Thursday, December 13, 2018

"A tax policy expert says he fundamentally disagrees with Mayor Rahm Emanuel that Illinois lawmakers must amend the state’s constitution to address the city’s looming pension crisis"


While it may be the only way to eliminate automatic annual 3 percent increases in what pension payouts, Ralph Martire of the Center for Tax and Budget Accountability says the plan is misguided.
“Why we disagree: Why take away the constitutional protection for workers when legislatively, you can create a Tier II, Tier III, Tier IV that has a different cost of living adjustment, COLA, for workers going forward?” he told WBEZ’s Morning Shift.
The constitutional amendment is the first of four "sequential steps" Emanuel laid out in a speech to the City Council Wednesday to address the additional $1.1 billion a year Chicago will need to pay into its pension system by 2023.
The second step is pension obligation bonds. By issuing POBs, the city could realize significant savings as long as the effective interest rate on those bonds is lower than the interest rate on the city’s pension liabilities, which the mayor says is currently between 7 and 7.5 percent. 
Mayor Emanuel likened that move to “refinancing your mortgage at a lower rate.” Martire, who supports the idea, said it’s like trading a more expensive form of debt — the debt owed on past-due pension payments — for a less expensive form of debt — the debt owed to bondholders. Issuing POBs does not increase the city’s overall debt burden.
The mayor also called for legalizing recreational marijuana and establishing a Chicago casino as ways to raise revenue.
So, are the mayor’s ideas the best solutions? Morning Shift explores the city’s pension woes and some possible fixes.
Tony Sarabia: We’re about to reach a pension ramp, meaning the city is on the hook for about $1 billion towards pensions a year right now, but by 2023, that will ramp up to more than $2 billion dollars. How did we get here?
Ralph Martire: Well, historically, the state had a funding formula for its pension system that ignored the actuarially required contribution, and what that is, in lay terms, is that actuaries look out 30 years forward and say that based on your current number of employees and actuarial tables for longevity, blah, blah, blah, blah, blah, here’s what you ought be putting in today to have sufficient assets to pay the benefits when these people retire over the course of the next 30 years. That was never funded. That would be a problem. And it created a significant mismatch between the amount of money going into the system and what the system actually needed to pay for future benefits.
Sarabia: What were some of those reasons why we didn’t do this?
Martire: The main reason is Illinois has historically been a relatively low-tax state. That’s number one. And elected officials don’t like to explain to taxpayers that you have to put some money in up front. And they don’t like us to raise taxes to cover long-term obligations. In fact, because pensions are long-term obligations, they are really hard to deal with appropriately in a political process if you think about it. A political process is very concerned with this budget year, this election cycle. Pension problems arise way down the road when you are out of office. That’s a good time for the problem to arise. So under funding it today doesn’t necessarily create political consequences for the people making the decisions to underfund it.
Sarabia: So, the current mayor is leaving office, but when it comes to this issue, what has he done to address it since he’s been in office?             
Martire: Well, actually, he’s been very fiscally responsible when it comes to dealing with this. He did pass that very significant property tax increase just a couple of years ago, and it was needed and it was the right thing to do. I mean, there are only so many revenue tools in the kit available to municipalities, and sadly, you know, property tax is the key one available. And I say sadly because in Illinois while we’re overall a pretty moderate-tax-burden state if you compare total tax burden in Illinois to all other states as a percentage of income we’re about 27th, below the halfway point. That said, if you isolate the property tax, we’re very high. And the reason for that is that the state has underfunded K-12 education for generations.
Sarabia: One of the things that the mayor does want to do...he wants to do away with the automatic annual 3 percent increase in how much pensioners receive. Those are known as COLAs, or cost of living adjustments. And, of course, doing that would require this amendment to the constitution. Do you agree with the mayor that this is a necessary step?
Martire: Not only don’t we agree with the mayor that this is a necessary step, it’s not constitutional to do it. And, so if you get your constitutional amendment that says alright, benefits are no longer guaranteed, that only works going forward. It doesn’t impact any employee who is in the system prior to the change to your constitution.
Sarabia: Didn’t the Supreme Court when they blocked the state [in 2015], was it for ‘going forward’ or what was the state trying to do, because this seems like a big roadblock…
Martire: You cannot reduce a benefit that was a pension benefit that was promised to an employee in the state of Illinois that’s a public sector worker as of the date of their employment. That is their benefit for their tenure. Period. End of story. Ironclad. If you change the constitution, that only changes the protection for the employees after you change the constitution. So all of the accumulated costs associated with this 3 percent compounding COLA that are accruing now and will be accruing for workers that are still getting it, can’t be taken away even if you change the constitution. So, why we disagree: Why take away the constitutional protection for workers when legislatively, you can create a Tier II, Tier III, Tier IV that has a different cost of living adjustment, COLA, for workers going forward? You accomplish the same thing in much less time, because passing a piece of legislation through Springfield is a much quicker process than getting a constitutional amendment.
Sarabia: The mayor will also propose legalizing recreational marijuana, allowing a Chicago casino. What do you make of those proposals?
Martire: Well, it just shows you how limited the revenue options are to a municipality. It’s far more limited than say what the state of Illinois has. And so, Mayor Emanuel already went after the property tax relatively significantly, raised a lot of money to help cover the growth in the pension payment under the ramp in the last four years, and now he’s frankly just looking for revenue alternatives to cover the growth in that ramp over the next four years, and you know, these are kind of speculative, right? First we have to pass the law, and then we have to establish, and there are some issues with them as revenue sources, so you know, casino money, just number one, as a revenue source, over time, tends not to grow with the economy, so it doesn’t grow with inflation over time. Over time it creates a little bit of a structural imbalance that will have to be back-filled with a new revenue source.
Sarabia: And it takes a while for that revenue to be realized. You’re talking about creating the casino facility, maybe from the ground up, all of that stuff, and then realizing the revenue…
Martire: Yeah, so there is a time delay. And it certainly is a regressive way to tax. I mean, it’s not the Pritzker family going out and betting the monthly rent on lucky number 7 at the casino. It tends to be low-to-middle income families, so it’s a relatively regressive way to raise money. And you know, if you look at it overall, it’s an inefficient way to raise tax revenue because for every $8 or $9 gambled, you get $1 of revenue, so a direct tax would be a lower cost on the taxpayer overall. The problem is the city doesn’t have many direct taxes available to go after, and the small fees they charge, the plastic bag fee, the this fee, the that fee, people feel nickel and dimed, so even if it’s not a significant cost, they generate a lot of animus among the voting public, which makes the environment more difficult to raise revenue.       
This interview has been edited for brevity and clarity. Click play on this link to hear the full conversation: Tax Policy Expert Disagrees with Key Piece of Mayor’s Pension Plan (Daniel Tucker), December 12,2018, WBEZ  


  1. Revamp the flawed Pension Ramp: “Starting in 1995, yet another funding plan was implemented by the General Assembly. This one called for the legislature to contribute sufficient funds each year to ensure that its contributions, along with the contributions by or on behalf of members and other income, would meet the cost of maintaining and administering the respective retirement systems on a 90% funded basis in accordance with actuarial recommendations by the end of the 2045 fiscal year. 40 ILCS 5/2-124, 14-131, 15-155, 16-158, 18-131 (West 2012). That plan, however, contained inherent shortcomings which were aggravated by a phased-in 'ramp period' and decisions by the legislature to lower its contributions in 2006 and 2007. As a result, the plan failed to control the State’s growing pension burden. To the contrary, the SEC recently pointed out:

    “‘The Statutory Funding Plan’s contribution schedule increased the unfunded liability, underfunded the State’s pension obligations, and deferred pension funding. The resulting underfunding of the pension systems (Structural Underfunding) enabled the State to shift the burden associated with its pension costs to the future and, as a result, created significant financial stress and risks for the State.’ SEC order, at 3. That the funding plan would operate in this way did not catch the State off guard. In entering a cease-and-desist order against the State in connection with misrepresentations made by the State with respect to bonds sold to help cover pension expenses, the SEC noted that the State understood the adverse implications of its strategy for the State-funded pension systems and for the financial health of the State. Id. at 10. According to the SEC, the amount of the increase in the State’s unfunded liability over the period between 1996 and 2010 was $57 billion. Id. at 4.5 The SEC order found that ‘[t]he State’s insufficient contributions under the Statutory Funding Plan were the primary driver of this increase, outweighing other causal factors, such as market performance and changes in benefits.’” (Emphasis added.) Id. at 4 (In re PENSION REFORM LITIGATION (Doris Heaton et al., Appellees, v. Pat Quinn, Governor, State of Illinois, et al., Appellants) Opinion filed May 8, 2015, JUSTICE KARMEIER delivered the judgment of the court, with opinion. Chief Justice Garman and Justices Freeman, Thomas, Kilbride, Burke, and Theis concurred in the judgment and opinion).

  2. The current “Pension Ramp” does not work for the five public pension systems. The “Ramp” entails larger payments today as a result of the 1995 funding law – Public Act 88-0593 – to pay the pensions systems what the state owes. There needs to be a required annual payment from the state to the pension systems. The debt needs to be amortized for a longer frame of time (a flat payment) just like a home loan that is amortized; though the initial payment will be difficult in the beginning, over the long term it will become a reduced cost and a smaller percentage of the overall Illinois budget as it is paid off throughout the years.

    “Decades of mismanagement and failure to match contributions are the predominant reasons that the state’s pension systems are suffering to the degree that they are today. Years of pension holidays, continually borrowing against the systems without a plan for repayment and a severe economic recession, which caused investments to plummet, further exacerbated the problem” (Senate President John Cullerton). Thus, there needs to be a required “actuarially-sound” annual payment from the state to the pension systems! Indeed, the State of Illinois has a revenue problem and its policymakers have stolen money for decades from public employees' pensions to hide this fact.

  3. What some of us have been saying for a very long time:

    The state’s regressive tax rate is what few legislators want to confront. Politicians, the Civic Committee, Civic Federation, Illinois Policy Institute, the Chicago Sun-Times, the Chicago Tribune, and the general news media have capitalized on a mostly vulnerable public by calling for radical pension reform as the solutions for the budget problems in Illinois. They were (and will continue to be) diversionary, scapegoating tactics that have allowed policymakers to escape their legal and ethical responsibilities.

    “At the core of the budget ‘crisis’ facing [Illinois] is [its] regressive state tax structure… That is, low-and-middle-income families pay a greater share of their income in taxes than the wealthy… [A regressive tax] disproportionately impacts low-income people because, unlike the wealthy, [low-income people] are forced to spend a majority of their income purchasing basic needs that are subject to sales taxes” (United for a Fair Economy).

    Illinois income tax uses a single-rate structure that results in low-income wage earners paying more taxes than the wealthy. Illinois is among 10 states in the nation with the highest taxes paid by its poorest citizens at 13 percent (The Institute on Taxation and Economic Policy).

    Pass a graduated rate income tax like the majority of states in this country. The state needs a tax rate that is “efficient with minimal impact on the economic decisions that taxpayers have to make” (Center for Tax and Budget Accountability), one that captures increased revenues in times of economic growth, one that maintains revenue collections during poor economic times, one that is simple and not liable to inconspicuous error, one that is transparent and builds trust with the state’s government officials (Center for Tax and Budget Accountability), and one that helps 99 percent of the state’s population.

  4. Focus on why the State of Illinois cannot obtain more revenue. Besides federal sources of income, the state uses only 11 sources of revenue: personal income tax (but note Illinois was tied for the fourth lowest individual tax rate on households in the top income bracket), corporate income tax (note extortionate tax breaks given to many Illinois corporations!), sales tax (Illinois does not tax services like most other states for another significant source of revenue), corporate franchise tax and fees, public utility taxes, vehicle use tax, inheritance tax, insurance taxes and fees, cigarette taxes, liquor taxes and other miscellaneous (or rather unsubstantial) tax sources (Commission on Government Forecasting and Accountability).

    “A majority of states apply their sales tax to less than one-third of 168 potentially-taxable services… [States that do not tax services, such as Illinois], could increase [its] sales tax revenue by more than one-third if [it] taxed services purchased by households comprehensively.” Illinois is one of five states with sales taxes on fewer than 20 services (The Center on Budget and Policy Priorities).

    Expand the state’s tax base. A broader-based taxation system that would provide a decrease in taxes for low-income and many middle-income families. Taxing services alone “would generate enough revenue to stabilize the General Revenue Fund and prevent structural deficits that lead to cuts in basic needs and social service programs” (Center for Tax and Budget Accountability).