CHICAGO — Amid the attention generated by the Illinois budget crisis, a long-term infrastructure problem is brewing behind the scenes, a report warns.
The state’s infrastructure shortcomings are as serious as its budget deficit and pension shortfalls, says author Martin Luby.
“We’re calling this Illinois’ third deficit,” said Luby, an associate professor at DePaul University and a visiting scholar at the University of Illinois Institute of Government and Public Affairs, which released the policy brief Monday as part of its The Fiscal Futures Project.
“Everyone has been focused on the budget, but governments also build things,” he said. “And that’s one area we think lawmakers are aware of, but not as much as possible, and we wanted to put it on the radar.”
The report, “All Bad Things Come in Threes: Illinois’ Third Type of Deficit: Infrastructure Funding,” estimates of the size of Illinois’ funding gap, taking into account all of the state’s capital needs – mostly for roads and bridges. It focused only on the state government, not its independent agencies or local governments.
The size of the deficit depends on several factors, including the state’s current debt position and credit profile, the group says.
At the report’s base-case scenario, the state would need annual new revenue ranging from $447 million in 2016 to $1.09 billion in 2020 and $2.33 billion in 2024 assuming it maintains its current 11% ratio of debt service to general fund spending.
“Given the fiscal and budgetary urgency of dealing with the other two deficits the state faces, it may be convenient to ignore the state’s infrastructure funding deficit,” the report says. “But this is perilous. Failing to maintain, replace and improve its infrastructure and other physical capital assets, Illinois limits the future productivity and income-earning potential of its businesses and workers.”
The report comes with Illinois mired in a budget stalemate between Republican Gov. Bruce Rauner and the Democrat-led General Assembly. The state has failed to approve a new budget for the fiscal year that started on July 1.
The dispute is tied to a structural general fund deficit estimated at between $4 billion and $5 billion with funding needs growing to cover the state’s unfunded pension obligations of more than $100 billion. Rauner won’t discuss tax hikes without Democratic support for his policy initiatives, including worker’s compensation reforms and local government union curbs that Democrats oppose.
While the governor and Democratic leaders have all expressed support for a new infrastructure program, no plan has been produced or revenue sources identified.
Illinois is considering ending its long absence from the market before the end of the year to fund its current capital budget.
The $31 billion Illinois Jobs Now program launched in 2010 is winding down. The state has issued $11.4 billion of debt to support the program, with its outstanding GO debt level now at about $28 billion.
The report notes that the state has seen a significant increase in bond debt since 2003. An analysis of debt service from 2014 through 2038 shows that pension bonds make up 50% or more of the payments through 2033. The group also notes that pension debt payments drop in 2020 and fall off entirely in 2034.
That “provides some budgetary space for future new GO bond debt service without further crowding out other state spending,” the report says.
Rauner did sign off on capital spending for fiscal 2016 after vetoing about $68 million for renovations to the state capitol.
The recommended capital budget of about $19 billion includes $3.3 billion in new appropriations and $15.6 billion in reappropriations. New projects would be funded by $145 million in federal funds, $2.9 billion in state funds, and $250 million in borrowing, according to the Illinois Commission on Government Forecasting and Accountability.
“Until new revenues are identified, the state’s ability to issue substantial new debt is constrained,” the commission’s review says.
Funding the infrastructure deficit would require “substantial new revenue,” Luby says.
“It has to be sustainable and has to account for economic changes in the environment and changes in consumers,” he said. “We may not be able to end up funding it, but we need to be able to recognize the trade-offs.”
The need for new revenue sources to support infrastructure is highlighted by the failure of taxes and fees tied to the Illinois Jobs Now to meet projections.
The package included taxes on new video poker machines, an expanded sales tax on candy and some beverages, the privatization of state lottery operations, a higher liquor tax, and higher license and vehicle fees.
The state’s full faith and credit backs much of the borrowing for Illinois Jobs Now with some additional sales-tax backed bonding also providing funding.
The package of new and higher taxes and fees was supposed to ease the burden on the state’s general fund.
“The taxes and fees have yet to produce the funding levels projected when Illinois Jobs Now! was originally approved,” the Civic Federation of Chicago’s Institute for Illinois’ Fiscal Sustainability wrote in an August review of the state’s capital spending. Revenues are projected to total $830.4 million in fiscal 2016; it was supposed to produce between $943 million to $1.2 billion annually, the federation said.
Video poker got off to a late start and some local governments ’won’t allow local establishments to install the machines.
The interest rate the state pays on its debt is another key factor in figuring the size of its infrastructure shortfall.
The state’s budget and pension problems will make it harder to solve the infrastructure shortfall, given the higher borrowing costs they impose on the state.
Without strides in structurally balancing the budget the state faces a fall into the triple-B category, a rarity for a state government.
The report estimates the need for $18 billion in additional present-value dollars between 2016 and 2040, assuming a 5% interest rate and maintaining the state’s current ratio of spending 11% of its general fund on debt service.
Revising the interest rate upward to 7% pushes the base-case deficit to $22 billion, a 22% increase.
“It clearly shows how the state’s current fiscal challenges can have a significant impact on its ability to fund its infrastructure needs,” the IGPA report says.
Illinois 10-year GO paper is currently trading at a 185 basis point spread to the top-rated Municipal Market Data benchmark.
Its spreads have fluctuated in recent years. The report outlines how the state’s interest rate spreads in the primary market peaked in a June 2013 borrowing at a 180 basis point spread and then fell to about 120 basis points on sales in 2014 that followed the December 2013 passage of a sweeping reform package.
Secondary market spreads shot back up following the Illinois Supreme Court’s decision in May overturning the 2013 pension reforms as unconstitutional. The state hasn’t sold any new money debt this year.
The borrowing costs show why it’s so important to solve the state’s current fiscal crisis, Luby said.
“Getting those first two deficits addressed is part of this infrastructure deficit,” he said. “Those need to be addressed because the spread is big and going to get bigger.”
The group hopes that putting a number on the infrastructure deficit for the first time will help move the debate forward. It has sent the policy brief to lawmakers and Rauner. Tackling the problem is just as important to the state’s future as the debate over the structural and retirement benefits shortfalls, according to the IGPA.
“Ignoring Illinois’ infrastructure funding deficit leads to a severely understated sense of the state’s fiscal challenges given the importance of infrastructure to the state’s long-term economic growth prospects,” the report says.
