A Chicago city income tax could be in our future because other alternatives are worse

A couple of grim thoughts as Chicago prepares for another Thanksgiving:

First, there’s a fair chance that someday soon we’ll be paying a city income tax.

Second, we’ll be grateful for it — because the alternative would be worse.

I have come to that conclusion after interviewing experts, reviewing financial reports and other data and doing some basic arithmetic. Here’s what I found out:

Chicago financial situation is worse than you realize

News accounts have focused on the city’s attempts to plug an $838 million gap in its 2020 budget. A few have mentioned that even bigger deficits loom later in the decade.

But hardly anyone has explained that Chicago must come up with additional billions of dollars annually for the next 35 years.

The problem is funding the pension plans for city workers. The city of Chicago has four such funds — for police, fire, laborers and municipal employees. The pension funds for teachers, CTA workers and so on are legally separate. But Chicago taxpayers are on the hook for those costs too.

The city underfunded its pension plans for decades, based on an antiquated formula. A few years ago, state law was amended to require the city to make an “actuarily required contribution” each year — the amount actually needed to cover expected payments to retirees.

The accumulated unfunded liability is now $28 billion for the four city funds, plus $14 billion for teachers, CTA, etc. That’s $42 billion altogether.

For the four city funds alone, according to the city’s 2018 financial analysis, Chicago must contribute $2 billion a year by 2023, rising to nearly $4 billion annually by 2055.

The teachers’ fund needs $836 million a year as of 2020, rising to $1.7 billion by 2059.

As for the CTA and the others, who knows? They’re still funded using outdated, often grossly inadequate formulas — the Chicago Park District’s pension fund will be insolvent by 2027.

Changing the Illinois constitution won’t save us

The Illinois constitution has an unusually strict pension clause that says state and local government pension benefits “shall not be diminished or impaired.” The Illinois Supreme Court has ruled multiple times that this provision confers an absolute right: The state can’t reduce pension benefits no matter how dire its financial predicament.

Some civic groups, editorial writers and others have urged amending the pension clause to give public officials more latitude to modify benefits. What’s been done in Arizona is sometimes cited. That state had equally strict language in its constitution and has now amended it twice.

But what happened in Arizona offers no support for the belief that a sweeping rollback of pension benefits is possible in Illinois. The amendments there applied only to certain types of employees — public safety officers and some others. They were narrowly drawn — mainly they modified a steep annual cost-of-living increase. And they were agreed to by both sides.

A constitutional amendment allowing unilateral cuts in already-earned pension benefits has zero chance of being passed in Illinois. Organized labor would oppose it, and it likely would be found to violate the U.S. constitution, which says “no state shall ... pass any ... law impairing the obligation of contracts.”

Even if both sides worked out a deal for an amendment that survived legal challenges — say, to reduce the annual 3% compounded cost-of-living benefit increase that applies to a declining number of public employees in Illinois — the impact would be modest. We’d still owe billions of dollars we don’t have.

The state won’t bail out Chicago

If, as proposed, a graduated income tax is enacted, Chicago and other municipalities could make a good case that a larger share of the state’s take ought to flow to the local level.

Years ago, 10% of state income-tax proceeds were distributed to local governments. Over time, that’s been whittled down, currently to about 6.5%.

If the graduated income tax goes through and the 10% share were restored, by one calculation Chicago would get an additional $200 million a year — real money but not enough to fix our problem.

A bigger state contribution isn’t in the cards. The state has its own severe financial difficulties, notably the $134 billion in unfunded pension liabilities.

Illinois’ local governments collectively have another $62 billion in unfunded liabilities, most of which is owed by Chicago and Cook County.

There’s no way the state can assume a significant part of that burden without courting collapse.

Few revenue schemes would cover what we owe

Many ideas have been proposed, ranging from a Chicago casino and an increase in the real estate transfer tax to taxes on cannabis, commuters, consumer services and securities transactions.

Most of these schemes realistically would generate in the tens to low hundreds of millions of dollars. Others would be risky — a securities transaction tax, for one, could provoke Chicago’s trading industry to leave town.

Even if all the non-risky plans were implemented, they’d bring in only part of the the money that’s needed. The risky schemes present worse drawbacks.

Huge property tax hike would invite disaster

By 2023, we’ll need to come up with an additional $1.3 billion in pension contributions annually. That includes the four city funds, the teachers fund and a contingency for all other funds, including the soon-to-be-broke park district fund. I base this on city and state financial reports and news accounts of the cost of the new teachers’ contract.

If all of this were paid out of property taxes, the average city tax bill would jump roughly 20% above 2018 levels, plus more each year after.

Chicago property tax bills already have gone up plenty — 13% due to Rahm’s 2015 tax increase and 11% more in the north and central parts of the city due to the 2018 reassessment. In the affluent parts of the city, it’s not unusual for property owners to owe double what they paid a decade ago. And they’re not all making twice as much money.

Yet another big property tax jump would surely chase some — maybe many — people out of the city, worsening the population drop that already gets Chicago a lot of bad press. Quite a few of those departing would be the high-earners we need to prop up the tax base.

Pushing the boost mostly onto commercial property owners would blunt the cost advantage Chicago enjoys relative to coastal cities — a big factor in the downtown jobs boom.

However it’s handled, a large property tax increase could put the brakes on progress the city has made over the past quarter century.

City income tax might be least bad option

A city income tax would be a last resort, considered only after all other, less painful means of cutting costs and raising revenue have been exhausted. But it probably would beat the alternatives.

Unlike a property tax increase, an income tax would bear some relation to the amount of money taxpayers had in their pockets. It could be structured so the burden would be shared among people who live in Chicago and those who just work in the city.

No doubt a city income tax would induce some residents and businesses to move to the suburbs. But a large-scale exodus seems unlikely. Chicago has one of the most attractive downtowns in the country. It’s hard to imagine professional firms and tech companies bolting en masse for Schaumburg just to avoid an income tax.

A city income tax would do two things.

It would provide an ample, reliable and growing revenue stream. A 2011 report by Chicago’s city inspector general estimated that a flat 1% city income tax — a common rate in other cities that do this — would generate $500 million annually. The amount would be considerably more now. As the accompanying chart shows, aggregate income in Chicago since 2010 has been growing briskly — faster than in the rest of Illinois and nationally.

Ed Zotti / Sun-Times

A tax also would enable the city to control its fate. Instead of constantly trekking down to Springfield to horse-trade for a few more dollars, Chicago could focus on continued investments to boost its middle class — the key to long-term stability.

No one I spoke with is enthusiastic about a city income tax. Ralph Martire, executive director of the Center for Tax and Budget Accountability, said “it’s a rational thing to do” but only after exploring all other avenues.

Exactly. Better a city income tax than slow suicide.

This is part of the ongoing series City at the Crossroads by journalist Ed Zotti on trends affecting Chicago and choices the city faces.

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