The Illinois Canary

One of the many advantages of federalism is that states are given broad latitude to do their own thing on taxing, providing services, and compensating the army of government employees and vendors who sit in between. At the national level, Republicans have difficulty dealing with repealing Obamacare, fixing the tax code, and putting Social Security and Medicare on secure footings because of the $20 trillion national debt – believing that eventually the piper will have to be paid, but probably not during this term of office. For the more somber, at the state level, we have 50 laboratories where politics and social policies meet economic realities, and the politicians have the ability to test the premise that deficit spending can go on forever. The formerly Great State of Illinois is volunteering to serve as the canary in the coal mine.

Where Illinois stands

– Illinois has not had a budget for three years. The state has $13 billion in unpaid bills. 100% of state receipts go to court-mandated payments – to the point that the state lottery will not be able to make payouts after June 30. The bond rating agencies have lowered Illinois’ credit ratings to one level above junk, with an unfavorable outlook.

– Republican Governor Rauner has proposed significant tax increases and fundamental reforms – increased top income tax rates from 3.75 % to 4.95% coupled with a hard spending cap, a four year property tax freeze, workers compensation reform, and pension reform. The Democratic legislative leadership wants the tax increases to be retroactive, and opposes any serious structural reforms.

– The state has $130 billion in unfunded liabilities for public employees, and the highest tax burden in the Midwest. Industry and high wage earners are leaving for surrounding states in droves.

How they got here

– Illinois is among the most corrupt states in the nation. Four of the last seven governors – Rod Blagojevich (D), George Ryan (R), Dan Walker (D), Otto Kerner (D) – have gone to jail. Much money which should have gone to public purposes wound up in the portfolios of elected officials and a vast network of (largely Democratic) party loyalists.

– Michael Madigan, the Speaker of the Illinois Assembly, has been the most powerful politician in Illinois for decades. His style derives from the worst of ward boss politics, emanating from his South Side Chicago base where he began as a lieutenant in the Daley machine. Party discipline prevails over any other concern.

– In 2011, the top individual income tax rate was “temporarily” increased from 3% to 5%, and the top corporate rate was raised from 4.8% to 7% in order to pay off debt and reduce borrowing. The promised “return to normal” came in 2015 with the individual rate dropping to 3.75%, and the corporate rate dropping to 5.25%. While this represented a true 25% increase in the personal rate and 9% increase in the corporate rate from 2010, nothing had changed on pensions, spending, or borrowing.

What can be done

– One whimsical Chicago Tribune editorialist has suggested that Illinois dissolve itself, with the pieces being incorporated into surrounding states, and remaining pockets of “Rahmonia”, “Taxwinkletopia”, and “Madiganistan” being left for Chicago Mayor Rahm Emanuel, Cook County Board President Toni Preckwinkle, and the Assembly speaker. That probably won’t work.

– Federal law prevents states from declaring bankruptcy. It is unlikely that the Illinois Congressional delegation could convince their peers to step in for a “one time exception” to allow defaults on bonds, renegotiation of contracts, and layoff of government workers. This is closer to home than the recent Puerto Rico restructuring of $70 billion in debt; Illinois’ debt exceeds $200 billion, public employee unions would be massively impacted, funding of programs like Medicaid and education would come into play.

– More likely, the Republican governor and the Democratic legislature will find a way for the stew to continue to simmer. Income, property, and gas taxes will be raised again. New state employees will have less generous pensions and medical coverage. There will be fewer teachers and clerks at the Department of Motor Vehicles. There will be more pot-holes and no new initiative to reduce the soaring murder rate in Chicago.

– If all else fails, the rest of us could build a wall.

Lessons for the other 49

– Corruption matters.

– It is very, very, very hard to ever reduce taxes once they have gone up. The Leviathan will consume all that is available.

– Capitalism and free markets work. Illinois’ failure is a boon to Scott Walker’s Wisconsin, Eric Holcomb’s Indiana, Rick Snyder’s Michigan, Eric Greitens’ Missouri, and Matt Bevin’s Kentucky. All Republicans. All benefiting from the outflow of capital and skilled labor.

– And perhaps the largest unreported effect: the voters of the Midwest understand Chicago and Illinois. The failure of Democratic machine politics is on center stage for all to see.