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The ‘Illinois Is Not Puerto Rico’ Fallacy

detail of the Illinois State Capitol at sunset
The Illinois State Capitol. Photo by Matt Turner.

I have been to both Chicago and San Juan in December, so I could not agree more with anyone who says Illinois is not Puerto Rico.

Well, almost anyone. If you are a bond investor, I’d say the comparison is a closer one than you think.

Sure, Illinois has a reasonably solid farm economy (though struggling now with low crop prices). It boasts the glitzy towers of the Loop, the Magnificent Mile along Michigan Avenue, and – wait for it – the world champion Chicago Cubs, a line I never thought I’d live to write. Puerto Rico’s rural economy is in shambles, the island’s population is shrinking as fast as people can pile onto planes bound for Orlando, and its proud baseball tradition rests mainly with the excellent ballplayers it still exports and the memory of the great Roberto Clemente.

At around $74 billion, Puerto Rico’s government debt is about triple that of Illinois – but only if you don’t count the nearly $15 billion in past-due debt the Midwest state racked up during two years without a state budget, a period which ended earlier this month. And, as a state admitted to the Union, Illinois can’t file for protection under current federal bankruptcy law, a shield of which Puerto Rico has already availed itself.

But just because a state can’t file for bankruptcy doesn’t mean it can’t default on its debt. On top of the nearly $15 billion of past-due bills currently on its books and an additional $25 billion or so of outstanding bonded debt, Illinois also has around $130 billion of unfunded pension liabilities. That’s not counting the unfunded pension obligations of the city of Chicago, either.

The budget that the Illinois House voted to enact, overriding Gov. Bruce Rauner’s vetoes, includes a permanent 32 percent increase to the state’s income tax rate. Individuals will now pay 4.95 percent tax on their income, and businesses will pay 7 percent. The budget also reduces state spending by more than $2 billion.

Rauner argued that this budget does not include enough cost-cutting, and that the tax increases it institutes will prove counterproductive in the long term. The vote to override his veto was, he said, “another step in Illinois’ never-ending tragic trail of tax hikes.”

Rep. David Harris, a Republican from Arlington Heights, countered that no one enjoys voting for higher taxes, but that lawmakers had no choice. “We are looking into a financial abyss.”

While Harris isn’t wrong about the dire nature of Illinois’ fiscal problems, he and many of his fellow legislators seem to be ignoring the looming $130 billion shortfall in pension obligations that the budget does nothing to address. The plan to reduce debt also involves taking on more; the budget allows Rauner to sell up to an additional $6 billion in bonds, in an attempt to pay some of the state’s overdue bills. This merely takes short-term debt and kicks the repayment obligation further down the road, albeit with the benefit of somewhat lower interest charges.

One particular irony of the Illinois budget that passed over the governor’s veto is a little-advertised provision that allows Chicago to improve the credit score of its own bonds by – astoundingly – dedicating some of the recurring revenue it gets from the state to sustain the new debt. It’s as if a broke guy walks into a bank, asks for a loan, acknowledges that his credit is shot, but reassures that banker that the debt will be financed by payments from another broke guy whose credit is also shot.

And make no mistake: Illinois’ credit is, indeed, shot. Maybe not mortally wounded, at least as of this writing, since none of the major credit agencies has yet reduced the state’s rating to “junk” status. But even with the budget passage, that rating cut could still come; Moody’s Investors Service explicitly said a budget deal was no assurance that the state’s creditworthiness would avoid a downgrade. So a rating cut may come soon, or maybe not until and unless it becomes evident that the budget’s hefty tax increases won’t generate the expected amount of revenue because of the incentive it creates for strong earners, corporate and otherwise, to move elsewhere.

Perhaps the rating cut won’t ever come at all. I wouldn’t bet on it, though, at least not as long as Illinois remains constrained by its own constitution from dealing with its enormous overhang of public pension debt. That debt is why Illinois is more like Puerto Rico than anyone cares to admit. Promises that can’t be kept won’t be kept, and Illinois is making promises to its workers and its lenders that it cannot keep. Someone is going to be disappointed.

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