CHICAGO — Indiana auditors warned that the long-struggling city of Gary could face insolvency as it tries to overcome massive drops in property tax revenue tied to the state’s two-year-old tax cap legislation.

“The amount of budget reductions that would be required for the city to fully implement the current tax legislation raises substantial doubt about the city’s ability to continue as a going concern,” said the annual financial report for fiscal 2009, issued Sept. 30 by the State Board of Accounts.

Gary has been able to fiscally survive so far partly because the state has granted it some relief from the property tax caps. The law caps tax bills at 1% of assessed value for homeowners, 2% for rental property, and 3% on commercial property.

But even that limited relief could end soon if voters, as expected, approve a November ballot measure to make the tax caps part of the state’s constitution.

Located in northwest Indiana about 45 minutes from Chicago, the Steel City, hometown of the late pop star Michael Jackson, was a once-thriving manufacturing hub that now suffers from a myriad of economic and fiscal challenges as business and residents have fled.

Gary, like other urban areas across the state, has been hit hard by the revised property tax law enacted in 2008. Since then, it has lost 25% of its property tax revenue — its chief revenue source — and is projected to lose a full 50% by 2012.

It is also struggling with recent drops in casino revenue, which marks another major special revenue stream for the city. The owner of the Majestic Star Casinos since 2008 has withheld roughly $11 million owed the city due to ongoing litigation.

“These decreases in revenues from property taxes and gaming revenues have had a tremendous effect on the city’s financial position,” the report said. “It is a tough state of affairs to reduce the city’s levy by 50%, and at the same time lose 27% in uncollected taxes, and $6 million per year in city development gaming revenues.”

At the same time, property tax distributions have been delayed for more than five months, placing an “incredible burden” on the city to continue its operations with little capacity for interfund borrowing, the report said.

Gary in 2009 overdrew its general fund account by nearly $10 million, postponed many vendor payments, and used $27 million of interfund transfers to deal with revenue drops, according to the report.

To offset the revenue declines, the city has cut more than 400 positions, consolidated some departments and abolished others, outsourced garbage collection and other services, renegotiated union contracts, and implemented new fees.

Lake County, where Gary is located, is one of the only counties in the state that has not enacted a local-option income tax as allowed under the law to help offset expected property tax declines.

Gary rarely issues general obligation debt. Its last sale was $5.3 million of GO judgment bonds in late 2007, and the previous issue was 14 years earlier. It has $8 million of outstanding revenue debt. Another $800,000 of taxable economic revenue bonds have been issued for redevelopment projects.

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