The first comprehensive public look at next year's state finances includes a warning from the governor's office to lawmakers: “Ability to fund new programs will be severely limited next fiscal year.”

That's according to the Governor's Office of Management and Budget, which forecast a potential budget deficit of $3.2 billion for the 2026 fiscal year, which doesn't begin until July 1.

The Illinois Economic and Fiscal Policy Report, released each November, is often seen as a precursor to the budget negotiations that will move forward in earnest when lawmakers return to the Capitol for the legislative year that begins in January.

GOMB expects revenue next year to remain flat at about $53.4 billion, while expenses will increase by $3.2 billion.

While the overall numbers may change quickly in the eight months leading up to the start of fiscal year 2026, the report could herald an even more challenging budget process than the one completed in May. Lawmakers entered the session last year with a deficit of about $891 million, according to last year's GOMB report.

After lengthy and sometimes difficult deliberations, ruling Democrats narrowly passed a budget that filled the gap by extending a cap on corporate net operating losses ($526 million), capping a tax break claimed by retailers ($101 million), and the state sports tax increased betting ($200 million) and other minor accounting measures or tax changes.

Read more: Lawmakers are working through the night again to finalize the $53.1 billion budget

As for the looming $3.2 billion deficit, the report states that only that “will be addressed in the Governor’s fiscal year 2026 budget.”

But the report said spending cuts “cannot be implemented across the board,” particularly for the 40% of spending mandated either by court order, law or other obligations such as debt service, pension payments and Medicaid. Another 24% of government spending goes to areas such as education and higher education.

“True-up” leads to stagnation in sales

The expected deficit is partly due to both rising spending and stagnating revenues as some one-time sources disappear.

Projected spending for FY26 includes an additional $350 million for K-12 education, while pension costs are expected to rise by $440 million, among other “moderate increases” in state spending across the board.

Health care costs are expected to increase by $1.1 billion, due in part to “the impact of medical inflation and the decline in one-time FEMA (Federal Emergency Management Agency) reimbursement revenues” for Medicaid and state health plans. According to the governor's office, FEMA had still reimbursed some pandemic-era costs borne by the state government, but those costs are expected to decline in the coming fiscal year.

Revenue is expected to remain stagnant in part because of a “true-up” process at the Illinois Department of Revenue that has temporarily inflated state coffers over the past two years due to a complex miscalculation by the department.

In short, IDOR over-allocated the amount of money collected under the Corporate Property Replacement Taxes – which go primarily to local governments – by approximately $800 million in tax year 2021. Corporate taxes were overstated by $200 million, while individual income taxes on pass-through businesses were underestimated by $1.1 billion. According to IDOR, the miscalculation was caused “by changes in tax policy” at the federal and state levels that impacted businesses.

The department has initiated a “true-up” process in fiscal years 2024 and 2025 that aims to address “overpayments” to local governments while increasing general government revenues.

This resulted in total revenues increasing by approximately $1 billion in each of fiscal years 2024 and 2025.

But the same won't happen in FY26, the Legislature's Commission on Government Forecasting and Accountability noted in its September report, as IDOR adjusted its payout percentages in 2023.

As a result, COGFA found that general fund revenues could be “significantly weaker” in the coming fiscal year – and the GOMB report suggests the same thing.

Revenue is also expected to slow as the Federal Reserve cuts interest rates, reducing government investment income.

The state is also entering the final step of a five-year process that will shift sales tax collected on fuel from the General Revenue Fund to the Road Fund. This shift was included in Pritzker's first budget in 2019 as part of the Rebuild Illinois infrastructure plan.

Still, the report forecasts combined corporate and personal income tax growth of about $1 billion, while sales tax is expected to decline by $330 million, presenting a mixed picture for the state's “big three” revenue sources.

A History of Surpluses

What happens to the projected deficit and how it is contested is up to the governor and the new General Assembly, which meets in January.

So far in his term, Pritzker's administration has shown that it can work with lawmakers to balance the books. Since the COVID-19 pandemic upended state finances in 2020, the state has posted significant surpluses every year. There were several reasons for this, including better-than-expected earnings as consumers spent more on goods and government stimulus packages that boosted the economy.

Some years have been fueled by one-time factors, such as the “true-up” process over the last two years and the state’s retroactive collection of Medicaid dollars in fiscal year 2024.

The surpluses are also partly due to the conservative estimates made by the Pritzker administration at the beginning of the budgeting process. In recent years, this has allowed lawmakers to funnel additional revenue into the state's “Rainy Day” fund, which now has a record balance of $2.2 billion, while also addressing about $11 billion worth of outstanding debt. dollars to settle.

Interest expense on late payments has increased from about $980 million at the height of the two-year budget crisis between Republican Gov. Bruce Rauner and Democrats in the General Assembly in fiscal year 2018 to $137 million in Pritzker's first year in office and $13 million decreased last fiscal year.

GOMB's forecast also assumes a surplus for the current year before a deficit next year. Personal income tax and interest income were higher than expected, while corporate tax was lower than initially forecast, in line with national trends.

Overall, according to the report, the state expects a surplus of $262 million for the current year, although $246 million of that would be reserved in the budget stabilization fund or “rainy day” fund.

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