January 9, 2015
According to a recent study, the State of Illinois does not set aside enough revenue to account for fluctuations in its volatile tax sources and needs to improve its rules for making rainy day fund deposits in order to prepare for future financial challenges.
The extensive report includes an in-depth study of the last 25 years of State revenues, previous legislation intended to establish a rainy day fund in Illinois and a 50-state review of best practices for managing rainy day funds.
As previously discussed here, last year the Illinois General Assembly mandated by law that the Commission on Government Forecasting and Accountability (COGFA), the legislature’s joint fiscal research body, prepare a revenue volatility study by the end of the 2014 calendar year.
The statute required the commission to include four specific topics in its report:
- An examination of Illinois’ tax base and tax revenue volatility;
- The identification of economic variables that may influence volatility;
- An analysis of the adequacy of the balances in the Budget Stabilization Fund in relation to the volatility of tax revenues; and
- An examination of options for a deposit mechanism linked to one or more tax sources on the basis of each tax source’s observed volatility.
As part of the review of possible deposit mechanisms, the legislature required that the report include a historical look at how a rainy day fund would have fared under the various deposit options. It also required projections on how these options might perform in the future based on current revenue forecasts.
COGFA showed that total General Funds revenues, excluding borrowing and one-time transfers, grew from $12.8 billion in FY1990 to $36.7 billion in FY2014. However, within those results the State’s two largest sources of tax revenue, individual income taxes and sales taxes, showed a wide range of volatility over the last 25 years.
Individual income taxes, which currently make up more than half of the State’s operating revenues, have shown annual changes ranging from growth of 9.4% in FY2007 to a decrease of 8.6% in FY2009. In FY2011 and FY2012, individual income taxes grew by 31.1% and 36.8% respectively after the rate was increased from 3.0% to 5.0% halfway through FY2011. However, the underlying base growth in those years was only 4.0% in FY2011 and 3.6% in FY2012.
Sales tax revenues, the second largest General Funds revenue source, made up between 25.0% and 35.0% of General Funds revenues. Annual changes in sales tax revenues fluctuated from growth as high as 8.3% in FY2011 to a decline of 6.9% in FY2010 according to the report.
The report concludes that, although the State has maintained a Budget Stabilization Fund since 2000 intended to be a rainy day fund, it has never held adequate deposits to make up for the volatility in its largest revenue sources.
As explained in this blog, the Budget Stabilization Fund has not received significant deposits since its inception. Rather it has provided short-term cash flow but never acted as a true rainy day fund. In its State Budget Roadmap for FY2015, the Institute for Illinois’ Fiscal Sustainability at the Civic Federation also urged the State to create a significant rainy day fund as part of a long-term plan to end its fiscal crisis.
The new COGFA report documents the full history of the Budget Stabilization Fund and all of the deposits and withdrawals made by the State from FY2000 through FY2014. According to the analysis, the rules enacted to determine when and how much the State deposits into the fund are too ambiguous to be effective.
The report concludes with a 13-step policy roadmap for lawmakers to proceed with either reforming the Budget Stabilization Fund into an adequate rainy day fund or to establish a new fund to serve this purpose.
COGFA’s recommendations include the possibility of raising the cap on funding (or target for funding) from 5.0% under current law to 10.0%. This would increase the limit to $3.5 billion from the cap of $1.7 billion under current law based on total FY2015 General Funds revenues of $35.4 billion. The actual balance in the fund since FY2012 has only totaled $275 million.
The report also considers how fast the State could begin to accumulate adequate balances in a rainy day fund. The analysis finds that states with rainy day funds have average deposits of 2.7% to 4.7% of annual expenditures, while Illinois has only maintained a balance of roughly 1.0% of expenditures in the Budget Stabilization Fund. If the State deposited 1.0% of total expenditures annually into a rainy day fund, it would amount to $353 million per year and take roughly 10 years to reach 10% funding.
The historical analysis from COGFA showed that as a percentage of total State-source General Funds revenues, the State would have needed to deposit 2.3% annually between FY2000 and FY2010 to withstand all of its revenue losses over that period.
The report recommends enacting clearer rules explicitly stating which government office is in charge of determining when and how much should be deposited in the fund. COGFA also calls for specific guidelines for when funds can be withdrawn and how they should be repaid.
The entire Illinois Revenue Volatility Study is available on the website of the Commission of Government Forecasting and Accountability.