2024 State of the State: Federal rescue is over, so Illinois needs caution

The pandemic had an upside for Illinois state finances – infusing federal dollars as state revenues exceeded projections. Now federal aid is gone. Illinoisans’ ongoing struggles warrant caution, reform in the state’s fiscal year 2025 budget.

With Gov. J.B. Pritzker poised to deliver his joint State of the State and annual budget address Feb. 21, the question is whether he will present another record spending proposal – $12 billion higher than when he took office – and how he will avoid the deficit his budget office projected.

The Governor’s Office of Management and Budget in November projected $52.3 billion in spending for fiscal year 2025 but only $51.5 billion in revenues. The state no longer has federal pandemic relief funds to cover any deficit.

While we await the full details of the governor’s proposal, it is worthwhile to examine where Illinois finances currently stand, what everyday Illinoisans are experiencing living in the state and what the state should contend with as the budgeting process unfolds.

State finances

Pritzker will be sure to tout the improvement in Illinois’ financial outlook. And yes, state finances have improved in recent years with billions in federal aid and higher than anticipated revenues. Illinois state government received more than $8.1 billion in federal funds after the pandemic to buoy the state budget. While these funds were meant to shore up state finances amid declining revenues, among other things, state revenues rebounded quicker than expected and have grown to far surpass original projections with total general funds revenues coming in $5.5 billion higher than expected in 2023. The combination of billions in federal aid and higher than anticipated revenues left Illinois with the opportunity to improve its fiscal footing.

Illinois was able to use federal funds and access to the Federal Reserve’s Municipal Liquidity Facility to pay down the state’s bill backlog, which stood at $5.4 billion at the beginning of FY 2021. The increased funds have allowed the state’s accounts-payable amounts to align with a normal 30-day bill payment schedule.

The state also used $4 billion in federal funds to repay the debts racked up in the Unemployment Insurance Trust Fund, which was depleted during the pandemic. Still, late payments to repay the fund left taxpayers on the hook for a tax hike after an increase in the wage base used to determine unemployment insurance taxes and $60 million in interest because of missed payments.

Enhanced revenues also allowed Illinois to begin to build up the state’s paltry rainy-day fund. The state had less than $6 million in the budget stabilization fund in fiscal year 2021, but now the balance totals more than $2 billion. Still, that amounts to only 15 days’ worth of state spending based on the FY 2024 budget, and Illinois’ total reserves remain the lowest in the nation.

That amount is also still extremely low compared to state Comptroller Susana Mendoza’s own target of 7.5% , or $3.8 billion to cover just over 27 days of state spending. But Illinois should have enough in reserve to run the state for 60 days, experts with the Government Finance Officers Association recommend. That is $8.3 billion for the 2024 fiscal year budget of $50.6 billion. Illinois needs to quadruple its rainy-day fund to have adequate savings on hand.

Bolstered state revenue – no matter the source – has allowed Illinois to pay down debts and begin to develop some semblance of a rainy-day fund. These improvements to state finances led Illinois to begin receiving credit ratings upgrades from all the major ratings agencies in recent years. Despite these upgrades, Illinois’ credit rating remains the lowest of any state, according to S&P ratings.

What particularly stings for Illinoisans is while Illinois was spending billions to correct past fiscal mismanagement, other states were able to take advantage of their improved financial situations to deliver real, permanent relief to citizens. In total, 26 states cut their personal or corporate income tax rates from 2021-2023, which will return an estimated $124 billion to taxpayers through 2028. All of Illinois’ neighboring states were able to provide tax relief to citizens during that time.

Illinoisans were not afforded any permanent tax relief because of the state’s precarious finances. Instead, lawmakers issued a temporary reduction in the state’s 1% grocery tax, temporarily delayed the annual gas tax hike – giving drivers two increases last year – made a one-year property tax rebate worth up to $300 and a one-year individual income tax rebate worth $50 per income earner and $100 per dependent for up to three dependents. In total these resulted in around $556 in temporary tax relief per household. Taxes returned to normal levels in 2023.

Illinoisans’ outcomes

While state finances have improved in recent years, Illinoisans still find themselves struggling on virtually every front.

First and foremost is the state’s rampant population decline. Despite the recent good news that Illinois was undercounted by 46,400 in the 2020 Census, more than 364,000 Illinoisans have left the state since then. Domestic outmigration is the sole cause of population decline and the Census Bureau has estimated Illinois’ population has shrunk for 10 consecutive years. Both population decline and domestic outmigration in Illinois are among the worst in the nation. Estimates of Illinois population decline have been substantiated by the IRS and moving companies U-Haul and United Van Lines.

One of the main reasons why Illinoisans move is because of the labor market, where outcomes for Illinoisans are poor. The state ranked 42nd for job growth in 2023. It has only added 4,000 jobs compared to pre-pandemic levels in January 2020. The national economy has added more than 5 million jobs during that time. Not only has job growth been stagnant, virtually every sector of the economy was lagging the national average when it came to adding jobs in 2023.

As a result of sluggish job growth, Illinoisans are battling the third-highest unemployment rate in the nation at 4.8%.

The national unemployment rate is currently 3.7% and the gap between Illinois and the rest of the country is growing, as Illinois’ unemployment rate has been increasing every month since July while the U.S. unemployment rate has fallen.

Not only are Illinoisans struggling to find jobs, those who do have them are seeing their wages grow at an abysmal rate compared to other states. Wage growth in Illinois is 43rd in the nation and average hourly wages, which total $33.61 in Illinois, were below the U.S. average of $34.36 in December 2023.

Making matters worse for Illinoisans contending with sluggish wage growth is that inflation is up 18% since the beginning of 2021, exacerbating slow growth in wages. While inflation has cooled in recent months, price levels for consumers are now far higher than just a few years ago.

The jobs market might not see substantial improvement soon, either. Growth in business formation activity in Illinois is at one of the lowest levels in the nation. Illinois ranked 42nd in growth in business applications in 2023, 40th in growth in high-propensity business applications – those deemed most likely to result in employer businesses. Only Wisconsin is doing worse among neighboring states.

Similarly, Illinois’ housing industry is also struggling compared to other states. Construction activity, measured by residential building permits, is among the lowest in the nation. Ranking 47th for all real estate types and 46th for single-family homes in 2023.

Low home building activity contributes to the growth in home prices as demand is limited. This exacerbates housing affordability for many Illinoisans whose wages are already below the national average and growing slower than in most other states. Another major component of housing affordability in Illinois is property taxes. Illinoisans pay the second-highest property tax rates in the nation, at an effective rate of 1.95%. Only New Jersey homeowners pay higher rates.

High property taxes represent nearly four additional mortgage payments every year for recent homebuyers – even at today’s higher interest rates. Those who purchased their homes at lower interest rates see property taxes take up an even larger share of their housing costs. Renters are also affected by high property taxes as rents are used to cover property tax costs for landlords. Nearly half of Chicagoans who rent spend more than 30% – the generally recommended amount – of their incomes on rent, with property taxes and little increase in housing supply being a large part of the reason why.

But high property taxes are just one of the many high taxes Illinoisans face. Overall, Illinoisans pay the seventh-highest state and local tax burden in the country and highest in the Midwest. The high tax burden is thanks to the nation’s second-highest property taxes, the second-highest corporate income taxes and the seventh-highest sales taxes. Ranked ninth, the state also has one of the worst unemployment insurance tax systems.

The combination of high taxes isn’t just bad for individuals: it hurts businesses. Overall, the state’s business tax climate ranks 37th in the U.S., the second worst of any state in the Midwest. Illinois’ saving grace is its flat 4.95% individual income tax rate, which the Tax Foundation ranks 14th best in the nation.

2025 budget implications

Illinois’ poor fiscal management has left taxpayers facing some of the highest burdens in the nation, and suffering from poor labor and housing markets as a result. Billions in federal funds and higher than expected revenues allowed the state to pay down some of the costs of past mistakes. However, there are several pitfalls the state needs to avoid in the upcoming budget season.

The most important item in the 2025 budget is the state’s pension contribution costs. Currently, Illinois plans to underfund pensions in the 2025 budget by more than $4.8 billion. Last year, the state shorted pensions by $4.1 billion despite Pritzker touting “extra” pension payments.

Illinois plans to contribute $11.3 billion to the state’s five state-run systems, according to the state’s current pension funding plan. The state needs to contribute nearly $16.1 billion to the systems to make an actuarially sufficient contribution – one that covers costs for the current year and begins to pay down the state’s debt pursuant to the Governmental Accounting Standards Board Statements 67 and 68. Shorting the pension funds is permissible by state law but makes the budget inherently unbalanced.

Even if Illinois’ budget is “balanced” pursuant to state law, there are still several concerns regarding state revenues. First, Illinois has fully expended its federal funds from the pandemic and higher-than-anticipated revenues can’t be expected to persists in perpetuity. Base general revenue funds are down $61 million so far compared to last year after a $696 million decline in overall January receipts. Meanwhile, the Governor’s Office of Management and Budget revised revenue projections for fiscal year 2024 upwards by $1.4 billion in November 2023.

The Commission on Government Forecasting and Accountability will issue new revenue estimates in March, but the governor should be cautious in his spending proposal to allow breathing room if revenues come in lower than expected.

The matter is further complicated because there is no standard, agreed-upon procedure for estimating revenues. These estimates can become highly politicized and unreliable. From 2008 to 2020, the legislature’s projections were “on target” just five times while the governor’s office projections were right just twice. The National Association of State Budget Officers defines solid projections as being within 0.5% of actual revenues.

Lastly, if Illinois’ state revenues continue to come in strong, the state should not be pursuing any radical new spending proposals. Rather, “excess” revenues should be dedicated to bolstering the state’s lowest-in-the-nation rainy day fund and pursuing permanent tax relief, like what most other states were able to do during the past several years. Setting aside revenue to pay down unexpected costs is essential and is one of the chief reasons Illinois was not able to take advantage of improved finances in the same way other states did after the pandemic.

Additional items to pursue

To make these goals a reality, state lawmakers must approve constitutional pension reform to both provide retirement security for those reliant on the pension system – remember the state is currently underfunding pensions by $4.8 billion annually – and provide stability to the state budget and tax relief for citizens.

A “hold harmless” pension reform plan such as one originally developed by the Illinois Policy Institute – based loosely on bipartisan 2013 reforms – could help to eliminate state and local unfunded pension liabilities and achieve retirement security for pensioners.

Previous analysis showed changes such as capping pensionable salary, replacing 3% compounding raises with true cost-of-living increases and adjustments to realign benefits with historical inflation rates would have saved the state $2.4 billion in the first year alone, and more than $50 billion by 2045. It would also fully fund the plans, as opposed to the state’s goal of 90% funding, to truly safeguard retirees’ benefits.

There are additional savings measures the state could also take to begin to reel in spending to a tenable level without compromising service. Realigning health care costs for public employees – who currently pay health insurance costs at half the rate of the private sector – would save the state nearly $500 million annually. Consolidating Illinois’ school district administration, without closing schools, could also save the state more than $500 million in administrative costs without affecting classroom funding.

A responsible spending cap that limits growth in state expenditures to the growth rate of the economy would alleviate the most fundamental problem with Illinois’ budget: expenditure growth exceeds taxpayers’ ability to pay. This misalignment means Illinois is bound to face either frequent budget shortfalls, perpetually rising taxes or both. Illinois needs a spending cap to protect taxpayers from continuous tax hikes and to rein in runaway state spending. Illinois overspending has driven:

• The two largest income tax hikes in state history, in 2011 and 2017
• Pritzker enact 20 new tax and fee hikes totaling $4.6 billion in 2019
• Voters forced to stop a $3.4 billion income tax hike in 2020
• Pritzker and some lawmakers push a $500 million to $1 billion tax hike on small businesses
• Pritzker threaten to raise the flat income tax by 20%
• Pritzker propose $932 million in tax hikes in his 2022 budget.

A spending cap would eliminate the constant call for these tax hikes. By linking growth in the state budget to the average growth in the Illinois economy, lawmakers would be able to reasonably predict how much additional state spending their constituents could afford in the coming year without the need to raise taxes. This procedure would create stability within the state budgeting process and allow for modest growth in government funding while also protecting taxpayers from future tax hikes.

Conclusion

Illinois’ state finances have undoubtedly improved in recent years after more than $8 billion in federal aid and stronger-than-projected revenue growth. As a result of these fortunate circumstances, Illinois has been able to pay off state debts and begin to build a more adequate rainy-day fund. However, because of historical fiscal mismanagement, Illinois was not able to provide any substantial, permanent relief to taxpayers or create stability in the state budget. Future budget shortfalls are also expected to return in the coming years, ranging from $891 million in fiscal year 2025 to $1.66 billion in fiscal year 2027, according to the most recent forecasts from the Governor’s Office of Management and Budget.

Rather than adding new spending, Illinois’ budget should focus on increasing reserves to build the foundation for future tax relief. This effort would benefit from constitutional pension reform, aligning government health care costs with the private sector, reducing the administrative costs of Illinois 850-plus school districts and enacting a responsible spending cap. These measures would put Illinois on a sustainable fiscal path and provide much-needed relief for Illinoisans who are struggling under the weight of Illinois’ highest-in-the-Midwest tax burden.