Illinois passed a budget, and its bonds may still be headed toward junk according to rating agency Moody’s. Springfield, the state's capitol, is shocked. Balanced or not, Illinois was expecting its credit rating not to be lowered to junk just because a budget was passed.
There is many a sign of a chronic debt problem that one may point to in showing that the issue has gotten way out of hand, but the expectation that a mere passing of a budget, whatever is in it, means “fiscal responsibility” may top that list.
In order to pass a budget, Illinois lawmakers raised taxes over the governor’s veto. The state income tax rose 32% from 3.75% to 4.95%, and the corporate income tax rose from 5.25% to 7%. This may not sound like much on its own, but in addition to the sales tax, personal federal income tax, corporate federal income tax, capital gains tax and everything else, it raises the question how much are the people of Illinois bringing home on net. Whatever the absolute amount, the answer is less than most. There will probably be a net migration out of Illinois because of this, and that will not help the state’s budget long term.
Net spending cuts, or the total budget of a given government – local, state or federal –Â being reduced in absolute terms is quite hard to come by these days, if not impossible. That’s why politicians now expect kudos and a pat on the back for passing a budget, regardless of the level of spending in that budget. This is, obviously, a serious problem.
The politicians in Springfield may be blindsided, but those of us that must manage our own finances without the ability to tax others for the money we need simply on majority vote understand that getting your credit downgraded for spending too much is just normal life. Most of us proceed to cut spending to the point of a balanced budget at the very least. While Illinois has indeed cut spending by $2 billion, it still has a budget deficit of $6.2 billion and $14.7 billion in bills past due already.
The danger of this is not really centered on Illinois itself. The danger is inherent in the government’s response to this crisis. If, as Moody’s has threatened, Illinois is cut to junk, then Illinois will either have to severely cut its promised pensions to retirees and union members or it will have to ask the federal government for a bailout.
No U.S. state has ever been downgraded to junk, not once in the U.S.’s 241-year history. Cities and counties have gone bankrupt but never a state. Illinois may be the first. And after that, New Jersey, Connecticut and Massachusetts may be next, widely considered in worse fiscal shape than Illinois.
If you follow debt statistics and the various fiascos at different levels, you may be familiar with Meredith Whitney, who forecasted the collapse of Citigroup during the 2008 financial crisis. She became too bold with her predictions of municipal financial collapse and bowed out of hedge funds subsequently in 2015, incurring much public embarrassment. She may have just been a few years too early though.
If this trend of states asking for better ratings simply for passing a budget continues, balanced or not, she may in the end be vindicated for predicting a debt implosion only slightly earlier than its time.
2008 may have been the limit by the sheer amount the federal government is willing and able to bail out. But if Illinois actually goes bankrupt by being unable to service its debt, Whitney may have the last laugh. The feds are already over 100% underwater by debt to gross domestic product. Bailing out an entire state may be beyond their ability to borrow.
With New Jersey, Connecticut and Massachusetts in worse fiscal shape than Illinois, it may only be a matter of time before the government says no to its first state bailout. Beware bond yields then, on both the federal and state levels, especially considering that the Federal Reserve is already on a rate hike path.
