Allowing Municipal Bankruptcy Could Save Cash-Strapped Illinois Governments

Published May 28, 2015

Much attention has been given to Illinois’ growing state pension issues, but many municipalities in the state also face pension liabilities that could lead them to bankruptcy even if they cannot declare it. 

On May 12 and 13, Chicago received a series of downgrades in its credit ratings for the city itself, the Chicago Board of Education (CBE), and the Chicago Park District. The downgrades began Moody’s Investors Service’s (MIS) decision to lower Chicago’s credit rating two notches to the noninvestment-grade “Ba1” level with a negative outlook. The embarrassment continued the next day when the CBE and Chicago Park District ratings dropped three notches to junk levels.

With these downgrades, MIS has reduced Chicago’s credit rating seven notches in a mere two years. Only the Detroit currently has a worse rating.

These downgrades will affect the value of Chicago bonds, which are backed by property, sales, and motor-fuel tax revenue. The downgrades will also make servicing municipal debt more expensive and further strain Chicago’s finances, which are currently unable to cover the city’s spending and debt. MIS’ rationale for the downgrade focused on the city’s high unfunded pension liabilities and the Illinois Supreme Court’s recent decision that declared the 2013 state pension reform plan unconstitutional.

Conservative estimates suggest Chicago owes $20 billion in unfunded pension liabilities across its four major funds, but other independent reports put the correct number at more than $30 billion. Although Chicago is the state’s most notable example of excessive municipal pension debt, it is by no means alone in its struggle. Across Illinois, municipal pension systems are creating severe problems for city budgets and forcing property taxes higher while cutting local services. There are approximately 650 locally run government pension funds in Illinois, most of which cover retired police officers and firefighters. Many of these pension funds are nearing insolvency.

In 2014, the Illinois Policy Institute (IPI) audited the state’s 114 largest cities in an effort to measure the impact of local pensions on taxpayers, property taxes, and city budgets. IPI found many of the cities had experienced a significant decline in the health of their pension plans. A decade ago, 31 of the 114 cities received a score of 80 or above, whereas in 2014 only one city reached that threshold. Eighty percent of Illinois cities were deemed in critical condition in 2014.

The study found the ballooning pension debt can no longer be covered by property taxes. Ten cities spend 100 percent of their property taxes on pension costs. In the 20 largest Illinois cities, taxpayer contributions through property taxes increased by 157 percent over the past decade, whereas local government employee contributions increased by only 35 percent.

A 2012 Policy Brief by The Heartland Institute found in the years 2000–10, taxing agencies in Cook Country, including Chicago, increased property taxes by an average of 48 percent. During that time, local governments increased numerous other taxes, including sales taxes, excise taxes, and fees, to try and keep up with their runaway spending problems and unsustainable pension obligations.

None of this should surprise state and local elected officials in Illinois. Nearly all levels of Illinois government have mismanaged their public worker pension systems and refused to fully fund or reform them to maintain their solvency, a problem that may be bigger than most people realize. Researchers at Truth in Accounting recently discovered the state government reported owing $40 billion in retirement and health care benefits when the real amount is $158 billion

Without reform, governments will continue to burden taxpayers with substantially higher tax rates to bail out legislators and special interest groups for their imprudent policies. If public-sector union bosses continue refusing sensible changes, more state workers will be laid off, taxes will increase, more people will flee the state, and the state’s economy will further decline. Illinois already leads the Midwest in depopulation and had the weakest economic recovery; both factors reduce tax revenues. Ignoring the pension problem for another decade is not an option.

Although the Illinois Supreme Court ruled even modest changes to existing public-sector pensions are unconstitutional, there are still some options short of a constitutional amendment that can improve the pension situation. Lawmakers should enroll all newly hired public-sector workers in defined-contribution pension plans and give current workers the option to transfer into them. Under these plans, workers own their pensions and can enter the private sector without losing their accrued benefits. Defined-contribution plans prevent the burden on taxpayers from rising automatically in future years.

The Illinois legislature and Gov. Bruce Rauner (R) should pass and sign legislation allowing cities such as Chicago to file for bankruptcy if union bosses won’t agree to even modest pension reforms that save a city from default. Such legislation might get the government-employee unions’ attention and encourage them to agree to state and local pension reforms that will save their areas from fiscal disaster.