Chicago’s Incoming Mayor Faces Revenue Reckoning

April 5, 2019, 8:46 AM

Chicago Mayor-elect Lori Lightfoot will soon have to face some harsh economic realities. Ushered into office facing mountainous long-term debt, a ballooning structural deficit, and woefully underfunded retirement systems, the political novice may have little choice but to quickly raise taxes to bolster the country’s third-largest city.

But finding new revenue will prove tricky given a climate of political hostility to regressive tax structures and constitutional limitations on home rule units of government to dream up new revenue plans.

LIghtfoot, who won a landslide victory April 2 and is scheduled to take over as Chicago’s chief executive May 20, will be forced to perform feats of fiscal magic just to maintain current city services and pay down Chicago’s escalating debt and pension obligations, fiscal policy analysts told Bloomberg Tax.

“New revenue is an absolute necessity,” said Ralph Martire, executive director of the Center for Tax and Budget Accountability, a progressive think tank focusing on fiscal policy. “And let’s be honest, she can’t get too creative.”

The business community warned against tax changes that might test the limits of Chicago’s constitutional authorities.

“Anything aggressive Chicago might do on a new tax is going to get challenged in the courts, especially if it’s on legal services or financial transactions,” said Todd Maisch, president and CEO of the Illinois Chamber of Commerce. “We believe many of the taxes Cook County and Chicago have in place now are not actually constitutional or go beyond the authority of a home rule municipality.”

‘Challenges and Opportunities’

Campaign representatives couldn’t be reached for comment, but Lightfoot issued a joint statement April 3 with outgoing Mayor Rahm Emanuel. The pair pledged to work together on transition issues and fiscal challenges facing the nation’s third-largest city.

“Today, we had a positive and productive conversation about the challenges and opportunities facing our city,” Lightfoot and Emanuel said. “It is abundantly clear that we both share a deep love for this city and a commitment to work together to move all of its communities forward.”

During the mayoral race, Lightfoot campaigned as a progressive and focused most of her attention on issues such as crime, police reform, public corruption, and economic opportunity. Lightfoot, a former federal prosecutor and partner at Mayer Brown LLP, said very little about tax policy, but touted “progressive revenue” to shore up Chicago’s finances.

Taxing Law Firms?

Lightfoot’s only tangible revenue proposal, expressed a week before the election, involves a value-added tax on large law firms and other large professional services organizations.

“Putting a small fee on the invoices they send their clients will barely be noticed, but yet could generate hundreds of millions of dollars in revenue,” Lightfoot told WGN Radio March 24.

Martire and Maisch both said Chicago likely doesn’t have authority to impose a VAT on professional services under the Illinois Constitution.

Three Daunting Challenges

The Civic Federation, a nonpartisan research organization focused on fiscal issues, laid out a road map for Lightfoot in a March 12 report, “Financial Challenges for the Next Mayor and City Council.” The federation said Chicago faces three daunting fiscal problems that will impact Lightfoot’s term in office.

Chicago’s four public retirement systems are woefully short of cash, carrying an unfunded liability of nearly $28 billion, the federation said. A state statute created a framework for achieving 90 percent funding over 35 years, but Chicago’s required contributions are expected to nearly double in the next five years.

In addition, the federation said Chicago faces a “chronic structural budget deficit” that can’t be erased with current revenue streams. Even without the higher pension contributions, the city faces a deficit of $97.9 million in fiscal year 2019, $251.7 million in FY 2020, and $362.2 million in FY 2021.

Finally, Chicago faces a high debt burden. Between 2008 and 2017, Chicago’s net direct debt rose nearly 57 percent to $9.6 billion.

Revenue Raisers

The federation presented nearly a dozen options for Chicago to boost tax revenue, but didn’t recommend any approach to the new mayor. The group said that almost all of the options would require permission from the Legislature because Chicago lacks proper home rule authority to impose such taxes under the Illinois Constitution. Among the options:

  • Income Tax. A 1 percent municipal income tax could raise $500 million annually.
  • Commuter Tax. Chicago could impose a tax on the wages of the nearly 600,000 nonresidents who work in the city.
  • Downtown Congestion Fee. Chicago could reduce traffic and boost revenue through special levies within congested sectors of the city.
  • Sales Tax. Chicago could gather new revenue if Illinois expands the sales tax base to certain types of consumer services and offers a local share to municipalities.
  • Financial Transaction Tax. Chicago, home to the world’s largest futures and options exchange, could raise revenue by imposing a tax on securities transactions.
  • Property and Real Estate Taxes. Chicago could raise its property taxes. Alternatively, the city could impose a special real estate transfer tax on high-value homes.
  • Head Tax. Chicago could reinstitute its occupational privilege tax, a special tax on businesses based on employment.

The report also points to strategies pursued by the state that could provide new revenue to Chicago. Likely scenarios include a statewide progressive income tax with a local share; a tax on retirement income with a local share; a tax on recreational marijuana with a local share; and either new gaming taxes or a casino for Chicago.

Few Good Options

Martire and Maisch expressed misgivings about many of the tax ideas.

Martire said a bump in property taxes would be the easiest to implement as a practical matter, but a nonstarter politically. He dismissed taxes on commuters, financial transactions, and real estate transfers as gimmicks that would prove controversial and generate little revenue.

Martire suggested Lightfoot solicit support from Gov. J.B. Pritzker (D) and the General Assembly for tax strategies that address deficiencies in the city’s core revenue programs. He pointed to possibly broadening the sales tax base to consumer services, generating $300 million in new revenue for Chicago. A statewide progressive income tax could also bring significant new revenue.

“Creative revenue sources just aren’t going to get the job done,” Martire said. “You need your primary revenue sources from income, sales, and property taxes to be well designed and to adequately fund your core services. That’s something Chicago has never done.”

Maisch said the business community would oppose taxes on financial transactions and professional services. He also warned the new mayor against headline-grabbing revenue ideas like Cook County’s ill-fated soda tax, which was effective for only a few months during 2017 and repealed before the end of the year.

Maisch encouraged Lightfoot to solicit input from many constituencies before landing on a revenue approach.

“The question is: ‘Is the mayor-elect going to be inclusive and collaborative, or doctrinaire,’” he said. “I think the early returns are that she is inclusive and we will have a say on these issues.”

To contact the reporter on this story: Michael J. Bologna in Chicago at mbologna@bloomberglaw.com

To contact the editors responsible for this story: Jeff Harrington at jharrington@bloombergtax.com; Karen Saunders at ksaunders@bloombergtax.com

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