This past fiscal year ended on June 30 2017, and it is my understanding that TRS investments made something above 10% for the year. As additional information comes from TRS holdings in private equity and real estate, it is expected that the gains will only grow. And with TRS funding level firmly above 40%, Illinois is no longer the worst-funded pension state. Illinois has moved up and is now in 48th place: Kentucky is 49th at 37.8%, and New Jersey is last with 37.5%. That is not the only reason to celebrate: Illinois finally has a budget.
According to the editorial writers and columnists across the state, Governor Rauner was the clear winner, except for those that gave the victory to Speaker Madigan. For more than two years, Governor Rauner tried to hold the budget hostage: first, for a set of union-busting demands, but in the end for several measures, such as term-limits, a property-tax freeze, and workmen’s compensation changes that were more popular.
In the end, while Governor Rauner got nothing for his efforts, he can and will use the tax increase as a hammer against Madigan and company in the 2018 election. One thing is certain: the two years without a budget was a loss for the state. Even with the increased income tax, the state bond rating hovers just above junk.
Illinois owes a total of over fifteen billion dollars to everyone it does business with, and the many candidates for governor and the legislature are all in full campaign-mode a year and four months before the election. The political pundits have already given Illinois claim to be the most expensive campaign in the nation for who will be our governor.
Even without a budget, a combination of court orders and continuing resolutions had the state of Illinois paying out $39 billion a year or, more accurately, a combination of paying or promising to pay a total of $39 billion. Now the increase in the state income tax from 3.75% to 4.95%, which is an increase of 1.2% according to Mike Madigan or 32% according to Bruce Rauner, is expected to bring in an additional $4.3 billion in revenue.
The rise in the corporate tax from 5.25% to 7% should grow the state’s revenue by an additional $460 million. The bill that gave us the tax increase also allows the state to borrow $8 billion to pay down debt. Normally, borrowing to deal with debt is not a good plan, but with some debts paying interest as high as 12% the state can borrow for far less and come out ahead. In addition, paying off some debts will free up matching grants from the Federal government.
Illinois needed the tax increases in order to fund TRS pensions. June 28, as the state headed into a third year without a budget, a federal judge ruled that Illinois was out of compliance with previous court orders to pay health care bills for low-income and other vulnerable groups. Judge Joan Lefkow ordered the state to come up with $586 million per month to make immediate payments and to start reducing the $2 billion debt which is owed to health care providers.
Without additional revenue, State Comptroller Susana Mendoza would have obviously needed to take the money from somewhere else. The monthly payments from the state going into the pension funds could likely have been taken by Mendoza to help satisfy the judge’s demand.
Over the last several years, following the advice from its own investment people and its outside consultants, the TRS Board has lowered its assumed rate of investment return in three steps from 8.5% down to 7%. Each decrease in assumed returns meant that the state of Illinois would need to increase its contributions to the pension fund. The last decrease in assumed returns caused the needed increased contribution from the state to TRS to grow by $402 million.
The necessity of these increased payments was not well received by the governor and the General Assembly and, as part of the legislation recently passed, TRS must now retroactively “smooth” the final effect of any changes made in the TRS assumed rate of investment in the last five years with 20% being phased in each year over the next five years.
Though the results of this calculation have yet to be announced by TRS, the estimate is that it could significantly lower the state's FY 18 contribution, and it may mean that the annual payment from the state of Illinois would remain approximately $4 billion, or even less than it was for last year
The FY 2018 budget included changes to the Illinois Pension Code with the creation of a new Tier III.
None of the Pension Code changes enacted on July 6, 2017 affect Tier I members or retired members in any way. There will be no changes to benefits, active Tier I member contributions, or health insurance. Tier III will only affect Tier II members and those teachers yet to be hired only if they want to be a part of it.
The optional Tier III calls for a “hybrid” retirement plan of two parts: a life-long-defined benefit pension and a defined contribution plan similar to a 401(K). Details on Tier III still need to be worked out and then the plans will be submitted to the Internal Revenue Service for their approval. It is a shame that that stipulation was not part of the creation of Tier II. Tier II members are paying 9% for a plan that is worth only 6% at best. Tier I is funded at just over 40%; Tier II is currently funded 151%.
One other change to the Pension Code should be noted: Local school districts will pay for the cost of a member’s pension if the member's salary is equal to or greater than the governor’s statutory salary of $177,412 – only the portion that is equal or over. Also local school districts will be responsible for the “employer contributions” for both the DB and DC plans that will be part of Tier III. For those of you who look ahead and fear the state wants to get out of the pension business, you should know that the billions of dollars that Illinois owes to TRS are binds that will not break. They owe it, and they have to pay it.