|Not standard issue: a state employee examines IOUs printed by California last year, an emergency measure taken to enable it to pay bills in the
face of a deficit that stood then at $26bn
As superintendent of education for Illinois’ high school district 201, Mr Kuzniewski oversees the teaching of 9,000 pupils in Chicago’s western
suburbs. The district has an annual budget of $100m – of which $35m
comes from the state.
Cash-strapped Illinois, however, is five months behind on paying its bills. It still owes the
district $3.6m from the last academic year and – because it hopes to cut
$300m from its schools budget this year – the state cannot say how much
it might hand over.
So Mr Kuzniewski has been forced to wield the axe. District 201 pupils who go back to high school on August 23 will
find 22 per cent fewer teachers and 44 per cent fewer teacher aides.
They will have five (longer) classes a day rather than six. They will
also need fewer credits to graduate.
“We don’t have a lot of options,” he says. “Every district in the state is in the same situation.”
Illinois – the “Land of Lincoln” and adopted state of President Barack Obama –
may be in its worst financial predicament yet but it is not alone. The recession
has savaged US states’ tax receipts. District 201 provides a potent
example of the devastating effect of their financial problems on public
services across swaths of America. The experience is also telling for
nations such as the UK that, to redress their own budgetary problems,
are starting to implement sharp cuts in what government provides.
Illinois has a budget deficit this year of more than $12bn – half of its total
operating budget. The state is at least 153 days behind on paying its
bills: by the end of June, it owed service providers $4.7bn – a figure
that is now nearer $6bn, according to the state comptroller’s office.
Illinois is not alone. In the past few years, states have had to close hundreds of billions of dollars of budget ..., collectively, according to the national conference of state
Explore the US state fiscal crisis and examine each state’s 2011 budget gap and credit ratings
legislatures. All but one, Vermont, must agree a balanced budget
The hope is that fiscal 2010, which ended on June 30, represents the revenue trough. Most states expect tax income to rise
this year. But the recovery is tempered by the extent of recent declines
and the waning influence of federal stimulus funds. Some are already
facing new gaps and are predicting that deficits will persist until
In response, states have employed cost-cutting measures. New Jersey slashed its education budget. Idaho cut aid to low-income
elderly people and the disabled. Mississippi eliminated more than 100
jobs in its only state-run training facility for juvenile delinquents.
Illinois released prisoners early – until public opposition forced an
has also been financial sleight-of-hand. Minnesota has moved some of
this year’s school funding bill to the next financial year. Arizona has
sold buildings and leased them back. States have considered selling
advertisements on vehicle licence plates and imposing taxes on fizzy
The woes of California being wrestled with by governor Arnold Schwarzenegger have received the
most attention. Yet in some ways Illinois’s position is worse: the hole
in its public pension fund is relatively bigger, it has received a
string of downgrades on its bonds in recent months and investors have
demanded higher yields than on Californian paper.
Shortfalls in public pension funds are the heart of the matter. State pension deficits
are estimated to total at least $1,000bn, according to the Pew Center
on the States, a think-tank. Illinois’ pension funds – which pay out to
retired teachers, state workers, university staff, judges and
politicians – are funded at less than 40 per cent, the lowest proportion
of any US state. The gap between assets and liabilities was about $71bn
by last September, the most recent available figures.
The unfunded liability could by now have grown to $80bn – more than twice
the state’s total annual budget, says Ralph Martire, executive director
of the Center for Tax and Budget Accountability, a think-tank.
Some say the shortfall is even bigger. Joshua Rauh, of Northwestern
University’s Kellogg School of Management, notes that states generally
assume their investments will generate 8 per cent returns a year. “It’s
an economic fallacy,” he says. “It would be like taking money from your
savings account, putting it into the stock market and then writing down
the cost of your mortgage.”
Using a rate of 3.6 per cent – what US Treasuries were yielding in June – Prof Rauh recalculates Illinois’
pension hole at $145bn – about $30,000 for every household in the state.
Illinois’ pension gap has worsened as a result of the downturn, but this is a longstanding problem. The state began skipping
contributions in the 1970s. By 1995 it faced unfunded liabilities of
$17bn and sketched out a 50-year plan to re-fund the system but skipped
contributions in the early years.
Liabilities built up: by mid-2008, before the full financial crisis hit, the pot was only 54 per
cent funded. As Mr Matire puts it: “We’ve basically been borrowing
against the pension system and writing IOUs to that.”
Unfunded pensions are a central reason the state cannot pay its bills to
institutions such as high school district 201. Interest payments on much
of the money Illinois borrows to fund pension contributions come out of
its general fund – the same pool that pays for elementary education,
keeping the peace and fixing potholes.
As the unfunded portion of the fund grows, so does the annual payment Illinois is required to make –
putting stress on the general fund and crowding out other spending.
The cuts in district 201 point to the longer-term effects. If educational
standards decline in an area where, Mr Kuzniewski says, many pupils
aspire to well-paying blue-collar jobs, Illinois may struggle to produce
a workforce that will attract investment. Employers already complain
that high school graduates lack literacy and numeracy skills. Ron
Bullock, owner of Bison Gear, an industrial motor-maker based near
Chicago, says half of those applying to his company fail a basic
If the pension problem was chronic before the downturn, it is now critical. Revenues to the state have plummeted.
Billions have been wiped off the value of pension funds. Illinois has
been hard hit by the decline in manufacturing. The need for welfare
services is greater than ever. “The recession peeled back a lot of what
Illinois has been papering over for years,” says Susan Urahn, managing
director of the Pew Center.
Yet the state continues to cling to the scheme it outlined in 1995, maintaining it will re-fund the pension
system by 2045. It is not clear how long it and others can continue on
this path. The assets in Illinois’ public pension funds will pay for
benefits only until 2018, says Prof Rauh, or until 2022 if the state
uses future contributions to pay for current pensioners.
Another 30 states will have run out of money to pay pensions by 2030, Prof Rauh
calculates. Tax revenues will not cover payments, so the federal
government is likely to come under pressure for a bail-out whose cost
could be more than $1,000bn, he says. Washington had a glimpse of the
future last week, when the Senate approved $26bn of federal aid to cash-strapped states.
Some observers try to compare Illinois to Greece. Such parallels are overdrawn, however. Fears over sovereign default in Europe
certainly spilt into the US market; but, while most municipal bond
experts predict an uptick in defaults, they are more likely to be by
hospitals and housing developers than states.
For states, default would carry a huge stigma. With cuts leaving money for debt servicing,
investors appear to feel safe enough. In spite of recent credit
downgrades by Fitch, and Standard & Poor’s, Illinois raised $900m in capital markets
last month. In a roadshow covering the US, Europe and Asia, officials
and bankers convinced investors – nearly one-third of them non-US – that
Illinois would always pay its bondholders.
The selling point was that the state requires itself to make bond payments before all other
bills. It also offered a hefty premium to comparable US Treasuries – as
much as 3.25 percentage points on debt due in 2035. Corporate bonds with
similar ratings were paying lower yields. The Illinois bonds have since
While the markets still have the appetite, the state continues to borrow. It issued $3.5bn in debt last year to pay its
pension contributions and plans another $4bn bond for this year’s
payment. However, this moves debts around rather than tackling long-term
The state slashed $1.4bn from the current year’s budget, but cost-cutting alone is no solution. Illinois is not, in fact,
profligate. Although it is the fifth biggest state by both economy and
population, it ranks 45th in state spending as a percentage of gross
state product and 46th in its combined state and local tax burden as a
proportion of income.
So, like other states, it is likely to need to increase revenue too. Proposals therefore focus either on raising
income taxes sharply and expanding the sales tax base; or on reforming
the pension system. Illinois recently passed legislation raising the
state workers’ retirement age from 60 to 67, the most extreme of a
number of such moves by several states. The measure is the first serious
attempt to tackle the growing pension hole but applies, like those
introduced by other states, only to new staff.
Many observers worry, however, that simply changing the rules for new employees is
insufficiently radical given the scale of the problem, since it only
stems the growth of liabilities. Legal experts in Illinois are therefore
debating the constitutionality of changing rules for those who have
been paying into the system for years.
Pat Quinn, Illinois’ Democratic governor who is running for re-election in November, wants to
raise state income tax from 3 per cent to 4 per cent. Some analysts
fear this will not be enough. Politically, the choices are so
unpalatable that for decades Illinois’ leaders have avoided them. This
was highlighted last month at the corruption trial of Rod Blagojevich,
the former governor being prosecuted on corruption charges, including
an alleged attempt to sell Mr Obama’s vacated Senate seat.
Robert Greenlee, former deputy governor, testified that his ex-boss was so
reluctant to discuss budgetary issues that, when the budget director
arrived for meetings, Mr Blagojevich would hide in the toilet.
|BUDGETS UNDER PRESSURE
|Can a US state default on its debt? Years of budget shortfalls in the run-up to the financial crisis and fears this year of sovereign default
in European countries have made this a pressing question, writes Nicole Bullock.
Provisions in the US constitution that protect the independence of the 50 states
also make them ineligible to seek protection under the federal
bankruptcy code from creditors, says James Spiotto of law firm Chapman
For most of the previous century, most dutifully paid their debts, the ups and down of the economy notwithstanding. But
default and debt repudiation are not unprecedented.
Debt has long been a part of the history of Arkansas, for example. In the 1800s, it
sold bonds to capitalise the state banks. When the Panic of 1837 – a
banking crisis that precipitated a recession – hit, it defaulted.
Arkansas sold further bonds to build railways but, upon running into
trouble after the civil war, amended its constitution to repudiate $17m
worth of debt. A round of borrowing for a highway system in the 1920s
resulted in a similar outcome. The state defaulted once again when the
Great Depression hit.
Arkansas is not alone. In the 1860s in the financial and social turmoil that followed the civil war, numerous
states and municipalities failed to pay their debts. “The reasons for
repudiations range from official misconduct to the carpetbagger era in
the South ... to railroads and real estate,” says Mr Spiotto.
This period led the states to pass statutory provisions prioritising debt
service and creating a legal obligation to pay debts. That laid the
ground for years of very low defaults. Since the 1930s, when Arkansas
ran into trouble, defaults in the $2,800bn municipal bond market, which
counts more than 50,000 issuers across the country, have been a fraction
of what investors have endured in the corporate market.
With the depth and breadth of the current downturn, however, some observers have begun to question how long this can last.
Many argue that access to cheap funding in the federally subsidised ”muni
market” is too important for states to risk it by reneging on their debt
again. Officials know their tax receipts would never be enough to
support the workings of government and infrastructure expenses, the
latter typically funded with municipal bonds. Indeed, states such as
Illinois are willing to dock payments to schools but keep servicing
But according to Matt Fabian of research group Municipal Market Advisors: “The risk is that the current financial
crisis begins to break down that sensibility, as it has among mortgage
and corporate borrowers, leading to a more adversarial relationship
between issuer and lender.”