May 29 (Bloomberg) -- Another May legislative session in Illinois, another financial crisis.
Lawmakers are shunning Democratic Governor Pat Quinn’s plan to extend tax increases in effect since 2011, while also balking at spending cuts. The impasse means the lowest-rated U.S. state faces a $2 billion budget hole for the year beginning July 1 and risks further bond downgrades. A house proposal relies on one-shot revenue and delayed payments, which rating companies scorn, as a stopgap before November elections.
The partisan haggling may cost taxpayers as it dredges up memories of the legislative session a year ago, when failure to produce a pension fix led to two rating cuts. Investors demand 1.12 percentage points of extra yield to own 10-year state bonds rather than AAA municipal debt, close to the highest since May 5, data compiled by Bloomberg show.
“The pattern in Illinois has been crisis management,” said Eric Friedland, head of muni research in New York at Schroder Investment Management North America, which oversees $4 billion in local debt. “I wouldn’t consider this a good entry point” for the bonds as “there’s going to be more news coming out of Illinois that may shake some investors.”
Illinois has benefited from demand in the $3.7 trillion municipal market after lawmakers in December broke through decades of gridlock to pass a measure addressing the worst-funded state pension systems. The state’s borrowing costs dwindled in bond sales since the pension bill.
A $250 million tax-free offering in April included 10-year debt priced to yield 0.93 percentage point above benchmark munis, the smallest yield spread since 2009.
The gains have halted amid the budget showdown, which threatens the state’s finances. House Speaker Michael Madigan said this week that the chamber lacks the votes to pass a tax extension.
The legislature, which is controlled by Democrats, is moving toward a 2015 budget that uses steps that have led to bond downgrades.
The house this week approved a $35.7 billion budget for next fiscal year. Without revenue from the extended tax increases, the proposal relies on fund transfers, delayed payments to vendors and forgoing paying for employee raises and increases in health-insurance costs. The senate still has to consider the budget.
“This is embarrassing to the state of Illinois,” Dennis Reboletti, a Republican, said on the house floor.
Senate President John Cullerton, a Chicago Democrat, said the state is headed toward a replay of circumstances that led to the 2011 tax boost -- lawmakers will have to return after November elections to come up with more money to pay for the budget, and could try to extend the higher tax rates then.
Quinn’s Republican challenger, venture capitalist Bruce Rauner, has said the tax boost should roll back at year-end, though he hasn’t recommended how to replace the lost revenue.
The temporary personal-income tax increase in 2011 raised levies to 5 percent from 3 percent and was the largest in Illinois history. The legislature passed the increase to help close a $13 billion budget deficit. Quinn in March proposed keeping the higher rate.
About 46 percent of Illinois’s general-fund revenue came from individual income taxes in fiscal 2013, according to a report last week from Comptroller Judy Baar Topinka.
“Decisions made by today’s lawmakers could determine whether the state can pull itself out of its current hole, or continue to flounder,” Topinka, a Republican, said in her report.
Moody’s Investors Service and Fitch Ratings maintain their negative outlook on Illinois because of questions over future revenue and the constitutionality of the pension bill. Standard & Poor’s has a “developing” view. All three rate the state four levels above speculative grade.
Fitch could cut the state’s rating if the budget isn’t balanced or counts on passing a tax extension in the future, said Karen Krop, an analyst in New York. Offsetting the lost revenue with spending cuts wouldn’t merit a cut, she said.
Illinois’s rating “is already an outlier and it factors in a lot of the pressures that are evident” in the budget battle, said Ted Hampton, a Moody’s analyst in New York. “At this point, it appears pretty clear that the 2011 tax rates aren’t going to be maintained.”
Illinois has benefited from muni interest rates falling to the lowest in almost a year, spurring a flight into riskier debt. Bonds from the state and its localities have gained 6.5 percent this year, compared with the entire market’s 5.7 percent advance, Barclays Plc data show.
“I wouldn’t say the market is overjoyed with what they’ve done here in Illinois,” said Tim McGregor, head of munis in Chicago at Northern Trust Corp., which oversees $30 billion of munis. “A lot of the credit-spread tightening may not be for fundamental reasons.”
The demand could evaporate if lawmakers let the tax boost expire, said McGregor and Friedland.
“They have a political structure that is all Democrats, so arguably they should be able to get anything passed, yet they can’t get anything passed,” said Justin Land, who helps manage $3 billion of munis at Naples, Florida-based Wasmer, Schroeder & Co. “That’s the history of Illinois politics.”
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