Despite New Taxes, Chicago’s Pensions Are Worse Off

Former Mayor Rahm Emanuel imposed new taxes, including a record increase in property taxes, to put the city’s pension system on a path towards solvency. Instead, a shortfall has grown from $23 billion to $30 billion.
by Hal Dardick and Juan Perez Jr., Chicago Tribune | October 4, 2019 AT 3:01 AM

(TNS) - A record-high property tax increase. A new tax on water and sewer service. A higher 911 emergency fee on telephone lines.

Former Mayor Rahm Emanuel’s series of tax hikes was painful, but he promised the extra money was part of a plan to get the woefully underfunded city worker pension funds on a “path to solvency.”

So what’s happened in the four years since taxpayers started digging deeper? The pension funds are actually worse off.

When Emanuel pushed through the tax hikes, the city worker retirement funds were about $23 billion short of what they needed to pay future retiree benefits. Now, they’re nearly $30 billion in the hole, a Tribune examination of pension fund reports shows.

There are three main reasons the gap widened by nearly $7 billion. By far the biggest is that the people who run the four retirement funds changed their economic assumptions. They reduced the amount they expect to earn by investing the money already on hand, and they increased how long they expect retirees will live and collect benefits.

Second, Emanuel’s plan put off the largest increases in pension contributions to get the system back on track until after he left office.

That meant even though the city was collecting as much as $822 million a year in new taxes for pensions as employees were kicking in more, it still wasn’t enough to cover the cost of retirement benefits going out. Emanuel said raising taxes any higher at that time could have hurt the city’s economy.

And third, pension fund investments didn’t meet their expected rate of return in recent years.

“(Chicago’s) pensions are the most poorly funded of the largest U.S. cities,” the Standard & Poor’s bond rating agency stated in a Sept. 23 report on pension funds across the nation. The annual contributions to pay off pension debt in cities like Chicago make it tougher to spend money on “priority services and infrastructure investment,” the report concluded.

It is against that backdrop that Mayor Lori Lightfoot took office. The biggest increase in pension contributions for the city comes during the next four years, posing a huge challenge. She’ll have to come up with an additional $989 million a year for pensions by 2023, according to her administration’s projections. If there’s a downturn in the economy that affects pension investments, that figure could go even higher.

It’s the "single most pressing fiscal issue Chicago faces,” the nonpartisan Civic Federation budget watchdog group stated in a March report.

How Lightfoot grapples with pension funding — as well as city worker pay hikes next year — could have a significant impact on taxpayers. While a Chicago casino and help from Springfield could solve some of the problem, further tax hikes and additional borrowing also are on the table.

History Of Neglect

For decades, then-Mayor Richard M. Daley and his predecessors did not contribute enough money to prevent city worker pension funds from losing ground. That allowed them to maintain city services without pushing politically unpopular tax increases — even as they further sweetened pension benefits for employees.

Recessions also caused the funds to lose money on their investments, and analysts increased their estimates of what would be needed to cover retiree benefits over the long haul.

By the time Emanuel took office in 2011, all four pension funds were on paths to run out of money as soon as 2030.

The Illinois Supreme Court consistently has ruled the state constitution doesn’t allow for pension benefits to be cut. So Emanuel turned to a series of tax and fee hikes. The monthly 911 fee was increased to free up money for the laborers pension. Property taxes were raised for police and fire pensions. A new water and sewer tax was enacted for the municipal workers pension.

Emanuel also went to Springfield and won new pension payment schedules for the four funds. For the first five years, the city would pay more than it had been into the pension system but not enough to prevent the overall shortfall from growing.

That strategy also meant the heaviest financial lift would start in 2020, when Emanuel either would be entering a third term or there would be a new mayor. Emanuel said he set up the 40-year payment schedule that way because raising taxes too fast could thwart the city’s rebounding economy in the wake of the Great Recession.

The biggest spike in pension costs is from 2020 through 2023, when the city’s contributions to the four funds are projected to rise from about $1.3 billion to nearly $2.3 billion a year. The increase begins next year, when payments to the police and fire funds are expected to rise by $281.2 million. For the municipal and laborers funds, payments increase in 2022, when the city will need an additional $370 million a year to cover the tab.

Why The Pension Debt Keeps Rising

Here’s the math on how the pension debt increased by nearly $7 billion from 2015 to 2018: about $5.8 billion is from the changed economic assumptions by the pension boards, and the remaining $1.1 billion is due to the city ramping up to the larger contributions over the last four years and investment returns that didn’t meet expectations. That’s according to the Tribune’s examination of pension fund reports.

Let’s look at the assumptions. The pension boards figured they would earn around 7.5% to 8% annually by investing the money collected from the city as well as employee paychecks.

Many experts criticized that as too high, and in recent years each of the four funds lowered expectations to a range of 6.75% to 7.25%. That led the pension boards to increase the amount of money they figure they’ll need to have invested to cover future benefits.

The analysts also took into account that retired workers are living longer and collecting more in lifetime benefits. That means the amount of money being spent by the pension funds would increase.

In addition, the pension system has less money in the four funds overall. That’s due in part to lower-than-expected investment returns. Last year was a particularly bad year. The funds lost between 5.5% and 6.6% of the total investments, according to their year-end accountings.

All of that means that at the end of 2018, the pension funds had about 23% of what they need for full funding, compared with about 30.5% when Emanuel’s first pension tax increase went into effect. The higher debt of nearly $30 billion comes to about $11,043 for each city resident.

The city’s overall pension debt is expected to continue to grow well into the 2030s. That’s because even with the higher payments required each year by state law, the city and employees still won’t be contributing enough money to cover the cost of benefits that are paid out.

“In the case of unfunded pension liabilities, elected officials traditionally have liked these backloaded pension ramps," said Ralph Martire, executive director of the Center for Tax and Budget Accountability. "It frees up revenue in your current budget to spend on current needs while deferring the actual cost of paying the debt owed to the system to future administrations. Sort of ideal political solution, right? Not a very good practical solution.”

Backloading the payments also boosts the overall, long-term taxpayer cost of ensuring the pension funds have enough money to meet their obligations to retired city workers.

“The unfunded liability is going to continue to grow,” said Sarah Wetmore, research director at the Civic Federation. “Every year (the city) doesn’t contribute enough, it costs more in the long run.”

Eventually, however, there’s expected to be enough money going into the pension funds to start shrinking the debt. The city will be kicking in significantly more. And as city employee wages grow with inflation, so too will their pension contributions. Workers pay between 8.5% and 11.5% percent of their salaries toward pension costs.

Potential Fixes

Lightfoot has yet to say how she’ll raise the money to increase how much the city puts into the pension systems.

At a recent investors conference, Lightfoot noted that increasing property taxes is her “biggest” power to raise revenue as mayor and said it remains on the table. She’s also aware it’ll be unpopular.

“I’ll tell you one thing that I hear from people all across the city: They’ll tolerate almost any other tax, but they don’t want their property taxes raised," Lightfoot said.

Two other major ideas to fund pensions are in the mix. Both are less than sure bets. One is a Chicago casino and the other is borrowing.

Lawmakers and Gov. J.B. Pritzker approved a casino for the city as part of a massive gambling expansion this year, and the city’s share of the proceeds is earmarked for police and fire pension fund payments.

But a study released in August concluded that the tax rates set by the state were too high to attract a casino investor. Getting lawmakers to adjust the rate will be politically tricky, and even then, it is not likely to quickly raise the kind of money the city needs in 2020 to make its police and fire pension contributions.

The other idea is a pension obligation bond, which one expert said is “basically placing a bet on the stock market.” The city would borrow money and pump it into the retirement funds, which would then invest it. The hope is that the investment returns would outpace the costs of paying off the money that was borrowed.

Lightfoot hasn’t ruled it out, but she has rejected the idea of a massive $10 billion bond issue that surfaced during the Emanuel administration.

The Civic Federation’s Wetmore called the idea “risky,” because if earnings on pension investments don’t keep pace with the interest due on the bond debt, the city could end up owing even more.

Martire, of the Center for Tax and Budget Accountability, endorses the idea.

“There’s no way the city of Chicago either has the revenue to put that additional money in (the pension funds), nor could feasibly raise it from the revenue sources available to them, including the property tax, because there’d be a revolt," Martire said. “So how do you bridge that gap?”

He points to a study by the Center for Retirement Research at Boston College. It looked at the performance of pension obligation bonds from 1985 through 2014. On average, the pension investment return outpaced the bond interest costs by 1.5%, the study concluded.

"This not incurring new debt,” he said. “It is refinancing your debt at a lower interest cost. That saves taxpayer money.”

The study, however, also noted that pension obligation bonds “involve considerable timing risk," given that those issued right before the Great Recession ended up being “a net drain on government revenues.”

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