Illinois is a good example as to why State balanced budget requirements are little more than hollow gimmicks. Even during periods of "balanced budgets" state government debt, especially unfunded liabilities that are off the balance sheet, have been mounting. IMO, Governor Quinn should take a number of steps:
1. Propose a two-year budget, with annual components, that reaches balance at the end of that timeframe; gimmicks ie., balancing a budget through borrowing, balancing the budget only because major drivers of debt are kept off budget, should be avoided. In fact, to maximize credibility, the governor should dissociate from the hollow mechanisms that led to a false sense of fiscal health in the past.
2. Significant spending reductions should be frontloaded to begin to re-establish credibility.
3. Investments should be given priority in being safeguarded, given the future value that they create, but some investments will also need to be reduced.
4. The situation where a broad slice of the potential tax base escapes taxation should be remedied and no new tax abatements should be issued. In exchange for broadening the tax base, tax hikes could be kept more modest.
5. Phased-in financial statement reform: Items typically kept off the balance sheet should gradually be moved onto the balance sheet. Immediately, annual costs associated with such items should be recorded as "on budget" and an annual charge related to the transition of off balance sheet items to on balance sheet status should be recorded in the budget.
6. Meaningful cuts in the net exposure to the major off balance sheet items should be implemented, including but not limited to future health and pension benefits currently estimated at
$140 billion (those currently receiving pensions should be held harmless if possible, though a modest "hair cut" should not be ruled out). By net exposure, I'm talking about reducing the benefits promised, raising the age limit for pensions, and increasing individual pension/health contributions so as to make the programs fiscally sustainable. An emphasis should be placed on trying to minimize the impact on current retirees and perhaps, if possible, near-term future retirees. Pensions that were the result of practices such as "spiking" should immediately be re-adjusted to reflect earnings excluding the final year earnings spike and, if legal challenges arise, the individuals who engaged in spiking and those who abetted it should be pursued for pension-related fraud.
7. A quasi-independent fiscal board should be created to provide transparency in the state's finances and to provide realistic macroeconomic assumptions on which a budget is based. The governor should have no influence over this board. Given Illinois' past lack of fiscal credibility, such a board is both necessary and appropriate.
8. The state should roll over its existing debt to capitalize on current abnormally low interest rates. But such a maneuver would provide modest relief. It would not be a substitute for the above fiscal consolidation and structural changes necessary to put the state on a sustainable fiscal course.
At present, Illinois would be characterized as a "speculative unit" under the Minsky methodology. In such a situation, Illinois' cash inflows do not cover its cash payment commitments arising from debts (in Illinois case, the unfunded liabilities), even as the state can cover its interest payments. As a result, Illinois continues to add to its debt. A Ponzi situation would evolve were the state unable to generate sufficient revenue to cover its interest costs. A prolonged absence of significant fiscal reform under which it largely pays its obligations via borrowing (current practice), as well as sustains a continuing increase in its unfunded liabilities, could lead to a general and significant rise in the state's borrowing costs. Were a dramatic spike in interest rates to occur, that outcome could threaten to push the state toward a Ponzi situation.
