An impasse between its Republican governor and Democrats who control the legislature has left Illinois as the only U.S. state without a complete budget 11 months into fiscal 2016. Court-ordered spending and ongoing and stopgap appropriations have allowed Illinois to keep operating.
Moody's said the long-running partisan standoff is impeding Illinois' powers to increase revenue or constrain spending.
"The state's structural budget gap equals at least 15 percent of general fund expenditures, if the state's underfunding of pension contributions is included," Moody's said in a statement.
It added that without a budget plan to offset a revenue loss from 2015's rollback of income tax rates, Illinois' chronic backlog of unpaid bills could reach prior peak levels of about $10 billion in the coming months.
Even before this latest downgrade, Illinois had the lowest credit ratings among the 50 states and has had to pay a big interest rate penalty to sell its bonds.
A $550 million Illinois GO bond issue is slated for competitive sale June 16.