Eugene Williams led his south Chicago suburb of Lynwood through the recession and the slow, unsatisfying recovery, always keeping his eye on the fundamentals – fix the streets, pay the bills. And then do it all over again.

“We need every tax dollar we get,” said Williams, who’s been mayor of this village along the Indiana border for 10 years.

Now Lynwood and more than a thousand other Illinois municipalities face the prospect that their primary source of income – the property tax – will be frozen permanently as part of a plan Republican Gov. Bruce Rauner says will revive the state’s sluggish economy, give taxpayers a break and halt decades of financial and political dysfunction in Illinois.

Police/fire pensions

Rauner is demanding the tax freeze as part of his price for ending a nearly two-year long budget standoff with Democrats that is straining state finances to near the breaking point. But if the governor were to get his way it could be unprecedented, not just in Illinois but in the history of the nation. 

While anti-tax initiatives have abounded for decades, and especially in recent years as Republicans took control of more than 30 state capitols, tax analysts say no state has implemented one like Rauner is pushing that both flatlines local property tax money and provides no alternative source of revenue to cushion the blow.

Under Rauner’s proposal, the only way local governments could increase property taxes would be to seek approval from voters in a referendum, a slow and cumbersome process that is by no means a sure-thing.

Police pension funding graphic

Rauner’s proposal is both gambit and gamble. Without the tax freeze, Rauner says he won’t budge on the budget. Illinois has the highest property taxes in the nation, Rauner says, and by reining them in he predicts new jobs will flock to the state.

But a freeze would also amount to a direct financial assault on the primary source of funding for municipalities, elementary and secondary education, and a further undermining of 663 suburban and Downstate police and fire pension funds, whose unfunded liabilities have leaped more than five-fold since 2000, to $9.8 billion, according to the Illinois Department of Insurance.

The proposal presents an incongruous picture. A state that has been stiffing vendors for years and has $13 billion in unpaid bills and $130 billion in unfunded pension liabilities would be ordering local governments to tighten their belts in an unprecedented manner.

“Changes are necessary to attract employers, create new jobs and save taxpayers money,” Rauner said in his February budget speech. “We need a permanent property tax freeze here.”

Lynwood offers a window into the potential impact of a freeze. In 2005, before the recession and the housing collapse, the village’s police pension fund was 69 percent funded and the unfunded liability totaled $932,000. A decade later the funding level was almost halved, to 35.7 percent, while the liability soared to $5.2 million.

“We’re obligated to try to keep the pensions funded as much as we can,” Mayor Williams said. “It’s embarrassing that it’s as low as it is. “But if you freeze the tax, the pension obligations continue to increase. We just hope nobody pulls the rug out from under us while we’re trying to deal with it.” 

The fiscal crisis at the state level is greatly aggravated by an enormous debt owed to teachers and state workers that has mounted after decades of inadequate funding. Credit markets consider pension funds financially deficient if they have on hand less than 80 percent of the resources they need to cover the cost of expected future payments to retirees. 

What gets far less attention than the plight of the state pension funds is that of hundreds of locally administered funds meant to cover benefits for police and fire in towns, villages and cities across the state.

And the problems in Lynwood are far from exceptional. Most Illinois municipalities have seen funding levels for their police and fire pension funds drop and liabilities leap. The Downstate Cairo firefighters’ pension is 12 percent funded, while the police fund is at 22 percent. The south suburban Robbins police fund is at 21 percent. In 2007 it was 66 percent funded.  In the past 15 years the average funding level of the police funds outside Chicago dropped to 57.7 percent from 74.1 percent, while suburban and Downstate fire funds fell similarly, to 58.7 percent from 76.6 percent.

Eugene Williams
Eugene Williams

Chicago was able to rescue its swooning pension for public safety workers in 2015 when the city council approved a $543 million property tax increase, the largest in the city’s history. 

But Chicago is something of a special case, granted by the state constitution more flexibility to raise its tax rates than most other municipalities in Illinois that lack so-called home-rule power to respond to financial emergencies. Meanwhile, school districts, even Chicago’s, must abide by limits on how much they are allowed to hike taxes. 

Brad Cole, executive director of the Illinois Municipal League, said some local government bodies are already at risk of being dragged under by pension obligations – and a permanent tax freeze would only worsen their plight.

“At some point, communities will put to the voter, ‘What is your priority? Schools, pensions, roads and bridges?’” said Cole, the former mayor of Carbondale. “And whatever’s last on the list doesn’t get funded.”

State battles over the widely loathed property tax have raged for four decades across the nation. A permanent property tax freeze, though, would be a first, tax policy experts say, as it would not allow for inflationary adjustments or provide another tax to cushion some of the blow.

Fire pension graphic

When voters in California and Massachusetts approved caps on property taxes, those states provided means to raise other taxes or provide revenue to soften some of the impact of restricted tax growth, said Joan Youngman, senior fellow at the Lincoln Institute of Land Policy, in Boston.

Michigan voters approved a dramatic property tax rollback plan in 1994, decreasing elementary and secondary education’s reliance on the unpopular homestead levy, then among the highest in the nation. That change in the law, though, was coupled with a two-percentage point hike in the state income tax.

Voters in North Dakota became so fed up with property taxes that they forced a vote on a ballot proposal in 2012 that would eliminate the tax entirely. The measure was defeated by a 3-1 margin, as there was no replacement revenue to compensate for the repeal.

“The fact that Illinois is in such a difficult financial position and wouldn’t be in a position to give financial aid to cities is extraordinary,” Youngman said.

“It’s clear that you can’t let property tax rates rise without any concern for the effect on taxpayers,” Youngman said. “But you can’t just decree that tax cuts or freezes are going to work because there can be so many unintended consequences.”

Rauner spokeswoman Catherine Kelly was asked by the Better Government Association to  comment on concerns that municipalities might be handcuffed by the governor’s freeze. Instead, Kelly pointed to recent remarks by the governor as he toured a manufacturing facility in the western suburbs.

“We have the highest property taxes in America and they keep going through the roof and if we do not change this system your property taxes are going to skyrocket in the next few years,” Rauner said. “We can’t have politicians raising your taxes all the time.”

Youngman noted that Massachusetts’ property tax cap allows for 2 1/2 percent annual growth, while Michigan’s property tax growth is pegged to inflation. California enabled municipalities to enact other levies beyond the property tax.

Tax analysts don’t necessarily agree with Rauner that property taxes are higher here than anywhere else. That said, most agree that Illinois property taxes are near the top among states, including New Jersey and Connecticut.

About 60 percent of Illinois’ property taxes go to public schools, primarily because the state lags behind the national average in financial aid to public schools. Municipalities collect between 8 and 14 percent of property tax revenue, said Cole of the Municipal League.  

Illinois has operated by financial sleight of hand for decades, using accounting gimmicks that have earned the state the lowest credit rating in the nation. The state has run on a stop-gap budget, partially fueled by court-ordered mandates, since July 2015. If and when there is an approved budget, its current financial status is at least $4 billion short of balance. 

Brad Cole
Brad Cole

Since taking office in January 2015, Rauner has insisted that the state will never pull itself out of a decade’s long cycle of financial irresponsibility without structural reforms, including spending cuts, workers’ compensation changes, term limits and a property tax freeze. Without those, Rauner said, he will not agree to tax increases that Democrats say are needed.

The tax freeze, Rauner says, will remove employers’ resistance to doing business in Illinois. Property tax relief is needed “to reduce the immense burden felt by our families and businesses, to give them reason to stay here in Illinois,” the governor said in his January state of the state message.

The hoped-for economic jolt from a tax freeze is reminiscent of the deep income tax cuts in Kansas, championed by Republican Gov. Sam Brownback and embraced by his party’s legislature in 2012.

Brownback said lower levies would spur Texas-size economic growth and boost the population. Instead the state wiped out its surplus and produced four years of large deficits. With skipped pension payments and raiding the state’s highway fund, Kansas has proved to be a cautionary tale as its  budget shortfall is projected to exceed $1 billion in the next two years in a state far smaller than Illinois.

“It is not clear to me that Illinois’ problem is a need to constrain revenue. That is so not the problem,” said Kim Rueben, a senior fellow at the Urban-Brookings Tax Policy Center, in Washington. “It seems like this is going in exactly the wrong direction.”

“It seems like the hole is so big I don’t even see how you say you’re going to pass an income tax hike and then trade it off with property tax cuts or limit,” Rueben said. “I feel like Illinois is less likely to attract businesses because of the fiscal mess, that places might be actively avoiding them because they know there is the long-term reckoning that is going to come.”

If, say, lawmakers and Rauner were to agree on a higher income tax rate and expanding the sales tax base, the line of creditors demanding payment is already long – vendors, pensions, social service providers and state colleges and universities who have lived on budgetary bread and water for almost two years. Municipalities would compete with them. 

Laurence Msalll
Laurence Msall

The fate of the tax freeze is uncertain, at best, although it remains one of Rauner’s pre-conditions for a budget deal. Laurence Msall, president of the nonpartisan Civic Federation, said recently that if the state is going to enact a “hard freeze, it should accordingly present a plan for how Illinois’ many distressed local governments can continue to fund their pensions and debt service along with critical core services.”

“Most importantly, before the state of Illinois puts restrictions on local governments’ ability to levy property taxes, it must have a comprehensive, balanced budget that puts Illinois on the path toward financial stability,” Msall said.

Read this story in Crain’s Chicago Business