NEW YORK – Chicago, America’s third largest city, could follow Detroit into bankruptcy, warned Mayor Rahm Emanuel in the city’s “Annual Financial Analysis 2013” released last week.

“Until we pass meaningful pension reforms in Springfield, the outlook for future years is unsustainable,” Emanuel concluded bluntly, anticipating a current budget crisis that could develop into a full-fledged budget meltdown within the next four years.

Emanuel noted that Chicago’s current budget deficit of $338.7 million is expected to grow to $1.6 billion by 2016, due largely “to ballooning obligations under current pension legislation.”

Compounding the fact that pensions for public employees are less than 40 percent funded, a decline in business activity during several years of prolonged economic downturn and an exodus of higher income residents from the city have resulted until recently in a dramatic decline in Chicago’s tax revenue.

While Chicago has attempted to cut back on city services, including public school employment and police and firefighters, the city’s operating expenses are plagued by extremely high salaries, with 2,400 municipal employees earning six-figure salaries annually.

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Meanwhile, the crisis of gun violence in Chicago, despite the city’s tough gun control regulations, prompted members of Congress from the city to demand last month that the National Guard be called in to stop the “mayhem.”

What is looming in Chicago and Detroit is a crisis of increased Democratic Party-controlled government spending and an era of union-controlled public employment that is causing Democrats to soul-search for solutions that do not involve raising taxes to a level that would cripple the business activity on which much of the government revenue depends.

The New York Times reported that last week Democratic leaders in the legislature sued Democratic Gov. Pat Quinn after he announced he was withholding lawmakers’ paychecks until the legislature came up with a solution to solve the state’s pension crisis.

In July, Moody’s downgraded Chicago’s debt rating by an unexpected two grades because of the city’s large and growing pension obligations and budget pressures related to the pension crisis.

This move will increase Chicago’s cost in financing the city’s $8.2 billion of general obligation and sales tax debt.

“The current administration [of Mayor Rahm Emanuel] has made efforts to reduce costs and achieve operational efficiencies,” Moody’s said in announcing the downgrade, “but the magnitude of the city’s pension obligations has precluded any meaningful financial improvements.”

Pension crisis

Chicago pensions are determined by Illinois state law that sets the contributions and benefits for municipal employees, including teachers in the public schools, firefighters, paramedics and police.

The city’s four pension funds are only 36 percent funded, meaning the amount of money the city contributes falls short on an actuarial basis by $19.5 billion.

The unfunded pension obligation is expected to grow to more than $24.5 billion by 2017 if nothing is done to address the problem.

Since 2000, Chicago’s pension funds took two major hits.

First, when the dotcom bubble burst in 2000, the assets of the funds fell from approximately 87 percent funded to approximately 62 percent funded, due primarily to investment losses.

Then, in 2007 and 2008, the real estate-driven market drove the investment value of the pension funds from approximately 62 percent funded to 38 percent funded.

The underfunding crisis in Chicago’s pension funds has continued to worsen due in part to automatic cost-of-living benefit increases passed by the state in 2010.

Beginning in 2015, Chicago’s budget deficit is likely to grow as the city is required by state law to make far greater contributions to the pension funds, costing the city as much as it would cost to hire another 4,300 police officers.

In managing Chicago’s looming pension deficit crisis, the city and state face a dilemma common to many municipalities nationwide.

Reducing pension obligations involves negotiating with unions that are reluctant to deprive retired and retiring government employees of the benefits they have earned.

Amending future benefits is extremely unpopular with current government union workers forced to change the conditions of their future employment to reduce substantially the benefits they may expect to receive at retirement.

Quickly, images arise of the crisis faced by Wisconsin Gov. Scott Walker when union mobs stormed the state capital in Madison and launched a recall efforts to force him out of office after he demanded a reduction in the pension benefits paid to retired and retiring unionized public employees.

The problem Chicago will soon face as the city’s annual deficit grows from $338.7 million to $1.6 billion by 2016 is that municipal employees not unreasonably want their pension benefits paid as specified by their union contract with the state of Illinois, regardless whether or not the city of Chicago can pay up.

“Given the size of the unfunded liability and the dollar amount that would be required to fully fund, even over many years, tax increases and service reductions cannot be the complete answer,” Emanuel’s annual financial report noted.

Emanuel has pressed for a serious of pension reform proposals in Springfield, arguing that cost-of-living adjustments written into current law are not sustainable and that major changes in benefits paid must be made to protect Chicago taxpayers and the retirement security of its workforce.

“Increased employee contributions need to be phased in, and retirement ages are out of line with reality and do not account for longer life expectancies,” the financial report stressed.

Salary crisis

In addition to the current pension crisis, Chicago faces a salary crisis with its current municipal workforce.

Chicago has dramatically decreased its public employee workforce from 40,506 positions (42,392 full-time equivalents, or FTEs) in 2003 to 32,420 positions (33,554 FTEs) in 2013, a decrease of approximately 20 percent in the past 10 years.

Yet, despite this reduction in workforce, Chicago’s total personnel costs increased by 15 percent between 2003 and 2012, with salary and wage expenses rising by 11 percent and healthcare costs by 38 percent.

Today, 90 percent of Chicago employees are represented by a union, up from 87 percent in 2003.

Chicago engages in collective-bargaining negotiations with 40 different unions. The Fraternal Order of Police and the Chicago Firefighters Union are the two largest, with 17,482 public safety positions, including police captains, lieutenants and sergeants.

Payroll, Chicago’s single highest expense, totals $2.4 billion, with 2,400 city employees, not including school employees, making more than $100,000 a year.

Payroll costs are expected to increase $100 million in 2014, and no discussions are underway about making any cuts to any municipal employee salaries.

Chicago’s budget deficits could intensify dramatically if the city fails to meet Emanuel’s rosy forecast that the city will increase revenue $466 million in 2014 and $580 million in 2015.

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