Chicago Mayor Rahm Emanuel says his plan to phase in a $543 million annual property tax hike is a last resort but needed to solve a pension funding crisis.

CHICAGO — Chicago Mayor Rahm Emanuel on Tuesday began the hard sell for a record property tax increase to make good on the city's enormous police and fire pension bill.

The Emanuel administration circulated the plan to raise property taxes by $543 million annually, including $318 million this year, among council members and the media a day earlier, softening the actual blow that came with release of the budget Tuesday. The overall figure rises to nearly $600 million if the council approves Emanuel's request for a $45 million Chicago Public Schools capital levy.

Chicago saw an immediate reward as secondary market spreads tightened by 10 to 15 basis points, according to trades reviewed by Markit. That tightening was in addition to a 10 to 20 basis points improvement seen in trading after word circulated earlier this month that Emanuel planned a substantial property tax hike.

In his budget address, the second-term mayor laid out his case for the steep hike in a levy that is currently generates $863 million a year. He offered a grim assessment absent the new revenue.

"Our greatest financial challenge today is the exploding cost of our unpaid pensions. It is a big dark cloud that hangs over the rest of our city's finances," Emanuel said, blaming past leaders for approving benefit packages without revenue to fund them. "Now the bill has come due."

Emanuel was referencing a mandate that takes effect next year to stabilize police and fire funds across Illinois. The city must pay the two funds $550 million more as it moves to an actuarially required contribution. The city budget banks on state legislation to trim next year's increase to $328 million.

While the budget includes some cuts and reform measures, Emanuel says the burden is so heavy that the city can't cut its way out of the crisis. He said such cuts would require the loss of 2,500 police officers, the closure of 48 fire stations, laying off 2,000 firefighters, cutting weekly garbage collection to bi-monthly pickups, and eliminating recycling. Emanuel said the city also could no longer afford road repairs, rodent abatement, or graffiti removal.

"Our city would become unlivable," he said. "And that would be totally unacceptable."

The municipal market has been clamoring for a substantial revenue-side solution as the city's ratings tumbled and its borrowing costs skyrocketed due primarily to the $20 billion of unfunded pension obligations on the city's balance sheet. Moody's Investors Service dropped the city's general obligation rating to junk in May.

Several buyside participants described the multi-year plan and use of a reliable revenue stream like the property tax as clear positives, but said concerns remain.

Howard Cure, director of municipal research at Evercore Wealth Management LLC, said he would like to see the city offer more savings on the expenditure side that could come through negotiations with labor on contracts, salaries and benefits because personnel costs make up a big chunk of the city's corporate fund.

"You can't solve the city's problems solely on the revenue side," Cure said Tuesday.

Cure also wants more clarity on how the property tax hike will play out, given Gov. Bruce Rauner's push to freeze property taxes, and whether those differences will interfere with pension help and other legislation being sought by the city and schools. "How is this going to work?" he said.

Some of those answers could come Friday at Chicago's annual investor conference.

In Tuesday address, Emanuel continued to cast blame on predecessor Richard Daley, without naming him, for the city's legacy liabilities and poor debt practices.

"We in this room today did not create our current challenges, but we can and must be the ones to fix them," he said. "The seeds of our financial crisis were planted many decades ago and were not addressed for far too long."

While Emanuel has made strides in cutting the structural budget deficit and ended the use of reserves to cover operations, he has continued other maligned practices and been slow to fully tackle the city's pension woes.

Emanuel reiterated his recent pledge to curtail practices like using debt restructuring for budget relief and using debt for operations, which "have masked our true fiscal picture," he said. The 2016 budget will push off $125 million of debt repayment, down by about $100 million from previous plans.

Such maneuvers are to be phased out by 2019, and the city will also end borrowing for operations and short-lived equipment.

"Our budget will finally begin to reflect the true annual cost of operating the city of Chicago," he said.

Emanuel stakes his political legacy and that of the council's on the fiscal plan.

"I know this budget is tough and therefore carries political risk," he said. "If we are willing to finally confront our fiscal challenges, I believe that we will be remembered as the men and women who pulled Chicago back from the financial brink and made Chicago stronger."

The record property tax hike would begin with a retroactive increase of the 2015 levy to bring in $318 million. That revenue along with $10 million from city enterprise funds would cover the $328 million additional payment the city plans to make toward police and fire pensions next year. The General Assembly has approved the reduction from $550 million by re-amortizing the payment schedule but hasn't sent the bill to Rauner amid concern it could be a victim of the state's budget impasse.

The 2016 budget relies on another $109 million of increased property tax revenue for the following year's additional payment. Additional revenue increases of $53 million would come in 2017 and $63 million in 2018.

Property tax bills would go up to bring in another $45 million under a city proposal to generate additional capital funding for the distressed Chicago school system.

The budget will total $9.3 billion when corporate, enterprise, and grant funds are added up, including a $3.6 billion general fund formally known as the corporate fund. Those figures are up from $9.2 billion and $3.5 billion, respectively, in 2015.

While the additional property tax revenue would go to police and fire pension contributions, the city would use a combination of new tax and fees expected to generate $125 million to help close a $233 million operating budget gap. The city would enact a first-ever garbage collection fee to raise $62.7 million, levy a new shared ride services/ taxi surcharge to raise $48.6 million, restructure building permits to generate $13 million, and levy a tax on e-cigarettes which will raise $1 million.

The budget also projects $7.8 million in natural revenue growth from existing tax streams and calls for $200 million in cuts, savings, and other efficiencies.

The revised 2015 levy means the city's contribution to all four of its pension funds this year will rise to $886 million from the original budget amount of $557 million and then grow to $978 million in 2016, according to budget documents.

The city is seeking state legislation to increase a homeowners' exemption that would ease the hit for low- and middle-income homeowners but its fate is uncertain.

Emanuel administration officials have sought to stress that the budget relies on very few one-shots, or non-recurring revenues, aside from $125 million in debt restructuring.

It does rely on freeing up $20 million in tax-increment financing revenues not earmarked for projects although some surplus is expected annually.

The city property tax hike proposal ends Emanuel's four-year run of budgets without a property, sales, or gasoline tax hike.

The administration stressed that the property tax hike was a last resort but its need became clear after the Illinois Supreme Court voided state pension reforms in May. The ruling made it impossible to push through cuts to police and firefighter pension benefits.

Another fiscal unknown for the budget is the fate of the municipal and laborers pension reforms adopted in 2014, which the city will defend this fall before the Illinois Supreme Court. If thrown out, the city would get some immediate relief in that its payment would drop by $93 million, but the funds would be back on track toward insolvency in the next decade.

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