January 26, 2017
After nearly 19 months without a budget, Illinois’ backlog of unpaid bills currently stands at over $10.9 billion [1]. Without a comprehensive plan to restore fiscal balance, the backlog will only continue to grow. However, even if balance is restored in fiscal year 2018, the backlog accumulated to date presents a challenge to the State and an ongoing burden on its finances.
As part of its compromise budget package, the Illinois Senate has proposed to borrow $7 billion to pay off a large portion of the existing backlog. Senate Bill 4 would raise the total borrowing limit by $7 billion, provide for the bonds to be issued in early FY2018 and calls for level debt service payments over seven years (as opposed to the State’s usual practice of level principal).The proceeds of the sale would be deposited into the General Revenue Fund, but the statute restricts their use to paying off the backlog and instructs the Comptroller and the Treasurer to make payments “as soon as practical.” Implementation of this bill is contingent on passage of the other bills in the Senate package (SB1-SB13), which provide for increased revenue, reforms to workers’ compensation and procurement, a two-year property tax freeze and appropriations to finish FY2017.
Is it appropriate for Illinois to borrow to pay off its backlog? In ordinary circumstances, the answer would be, emphatically, “No.” That governments should not borrow to pay for operating expenses is a core principal of the Civic Federation, and to do so is a hallmark of fiscal irresponsibility. In fact, the Civic Federation, in its analysis of the proposed FY2012 budget, opposed Governor Quinn’s plan to borrow to pay off a previous backlog of bills.
However, the prolonged budget impasse has worsened the State’s fiscal condition considerably. Since the impasse began at the end of FY2015, spending has continued[2] through the stopgap appropriation and court-ordered spending, and bills have continued to accumulate without appropriation. Given the enormity of the task of rebalancing the budget itself, the idea of borrowing to repay the accumulated backlog merits a reevaluation.
A few arguments in favor of borrowing exist. The first and most compelling is that for a considerable portion of the backlog the state could save on interest cost. Under the State Prompt Payment Act, most bills that are more than 90 days old accrue interest at 1% per month, or more than 12% annually. Bills from healthcare providers accrue 9% after 30 days, as specified by the Illinois Insurance Code. Since the percentage of bills that bear interest at each rate could not be determined, and since interest is only paid when the bill is finally paid, it is difficult to calculate the total interest cost on the bill backlog. However, interest payments in past years, when the backlog was much smaller, were considerable, and peaked at $318 million in FY2013. Interest payments have been lower in FY2016 and FY2017 only because the lack of a full-year budget has delayed the payment of bills. The Comptroller’s Office estimates that accrued but unpaid interest penalties in FY2017 were in the hundreds of millions of dollars.
On the other hand, the State’s most recent general obligation bond issuance in November 2016 priced with a five-year yield of 2.88%. This includes a spread to the AAA-rated benchmark of 1.76%. Prevailing interest rates have risen since that issuance and are expected to continue to rise, the State is likely to face increased spreads on future deals, and the new issuance would not be tax-exempt because it covers operating costs. Nevertheless, even if there is a substantial increase in interest rates, the total borrowing cost of the bonds would still be lower than the 9% to 12% the state currently pays.
A second argument in favor of borrowing is that proceeds of the bonds could be restricted to paying existing bills. New revenues not tied to expenditures will be needed whether the State is paying debt service on backlog bonds or paying the backlog bills directly. But issuing bonds and restricting the proceeds, as Senate Bill 4 proposes to do, could help avoid political pressure to divert new revenues to new spending.
A final argument in favor of borrowing is that vendors would be paid immediately. Many vendors have had to wait for payment, which has resulted in some vendors cutting off service to the State and in social service providers reducing support for the most vulnerable citizens. Some vendors are able to mitigate the delay by participating in the Vendor Support Initiative, which allows those vendors to assign bills to authorized third party collectors. The collectors pay the vendors 90% of the bills up front and the remaining 10% when the State pays. In return, the collectors get to keep any interest penalties. While this may help vendors survive the budget impasse, it results in state money being diverted to third party financial firms that do not provide any of the valuable contracted services. Eliminating the bill backlog immediately could help stabilize vendor finances and help restore confidence in Illinois.
Despite these advantages, borrowing is still a costly proposition, with debt service payments estimated to be approximately $1.1 billion per year for the seven-year life of the bonds. The large size of the issue could result in higher borrowing costs for capital projects if it exhausts the market’s appetite for Illinois’ credit. Moreover, it remains unclear whether the market would absorb such a large issuance from the lowest-rated state in the absence of a comprehensive plan to the budget back into balance. The ratings agencies have indicated that the State’s rating will be downgraded if the impasse and structural deficits persist. The City of Chicago faced high yield penalties for its recent general obligation issuance, in part due to continued statewide instability. At a minimum, the State should adopt the following principles to guide any plan for borrowing to pay off the backlog:
- The borrowing must be paired with a comprehensive, credible plan to balance the budget in FY2018 and match expenditures to revenues for the foreseeable future;
- The borrowing should be as short as possible in duration to minimize the burden on future fiscal years;
- The proceeds should be strictly limited to repaying existing, overdue bills; and
- The State should identify revenues for debt service not otherwise needed to balance the budget.
What is clear is that only painful, expensive solutions remain if the State is to return to a sustainable financial situation. However the State ultimately clears the backlog, it must make a plan to do so quickly or the solutions will need to become increasingly drastic.