Moody’s report: Illinois one of two states unprepared for next recession

Financial stress testing shows Illinois and New Jersey are the most unprepared for the next recession. Both states lack sufficient rainy day funds and struggle with large pension debt.

A new report from credit rating agency Moody’s Investors Service highlights the potential consequences of Illinois’ poor fiscal health. Lawmakers in Springfield should take away a simple lesson: without meaningful action to structurally reform the state budget, the next recession will cause serious problems for the Prairie State.

Recent surveys have found 75% of business economists in the U.S. expect the next recession to hit by 2021.

According to Moody’s, Illinois and New Jersey are the two states least prepared for the next economic downturn and “are likely to face more difficult challenges than other states.” Recession preparedness is stronger for 22 states and moderate for the other 26.

Moody’s stress test looks at four factors:

• Revenue volatility, which measures how much state revenues decline when the economy slows
• Coverage by reserves, or whether a state has enough rainy day funds set aside to offset lost revenue from a recession
• Financial flexibility, which looks at both the number of restrictions imposed on state budget making and the percentage of revenue going to fixed costs such as debt service, as well as each state’s long-term structural balance
• Pension risk, a measure of what would happen to public pension funds if a recession leads to a loss in investment assets on hand to pay benefits

Consistent with past research, Moody’s finds that Illinois scores particularly badly on pension risk and coverage by reserves. The state’s paltry rainy day fund could not cover even half of the revenue loss likely to be caused by a downturn, and Illinois’ pension debt-to-revenue ratio is far worse than any other state’s. If Illinois continues on its current path, the only way to pay pension benefits and balance budgets after a recession would be severe cuts in services, more tax increases or more borrowing.

While Illinois scores as “moderate” on the other two criteria, Gov. J.B. Pritzker’s plan to scrap Illinois’ constitutionally guaranteed flat tax in favor of a graduated or “progressive” income tax structure would make Illinois’ revenues more volatile. Tax systems that rely heavily on the wealthy experience more dramatic ups and downs with the economic cycle. That’s because a bigger share of revenue is coming from a smaller number of people whose income contains more earnings from capital gains and other investments likely to decline in a poor economy.

Moody’s acknowledged the link between progressive income tax systems and volatility in its report. “States with historically the most volatile revenues are those that rely on the energy sector as well those relying on the highest earners through high and progressive personal income tax rates,” Moody’s stated.

Illinois must break with the status quo to prepare for the next recession

Unfortunately, bad budget news is nothing new to Illinois residents.

Illinois’ pension debt-to-revenue ratio of 601% was an all-time high for any state, Moody’s reported last year. From 2005 to 2018, Illinois’ average annual rainy day savings of less than 1% of operating revenue placed it at 45th in the U.S., the Illinois Policy Institute found. Finally, Illinois’ overall budget health was ranked as the worst in the nation by the Mercatus Center at George Mason University.

But despite the poor state of affairs, Illinois’ fiscal health is not beyond repair.

The Illinois Policy Institute shows how necessary, commonsense reforms can be achieved in its recently released “Budget Solutions 2020: A 5-year plan to balance Illinois’ budget, pay off debt and cut taxes.”

State lawmakers must rein in the growth in spending, and the most critical single aspect of any good budget plan in Illinois is meaningful pension reform. Amending the Illinois Constitution’s pension clause to allow for adjustments to the growth in future benefits could put the state on a trajectory where pension contributions are significantly lower in the short term, but also sufficient to eliminate the state’s unfunded liability more quickly than planned under current law.

Springfield has the power to eliminate annual budget deficits, pay off growing debt and set aside sufficient reserves to prepare Illinois to comfortably weather the next recession. To do so, lawmakers must have the courage and political will to break with the state’s failed status quo.

Moody’s most recent report is yet another warning. Illinois leaders need to act.