Illinois Blows Budget Deadline, Pushing It Closer to Junk Rating
Illinois entered its third straight fiscal year without a budget as Republican Governor Bruce Rauner and Democratic lawmakers struggle to agree on how to rein in the government’s chronic deficits, pushing it closer toward becoming the first junk-rated U.S. state.Illinois has $14.7 billion in back payments. With GDP of about $800 billion, this is equivalent to about 1.8% of GDP. Illinois only collects about 4.3% of GDP in taxes and fees. it's backlog is 40% of the incoming tax revenue and 38% of the 2017 budget. If Illinois spreads out the back payments over a decade (with debt repaid by spending cuts), it would only require a 5% tax increase or 5% growth, or some combination, to fix it. That's not an insurmoutable problem. Its totally doable in a functioning state, dare I say even trivial as far as the math goes. But Illinois is not a functioning state. The back payments are a sign of dysfunction, not a one-time budget battle. There are unfunded pension liabilities, a growing annual budget deficit, a growing pile of debt. Illinois doesn't have a flat tire. The car is coming apart and a wheel is about to come off the axle.
Illinois legislators failed to enact a budget by the end of Friday, the last day of the budget year. While negotiations continued and lawmakers planned to meet over the weekend, the failure marked a continuation of the unprecedented impasse that’s left Illinois without a full-year budget since mid-2015. Without a deal around July 1, S&P Global Ratings has warned that the nation’s fifth-most-populous state will likely get downgraded again, losing its investment-grade status.
A lot of investors are passive investors in 2017. Passive indexes have clear cut rules. If Illinois is cut to junk, any fund that holds only investment grade bonds must sell the Illinois bonds. Over the following 12 months, all of these funds will sell their Illinois bond holdings (muni junk bond funds will buy). Since everyone knows this will happen, they will sell their bonds as soon as possible. The average price of all municipal/state bonds will fall (interest rates will rise) because Illinois bonds are still part of the market. At some price (interest rate), investors would rather hold Illinois bonds at say 7%, than a California bond at 5%, especially if they think California finances are at least as bad as Illinois. Or, if you expect the U.S. Treasury to bail out Illinois, why not buy an Illinois bond at 7%, instead of getting only 3% on a 30-year U.S. Treasury.
If you don't think a bailout is coming, then you need a larger margin of safety to hold Illinois bonds. The price drops further, maybe you're looking at 8% or 9% interest (I'm using big numbers to make clear how investors react to pricing variation). A lot of state bonds are held within the state because of tax benefits. It's not bond holders in Texas or Japan who are hit hardest by a downgrade in Illinois bonds, but bond holders who are Illinois residents. That's before considering how higher interest rates chews up a larger share of the budget. Illinois' economy will contract outright or at least relative to the rest of the United States. A self-reinforcing cycle of collapse begins until a new level of stability is reached.
Illinois isn't the only dysfunctional state. Even states dominated by Democrats cannot function. Connecticut Democrats control the lower house in the legislature, have split control in the upper house, and control the governor's office, but Connecticut governor to control spending after budget fails to pass.
Connecticut Governor Dannel Malloy took control of the state's spending on Friday after lawmakers failed to pass a budget before a July 1 deadline due to discord over how to close a $5.1 billion shortfall over the next two years.The cost of diversity and progressive economic policy was pushed into the future with debt. The bill is coming due. Democrats want to use the federal government to pay for state spending. Either through inflation (borrowing) or tax increases at the federal level. Cuckservatives will side with them. Deficit hawks and "woke" GOPers will refuse bailouts. Without outside funding, the Democrats will eat each other alive with budget cuts. Or GOP-run states will eat their lunch. They'll poach their prime producers fleeing punitive tax increases.
Connecticut, which has one of the lowest credit ratings of all U.S. states despite being one of the wealthiest by personal income, will continue operations under an emergency executive order signed in Hartford by Malloy, a Democrat.