All this construction is indeed giving a boost to Chicago’s economy. According to the Bureau of Labor Statistics, as of July 2016, the number of Chicago construction jobs increased by 6.0% from a year earlier, a significant support to Chicago’s job market. Interestingly, the buildup in construction projects mirrors the city’s high-rise and construction boom before the Great Recession hit in 2007.
In fact, before the recession hit, the city had plans to build the tallest skyscraper in the U.S. and the 2nd-highest in the world (the Chicago Spire, at 116 stories and 2,000 feet high). Financial difficulties put an end to that plan, particularly after the recession hit and backing from financial institutions came to a halt. Is history repeating itself, where the build-up in mega-building projects in Chicago (as well as other cities across the country) follows the familiar pattern where large construction projects are begun near the end of economic expansions, when credit is plentiful and caution is limited?
Over the last decade, governments in and around Chicago have been very free about spending its taxpayer dollars. According to usgovernmentspending.com, Illinois government spending increased 38% over the decade to 2016, double the 19% inflation rate over the same period, using official government CPI data. To pay for such spending the city hasn’t been shy about accumulating debt to finance its various projects. And after years of spending more than it collects in taxes, government debt in Chicago has exploded. All told, according to the city’s Comprehensive Annual Financial Reports, including its share of county pensions, healthcare costs, and long-term debt, residents and businesses of the city owe more than $65 billion.
Property taxes are of course used to finance city projects, but because of existing debt, almost none of Chicago’s property tax revenues go to city services. Since city officials have been unwilling to limit spending to property tax revenue, they have sold billions of dollars of property tax bonds based on future property tax collections. As a result, current property taxes go first to pay interest on those bonds. The money from those bonds has been spent, replaced with a long future of outstanding debt and interest costs instead of city services.
At the end of 2015, the amount of city debt backed by future property tax collections was $9.4 billion, more than $1 billion higher than the year before. The city currently collects about $1.2 billion in property taxes annually. Nearly all of that yearly revenue is used to pay the interest on the debt and to employee pensions - with almost nothing left over for other city services, and certainly nothing left over to pay down that large debt. Below is a debt by Truth in Accounting that shows the sharp increase in bond interest payments the city has been paying over the last decade.
Note that this only reflects a portion of Chicago’s debt. Its massive unfunded liabilities that have not (yet) been sold off as bonds represents an obligation which grows every year. But the rapid increases in interest costs on just a part of Chicago’s debt – its outstanding bonds - are alarming. They show the ramifications of issuing debt without any strategy to pay it down or eliminate it.
Municipal employee and retiree pensions comprise the largest share of Chicago debt, and because of rigid unions and inflexible employee benefits, they provide even less financial flexibility for the city than its municipal bonds. Because of this year’s Illinois Supreme Court ruling that city’s municipal pensions may not be restructured according to the wishes of Chicago Mayor Rahm Emanuel and other city planners, pension insolvency in Chicago is now essentially locked in.
According to the city’s own annual report, Chicago’s Municipal Employees’ Annuity and Benefit Fund is now funded at an incredibly low 32%, down from 42% just a year earlier. Simply to pay out pension benefits the fund is forced to sell off assets every year. This leads to continually worsening pension funding. According to debt-rating agency Moody’s, Chicago’s unfunded pension obligations total $29.8 billion for its four main municipal employee pensions. That’s nearly $30 billion missing from the city’s piggy bank to pay for future obligations. And those promised benefits will only rise. Insufficient contributions from the city and employees and generous retiree benefits (including mandatory 3% yearly cost-of-living increases for retirees) nearly guarantee that the majority of Chicago pensions will face insolvency within a decade.
Officials in Chicago have been playing a shell game in recent years, issuing new debt to pay for old and using other “restructuring” devices, but they are generally only forestalling the inevitable. Worse, such tactics allow overspending and debt accumulation to continue. The graph below by Munitrends compares the amount of government debt in Chicago to its tax revenues. Chicago ranks first, or worst, among the ten largest cities in the U.S.
As debt has grown over the past decade debt-rating agencies have found good reason to downgrade Chicago’s debt. That is especially true since the Illinois Supreme Court ruling and the associated unwillingness by the pension funds to reduce retirement benefits or increase employee contributions. After the court ruling, debt-rating agency Fitch lowered $10 billion of Chicago’s debt to BBB-, one notch above “junk” status. Bond rater Moody’s already rates much of the city’s debt as “junk” status, with a generally negative outlook. Moody’s also expects that the city’s balance sheet will weaken.
Moody’s ratings also reflect what it calls the “deepening financial stress” of the Chicago Public School System. Chicago’s school spending per pupil is 3rd highest among the 10 largest school districts in the nation, behind only New York and Honolulu, according to Crains. Chicago Public School’s revenues do not cover its costs and for years it has been selling bonds to raise money to cover the shortfall. Because of the massive and growing debt, the bonds are issued at “junk” status with very high borrowing costs. This only ensures that debt will grow that much quicker.
New school debt is required to pay the interest on the old and the cycle continues in a negative spiral. There have been cutbacks within the school system, but the big one – employee pensions – are not allowed to be touched, with the result that cutbacks will do nearly nothing to stem the tide of Chicago Public School insolvency. Their hope is of course, to be bailed out by city, county or state taxpayers. Or perhaps taxpayers in other states. All options are “on the table” when it comes to governments seeking bailouts for past spending mistakes.
At this point, perhaps the only way out of the financial mess the city is in is if it experiences outsized economic growth for an outsized period of time. That is likely the hope of city planners to rescue its financial condition. But the fact remains that despite the optimism built into the city’s many construction projects, in recent years, Chicago has not been a city with strong economic growth. Year over year employment growth was just 1.3% in July, below the level of U.S. as a whole. In fact, Chicago employment growth has been consistently below national levels for the last three years. According to the Bureau of Labor Statistics, as of July 2016, the unemployment rate in Illinois was 6.2% (6.0% in the Chicago metro area), easily the highest of the 12 Midwestern states.
The Chicago Purchasing Managers Index (see the graph below), a composite measure of general business activity in Chicago, has been stagnant since the beginning of 2015. On this index, a reading above 50 generally shows economic expansion, while one below 50 indicates contraction. Over the past 18 months, this index has been negative nearly as often as it has been positive, generally showing little or no economic growth.
The city has also attempted to slow the growth of its debt and fiscal woes with, of course, more and higher taxes, but it’s a stop-gap measure at best. In October 2015, Chicago raised property taxes by $750 million, but much more will be necessary to make a dent in its debt. According to the Tax Foundation a proposed state tax rate of up to 11.25% on small businesses would cause the state to fall to 48th of the 50 states on its Business Tax Climate Index. Similar proposals for individual income tax rate increases are also in the works. But with tens of billions of dollars more in unfunded debt, the tax hikes for Chicago taxpayers are likely only getting started. Past spending and lack of fiscal discipline has caught up with policymakers and they are now painted in a corner. In their eyes, higher taxes are the only way out. Unfortunately for tax collectors, high taxes have already led many individuals and businesses to leave the state. Higher taxes will cause more of the same.
An interesting poll two years ago by Gallup found that 50% of Illinoisans said they would move from the state if they had the opportunity. That was the highest percentage of respondents for any state, surpassing the percentage of dissatisfied residents in states such as Connecticut, Maryland, New York and New Jersey. Illinois residents ranked second only to Nevada in the percentage (19%) who actually intended to move from the state in the following twelve months.
In that poll, reasons for wanting to move given by Illinoisans include work and business opportunities, quality of life, cost of living, school options, and yes, taxes. Since the time of that poll, tax rates in Chicago have risen – sharply, in the areas of property taxes and sales taxes. At the beginning of 2016, Chicago sales taxes rose to the highest rate in the country, at 10.25%. Higher taxes will lead to higher costs of living expenses, weaker economic conditions, and a state exodus for many.
And despite the city’s self-portrayal that it is a growing and dynamic city, the evidence doesn’t support it. From the 1800s to the mid-1900s, Chicago was one of the fastest-growing and important cities in the country. From the 1950s onward the inner city’s population spread outward into the suburbs, but the broader metro area was growing. However, for much of the past two decades, population growth in the entire Chicago area has been in decline and in recent years has been flat.
According to the U.S. Census Bureau, in 2015 the city of Chicago’s population was estimated at 2,720,546 (exactly! ), a decline of almost 3,000 people from the previous year. After six decades of declining city population, its population now equals that first reached around the year 1920, and 25% below the levels of peak population, around the year 1950. While much of the city population loss was accounted for by population migration into the surrounding areas, in recent years, the entire metropolitan area has seen its growth come to a halt.
Including the metropolitan city population extending into western suburbs, as well as Wisconsin and Indiana, the total population was around 9.5 million last year. That population was 3rd highest in the country, but nearly unchanged over the previous three years, and in fact, a decline of more than 6,000 from the previous year. This decline is the continuation of a trend away from robust population growth two and three decades ago and toward slow growth and now, no or negative growth (see chart below).
So what the lessons learned from Chicago’s challenges and the responses to those challenges? First, we learn that governments can “successfully” overspend for many years by borrowing, and far more than what would be considered prudent for individuals or households. What is unthinkable spending at the personal level is routine for state and local governments, many of which seem more than willing to rack up massive amounts on their credit cards, financed on the backs of taxpayers.
In addition, we see that even during times of economic expansion governments routinely spend more than they take in in revenues. In the old days, governments would spend more than they took in, but generally, only in recessions. When times turned around they would go back to balancing their books and paying down their accumulated debt. Now, however, governments have learned that voters are more accepting of government overspending. They are still not willing to see their taxes go up, but are fine with governments issuing bonds to raise more money. What that means of course, is that future taxpayers will have to pay most of the bill.
We also see that despite their declining membership, unions still have tremendous control of city governments. Governments are afraid of unions and rely on their votes to remain in office. Governments are much more willing to issue more debt or even raise taxes than to take on the mighty unions. Government officials want to stay in power and are willing to jeopardize their city’s financial future to appease the union and keep their votes.
Another lesson from Chicago is that private money can be as irresponsible as public money if the bar to prudence is lowered enough. That bar of fiscal restraint is interest rates. Much of what has been fueling Chicago’s economic, tepid though it may be, is cheap money. Nearly free borrowing lowers the bar to what is reasonable and acceptable. Projects that would never be considered at normal interest rates become acceptable and even prudent at very low interest rates. Indeed, if interest rates are low enough, nearly every project becomes viable. In the first half of 2016, Chicago construction projects surged 66% over the prior year to more than $4 billion. This for a city with a flat economy and population base. Will the future show this spending as reasonable based on economic conditions or will it show it as risky and “doomed to fail”? To paraphrase a line from the movie Wall Street, the problem with cheap money is that “it makes you do things you don’t really want to do.”
As far as government spending, Chicago shows us that while spending and overspending mistakes can be covered over for many years, even decades, eventually there comes a day of reckoning. Chicago is near that point. Already, past spending and bond sales are resulting in tax revenues going to bond interest payments, instead of city services. It is one thing for residents of a city to pay high taxes and receive high benefits. It is another to pay high taxes with nothing to show for it.
Undoubtedly, the number of residents voting with their feet will continue. A shrinking population base will only make it more difficult to provide the economic growth and tax revenue required to stabilize the giant ship that is Chicago. After years of denial and delay the city may be past the point of reckoning, but hopefully their struggles will highlight their past mistakes to other cities that are not so far gone. However, if Chicago is financially bailed out, it will send a message to other cities to travel the way of Chicago. When there is no downside to overspending and taking on debt, any remaining hesitations to fiscal responsibility are removed.
The main lesson I think for individuals is to not follow in the steps of those who are supposed to be leading and setting an example. In the area of finances many governments set a terrible example of prudence and a terrific one of irresponsibility. While governments may act like it is perfectly reasonable to spend more than one earns and simply take on more debt when one wants to spend more, this is not the path to financial success for individuals. While city (and state and federal) governments may not see it this way, for individuals, debt is a burden that is never relieved until the debt is extinguished months, years or decades in the future. Loans and debts do come with consequences, most of them negative. Governments may be able to avoid those consequences for many years and decades, but for individuals, they come much quicker.
Finally, it is not my intent to pick on Chicago in particular. I was born in a western suburb of the city and lived my first five years there. Since then, I have visited the city many times, especially as a child. And unfortunately, there are many other cities in the U.S., as well as other countries, that face similar financial challenges. But as the 3rd largest U.S. city, and one estimated to be the 21st largest economy in the world, looking at the course Chicago is taking to deal with its challenges is providing something of a model for other cities to follow, for better or worse.