Testy Illinois governor race holds no cure for state finances

Neither incumbent Democratic Governor Pat Quinn nor wealthy Republican private equity investor Bruce Rauner has revealed a workable “Plan B” to strengthen the pension system, the most underfunded of any U.S. state.

In the municipal bond market, the credit ratings for Illinois’ bonds are A3 and A-minus, the lowest among the U.S. states. Credit rating agencies have warned that without cost-saving pension changes, ratings on the state’s nearly $30 billion of general obligation debt could fall to the triple-B level. Only a few states have ever had their ratings drop this low.

The ratings could also take a hit from a scheduled partial rollback of a temporary hike in state income tax rates in January. The added tax revenue has helped the state make its pension payments.

Illinois’ pension reform law, on hold due to litigation in a county court, reduces and suspends cost-of-living increases for pensions, raises retirement ages and limits salaries on which pensions are based.

Quinn hopes the law, enacted last December to ease a $100 billion unfunded liability, will survive the court challenge brought by unions and others claiming it violates a state constitutional provision designed to protect public worker pensions.

“We don’t have a decision in the supreme court. If the court acts in a way that is contrary we will take necessary steps,” Quinn said during a recent gubernatorial debate.

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Rauner, who was previously a top executive at private equity firm GTCR for more than 30 years, contends the pension law is unconstitutional. His campaign website says he would ensure pay and benefits do not rise faster than the rate of inflation; eliminate massive pay raises before retirement that increase pensions; and move toward a defined contribution system.

Union leaders say Rauner’s approach would not survive a court challenge.

“It’s blatantly unconstitutional. It would strip public employees of security in retirement, and it would bankrupt the retirement systems by draining them of funds,” said Anders Lindall, a spokesman for American Federation of State, County and Municipal Employees Council 31, the state’s biggest public labor union.

Pension reform remains at the center of the governor’s race in part because of a state supreme court ruling in an unrelated case in July. The court found that health care for retired state workers is a pension benefit, and as such is protected from cuts by the state constitution.

Amanda Kass, research director at bipartisan think-tank Center for Tax and Budget Accountability, said the correlation with the state pension law is clear. “That ruling indicates that the law is going to be struck down,” she said.

CALLS FOR ACTION

Business groups worry that the two candidates have offered no realistic plan for dealing with a likely court setback.

“The would-be governor and the members of the General Assembly have to be thinking about what do we do if they overturn it,” said Ty Fahner, president of the Civic Committee of The Commercial Club of Chicago.

Fahner, a former Illinois attorney general, said the state could prevail with its argument that its duty under the state constitution to protect health and welfare overrides the constitution’s pension provision.

Laurence Msall, president of The Civic Federation, a Chicago-based fiscal watchdog, said the next governor needs “a laser-like focus” on a long-term fiscal plan that eschews gimmicks. The group estimated the $1.8 billion revenue loss from the upcoming tax rate rollback would balloon Illinois’ chronic stack of unpaid bills to $6.4 billion by June 30, the first increase in three years.

Quinn based his fiscal 2015 budget on maintaining the tax increase. Rauner’s plan calls for eliminating the 2011 income tax hike, raising more than $600 million by extending the state sales tax to certain services, and freezing local property taxes.

Regardless of who wins, Illinois is headed for tough times even if the court approves pension reform, according to the Institute of Government & Public Affairs at the University of Illinois. Taking into account the projected $1 billion in annual budget savings from pension reform and no rollback in tax rates, Illinois over the next decade would still see budget deficits topping $1 billion a year, the institute estimates.

John Miller, co-head of fixed income at Nuveen Asset Management, said municipal bond investors already are demanding fatter yields on the state’s debt. The yield spread for Illinois bonds due in 10 years is about 150 basis points over the market’s benchmark scale for triple-A-rated bonds.

“That is costing taxpayers,” Miller said.

(Reporting By Karen Pierog, editing by David Greising and David Gregorio)