Mayor Rahm Emanuel

CHICAGO – The Chicago City Council overwhelmingly approved a $7 billion 2014 budget Tuesday, balanced through a mix of spending cuts, one-time revenues, higher fees, fines and cigarette taxes that leaves little buffer to absorb the jolt of a $600 million pension payment spike looming in 2015.

Without a sales or property tax increase, the vote on Mayor Rahm Emanuel’s budget was an easy one for many council members given the fiscal cliff that looms in the 2015 when the deficit could skyrocket to $1 billion due to the pension spike. The city’s near-and-long term pension funding strains have driven triple-notch downgrades of its $8 billion of general obligation bonds by two rating agencies in recent months.

The city will feel effects of its credit deterioration next year when it anticipates issuing about $800 million of new-money and restructuring GOs. The city also plans another $700 million of sewer and water borrowing.

Emanuel focused on the 2014 budget’s accomplishments in addressing the council after the 45-5 vote. “We do have tough decisions ahead of us, much tougher than we reflect here,” he said. “But we didn’t defer the tough decisions. We actually made them and we are doing that in a responsible way that I think allows the economy to fundamentally continue to grow while doing it in a way that protects the hard-earned dollars of our taxpayers.”

The vote followed council member speeches mostly filled with praise for the spending plan tempered by the acknowledgment of the difficult tax and spending decisions that lay ahead next year due to the pension crisis.

Emanuel has long warned Chicago can’t afford either crippling budget cuts or a doubling of its property tax levy to stabilize its pension system without driving businesses and homeowners away. The city is banking on state lawmakers for a solution.

It wants lawmakers to overhaul pension benefits and contributions. Reforms would address its long-term woes underscored by unfunded liabilities that have risen to $19.5 billion and stave off the looming insolvency of its municipal employees and laborers’ funds. The pension system is collectively funded at just a 35% ratio.

The city also wants lawmakers to approve legislation to deal with its more pressing crisis aimed at stabilizing its public safety pension funds under a previous state mandate. A pending bill would delay the full $600 million spike above what’s now a $467 million contribution. Property taxes would rise between 2018 and 2021 but a shift in the in the contribution scheme from a statutory one based on employee contributions to a sounder one based on an actuarially required contribution would be put off until 2022.

State action is uncertain and the city’s lack of an alternative plan has contributed to the dramatic downgrades. Emanuel earlier this year did strike a deal with the leadership of the Chicago Police Sergeants Association on pension reforms but the rank-and-file rejected it.

State lawmakers are expected to return Dec. 3 for a special session to vote on an overhaul of the state’s woefully underfunded system which has driven Illinois’ own credit deterioration. If approved, lawmakers may then tackle local government reforms but the timing and chances for success are unclear.

The 2014 budget mostly sailed through committee hearings over the last month with just two key sticking points. Some council members opposed Emanuel’s 75 cent per pack cigarette tax hike over concerns it would drive up black market sales and drive some consumers across city borders. Emanuel compromised by lowering the increase to 50 cents, but Chicago will still become the most heavily taxed location in the country to buy cigarettes.

Some council members also wanted to divert budgeted police overtime spending to instead hire more officers as the city grapples with crime that has garnered national attention. The proposed change was stalled in committee.

The 2014 budget chips away at a $339 million gap through a mix of spending cuts, fiscal maneuvers, one-shots, and tax, fee, and fine hikes. Expenses are being cut by $84.7 million with about $24 million coming from healthcare savings as the city shifts most retirees over to healthcare exchanges.

About $101 million of the deficit is cut by anticipated revenue growth, $35 million will be swept from old grant and revenue accounts, $30 million drawn from tax-increment financing surpluses, and $53 million from the anticipated 2013 ending budget balance. Another $34 million will come from targeted tax and fee increases.

The $7 billion budget is up by 7% over 2013 and it includes a $3.29 billion corporate fund. It’s Emanuel’s third budget since taking office and all were balanced without a property or sales tax hike although property tax hikes will be needed eventually to cover increased pension contributions.

The Emanuel administration has made strides in increasing reserves and trimming the city’s structural imbalance. The city faced a much higher $790 million deficit heading into 2012. The budget does, however, continue to rely on some one-time revenues including relief through a multi-year debt restructuring that pushes off some near-term debt service.

The budget won the Civic Federation of Chicago’s endorsement but it was tempered with a warning.

“Mayor Emanuel and his team have made significant fiscal progress in recent years, much of which will be derailed when the city’s unaffordable pension contribution increase takes effect next year,” said Laurence Msall, president of the local government research group. The federation urged the city to continue to press labor and lawmakers on reforms.

The Civic Federation called on the city to revise its debt management policies to ban debt restructuring that pushes debt service off.

Chicago’s chief financial officer Lois Scott defended the city’s ongoing debt restructuring during a recent budget hearing as needed to keep rising debt service payments on par with recent years. “While we would prefer to not restructure debt at all, we believe that this mitigates the impact on our taxpayers as our economy begins to recover,” she said. The city also will convert some floating rate commercial paper into longer term debt.

Emanuel recently signed an executive order requiring the transfer of at least 10% of the city’s unreserved fund balance to city reserves. That figure will be modest as the city’s ending balance in recent years has been narrow. The 2014 budget earmarks $5 million for the reserve following infusions of $15 million this year and $20 million in 2012. Though modest, it marks a reversal of former Mayor Richard Daley’s practice of using reserves to balance his last few budgets. The city closed 2012 with $625 million in reserves built with asset lease proceeds.

One no vote came from Alderman Bob Fioretti who said had deep concerns about “long term borrowing that is not sustainable” in the budget. He wants greater oversight of the city’s use of debt to cover short- term costs and use of taxable borrowing to cover such expenses as judgments. He also expressed concerns over the city’s use of speed cameras, retiree healthcare changes, and the lack of additional police hiring.

Moody’s Investors Service dropped the city’s GO rating three notches to A3 in July as it applied new rating criteria putting more emphasis on a local government’s pension health. Fitch Ratings Nov. 8 then socked the city by three notches, lowering its GO and sales tax ratings to A-minus from AA-minus and assigning a negative outlook.

Standard & Poor’s shifted its outlook on the city’s A-plus rating to negative in September. The downgrades and negative headlines drove up the city’s interest rate penalties in trading on its 10-year paper to a high of 190 basis points in August over the triple-A benchmark although it’s since leveled out.

The city intends to sell about $425 million of GOs in the first half of 2014 to raise $300 million of new-money to support its 2013 capital budget. Another $125 million of debt is being restructured to push off near-term debt service.

The city will return in the second half with up to $470 million of GOs that would include $300 million of new money for the 2014 capital budget and up to $170 million of refunding bonds.

The city plans a $400 million new-money issue of water revenue bonds and another $300 million of new money under the sewer credit. Both deals are slated for the second half of 2014 and the city is also eyeing refunding opportunities.

Finance teams have not yet been named. The city has an $8 billion capital program for 2013-2017.

“That triple downgrade [of the GOs] means it is much more expensive for us to keep the city operating financially and limits our flexibility going forward,” Chicago’s Scott warned during the recent hearing, estimating the downgrade will raise the city’s GO borrowing cost by $1 million annually for every $100 million issued.

The city’s heavy debt load and the pension burdens of overlapping governments further strain the city’s credit. “Pension stress exacerbates the already weak debt profile, which features above-average debt burden and slow payout,” Fitch wrote in its downgrade report.

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