Illinois needs tax increase, but not because of pensions

It's relieving to know that, as a matter of Illinois state constitutional law, words in the English language actually have the meanings identified in the dictionary. Which is really what the Illinois Supreme Court ruled when it held that the "pension reform" legislation of 2013 was unconstitutional.

That law attempted to reduce the significant - as in currently north of $100 billion significant - unfunded liability in the five state pension systems, by cutting benefits of current workers and retirees. That's verboten, because Article XIII, Section 5, of the Illinois Constitution specifically provides that public pension benefits in Illinois "shall not be diminished or impaired."

Emphasizing the constitution's "plain and unambiguous language," the Supreme Court found that "the clause means precisely what it says: if something qualifies as a [pension] benefit ... it cannot be diminished or impaired." Score that as a win for Merriam-Webster.

So does this decision mean Illinois will have to raise taxes? No. See, regardless of how the Supreme Court ruled, Illinois has actually needed to raise taxes for decades. Indeed, the state's outsized unfunded pension liability isn't the cause of Illinois' fiscal problems, but rather a very significant consequence of its poorly designed tax policy.

Here's why. Back in FY1994, the aggregate unfunded liability across all five state systems was $17 billion. Which sounds like peanuts given the size of the problem today, but it meant the systems were only 37 percent funded, a long cry from the 80 percent recognized as healthy.

And the reason Illinois had accrued $17 billion in pension debt in FY1994 had nothing to do with generous benefits. Instead, it had everything to do with debt. Even then, the state's flawed tax policy wasn't working in the modern economy.

In fact, there's been a long-standing imbalance between revenue growth and service cost growth, which prevents Illinois from sustaining the same level of services from year-to-year.

This in turn creates a real challenge for politicians, because $9 out of $10 the state spends on services goes to education, health care, social services, and public safety. Cutting those core services every year is hardly a blueprint for re-election (or good public policy, for that matter).

That said, raising taxes always scares politicos, no matter how rational or needed the tax increase would be. So decision-makers consistently chose a third, irresponsible path: using the pension systems like a credit card - by diverting revenue that should have funded the normal cost of retirement benefits to instead fund current services.

This avoided the need to make draconian service cuts or distasteful tax increases, while allowing constituents to consume services without paying the full cost thereof in taxes. It also became such a political crutch that the practice of borrowing from what was owed the pensions to fund services was codified into law as part of the 1995 pension "funding ramp."

This so-called "funding ramp" so aggressively borrowed against the pensions, that it ballooned the unfunded liability from $17 billion in FY1994 to $54 billion in 2008 - when the Great Recession hit and financial markets crashed.

It accomplished this boondoggle by using an amortization schedule that was so backloaded it resembled a ski slope, calling for annual payments in excess of $16 billion in out years. And it's this goofy debt repayment schedule that's causing problems.

Now that we know the Illinois Constitution means what it says - benefits can't be cut - the best, indeed the only viable and constitutional solution going forward, is replacing the current backloaded repayment schedule with a longer, level dollar amortization that: permits payment of all retirement benefits when due; increases the funded ratio to a point that's considered healthy; and is affordable, so bond rating agencies have confidence the payments will actually be made.

Oh, Illinois still has to raise taxes so it finally has the means to sustain core services without irresponsibly borrowing to pay for them.

Ralph Martire, rmartire@ctbaonline.org, is executive director of the Center for Tax and Budget Accountability, a bi-partisan fiscal policy think tank based in Chicago.