Financial Times

Illinois state ‘on brink of collapse’

Tuesday, March 06, 2012

Illinois’ financial problems are forcing it to choose between its pensions and its teeth.

Governor Pat Quinn says the state needs to face its “rendezvous with reality” and tackle its dysfunctional budget habits. Top of the list, Mr Quinn says, is to slash spending on Medicaid, a federal programme that provides healthcare to poor Americans.

To save a system he says is “on the brink of collapse”, Mr Quinn proposes cutting $2.7bn from Illinois’ $11.5bn Medicaid bill. Few would dispute that the state needs to change its behaviour. Last year, Illinois underfunded Medicaid by $2bn as it struggled with debts totalling more than $280bn, an $86bn hole in its public pension funds and a $9bn backlog of unpaid bills.

The Medicaid tab has grown since the financial crisis, which pushed more people into poverty. In 2007, 2.1m Illinois residents were eligible for the low-income programme. Today, 2.7m qualify – 1.7m of them children, according to the state’s department of healthcare and family services.

Milona Van Kanegan, a dentist at a clinic serving poor adults in Humboldt Park, a neighbourhood in West Chicago with a high population of Latin American immigrants, says cuts could have a devastating effect on her patients. She worries that thousands of people across Illinois could be excluded from the system.

“Now, people are getting care because they are insured,” she says. “If they’re pushed out, they’ll ignore their problems and their teeth will just get worse and worse. Dental disease is cumulative. It builds up over years of neglect.”

The risk that decades of financial mismanagement in Illinois could be paid for with the teeth of some of its poorer residents is a vivid demonstration of the ways average Americans’ lives will be affected as the US tackles its local, state and federal debts. The irony is that because Medicaid is jointly funded by the state and the federal government, cuts at the state level also will help reduce the US deficit, since Washington matches state money.

To stem the growing shortfall in its public pension funds, Illinois pledged to pay its full pension obligations – $5.2bn next year – without borrowing, something budget watchdog groups have long urged it to do.

However, the state can only afford to do this by cutting sharply elsewhere. “This represents the ‘crowding out’ of spending as a result of the demands of the pension system,” says Joshua Rauh of Northwestern University.

In that sense, Illinois – which has the most underfunded public pension system in the US – could be a leading indicator for a pension crunch that will hit other cash-strapped states. “We’re going to see more and more states cutting spending to meet pension obligations mandated by the state’s own statutes,” says Prof Rauh.

In Illinois, the axe will not just fall on healthcare spending. Among other big cuts, Mr Quinn also proposes closing two state prisons and six halfway houses. Already, the system’s 48,620 inmates are crammed into space designed to hold 33,704, according to the state’s department of corrections.

The budget squeeze comes a year after Illinois hiked taxes, raising corporate tax rates from 7.3 per cent to 9.5 per cent and income tax from 3 per cent to 5 per cent. However, that has been undermined by tax cuts for companies – including Sears, truckmaker Navistar and futures exchange CME Group – designed to prevent them moving to lower-tax states.

Illinois is only remaining solvent by not paying its bills on time, a practice that hurts thousands of small contractors that do business with the state. When payments do arrive, they are often incomplete. If Illinois continues this practice, it will rack up $35bn in unpaid bills by 2017, according to the Civic Federation, a Chicago think-tank.

Yet state legislators are in little mood to cut spending when they are facing re-election in November. Mr Quinn declines to specify what programmes should be cut, saying this is a decision for the legislature. Many expect this to water down the proposed cuts.

Prof Rauh reckons that ultimately, fiscal discipline will only come when the bond market demands it. Moody’s, the rating agency, downgraded Illinois in January to the lowest credit rating of any US state. Yet less than a week later, the state auctioned $525m of general obligations bonds at 3.9 per cent, the lowest rate on such a bond in recent history.

Ms Van Kanegan accepts that the state is effectively broke, but says it needs to find a fairer way of spreading the burden. “The big legacy costs are overwhelming the system,” she says. “We’re balancing that on the backs of the poor and vulnerable.”