up the compounded losses since 2000 and Illinois’ cumulative AGI loss totals $410 billion.
The taxes lost as AGI has left have contributed to the state’s deepening fiscal woes. Illinois’ record losses to out-migration have been just one part of the state’s overall demographic collapse.
Net foreign immigration to Illinois has fallen by half since 2001. And the state’s net natural increase (births minus deaths) is down more than 50 percent.
All those demographic factors combine into a single fact: Illinois is shrinking. There are 170,000 fewer people in Illinois today than in 2010. No other state lost as many people and, in fact, only four states nationally lost population over that time period.
A falling population has perpetuated Illinois’ downward spiral. Lower demand for homes, in tandem with growing debts and rising taxes, has pushed real home values down. U.S. Census Bureau data show Illinois median home values have grown just 11 percent since 2005, the 6th-worst growth nationally. That’s far short of inflation, which was up 30 percent over the same period.
Chicagoans, in particular, have been hit hard since 2000 when it comes to their home values. Windy City residents would have been far better off today if they’d owned property in any of the other nine cities that make up the Case-Shiller 10-City Composite Home Price Index.
Chicago home prices have grown just 44 percent since 2000. By comparison, inflation was up 46 percent over the same time period. Meanwhile, home prices in Los Angeles grew four times those in Chicago, or 181 percent. Prices in Miami, up 143 percent, and Washington D.C., up 130 percent, have grown three times more than those in Chicago.
All these facts reflect Illinois’ outlier status before the COVID-19 crisis. The damage inflicted by the virus and the economic shutdown will inevitably make those numbers even worse.
Illinois’ per capita debts are overwhelming
Another way to understand the depth of the retirement crisis is to look at Illinois’ $420 billion in Moody’s calculated retirement debts on a per household basis. (See the Appendix for a full breakdown of the $420 billion.)
Residents in the City of Chicago are burdened with $141 billion of those retirement debts. That’s the total overlapping city, county and state debt, based on Moody’s calculations, each Chicago household is saddled with. Divide that shortfall between the city’s one-million-plus households and the burden works out to $135,000 each. Call it a “shadow mortgage.”
Take the remaining $279 billion in debt and divvy it up among the 3.8 million households outside of Chicago, and their burden amounts to $74,000 each.
The true household burden is far larger
The reality is many Illinois families don’t have the means to contribute toward Illinois’ retirement shortfalls. Nearly 15 percent of all Illinoisans are in poverty and just 44 percent of Illinois households make more than $75,000 – a proxy for which households are more capable of taking on a shadow mortgage.
When the burden of that $420 billion debt is placed solely on those households earning $75,000 or more, Chicagoans are saddled with $370,000 each. And non-Chicago households are on the hook for $174,000 each.
The amounts are overwhelming and will only get worse as Illinoisans continue to escape that shadow mortgage. As more Illinoisans leave, the debt on those that remain will grow even larger.
Illinois’ outlier status isn’t just a grim anecdote. Illinois’ reputation as financially irresponsible has serious consequences, encapsulated in its near-junk status and its record flight of residents.
The state has reached the point where gimmicks used to avoid real reform – the same ones that landed Illinois its rating – are no longer available. The impact of COVID-19 has only further restricted the state’s options. Borrowing any meaningful amount, without additional federal backing, will be extremely difficult. Tax hikes will inflict additional harm on residents and businesses that have been crippled by the economic shutdown. Shorting the pension funds will trigger even more punishment from rating agencies. And reamortizing pension debts further into the future won’t be accepted by the agencies either.
The state’s retirement debt is insurmountable without significant changes to Illinois pension systems. But before a solution can be adopted, a proper diagnosis of the problem must be performed.
The second part of Wirepoints’ four-part series will cover how overpromised benefits, and not underfunding, has been the main cause of the state’s retirement crisis. And it will show how overly generous pension and retiree health insurance benefits have driven those unaffordable promises.
Appendix: The Numbers
Summary of Illinois’ state and local retirement shortfalls
Illinois had $288 billion in official state and local public sector retirement shortfalls in 2018. That was made up of $134 billion in unfunded pension debt for its five state-run pension funds.
Additionally, Illinois has a $56 billion retiree health insurance shortfall and $11 billion in pension obligation bonds. Local government retirements were short another $87 billion. As large as those amounts are, the official numbers vastly understate the true size of Illinois’ debts.
Official government numbers use rates near 7 percent to discount future obligations, while true market rates are far lower.
Financial experts – from Nobel prize winners like Stanford’s Prof. William F. Sharpe and University of Chicago’s Prof. Eugene Fama to other academics including Hoover Fellow Joshua Rauh and Jeremy Gold – criticize the use of inflated discount rates.
Moody’s Investors Service uses more appropriate discount rates based on AA-rated corporate bonds, resulting in pension shortfalls that are far higher than official estimates. The discount rate used by Moody’s for its 2018 calculations was 4.14 percent.
When Illinois’ debts are added up based on Moody’s analysis, Illinoisans are subject to $420 billion in state and local retirement shortfalls. That’s a 46 percent increase in the debt Illinoisans are on the hook for when compared to official numbers.
Illinois’ total debts will get far larger, however, as Moody’s updates its calculations with even lower discount rates. As of April 30, 2020, that rate had fallen to 2.8 percent, a reflection of the continued collapse in long-term yields. Structurally, those rates have fallen in tandem with the 10- year U.S. Treasury rate, which is now below 1 percent.