latest from AAUP

from Cary Nelson, AAUP President (and longtime CFA member) and Howard Bunsis, AAUP Treasurer

The State does have a fiscal problem, and it has been solving the problem in the short term by delaying payments to vendors, and now the State is delaying the appropriation for higher education.

Moody’s downgraded the State of Illinois debt in December of 2009. Fitch, another ratings service, gave Illinois an A rating on 12/30/2009, and put the state on a watch list for a possible downgrade as well.

The reason for Illinois’s fiscal problem is that income tax receipts have been lower than expected. The size of the problem for the 2010 budget is $2 billion, which is approximately 7% of the State’s General Fund budget.

Looking further in the future, there has been talk of budget holes in the $12-$13 billion range. The current governor wants to raise the income tax rate on those earning more than $250,000 per year, and a democratic candidate for governor wants to implement a progressive income tax system (instead of the current flat tax system). Every Republican candidate for governor is against a tax increase.

What is the response to this?

1. What is the State likely to do? The State appropriation is only 16% of the total revenue source for the UI system. There may be a 6% reduction in the appropriation. The appropriation is only 16% of the UI system’s revenue, so in terms of total revenues, the 6% reduction will reduce overall UI revenues by less than 1%. This reduction is not large enough to lead to furloughs.
2. The UI administration, in its budget documents, at times implies that the State appropriation funds the entire academic mission at the UI, which overstates reality. Administrators often argue that “this” money can only be used for “this,” and “that” money can only be used for “that.” However, the reality is that the UI system is one system, not a General Fund only system or a State Appropriation only system. That is why an analysis must focus on the health of the entire system, and not some component of the system that the administration claims is out of money.
3. The State is not considering eliminating the entire appropriation; they are considering delaying payments to the UI system. These payments are going to be repaid at some point. Note that the rating agencies did not rate the State bankrupt or junk; they gave the State “A” ratings, which is the 3rd highest rating for both Moody’s and Fitch. If the rating agencies believed that the higher education appropriation would NEVER be paid back, then the rating would have been much lower (such as the Baa2 rating given to the State of California).
4. What about the current cash flow problem caused by the delay of payments? Michigan faced this exact situation about 18 months ago, when the State delayed 2 months of the annual higher education appropriation. In Michigan, like Illinois, the state funds between 15% and 30% of the public universities’ total revenues (note: this percentage is over 65% in California). Not one public institution in Michigan asked the employees to give back salary money, nor did the administrations at these schools give back their salaries. All that happened was that the universities used their existing cash reserves to deal with the short term problem, and then were made whole when the full payments were made about 6 months later (it was 6 months from the time a payment was delayed to when it was repaid in full by the State). Now, is Michigan in worse shape than Illinois? Absolutely.
5. What should the UI do in response to a short-term cash flow problem?
6. a. The first thing would be to use existing reserves. The Moody’s viability ratio measures how many months of reserves an institution has in relation to total expenditures. If we omit the UI Foundation (which is a very conservative approach), the UI system had approximately 12% or 2 months of reserves as of June 30, 2008. The standard recommendation is to have between 5% and 15% of reserves. Note that these reserves are 12% of total expenses. Therefore, a reduction in a few months of the state appropriation should easily be handled from current cash reserves, which are significant.

b. If the administration claims they have no cash reserves, they can borrow short term money to guide them through this period. Borrowing money is not a long term solution, but this is a short term cash flow problem. The UI system still has a very strong credit rating.

c. Any reduction in spending should not come from the employees, but from administrative costs and administrative spending.

d. The reserves of the UI Foundation should be used to help with any short term cash flow problem. The UI Foundation has over $1 billion in assets; any temporary shortfall can be borrowed from the Foundation, and then repaid when the State pays the appropriation. It is not advisable to use Foundation dollars, but since they will be repaid in a short time, it is a solution that is preferred to reducing the pay of current employees.

e. The last option, after the above three have been exhausted, would be to ask the UI system’s employees to accept a temporary reduction in pay. When the administration gets the appropriation back from the State, then the pay reduction should be paid back to the employees, with interest. Let’s be clear: the 6% decline in the annual appropriation may be a permanent reduction. However, this small reduction is not nearly large enough to support any furlough. Consider this: if the UI system is receiving a temporary decline in the appropriation, then any reduction in pay should be temporary and should be fully refunded.