CHICAGO — Chicago faces a $635.7 million budget gap in 2012 that could rise to nearly $800 million in 2014 if the city doesn’t take steps to better align its spending and revenues, Mayor Rahm Emanuel warned Friday in announcing preliminary budget figures.

Signaling that the city’s day of fiscal reckoning has arrived, Emanuel vowed he would bridge the gap without a property tax increase or one-time maneuvers such as the use of reserves set up with the city’s asset leases. Emanuel’s predecessor, Richard Daley, relied heavily on reserves to eliminate red ink in the last few city budgets over deeper spending cuts or tax hikes.

Emanuel did not offer specifics as to how he would close the gap without tax increases, one-shots, or cuts in the police force, but he left most other options on the table as he pledged to overhaul city government operations, cut middle management, and increase competition to deliver city services. “I can’t ask people to put more money into a system that needs fundamental restructuring,” he said.

The annual release of preliminary budget estimates marks the formal start to the city’s budgeting process for the next year, though much attention has been paid to the city’s fiscal woes since Emanuel took office in May.

Just before Daley handed over control, his finance team announced a looming deficit in the next year of $587 million. Emanuel’s finance team had their own figure in the range of $600 million to $700 million. Emanuel has used the city’s budget struggles to press for union concessions to trim costs that Daley avoided. Personnel costs account for 72% of the city’s general fund.

The gap estimated Friday is near what the city faced one year ago — $655 million — in the $6.15 billion budget. Some revenue collections have slightly picked up while expenses have been controlled. City revenues have been unable to keep pace with rising city personnel, health care, and debt costs.

The pressures and the use of one-shots last year drove a round of downgrades of the city’s nearly $7 billion of general obligation debt. Fitch Ratings last year dropped Chicago’s GO rating one notch to AA-minus and Standard & Poor’s dropped the credit to A-plus. Moody’s Investors Service in August lowered the credit to Aa3. All three agencies have stable outlooks.

The city is on course to close out 2011 with a fund balance of $81.2 million. Revenues next year will fall by 19% to $2.66 billion from $3.27 billion due to the use of one-time revenues in 2011 from reserves and an anticipated decline in some tax revenues for use in the general fund. Meanwhile, expenses are expected to grow by 2.8% due to scheduled wage increases and the end to furlough days.

The estimates are based on a projection of modest economic growth and don’t take into account the impact should the federal government fail to reach agreement on increasing the debt ceiling or the United States is downgraded.

Along with the preliminary budget figures, Emanuel released a report that presents an overview of city revenues, spending, and key issues affecting its fiscal health. The report includes a three-year fiscal forecast based on scenarios that range from negative to positive revenue growth. Chicago faces red ink under all three scenarios if no structural action is taken and the deficit could hit $790 million in 2014.

“This makes evident the city’s long-standing structural deficit — it costs more to operate the city than the city receives in revenues, and the city has been using one-time revenue sources to fill the resulting gap,” the report warns.

The five additional areas covered in the report are a review of the status of the city’s asset lease and reserve funds, capital investments, tax-increment financing funding, an examination of the city’s debt load, and pension funding.

Chicago expects to close out 2011 with $624 million in its asset lease reserves, including $500 million in its permanent Skyway toll bridge lease established in 2005. Little remains from reserves set up with proceeds of the city’s 2009 $1.15 billion lease of its parking meters.

The report also notes that its unfunded pension liabilities were estimated at more than $15 billion at the end of 2010. City payments are set by statute and fall short of what is needed to fully fund them.

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