Mission Possible: An Update to the Pension Funding & Fairness Act

8/9/2019 Mission Possible: An Update to the Pension Funding & Fairness Act

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Policy

BriefJune9,

2010

Mission Possible:

An update to the Pension

Funding & Fairness Act

Introduction

Much has been written in the press and amongpublic policy organizations on the need for

public employee pension reform. The vastmajority of these discussions revolve around

reforming pension benets. Recent legislationreforming benets for new governmentemployees is a small step in the right direction,

but it remains inadequate. Benet reforms mustalso be put into place for current employeesgoing forward.

While worthwhile, however, none of thesereforms address the critical root causes of thestates existing $83 billion unfunded pension

liability and ongoing budgetary crisis. Pensionfundingproviding funds to pay for thebenets already earnedmust be secured. Allbenet reforms, however worthy, will be for

naught if this fundamental issue is neglected.

First, until a reliablepension fundingmechanism is put into place, future legislaturesand governors will simply continue the badbehavior that created the current crisis in the rstplace.

Further, the root problem of Illinoiss perpetualdecit spending (despite a balanced budget re-quirement) is a lack of aspending brakethatprevents continuous irresponsibility on the part ofthe General Assembly and successive governors.

On January 19, 2010, the Illinois Policy Institute

issued a groundbreaking policy proposal1 to

solve the states pension funding crisis. The

Pension Funding & Fairness Act createsrules of the game to stop the states annualbudgetary shenanigans that lead to unbalanced

budgets, underfunded pensions and an ever-growing debt burden despite record revenuesowing into state coffers.

This report updates and revises our initialPension Funding & Fairness Act proposal toaccount for developments that have occurredsince its release. This report is designed to be

used in conjunction with our in-depth BudgetSolutions 2011 alternative budget.2

The Problem

With the understanding that pension benetreforms are necessary for current and new

employees, it remains a fundamental truth thatthe reason we have an $83 billion unfundedpension liability in the rst place is because

the Illinois General Assembly and successivegovernors have not fully funded the annualpension payment for many years.

Further, the General Assembly has negotiatedsalaries, benets and pensions that are not onlyunaffordable but create inequity between thosewho pay for them and those who receive them.

Today, on average, an Illinois public employeeearns 15.7 percent more than a private sectorworker.3 Public employees also receive generousbenets, pensions and job security.

Illinoiss debt per capita has risen from $676in 2001 to $1,682 in 2010.4 How does this

happen? Legislatures and governors appropriatemore than what comes in each year and bondadditional spending. They use budgetarylegerdemain to paper over actual decits, ignore

the balanced budget requirement, and place

John Tillmanis CEO of the Illinois Policy Institute.J. Scott Moody, M.A., has worked as a tax policy economist for over12 years. Dr. Wendy P. Warcholikhas worked as an economist in public policy settings for over 12 years. This paper is anupdate of our original Pension Funding & Fairness Act study, which was originally released January 19, 2010.


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It is a

fundamental

truth that

the reasonwe have an

$83 billion

unfunded

pension

liability in

the rst place

is becausethe Illinois

General

Assembly

and successive

governors

have not

fully fundedthe annual

pension

payment for

many years.

Additional steps required by the Pension

Funding & Fairness Act include:

Using initial surpluses above the Spending

Growth Index to pay down the past duedebt, now estimated to be nearly $6 bil-

lion coming into Fiscal Year 2011.7

Sever-al years of overspending created this debt,

and it will take several years to reduce itto zero. We estimate that this debt canbe paid down by Fiscal Year 2014 with aPast Due Paydown Fund.8

Establishing a Budget StabilizationFund. This fund would be lled from

revenues above the Spending Growth In-dex once the past due debt is paid down.The Budget Stabilization Fund would

equal no more than 8 percent of the Gen-eral Revenue Funds total spending andcould only be accessed during revenueshortfalls that occur during economicdownturns. This provides a safety mecha-

nism to ensure smoother, more predict-able state spending on core services dur-ing an economic crisis.

Establishing aTaxpayer Relief Fund.This fund would be lled from revenuesabove the Spending Growth Index once

the past due debt has been paid downand the Budget Stabilization Fund is fullyfunded. We anticipate that the TaxpayerRelief Fund would begin being funded in

2015. Refunds would then be issued annu-ally to Illinois taxpayers according to thenumber of exemptions led on their most

recent tax returns.

Please see Graphic 1 for a summary of theeffects of this proposal.9

Our proposal provides a safety mechanism (seeAppendix A for model legislation language)

so that future legislatures can put a questionbefore the voters of Illinois to use surplusrevenues above the Spending Growth Index fordesignated purposes.

borrowing costs on tomorrows taxpayers.

There is no mechanism in place to stop thisbudgetary recklessness, and it comes with ahigh price. Each and every Illinois household is

now burdened with $4,423 in state governmentdebt.5

Until a mechanism that prevents irr esponsible behavior

by state leaders is put into place, Illinois will continuethe long, slow economic decline that has been underwayfor over 30 years.

The Solution

The Pension Funding & Fairness Act solves

this problem by:

Instituting a constitutional amendment

that establishes a Spending Growth Indexof ination plus population growth. Thisallows state spending to grow each andevery year in a predictable way, helpingpolicymakers provide services efciently

and effectively. Historically, over the last20 years, state tax growth has increasedat an average annual rate of 4.8 percent,

while ination plus population is pro-jected to grow at an average annual rateof 2.4 percent.6

Requiring that the rst appropriation eachyear be to the annually required publicemployee pension payment. We have amoral obligation to fund pensions that

have been promised and earned. Illinoismust put the pension contribution at thetop of the payment list, just as a home-

owner puts the mortgage payment rst onthe payment list at the kitchen table. Weneed to make this payment rst in orderto stop burying our children and grand-

children with unsustainable debt that de-stroys their economic opportunity.

With these two steps in place, policymakerscan then allocate the remaining general fundsto core government priorities. These two stepswill, for the rst time, require legislators and

governors to set priorities while allocating nitetaxpayer resources.


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Graphic 1. How A Spending Growth Index Secures Pension Funding & Provides Taxpayer ReliefFiscal Years 2011 to 2045

All Dollar Amounts are in Millions

Pension Funding & Fairness Act under Public Act 096-0889 (Pension Reform for New Employees)

Fiscal

Years

General Fund

Spending (a)

General Fund

Revenue (b)

Budget

Surplus

Past Due

Paydown Fund

Contribution(c)

Budget

Stabilization

Fund

Contribution

Cumulative

Budget

Stabilization

Fund

Taxpayer

Relief Fund

Contribution (d)

2011 $26,820 (e) $27,064 (f) $243 $243 $0 $0 $0

2012 $26,950 $28,370 $1,420 $1,420 $0 $0 $0

2013 $27,496 $29,739 $2,244 $2,244 $0 $0 $0

2014 $28,167 $31,175 $3,008 $1,961 $1,047 $1,047 $0

2015 $28,840 $32,679 $3,839 $0 $1,260 $2,307 $2,579

2016 $29,530 $34,256 $4,726 $0 $55 $2,362 $4,671

2017 $30,236 $35,910 $5,674 $0 $56 $2,419 $5,617

2018 $30,959 $37,643 $6,684 $0 $58 $2,477 $6,626

2019 $31,700 $39,460 $7,760 $0 $59 $2,536 $7,701

2020 $32,457 $41,364 $8,907 $0 $61 $2,597 $8,846

2021 $33,233 $43,360 $10,127 $0 $62 $2,659 $10,065

2022 $34,027 $45,453 $11,426 $0 $64 $2,722 $11,362

2023 $34,841 $47,647 $12,806 $0 $65 $2,787 $12,741

2024 $35,673 $49,946 $14,273 $0 $67 $2,854 $14,207

2025 $36,525 $52,357 $15,832 $0 $68 $2,922 $15,764

2026 $37,398 $54,884 $17,486 $0 $70 $2,992 $17,416

2027 $38,291 $57,533 $19,242 $0 $71 $3,063 $19,171

2028 $39,205 $60,309 $21,104 $0 $73 $3,136 $21,031

2029 $40,141 $63,220 $23,079 $0 $75 $3,211 $23,004

2030 $41,099 $66,271 $25,172 $0 $77 $3,288 $25,095

2031 $42,080 $69,470 $27,390 $0 $78 $3,366 $27,311

2032 $43,084 $72,822 $29,738 $0 $80 $3,447 $29,658

2033 $44,112 $76,337 $32,225 $0 $82 $3,529 $32,142

2034 $45,165 $80,021 $34,857 $0 $84 $3,613 $34,772

2035 $46,242 $83,883 $37,641 $0 $86 $3,699 $37,555

2036 $47,345 $87,932 $40,587 $0 $88 $3,788 $40,499

2037 $48,474 $92,176 $43,702 $0 $90 $3,878 $43,611

2038 $49,630 $96,624 $46,994 $0 $92 $3,970 $46,902

2039 $50,813 $101,288 $50,475 $0 $95 $4,065 $50,380

2040 $52,024 $106,176 $54,152 $0 $97 $4,162 $54,055

2041 $53,264 $111,300 $58,036 $0 $99 $4,261 $57,937

2042 $54,533 $116,672 $62,139 $0 $102 $4,363 $62,037

2043 $55,833 $122,303 $66,470 $0 $104 $4,467 $66,366

2044 $57,163 $128,206 $71,043 $0 $106 $4,573 $70,9362045 $58,524 $134,393 $75,869 $0 $109 $4,682 $75,760

Total $1,411,876 $2,358,244 $946,368 $5,868 $4,682 n.a. $935,818

(a) Spending growth based on population + ination projections from U.S. Census and Congressional Budget Ofce.

(b) Revenue growth based on 20-year historical average of 4.8 percent.

(c) Accounts for the past due operating debt from Fiscal Years 2009 and 2010.

(d) This analysis does not include the increased growth in the economy and revenues associated with the tax refunds from the

Taxpayer Relief Fund.

(e) FY 2011 $26,820 spending = $21,299 (Budget Solutions 2011 appropriations) + $169 (net value of transfers) + $3,520 (pension

contribution) + $488 (add-back for half-year pension savings) + $542 (2003 POB payment) + $802 (2009 pension note).

(f) FY 2011 $27,064 revenue = $19,684 (state sources) + $5,300 (federal sources) + $1,728 (statutory transfers in) + $352 (fund sweeps).

Source: Commission on Government Forecasting and Accountability and Illinois Policy Institute.


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The PensionFunding &

Fairness Act

limits overall

spending

growth to a

reasonable,

affordableamount

through the

use of the

Spending

Growth

Index.

the good times that build in spending levels

that become unsustainable when inevitableeconomic slowdowns occur.

The Pension Funding & Fairness Act solvesthese issues. It limits overall spending growth

to a reasonable, affordable amount through theuse of the Spending Growth Index. This index

will let government grow each year to keeppace with ination and population growth;according to U.S. Census and CongressionalBudget Ofce projections, ination plus

population will increase at an average annualrate of 2.4 percent. The Pension Funding &Fairness Act will also change incentives for

government policymakers. For the rst timeever, Illinois government will be required tobecome more productivejust as the private

sector must do when resources are nite butdemands for services continue.

The Pension Funding & Fairness Act alsocreates a mechanism to pay down past due

debt, the Past Due Payment Fund. Further,during those periodic years when revenuesdont grow with ination plus population, the

Why This Works

The fundamental problem in Illinois stategovernment is a lack of spending discipline.

For years, the taxpayers provided Illinoisgovernment with record revenues. State

spending increased 39 percent after inationfrom 1998 to 2008.10 State leaders spent every

dime and borrowed billions more, with the totalgeneral obligation and capital debt growingfrom $8.4 billion in scal year 2001 to $25.4billion in scal year 2011.11 Illinois now ranks

37th in debt service as a share of revenueamong the 50 states; only 13 states have worseburdens than Illinois.12

The General Assembly and successivegovernors have demonstrated year after year

that they lack the discipline to set priorities andrein in spending. Each year they have spentmore and more by expanding governmentobligations to unsustainable levels. Theseexpansions of state government obligations

create structural overspending, in turn leadingto the so-called structural decits. It is therapid, excessive growth in spending during

$0 $10,000 $20,000 $30,000 $40,000 $50,000 $60,000 $70,000 $80,000

2011 2014 2017 2020 2023 2026 2029 2032 2035 2038 2041 2044

MillionsofDollars

Fiscal Years

How A Spending Growth Index Secures Pension Funding & Provides

Taxpayer ReliefFiscal Years 2011 to 2045

Taxpayer Relief Fund

ContributionBudget Stabilization Fund

ContributionPast Due Paydown Fund

Contribution


Graphic 2


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There is a

workable,

and yes,

difcult,

solution t

solve Illin

perpetual

scal crisi

once and f

all.

to once and for all turn Illinois aroundto

turn our state away from perpetual decline andinstead put us on the path to prosperity. Thepublic must become engaged and advocate forpolicies that will work.

Further, the policies proposed must offersomething to all interested parties. The PensionFunding & Fairness Act offers the following

groups real advantages over the status quo:

Public employees. In return for supporting

the reforms outlined here, public em-ployee unions and their members receivea constitutionally-protected fundingmechanism that puts pension payments at

the top of the appropriation list. Currentand future retirees will rest easy knowing

their earned pensions are safe from politi-cal shenanigans from future legislatures

and governors. True, the public employeeunions and its members must concede onsome fronts. They must forego inequi-

table salaries, benets and pensions. Theymust accept that there must be equitybetween those who pay the taxes to fundgovernment and those who benet from

government. For more on the currentinequity, please see our May 2009 report13

on public employee and private sectorcompensation disparity.

Taxpayers. Illinois residents, too, mustsacrice by continuing to pay a high level

of taxes until the Taxpayer Relief Fundis funded and tax refunds begin. Theywill bear the burden of paying down thepast due debt and funding the Budget

Stabilization Fund. But in return, Illinoistaxpayers will rest easy knowing that Il-linois state government is constitutionally

limited from taking too much from theirwallets.

Public aid recipients. Those who benet

from government spending in education,in health and human services, in publicsafety and in other areas will know thatspending will be based upon core priori-

ties. As demands for services increase, sotoo will resourceswithin the SpendingGrowth Indexs proscribed limit.

Budget Stabilization Fund creates the safety

net to allow spending to continue without atax hike or difcult spending cuts. This createscontinuity and certainty for policymakers andthe entrepreneurs, investors and workers who

fund government.

Finally, the Pension Funding & Fairness Actprovides a mechanism to reward taxpayers

for the sacrices they make every day. With aconstitutionally-protected spending brake inplace, taxpayers know that government will be

well fundedbut not excessively funded. Whenthe hard work of entrepreneurs, investors andworkers pays off, the rewards will be returnedto those who took the risks and delivered: the

taxpayers.

Is This Politically Possible?

Our purpose is to illustrate that there is aworkable, and yes, difcult, solution to solveIllinoiss perpetual scal crisis once and for all.

The November 2010 election will tell us muchabout whether these policies are viable in 2011.We believe the Pension Funding & Fairness Act

is both necessary and appealing, but it will notbe achieved without hard work. As to creating

the political will and the coalitions necessaryto implement the policies discussed here, that

will take active effort by the Illinois public, itscivic organizations, the media and courageousleadership from genuinely reform-minded

political decision makers and candidates ofboth parties.

It is true that this proposal will require

the General Assembly itself to refer out aconstitutional amendment for a vote by thepeople of Illinois. While we explicitly propose

that the Pension Funding & Fairness Act beadopted immediately by statute, the key forIllinoiss long-term health is to amend theconstitution so that when the current crisis

passes future legislatures and governors cannotundo the difcult, but effective, policy changesadvocated here.

The only way the constitution can be amendedis if the people of Illinois send a signal tocandidates and legislators that the time is now


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The time isnow for real

reform and

revitalization.

Illinois can

once again

stand as an

economicpowerhouse

and a beacon

of prosperity.

other issues to put the choice before the voters

for debate and decision.

Conclusion

Illinois was once a growing, vibrant state

admired the world over. Illinois stood tall as acolossus of economic might. Illinois built the

tallest buildings; it reversed rivers; it producedmore manufacturing goods than just about anyother state; it was an agricultural and energygiant; it was a transportation hub by road,

by rail, by air and by river; it was a pioneer innancial markets; and its reputation as the can-do state had not yet faded.

Our history is lled with stories of a can-dospiritthe American spiritof opportunity,

self-reliance and accomplishment. People wereonce proud to be from Illinois.

Not so much today. Most of us areembarrassed. We are embarrassed by our

reputation for corruption. We are worriedabout our long economic decline. And toomanytoo many that work in Springeld, to be

frankhave resigned themselves, accepting abusiness as usual attitude that will inexorablylead to perpetual decline.

It does not have to be that way. And that is whywe are providing this proposal.

We do not see these policies as partisan, but

rather common-sense solutions to what ailsour state. The solutions wont be easy and theywill require political courage and will. The

time is now for real reform and revitalization.Illinois can once again stand as an economicpowerhouse and a beacon of prosperity.

But only if we choose the right path. ThePension Funding & Fairness Act, in concertwith the Institutes Budget Solutions 2011, if

adopted, will put Illinois back on that path toprosperity.

The time is now to turn Illinois around

before it is too late.

Service providers. State vendors and contrac-

tors who provide services on behalf ofthe state, and advocates for state spendingon social services, health care services,

education, and public safety will knowthat resources will grow each and every

year in a reasonable, affordable way. Ifdemands for services grow beyond the

nancial resources available, state workers,vendors, contractors and advocates mustseek productivity improvements in orderto expand services.

It is time for a new paradigm to beginthe paradigm of increasing government

productivity rather than increasing governmentconsumption of the taxpayers wallet.

What This Proposal Does Not Address

This is a comprehensive proposal that accountsfor many of the root causes of todays scalcrisis in Illinois. Nevertheless, it does not

attempt to address every single issue, manyof which are important. In this proposal wedo not address the issue of converting Illinois

to accrual accounting, nor do we addressthe issues of post-employment benets orexpanded pension benet reforms. Othershave done good work in these areas, including

the Institute for Truth in Accounting, theCivic Committee of the Commercial Club ofChicago, Americans for Prosperity, the CivicFederation and the Taxpayer Action Board.

Broadly speaking, we are supportive of theirrecommendations.

Our guiding focus remains that we rstrestructure the rules of the game to put Illinoison a cash basis surplus annually. We must makethe pension payment the rst appropriation

each year, pay down past due debt, establisha workable safety net with the BudgetStabilization Fund and then begin returning

the taxpayers their hard-earned cash. Further,we believe that this must be done without tax/fee hikes, without creating new categories oftaxation and without borrowing.

When we have xed the root causes ofthe current crisis, as this proposal does, weencourage those who want to solve these and


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Endnotes

1 See J. Scott Moody and Wendy P. Warcholik,Mission Possible: Fully Funding Illinoiss State

Pensions While Respecting Hardworking Taxpayers,Illinois Policy Institute, January 19, 2010, http://

tinyurl.com/illinoispensions.2 Budget Solutions 2011: A New WayForward, Illinois Policy Institute, March 15,2010, http://www.illinoispolicy.org/news/article.

asp?ArticleSource=2284.

3 U.S. Department of Labors Bureau of LaborStatistics, Quarterly Census of Employment andWages, http://www.bls.gov/cew/.

4 The Institute for Illinois Fiscal Sustainabilityat the Civic Federation, A Fiscal Rehabilitation

Plan for the State of Illinois, February 22,2010, http://civicfed.org/sites/default/les/IllinoisFiscalRehabilitationPlan.pdf.

5 Household debt of $4,423 equals per capita debtof $1,682 multiplied by average Illinois household

size of 2.63. The Institute for Illinois FiscalSustainability at the Civic Federation, A FiscalRehabilitation Plan for the State of Illinois, February22, 2010, http://civicfed.org/sites/default/les/

IllinoisFiscalRehabilitationPlan.pdf. U.S. Census,Illinois QuickFacts, http://quickfacts.census.gov/qfd/

states/17000.html.6 The historical state tax data and projectedpopulation change is from the U.S. Department of

Commerces Census Bureau, while the projected inationrate is from the Congressional Budget Ofce.

7 State of Illinois, FY 2011 Budget, http://www2.

illinois.gov/budget/Pages/default.aspx.

8 An alternative to pay this past due debt down fasterwould be to sell or lease assets, including the IllinoisTollway. However, the proceeds in excess of the past due

debt should not be used to fund general operationsthatspending level must stay within the limits proscribed inthe Illinois Policy Institutes Budget Solutions 2011and the Pension Funding & Fairness Acts SpendingGrowth Index. Excess proceeds after paying down

the past due debt could be used either to pay down theunfunded pension debt or for capital projects. Anotheralternative would be to use the savings from prospective

benet reform for the same purpose.

9 These calculations reect the states reduced

contribution schedule under Public Act 096-0889,

as calculated by the Commission on Government

Forecasting and Accountability.

10 Kristina Rasmussen, Out Of Control: TheExplosion of Illinois State Government Spending,Illinois Policy Institute, August 21, 2009, http://tinyurl.com/illinoisspending.

11 The Institute for Illinois Fiscal Sustainability

at the Civic Federation, A Fiscal RehabilitationPlan for the State of Illinois, February 22,2010, http://civicfed.org/sites/default/les/IllinoisFiscalRehabilitationPlan.pdf.

12 Arthur B. Laffer, Stephen Moore & JonathanWilliams, Rich State, Poor State: 2010 ALEC-

Laffer State Economic Competitiveness Index:Illinois, American Legislative Exchange Council,2010, http://www.alec.org/AM/Template.

cfm?Section=Rich_States_Poor_States.13 Kristina Rasmussen, Robbing Peter to Pay Paul:

A Closer Look at Public Employee Pay, IllinoisPolicy Institute, May 26, 2009, http://tinyurl.com/publicemployeepay.


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Appendix A: Model Pension Funding & Fairness Act

The following provides a general outline of how the Pension Funding & Fairness Act would look, at a level of detailto serve as a platform for actual legislation (and including all of the features described in this study). This Act wouldinitially be implemented statutorily and then referred by the legislature to the voters for consideration as a constitutional

amendment. Only by amending the Illinois Constitution in this way can future legislatures be prevented from taking

Illinois back down the irresponsible course it has long been following.

Pension Funding & Fairness Act

Denitions

Emergency. Emergency means extraordinary circumstances outside the control of theLegislature, including:

Catastrophic events such as a natural disaster, terrorism, re, war and riot;

Court orders or decrees.

Increase in Revenue. Increase in revenue means any legislation or tax levy that is estimated to

result in a net gain in state revenue of at least 0.01 percent of General Fund revenue in at leastone scal year, and:

Enacts a new tax (or fee);

Increases the rate or expands the base of an existing tax (or fee);

Repeals or reduces any tax exemption, credit or refund; or

Extends an expiring tax increase (or fee).

Ination adjustment factor. Ination adjustment factor means the increase in the ChicagoMetropolitan Statistical Area Consumer Price Index for the most recently available calendaryear as calculated by the United States Department of Labor, Bureau of Labor Statistics. The

ination adjustment factor may not be less than zero but never more than 10 percent.

State spending. State spending means any authorized state appropriations and allocations.

Population adjustment factor. Population adjustment factor means the average annualpercentage increase in population for the three most recent years for which data is available,as determined annually by the United States Department of Commerce, Census Bureau. The

population adjustment factor may not be less than zero.

Revenue. Revenue means taxes and fees collected by the State.

Tax. Tax means any amount raised for the general support ofgovernment functions.

Spending Growth Index

State Spending Growth Index. Beginning with the scal year that starts after this section takeseffect, the maximum annual percentage change in state scal year spending in the categories


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specied equals the ination adjustment factor plus the population adjustment factor and

any increases attributable to measures approved under Approval of revenue increases. Thislimitation must be calculated separately for the following categories:

General Fund;

Highway Fund; and

Other Special Revenue Funds.

Exceptions. The following may not be counted in calculating expenditure limitations:

Amounts returned to taxpayers as refunds of amounts exceeding the expenditure limitation ina prior year;

Amounts received from the Federal Government;

Amounts collected on behalf of another level of government;

Pension contributions by employees and pension fund earnings;

Pension and disability payments made to former government employees;

Amounts received as grants, gifts or donations that must be spent for purposes specied bythe donor;

Amounts paid pursuant to a court award; or

Reserve Transfers.

Approval of Expenditure increases. The following form of approval is required to adopt anincrease in state spending beyond the limitation:

For an increase in state spending:

The measure must be approved by a three-fths supermajority vote of all members ofeach House of the Legislature; and

The measure must be approved by a majority of voters.

Exceptions. Voter approval is not required if the spending is as a result of an increase in state

revenue under Approval of revenue increases.

Approval by voters; emergency approval. The question of whether to adopt legislation to impose

an increase in State spending beyond the limitation must be submitted to the voters for approvalat the next general election. If the Legislature determines by a three-fths supermajority vote thatlegislation to increase spending beyond the limitation should take effect sooner than the next generalelection, the Legislature may provide for submission of the question to the voters at any regular or

special election.

Spending estimates. A measure submitted to the voters must include an estimate of the spendingincrease by the measure for the rst three scal years of its implementation.


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Notice.At least 30 days before an election, the Secretary of State shall mail, at least cost, a titlednotice or set of notices addressed to All Registered Voters at each address of every activeregistered voter. Notices must include the following information and may not include anyadditional information:

The election date, hours, ballot title and text, and local election ofce address and telephonenumber.

For each proposed spending increase, the estimated or actual total of scal year spending forthe current year and each of the past four years, and the overall percentage and dollarchange; and

For the rst full scal year of each proposed spending increase, estimates of the maximumdollar amount of each increase and of scal year spending without the increase.

Ballot questions for spending increases must begin: Shall state spending increase by (amountof rst or, if phased in, full scal year dollar increase) annually for the purpose of . . .?

Costs. The State shall reimburse municipalities for the costs of a special election.

Approval of Revenue Increases

Approval of increase. The following form of approval is required to adopt an increase in staterevenue:

For an increase in revenue of the State:

The measure must be approved by a three-fths supermajority vote of all members ofeach House of the Legislature; and

The measure must be approved by a majority of voters.

Exceptions. Voter approval is not required if:

Annual state revenue is less than annual payments on general obligation bonds, requiredpayments relating to pensions and nal court judgments; or

The measure is an emergency tax.

Approval by voters; emergency approval. The question of whether to adopt legislation toimpose an increase in revenue of the State must be submitted to the voters for approval at thenext general election. If the Legislature determines by a three-fths supermajority vote thatlegislation to increase revenue via an emergency tax should take effect sooner than the next

general election, the Legislature may provide for submission of the question to the voters atany regular or special election.

Revenue estimates. A measure submitted to the voters must include an estimate of the amount

to be raised by the measure for the rst three scal years of its implementation.Notice.At least 30 days before an election, the Secretary of State shall mail, at least cost, a titled

notice or set of notices addressed to All Registered Voters at each address of every active


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registered voter. Notices must include the following information and may not include any

additional information:

The election date, hours, ballot title and text and local election ofce address and telephone

number.

For each proposed revenue increase, the estimated or actual total of scal year spending forthe current year and each of the past four years, and the overall percentage and dollar

change; and

For the rst full scal year of each proposed revenue increase, estimates of the maximumdollar amount of each increase and of scal year spending without the increase.

Ballot questions for revenue increases must begin: Shall (description of the tax increase) toincrease state revenues by (amount of rst or, if phased in, full scal year dollar increase)

annually for the purpose of . . .?

The State shall reimburse municipalities for the costs of a special election.

Emergency Taxes

Emergency taxes permitted; condition.The state may impose

emergency taxes only in accordance with this section:

The tax must be approved for a specied time period by a three-fths majority of themembers of each House of the Legislature;

Emergency tax revenue may be spent only after other available reserves are depleted and must

be refunded 180 days after the emergency ends if not spent on the emergency; and

The tax must be submitted for approval by the voters at the next regular election.

Absence of approval. If not approved by the voters as provided in this section, an emergency taxexpires 30 days following the election.

Past Due Paydown Fund

Establishment. The Past Due Paydown Fund, referred to in this section as the fund, is

established and must be administered for the purposes identied in this section.

Transfer to fund; limits.At the close of each scal year beginning in 2011, the State Comptroller

shall identify the amount of General Fund unappropriated surplus above the SpendingGrowth Index limitation and transfer to the fund any amount necessary up to the total pastdue operating debt owed by the state as of the close of scal year 2010.

Use of fund. The Legislature must authorize transfers, appropriations and allocations from thefund only to fund the costs of paying down the remaining past due debt until such debt iszero. Remaining funds shall be transferred to the Budget Stabilization Fund.


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Budget Stabilization Fund

Establishment. The Budget Stabilization Fund, referred to in this section as the fund, isestablished and must be administered for the purposes identied in this section.

Transfer to fund; limits.At the close of each scal year, the State Comptroller shall identify the

amount of General Fund unappropriated surplus above the state Spending Growth Indexexpenditure limitation and above the amount necessary to fully fund and pay down the pastdue operating debt to zero. The fund may not exceed eight percent of the total General Fund

revenues received in the immediately preceding scal year.

Use of fund. The Legislature may authorize transfers, appropriations and allocations from the

fund only to fund the costs of State Government up to the expenditure limit calculated underExpenditure Limitation in years when state revenues are less than the amount necessaryto nance the level of expenditures permitted under Spending Growth Index ExpenditureLimitation. Transfers require a three-fths supermajority vote of the Legislature.

Investment of funds; proceeds.The money in the fund may be invested as provided by law, with

the earnings credited to the fund. At the close of every month during which the fund is at theeight percent limitation, the State Comptroller shall transfer the excess to the Taxpayer Relief

Fund.

Taxpayer Relief Fund

Establishment. The Taxpayer Relief Fund, referred to in this section as the fund, is establishedand must be administered for the purposes identied in this section.

Transfer to fund; limits.At the close of each scal year, the State Comptroller shall identifythe amount of General Fund unappropriated surplus above the state expenditure limitation

and above the amount necessary to fully fund the Past Due Paydown Fund and the BudgetStabilization Fund.

Notication. By September 1st annually, the State Comptroller shall notify the Legislature and theDepartment of Revenue of the amount in the fund as a result of the transfers.

Refund. If the amount in the fund exceeds 1 percent of General Fund expenditures, theLegislature shall, by September 15th, enact legislation to provide for the refund to taxpayersof amounts in the fund. Refunds may take the form only of temporary or permanent broad-

based tax rate reductions.

Refund in case of legislative inaction. If the Legislature does not enact legislation by

September 15th to provide refunds, then the State Comptroller shall, by September 30th,notify the Department of Revenue of the amount in the fund. The Department of Revenueshall calculate a one-time bonus personal exemption refund. The amount of the personalexemption refund must be calculated by dividing the amount in the fund identied by the State

Comptroller by the number of personal exemptions claimed on income tax returns led fortax year beginning in the previous calendar year. The Department of Revenue shall issue arefund by October 15th to a taxpayer who led an income tax return by April 15th of the samecalendar year based on the number of exemptions claimed (times refund per exemption) on

the taxpayers return without regard to the taxpayers tax liability for the year.


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Appendix B: Legislation to Prioritize the Pension Payment

The following provides a general outline of how the Pension Funding & Fairness Acts requirement to make thepension payment the rst appropriation authorized each scal year would work. The goal is to ensure that the actual

expenditures are made as a rst action each month. This provision would initially be implemented statutorily andthen referred by the legislature to the voters for consideration as a constitutional amendment. Amending the Illinois

Constitution will prevent future legislatures from taking Illinois down the ir responsible course it has long beenfollowing. This language is intended to provide a framework and guide only.

Pension Funding & Fairness Act

Provision to Make the Pension Payment the First Appropriation and Actual Expenditure

Each Year

Denitions

Pension Payment. Pension Payment means the total annual required pension payment for eachscal year as dened by the Commission on Government Forecasting and Accountability

(COGFA) andin keeping with generally accepted accounting principles (GASB).

First Appropriation. First Appropriation means any legislation as part of the annual budgetaryand appropriation process must be directed to authorize and require the full pension paymentprior to any other appropriations or expenditures.

Actual Expenditures. Actual Expenditures means the payment of state funds to satisfy anystate nancial obligation.

First Expenditure. First Expenditure means that any authorized state appropriation andsubsequent actual payments must have the rst payment be made toward the annual requiredpension payment as dened herein.

Monthly Pro Rata Pension Payment. Monthly Pro Rata Pension Payment means the averagemonthly pension payment calculated by dividing the total scal year annual pension paymentby 12 months.

Pension Appropriation and Payments

Pension Appropriation. Beginning with Fiscal 2011 and for each budget year thereafter, theGeneral Assemblys rst appropriation each year must be directed to make the full annualpension payment dened by COGFA and in compliance with generally accepted accountingprinciples (GASB). This appropriation must be made rst and executing it (making the actual

payments required by it) shall take precedence over any other appropriation or expenditure.

Exceptions. There shall be no exceptions to this requirement.

Actual Expenditures. The following terms dene how actual expenditures must be made tocomply with the pension payment appropriation dened above:

By March 1 of each year, the State Comptroller shall take the total annually required pensionpayment for the upcoming scal year (beginning on July 1) and divide that number by12. This amount becomes the Monthly Pro Rata Pension Payment for each month of theupcoming scal year.

If during the scal year, COGFA adjusts the annually required pension payment for the current


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year upward, the State Comptroller shall recalculate the Monthly Pro Rata Pension Paymentupward accordingly and allocate the increase evenly over the remaining months to ensure thatthe full annual pension payment is made for the scal year.

If during the scal year, COGFA adjusts the annually required pension payment downward, theoriginal payment schedule shall be maintained. Payments in excess of the revised paymentschedule shall be allocated to any existing unfunded pension liability.

If during the scal year, COGFA adjusts the annually required pension payment downward, and ifthere is no remaining unfunded pension liability as calculated by COGFA and in compliancewith generally accepted accounting principles, then the State Comptroller shall recalculate the

Monthly Pro Rata Pension Payment downward accordingly and allocate the reduction evenlyover the remaining months to ensure that the full annual pension payment is made for thescal year.

By no later than the 5th of each month, the Comptroller will disburse funds as authorized bythe Pension Payment Appropriation to the various state retirement funds such that the total

payment equals the Monthly Pro Rata Pension Payment. Said payments will be allocatedproportionally to each retirement fund as calculated by COGFA.

Exceptions. There shall be no exceptions to this provision.

State Spending Freeze. If for any reason the Monthly Pro Rata Pension Payment is not made bythe 5th of the month, or if for any reason the accumulated payments for the year do not equalthe sum of the Monthly Pro Rata Pension Payments for the months having passed during the

scal year, the State Comptroller shall cease all payments from state resources until such timeas the pension payment is brought current for the year.

Exceptions. There shall be no exceptions to this provision.


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Whether you are a public employee worriedabout how your pension is going to be funded

or an Illinois taxpayer concerned you will haveto pay even higher taxes to fund pensions, wehave a solution that will put your mind at ease.

By law, the Illinois pension system must be 90percent funded by FY 2045. But in fact, thepension system is running a large decit, calledthe unfunded pension liability. For example,

in FY 2010, pension system assets are estimatedto be $48.6 billion, while liabilities are estimatedto be $131.6 billion. If you subtract the assets

from the liabilities, this leaves an unfundedpension liability of $83 billionwhich is theequivalent of three years worth of GeneralFund revenue.

A common way to show the unfunded pensionliability is the funded ratio, which is assetsdivided by liabilities. The overall funded ratio

in FY 2009 was a dismal 38.2 percent. Moredisturbingly, the trends show the funded ratiocontinuing to deteriorate as time marches on,

rather than increase. The State Employees

Retirement System recently released fundedratio for FY 2009 showed a dramatic decline of26 percentfrom 46.1 percent in FY 2008 to a

paltry 33.9 percent in FY 2009.

In order to make up the unfunded pensionliability, the state governments contribution will

have to be larger. Under current law, the annualstate contribution to the state retirement systemand debt service is estimated to grow more than

six-fold, from $4.5 billion in FY 2010 to $25.7

billion by FY 2045. To put this into perspective,the FY 2010 state pension contribution alonewould consume nearly half (40 percent) of

individual income tax collections, or more thanhalf (60 percent) of sales tax collections.

Unfortunately, politicians have every incentive

to defer payment into the pension fund becausethe consequences of not doing so are years,if not decades, awaycertainly well beyond

the next election cycle. Not surprisingly,nding creative ways to postpone the states

responsibility to state retiree programs hasbecome endemic. Consider the following

examples of such irresponsibility:

The largest cause of the unfunded pensionliability is insufcient state contributions.

The FY 2003 Pension Obligation Bond(POB) was severely back-loaded. This isan enormous gamble, and if it fails, future

Illinois taxpayers will pay the price.

The other postemployment benets

(OPEB) bill has been entirely ignored and,as a result, is also unfunded.

The recent legislation mandating asset

smoothing injects politics into whatshould be straightforward actuarial analysisfor short-term budget savings.

Bond rating downgrades by rating agencieshave raised future borrowing costs, andthreats of additional bond downgrades

have been ignored.

The Pension Funding & Fairness Act willeliminate this destructive behavior. It will put

reasonable speed limits on the growth of stategovernment spending, based on the increasein ination plus the increase in population.In effect, this will prevent politicians from

neglecting to pay the bills. The limits can onlybe exceeded with approval by the majority ofvoters in a statewide referendum. Furthermore,

all surplus revenue above the spending limit

will be required to fund the annual statecontribution to the pension system rst andforemost. Once the annual state contribution is

at 100 percent, the surplus revenue would owto (in order of priority): pension debt payback,the Budget Stabilization Fund and the TaxpayerRelief Fund.

This comprehensive approach to solvingIllinoiss unfunded pension liabilities is bold and

forward thinking. As with any policy proposal,the idea does come with transitional challenges,

Appendix C: How Did We Get Here? Dening the Pension Funding Problem.

This appendix comes from our original Pension Funding & Fairness Act r eport (released in January 2010), whichhas since been updated in this paper.


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Assets: The market value of stocks, bonds

and other investments that are held by thepension system. Each year assets grow inone of two ways. First, the value of the

assets changes, and second, the Illinoisstate government deposits an annual

contribution.

Liabilities: The present value of pensionbenets to be paid out to current andfuture retirees. Each year liabilities growbased on a number of assumptions, such

as expected salary increases, mortality,turnover and other factors.

For the pension system to be considered fullyfunded, assets must equal liabilities. UnderPublic Act 88-0593 passed in 1995, the Illinois

pension system must be 90 percent fundedby FY 2045. Chart 1 and Table 1 show theprojected game plan to reach this funding goal.

Unfortunately, the Illinois pension system is far

from being fully funded. Instead, it is currentlyrunning a large decit called the unfundedpension liability. For example, in FY 2010,

pension system assets are estimated to be $48.6billion, while liabilities are estimated to be$131.6 billion. This leaves an unfunded pensionliability of $83 billionwhich is the equivalent

of three years worth of General Fund revenue.

A common way to show the unfundedpension liability is the funded ratio, which is

assets divided by liabilities. Table 1 shows theprojected funded ratio for the entire pensionsystem, while Table 2 shows the actual funded

ratio by each separate retirement system. Theoverall funded ratio in FY 2009 was a dismal38.2 percent. However, the funded ratio variesconsiderably by individual retirement system,

from a low of 22.7 percent for the GeneralAssembly Retirement System to a high of 41.9percent for the State Universities Retirement

System.

More disturbingly, the trends show the fundedratio continuing to deteriorate. As shown in

Table 2, the State Employees RetirementSystem recently released its funded ratio for FY2009. The funded ratio fell by a dramatic 26

including initial borrowing while the economy

continues to recover, a budget freeze for up tothree years in the beginning, and an increasein the amount public employees pay for their

health care benets. Yet all of these matters aretemporary and surmountable.

Beyond the Pension Funding & Fairness Act,

the state needs to work toward the eventualimplementation of a two-tier system, withnew employees shepherded into a denedcontribution system rather than a dened

benet program. Governor Quinns pensionreform proposal was only a modest step towardthis goal, but analysis of the plan shows how

even small changes can yield large savings.

By embracing the Pension Funding & Fairness

Act, Illinois will be able to fully fund the annualrequired contribution in compliance with thespirit of the law and pay off all pension-relateddebt by FY 2024with the exception of the30-year FY 2003 Pension Obligation Bonds.

These bonds cannot be paid off early sincethey are not callable bonds. Further, this willput a permanent spending brake in place to

prevent state government from letting spendinggrowth spiral out of control once again.Overall, this plan will help the governmenthonor its commitments while also honoring its

responsibility to the taxpayersall whilelaunching a new period of growth andgovernment accountability in Illinois.

Understanding the Unfunded Pension

Liability

The Illinois pension system consists of veseparate retirement systems: the TeachersRetirement System (TRS), State Employees

Retirement System (SERS), State UniversitiesRetirement System (SURS), Judges RetirementSystem (JRS) and the General Assembly

Retirement System (GARS)they will hereafterbe referred to collectively as the Illinoispension system.

The health of the Illinois pension system isbased on two elementsassets held versusliabilities accrued:


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Table 1Unfunded Pension Liability is the Gap Between Assets and Liabilities

Fiscal Years 2010 to 2045

Billions of Dollars

Projections under Current Law (a) Projections under Gov. Quinn's Proposal (a)

Fiscal

Year Assets LiabilitiesUnfundedPension

Liability

FundedRatio

Assets LiabilitiesUnfundedPension

Liability

Funded Ratio

2010 $48.6 $131.6 $83.0 36.9% $46.3 $131.5 $85.1 35.2%

2011 $52.1 $138.1 $86.0 37.7% $49.1 $137.9 $88.8 35.6%

2012 $55.7 $144.8 $89.2 38.4% $51.8 $144.4 $92.6 35.9%

2013 $59.4 $151.8 $92.3 39.2% $54.6 $151.0 $96.4 36.2%

2014 $63.3 $158.8 $95.5 39.9% $57.5 $157.7 $100.2 36.5%

2015 $67.4 $166.1 $98.7 40.6% $60.4 $164.4 $104.0 36.7%

2016 $71.6 $173.5 $102.0 41.2% $63.3 $171.2 $107.9 37.0%

2017 $76.0 $181.2 $105.2 41.9% $66.3 $178.0 $111.7 37.2%

2018 $80.5 $189.0 $108.5 42.6% $69.3 $184.9 $115.6 37.5%

2019 $85.4 $197.1 $111.7 43.3% $72.4 $191.8 $119.4 37.7%

2020 $91.4 $205.4 $114.0 44.5% $75.6 $198.8 $123.2 38.0%

2021 $95.8 $214.0 $118.2 44.8% $78.8 $205.8 $126.9 38.3%

2022 $101.4 $222.9 $121.4 45.5% $82.3 $212.8 $130.5 38.7%

2023 $107.5 $231.8 $124.4 46.4% $85.8 $219.7 $133.8 39.1%

2024 $113.9 $241.1 $127.2 47.2% $89.6 $226.5 $137.0 39.5%

2025 $120.8 $250.8 $130.0 48.2% $93.5 $233.4 $139.9 40.1%

2026 $128.1 $260.7 $132.6 49.1% $97.7 $240.2 $142.5 40.7%

2027 $136.0 $271.1 $135.1 50.2% $102.1 $247.0 $144.9 41.3%

2028 $144.4 $281.8 $137.3 51.3% $106.9 $253.7 $146.8 42.1%

2029 $153.5 $292.8 $139.3 52.4% $112.0 $260.3 $148.3 43.0%

2030 $163.3 $304.4 $141.1 53.7% $117.5 $266.8 $149.3 44.0%2031 $173.8 $316.3 $142.5 55.0% $123.4 $273.2 $149.8 45.2%

2032 $185.2 $328.7 $143.5 56.3% $129.9 $279.4 $149.5 46.5%

2033 $197.5 $341.6 $144.1 57.8% $137.0 $285.5 $148.5 48.0%

2034 $212.2 $355.0 $142.8 59.8% $144.8 $291.4 $146.7 49.7%

2035 $228.1 $368.9 $140.8 61.8% $153.3 $297.2 $143.9 51.6%

2036 $245.5 $383.4 $137.9 64.0% $162.8 $302.8 $140.0 53.8%

2037 $264.2 $398.5 $134.2 66.3% $173.2 $308.2 $134.9 56.2%

2038 $284.7 $414.1 $129.3 68.8% $184.9 $313.4 $128.6 59.0%

2039 $307.0 $430.2 $123.2 71.4% $197.8 $318.6 $120.8 62.1%

2040 $331.1 $446.9 $115.8 74.1% $212.3 $323.8 $111.5 65.6%

2041 $357.3 $464.3 $107.0 76.9% $228.5 $329.0 $100.5 69.5%

2042 $385.8 $482.5 $96.7 80.0% $246.9 $334.4 $87.6 73.8%

2043 $417.1 $501.7 $84.6 83.1% $267.6 $340.2 $72.6 78.7%

2044 $451.2 $521.8 $70.5 86.5% $291.2 $346.5 $55.2 84.1%

2045 $488.6 $542.9 $54.3 90.0% $317.9 $353.2 $35.3 90.0%

(a) Based on state actuarial estimates prior to the enactment of "asset smoothing."



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percent, from 46.1 percent in FY 20081 to just

33.9 percent in FY 2009.In order to make up the unfunded pensionliability, the state governments contribution

will have to be larger. As shown in Chart 2 andTable 3, under current law, the annual statecontribution to the state retirement system anddebt service is estimated to grow more than

six-fold, from $4.5 billion in FY 20102 to $25.7billion by FY 2045. To put this into perspective,the FY 2010 state pension contribution alone

would consume a full 40 percent of individual

income tax collections, or 60 percent of salestax collections.3

More worrisome, even if the state were to makeits full contribution, the unfunded pensionliability will grow from its current level of $83

billion in FY 2010, before peaking at $144billion FY 2033. Only within the last thirteenyears prior to FY 2045 will the unfundedliability drop signicantly to $54 billionnally

yielding the required 90 percent funding ratiothat is currently mandated by law. This back-

loaded payoff schedule leaves little room forerror, so the state mustbe prepared to meet its

annual state pension contribution.

In addition to the annual state contribution,

the state government must also nancethe repayment of the $10 billion PensionObligation Bonds issued in FY 2003 and the$3.5 billion Pension Notes issued in FY 2010.

These will be discussed in more detail later inthe study.

The Status Quo Has FailedWhy Illinois

Needs the Pension Funding & Fairness Act

Under current political realities, politicianshave every incentive to defer payment into

the pension fund because the consequencesof not doing so are years, if not decades,awaycertainly well beyond the next electioncycle. Not surprisingly, nding creative ways

to postpone the states responsibility to stateretiree programs has become endemic.Consider the following examples of such

irresponsibility:

The largest cause of the unfunded pension liabilityis insufcient state contributions.

Chart 3 shows the reasons for the additionof $39 billion to the unfunded pension

liability between June 30, 2000 and June20, 2008.4 Nearly 35 percent of the $39billion shortfall, or $13.6 billion, is due toinsufcient state contributions. The second

reason is lower-than-expected investmentreturns at $9.5 billionalthough even this

does not fully reect the toll the recentrecession has taken on investment returns.

Unfortunately, deferments come at asignicant long-term cost. Since the state

government is under constitutional andlegislative mandates to reach a 90 percentfunding ratio in the pension system by FY2045, any deferment will eventually have to

be paid with interest. The implicit interestrate is 8.5 percent, since that is the assumed

Retirement System 6/30/06 6/30/07 6/30/08 6/30/2009 (b)

General Assembly 37.1% 37.6% 32.0% 22.7%

Judges' 46.4% 48.4% 42.0% 31.2%

State Employees' 52.2% 54.2% 46.1% 33.9%

Teachers' 62.0% 63.8% 56.0% 39.1%

State Universities 65.4% 68.4% 58.5% 41.9%

Total 60.5% 62.6% 45.7% 38.2%

Other Postemployment Benefits (a) n.a. n.a. 0.0% n.a.

Table 2

Funded Ratios by Retirement System

Various Fiscal Years

(a) Includes health, dental, vision and life insurance.

Source: State Comptroller, Commission on Government Forecasting and Accountability and Illinois Policy

Institute.

(b) Without asset smoothing.


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Fiscal YearState PensionContribution

(Current Law) (a)

State PensionContribution (Gov.

Quinn's Proposal)(a)

FY 2003 PensionObligation Bond

(POB) Pay-Off

FY 2010 Pension

Note Pay-Off (b)

State PensionContribution Plus

POB and Note(Current Law)

State PensionContribution Plus

POB and Note(Gov. Quinn's Plan)

2010 $4.0 $4.0 $0.5 $0.0 $4.5 $4.52011 $5.4 $4.4 $0.5 $0.8 $6.7 $5.8

2012 $5.6 $4.6 $0.6 $0.8 $6.9 $6.02013 $5.8 $4.8 $0.6 $0.8 $7.2 $6.2

2014 $6.1 $5.0 $0.6 $0.8 $7.5 $6.42015 $6.4 $5.2 $0.6 $0.8 $7.8 $6.62016 $6.7 $5.4 $0.6 $0.0 $7.2 $6.0

2017 $7.0 $5.7 $0.6 $0.0 $7.6 $6.32018 $7.3 $5.9 $0.6 $0.0 $7.9 $6.5

2019 $7.6 $6.2 $0.6 $0.0 $8.2 $6.82020 $7.9 $6.4 $0.7 $0.0 $8.6 $7.1

2021 $8.3 $6.7 $0.7 $0.0 $9.0 $7.42022 $8.6 $7.0 $0.7 $0.0 $9.4 $7.8

2023 $9.0 $7.3 $0.8 $0.0 $9.8 $8.12024 $9.4 $7.7 $0.8 $0.0 $10.3 $8.52025 $9.8 $8.0 $0.9 $0.0 $10.7 $8.9

2026 $10.3 $8.4 $0.9 $0.0 $11.2 $9.32027 $10.8 $8.7 $0.9 $0.0 $11.7 $9.7

2028 $11.3 $9.1 $1.0 $0.0 $12.2 $10.12029 $11.8 $9.5 $1.0 $0.0 $12.8 $10.5

2030 $12.3 $10.0 $1.1 $0.0 $13.4 $11.02031 $12.8 $10.4 $1.1 $0.0 $14.0 $11.5

2032 $13.4 $10.9 $1.2 $0.0 $14.6 $12.02033 $14.0 $11.3 $1.2 $0.0 $15.2 $12.52034 $16.0 $11.8 $0.0 $0.0 $16.0 $11.8

2035 $16.7 $12.3 $0.0 $0.0 $16.7 $12.32036 $17.4 $12.9 $0.0 $0.0 $17.4 $12.9

2037 $18.2 $13.5 $0.0 $0.0 $18.2 $13.52038 $19.0 $14.1 $0.0 $0.0 $19.0 $14.1

2039 $19.8 $14.7 $0.0 $0.0 $19.8 $14.72040 $20.6 $15.3 $0.0 $0.0 $20.6 $15.3

2041 $21.5 $16.0 $0.0 $0.0 $21.5 $16.02042 $22.5 $16.7 $0.0 $0.0 $22.5 $16.72043 $23.5 $17.4 $0.0 $0.0 $23.5 $17.4

2044 $24.6 $18.2 $0.0 $0.0 $24.6 $18.22045 $25.7 $19.0 $0.0 $0.0 $25.7 $19.0

Total $456.9 $354.7 $18.9 $4.0 $479.7 $377.6

Table 3

The Growing Burden of Pension Funding



Billions of Dollars

(b) Estimated.(a) Based on state actuarial estimates prior to the enactment of "asset smoothing."


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the payoff on the FY 2003 POB, whichis severely back-loaded. In fact, in the lastyear of the bonds, the states paymentwill be $1.156 billion. This is almost 2.5

timesthe size of the rst payment of $481million.

More disturbingly, the back-loading ofpayments is due to the structure of theprincipal payments, which grow from $0in the rst four years to an average of $1

billion in the last four years. In other words,the rst four years of the POBs were aninterest-only loan! As a result, to date, amere $100 million in principal has been

paid. By the end of the 30-year schedule,Illinois taxpayers will have paid $11.934billion in interest on the original $10 billion

bond.

Finally, the notion of borrowing money inan attempt to reduce the unfunded pension

liability is a game of chance for the state.

The gamble is that the returns earned oninvesting the borrowed money will exceedthe costs of borrowing the money

commonly referred to as risk arbitrage.Fortunately, the POBs were issued witha favorable average interest rate of 5.05

percent. If the assumed rate of returnof 8.5 percent comes to fruition, thenthe pension system will have netted 3.45percentage points. However, that is a big

if. Recent economic conditions

rate of return on investments. But if thereturn is notearned on investments, it is upto the state to compensate for it throughhigher future pension contributions.

Therefore, if the $9.5 billion loss due tolower-than-expected investment returns

is not recouped in the future, the statepension contribution will be increased inorder to compensate for the loss. Currentpension contribution deferments mean

fewer assets in the pension system, which,if invested wisely, could plausibly make upfor the recent investment losses over thelong-term.

The FY 2003 Pension Obligation Bond (POB)was severely back-loaded. This is an enormous

gamble, and if it fails, future Illinois taxpayerswill be on the hook.

The purpose of the POB was two-fold.

First, $3.4 billion was used to pay part of

the states FY 2003 pension contribution,all of the states FY 2004 pensioncontribution, and administrative fees. This

was a shortsighted gimmick to balancethe budget. Second, the remaining $7.3billion was used as a one-time infusion into

the pension system in order to increasethe funding ratio. After the infusion, thefunding ration rose to 60.9 percent in FY2004 from 48.6 percent in FY 2003.

Chart 4 and Table 4 show the structure of


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remind us that one never knows when theeconomy might take a nosedive, or how

long it may take to recover.

Economist James B. Burnham, the MurrinProfessor of Global Competitiveness at

Duquesne University, summed up thesituation by saying, Facing a $5 billionbudget decit for scal year 2004, the

State of Illinois recently turned to itsve retirement systems for savings in itsoperating budget. The plan: borrow moneyto renance a portion of the states $36

billion unfunded pension liability and use achunk of the proceeds to cover operatingbudget contributions to the pensionsystems, thus freeing up nearly $2 billion

to offset budget decits. As attractive asthis plan may appear from a budgetaryperspective, the issuance of pension bonds

generally carries signicant risks that areoften downplayed in light of immediatescal pressures and the concerns ofpensioners.5

Overall, the FY 2003 POB was a goodshort-term deal for politicians, but apotentially very bad long-term deal for

taxpayers. Unfortunately, the outcome ofthis gamble is out of everyones hands,since the FY 2003 POB are not callable

meaning they cannot be paid off before

Table 4

FY 2003 Pension Obligation

Bond Payoff Schedule


Millions of Dollars

FiscalYear

Principal Interest Total

2004 $0 $481 $481

2005 $0 $496 $496

2006 $0 $496 $496

2007 $0 $496 $496

2008 $50 $496 $546

2009 $50 $495 $545

2010 $50 $494 $544

2011 $50 $492 $542

2012 $100 $490 $590

2013 $100 $486 $586

2014 $100 $483 $583

2015 $100 $479 $579

2016 $100 $475 $575

2017 $125 $470 $595

2018 $150 $465 $615

2019 $175 $458 $633

2020 $225 $450 $675

2021 $275 $438 $713

2022 $325 $425 $750

2023 $375 $409 $7842024 $450 $390 $840

2025 $525 $367 $892

2026 $575 $340 $915

2027 $625 $311 $936

2028 $700 $279 $979

2029 $775 $244 $1,019

2030 $875 $204 $1,079

2031 $975 $159 $1,134

2032 $1,050 $110 $1,160

2033 $1,100 $56 $1,156

Total $10,000 $11,934 $21,934

Source: Commission on Government

Forecasting and Accountability andIllinois Policy Institute.


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To put it another way, ignoring the

unfunded OPEB liability saved the statebudget at least $1.6 billion in FY 2008.7And it was relatively easy to ignore, because

it is not constitutionally protected (unlikepension benets, which are constitutionally

protected).

The recent legislation mandating asset smoothingpoliticizes the actuarial analysis for short-termbudget savings.

When politicians play actuaries, taxpayersneed to hide their checkbooks. In FY1997, Illinois politicians wanted to

boost the funding ratio of the pensionsystem without having to increase thestate contribution. They accomplished

this goal by changing the asset valuationmethodology from book value (value ofasset at time of purchase) to market value(current market value of asset), also calledfair value.

The Civic Federation found that thefunded ratio jumped from 54.9 percent in

FY 1996 to 70.1 percent in FY 1997 dueprimarily to a change in asset valuationmethodology (changed from book value tomarket [fair] value of assets).8

Now politicians are at it again. Theenactment of Public Act 96-0043 (effectiveJuly 15, 2009) mandates that the pension

system should replace fair valuation ofassets with actuarial valuation of assetsamethod known as asset smoothing. Asset

smoothing recognizes any unexpected gainsor losses over a ve-year period, ratherthan in the year of change.

Asset smoothing is a thinly-veiled attemptto mitigate the market losses incurredduring the recent nancial crisis. According

to a fresh analysis of the State EmployeesRetirement System, the fair valuation ofassets shows a decline of 19.56 percent forFY 2009.9 As shown in Table 2, the funded

ratio plummets to 33.9 percent in FY 2009from 46.1 percent in FY 2008.

their date of maturity in FY 2033. All

taxpayers can do is hope the long-termbenets outweigh the potential costs.

The unfunded other postemployment benets(OPEB) bill has been entirely ignored and, as a

result, is also unfunded.

As alarming as the state of the pensionsystem is, the OPEB bill is even worse,with a funded ratio of 0 percent in FY2008 (see Table 2) and a total liability of

$24 billion. Unfortunately, there is notyet much information on the status ofthe OPEB liability because reporting

requirements are still fairly new under therecent Government Accounting StandardsBoard (GASB) 45 ruling. GASB 45 covers

all other postemployment retirementbenets, which include health, dental,vision and life insurance.

This recent revelation from GASB 45

shows substantial negligence by Illinoisstate policymakers. It is much moreserious than a mere oversight. To put it

into perspective, imagine the uproar ifthe State Comptrollers Ofce discoveredthat General and Special Obligation Bondprincipal in FY 2008 was not $21.6 billion

as reported, but was actually $46.6 billion,due to found bonds worth $24 billion.6In essence, GASB 45 has resulted infound debt worth more than doublethe

amount of currently outstanding Generaland Special Obligation Bonds.

Of course, there is a rational explanationfor such negligencebudget savings. Forcomparisons, in FY 2008, the $24 billionOPEB liability was slightly less than the

$30 billion unfunded teachers pensionliability. The states required contributionon the unfunded portion (interest costs)

to the teachers retirement system in FY2008 was $2 billion. As such, we couldsurmise that states minimum contributionto the unfunded OPEB liability would be

approximately 80 percent of the teacherscontributionor $1.6 billion.


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lowered Illinois bond rating again to A2

from A1.13

Additionally, both Standard and Poors andFitch IBCA, Inc. have recently downgraded

Illinoiss general obligation bond rating

from AA to AA-.14

Overall, Illinois now has the second

lowest bond ratings from the three creditrating agenciesonly California has lowerratings.15 These downgrades in Illinoiss

bond ratings will mean higher futureborrowing costs.

However, under the new actuarial valuation

of assets, the drop in the funded ratioappears signicantly less severe, fallingonly slightly to 43.5 percent in FY 2009from 46.1 percent in FY 2008. Better

performance is due to the $2.4 billion

increase in asset values, from $8.6 billionunder fair valuation to $10.9 billion underactuarial valuation.

Clearly, this shell game from book valueto fair value to actuarial value undermines

the integrity of the actuarial valuations ofthe pension system. Without a consistentbenchmark, it is impossible for simplejudgments to be made about the pension

systemsuch as whether or not the state isactually making real progress in tackling the

unfunded pension liability.

Unfortunately, actuarial integrity takes aback seat to the bottom line. In additionto the improved funded ratio, the analysis

also states that [b]ecause asset smoothingwill produce articially higher asset levelsin FY 2009, the required FY 2011 statecontribution to the systems pursuant to the

current pension funding law will be lowerthan it would otherwise be had P[ublic]

A[ct] 96-0043 not been enacted.10

Onceagain, short-term budget maneuvers trump

paying the unfunded pension liability.

Bond rating downgrades by rating agencies have

raised future borrowing costs, and threats ofadditional bond downgrades have been ignored.

With the explosion in the unfunded

pension, OPEB liabilities and other debt,such as the FY 2003 POB, Illinoiss oncepristine debt rating has been taking hits.

In April 2009, Moodys Investors Servicedropped Illinoiss bond rating fromAa3the bottom tier of high grade,

high quality bondsto A1the top tierof upper-medium grade bonds.11Afterthe downgrade, another Moodys reviewalso suggested further downgrades were

possible.12 Unfortunately, in December2009, Moodys did act on the warning and


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Endnotes for Appendix C

1 Mallory Morton, Highlights of the StateEmployees Retirement Systems FY 2009 Actuarial

Valuation, Commission on Government Forecastingand Accountability, Monthly Brieng, October,

2009, http://www.ilga.gov/commission/cgfa2006/Upload/1009revenue.pdf

2 Dan Hankiewicz, Fiscal Analysis of theGovernors Pension Reform Proposals, Commissionon Government Forecasting and Accountability,

Pension Brieng, April 2009, http://www.ilga.gov/commission/cgfa2006/Upload/409%20PENSION%20BRIEFING.pdf

3 FY 2010 Economic and Revenue Forecast andUpdated FY 2009 Revenue Estimate, Commission

on Government Forecasting and Accountability,April 1, 2009, http://www.ilga.gov/commission/cgfa2006/Upload/FY2010%20Economic%20&%20Revenue%20Update%20APRIL%201,%202009%20FINAL.pdf

4 Pensions: A Report from the Commission onGovernment Forecasting and Accountability on the

Financial Condition of the State of Illinois RetirementSystems as of June 30, 2008, Commission onGovernment Forecasting and Accountability, February2009, http://www.ilga.gov/commission/cgfa2006/

Upload/2009FinCondReport2.pdf

5James B. Burnham, Risky Business? Evaluatingthe Use of Pension Obligation Bonds, Government

Finance Review, June 2003, http://www.gfoa.org/downloads/GFRJune03.pdf

6 Bonded Indebtedness and Long Term Obligations,Illinois State Comptroller, March 2009, pg. 1, http://www.apps.ioc.state.il.us/ioc-pdf/2008BondReport.pdf

7 This is in addition to current years OPEB cost ornormal costs.

8 The State of Illinois Retirement Systems: FundingHistory and Reform Proposals, The Civic Federation,September 30, 2008, http://civicfed.org/sites/default/les/civicfed_279.pdf

9 Mallory Morton, Highlights of the State

Employees Retirement Systems FY 2009 ActuarialValuation, Commission on Government Forecastingand Accountability, Monthly Brieng, October,

2009, http://www.ilga.gov/commission/cgfa2006/Upload/1009revenue.pdf

10 Ibid.

11 Kerry Grace Benn, Moodys Warnson Illinois Bond Ratings, Wall Street

Journal, July 16, 2009, http://online.wsj.com/article/SB124775413237351801.html#articleTabs%3Darticle

12 States Debt-laden Budget Prompts Moodysto Put it on Watch List, Daily Herald, July16, 2009, http://www.dailyherald.com/

story/?id=307415&src=109

13 Moodys Knocks Down Illinois BondRating, Chicago Business, December 8, 2009.

http://www.chicagobusiness.com/cgi-bin/news.pl?id=36373&seenIt=1

14 Bonded Indebtedness and Long Term Obligations,

Illinois State Comptroller, March 2009, pg. 1, http://www.apps.ioc.state.il.us/ioc-pdf/2008BondReport.pdf

15 Kapp, Lynnae, States Bond Rating Lowered,Commission on Government Forecasting andAccountability, Monthly Brief, December, 2009.http://www.ilga.gov/commission/cgfa2006/

Upload/1209revenue.pdf

Documents

Mission Possible: An Update to the Pension Funding & Fairness Act