The Chicago mayoral election is more than six months away, but 10 candidates have already lined up. An important issue for the 2019 mayoral election will be Chicago’s public pension funds. More specifically, how the City will raise sufficient revenue to pay its required contributions. In fact, this might be the most important issue, but since it’s so confusing it’s unlikely to get the attention it deserves – and that’s why I’m laying it out here.

Why is this such a crucial issue? Because the City’s 2020 pension contributions – the first fiscal year the new mayor will have to tackle – will be an estimated $400 million increase from the previous year. This increase is because of two relatively new provisions of state law that govern the City’s pension contributions to its four pension funds: the Firemen’s Annuity and Benefit Fund of Chicago (“Fire Fund”), the Laborers’ Annuity and Benefit Fund of Chicago (LABF), the Municipal Employees’ Annuity and Benefit Fund of Chicago (MEABF), and the Policemen’s Annuity and Benefit Fund of Chicago (“Police Fund”). (I dive into the details of the funding laws at the end this piece).

Under current state law the payments to the Police and Fire Funds are fixed dollar amounts for years 2015-2019,* and then starting in 2020 required contributions are based on actuarial funding.** The fixed-year ramp periods for the LABF and MEABF go from 2017-2021, and then starting in 2022, the City’s contributions to those two funds are also based on actuarial funding.

Because 2019 is the last year of the ramp period for the Fire and Police Funds, mayoral candidates will have to grapple with how they’ll pay for the City’s 2020 pension contributions, which in total will be a 31% increase from the previous year. This means the City either has to increase taxes, cut services, or do a combination of the two. Another large increase will occur in 2022, when total contributions are projected to be a 19% increase from the previous year. Moreover, the City’s annual pension contributions will increase each year thereafter.

What Are the Candidates Saying?

It’s early for the mayoral campaign, but there are already 10 declared candidates, and at least five more people are also considering running for office. I looked through campaign websites and media appearances to see what the declared candidates have said about the City’s pensions and upcoming required payments thus far. There isn’t much, but here are some relevant statements I found:

As of June 2018, I didn’t see any campaign statements specifically about the City’s pensions and the upcoming pension payments from the other four declared candidates (Rahm Emanuel***, Ja’Mal Green, Troy LaRaviere, and Neal Sales-Griffin). If I missed something please let me know.

One commonality I see amongst the candidates is a general pledge to pay pensions. Another theme is criticism that the current tax structure is regressive, and a desire to find new progressive revenue sources.

Voters (and reporters) should press for more details though about how candidates are going to pay the pension contributions and unspecified taxes. What’s the specific tax? Will implementing the tax require legislative action from the state’s General Assembly and Governor? Legalizing recreational marijuana, as Wilson has proposed, certainly would. Will proposed progressive taxes require a constitutional amendment? A progressive income tax, for example, requires amending Article IX, Section 3 of the Illinois Constitution. Moreover, the earliest amending the constitution could happen is the November 2020 election.

Whoever wins the mayoral election in 2019 will have to come up with a revenue solution quickly to make the City’s 2020 pension contributions. The election is in February 2019 (a runoff would be in April), and the elected Mayor will need to introduce the 2020 budget by late September/early October. In addition to proposing a new tax, the elected Mayor will also need to get it approved by the City Council (and state lawmakers if needed), as well as plan for its implementation.

Chicago owes what it owes to the pension funds, and recent state supreme court rulings (like the 2016 ruling against benefit cuts to Chicago’s public pensions) have made it abundantly clear that benefits for current employees and retirees cannot be cut. Moreover, reducing the City’s required contributions in 2020 (or any year for that matter) is a terrible idea that would only increase future contributions. One of the reasons that Chicago’s contributions are going to be so high in the coming years is that its contributions for decades were too low. Even now, the ramp period contributions are continuing to underfund the pensions, albeit less than before. Analysis by Jason Horwitz, for example, showed that the ramp periods will end up costing the City more in the long run than if it had just started properly funding its pensions in 2015.

I’ll continue to see whether any candidates have a detailed plan for making the 2020 payments.

Getting Into the Weeds: How are the City’s Required Pension Contributions Determined?

As previously mentioned, the City of Chicago is responsible for paying the employer contributions for four pension funds: the Fire Fund, the LABF, the MEABF, and the Police Fund. The City’s annual contributions to each fund are based on state statute. There are other Chicago-based pension funds: the Public School Teachers’ Pension and Retirement Fund of Chicago, the Chicago Transit Authority Retirement Fund, and the Park Employees’ Annuity and Benefit Fund of Chicago. However, those funds are tied to separate units of government. While the other funds impact Chicago taxpayers, in this piece I am only focusing on the four funds that are directly part of the City of Chicago’s budget.

Until recently the City’s contributions to its four funds were based on multipliers of employee contributions. This meant that for every $1 a municipal employee put in, for example, the City put in $1.25. There were different multipliers for each fund. The multipliers for the Fire and Police Funds were 2.26 and 2 (both were set in 1982), while the ones for the LABF and MEABF were 1 and 1.25 (both set in 1999).

The multipliers were also arbitrary and static, which meant the City’s pension contributions weren’t tied to the cost of benefits being earned or paying off unfunded liabilities. The actuarially sound way to fund a pension system is to have the employer contribution be tied to those two things, and in an ideal situation employer contributions increase as a pension fund’s financial condition decreases (which could happen due to poor investment returns, an increase in benefits, change in actuarial assumptions, or a number of other factors).

Unfortunately, because the City’s contributions were determined using those arbitrary multiplies the City was underfunding its pensions, and as a result unfunded liabilities grew, and grew, and grew (the situation was exacerbated by the Great Recession). As a result each of the four pension funds is significantly underfunded today, and combined they’re only 28% funded.

Rather than starting to properly fund the pension systems right away, state lawmakers (at the behest of Mayor Emanuel) put in place new funding laws that have five year ramps. The new funding law for the Fire and Police Funds became effective in 2016,**** while the new funding law for the other two funds became effective in 2017. Table 1 shows the old multipliers, the ramp periods, and the actuarial requirements for determining the City’s contributions after the ramp periods for each fund.

During the ramp periods the City’s contributions are fixed dollar amounts (the amounts are specified in state statute). The ramps steadily increase the City’s contributions over a five-year period, and after the ramps the City’s contributions will actually be based on the cost of benefits and unfunded liabilities. Table 2 shows the City’s required pension contributions for 2015-2022, and the ramp periods for each fund is highlighted in yellow.

The City’s contributions shown in Table 2 for the years after the ramps (2020 through 2022 for the Fire and Police Funds, and 2022 for LABF and MEABF) are estimates, and what the City actually has to pay will be more or less depending on how unfunded liabilities change between now and then.

Importantly, the City’s required pension contributions are projected to jump significantly from the end of the ramp period to actuarial funding. For example the City’s Police Fund contribution is estimated to increase by $203 million (or 35%) from 2019 to 2020. As previously stated, the total 2020 pension contribution is a 31% increase (or $400 million) from the previous year.

To put the 2020 increase in context, the City’s overall 2018 budget is about $10 billion, so a $400 million increase in the pension contributions would increase the overall budget by less than 10%. That, however, assumes there’s no other spending increases, which is unlikely. Moreover, regardless of the net increase in the budget, the City still has to come up with the revenue to pay for it.

The City’s pension contributions will be an ongoing challenge as there’s another big jump in payments from 2021 to 2022, and as dollar amounts, the contributions grow from year-to-year. Thus, whoever wins the election in March (or April) will need to come up with a long-term plan for paying the City’s pension contributions.

Notes:

Special thanks to Bettina Chang for encouraging me to write this post, and reviewing an earlier version.

*The City’s contributions can be tricky to discuss because there’s a difference between when revenue is collected and when the actual payment is made (this is in part a function of the property tax cycle). State law dictating the funding provisions discuss both a “payment year” and the “property tax levy year.” So, the City’s payment year 2018 contribution corresponds to the 2017 property tax. The City’s budgeted pension contributions correspond to the property tax levy year–in other words the City’s 2018 budget includes the property tax levy year 2018 pension contributions. Other documents, however, may report the pension contributions differently, so it’s important to pay attention to whether they’re reported per the payment year or tax year.

**It’s important to note that the funding target for each of the City’s four pension funds is 90%, and the actuarial best practice is to have a funded ratio target of 100%. In addition, the maximum recommended amortization period (meaning the number of years in which unfunded liabilities are paid off) is 25 years, and the amortization period for all four of Chicago’s pension funds exceeds that amount of time.

***Interestingly, part of Mayor Emanuel’s 2018 budget proposal makes it sound like the ramps for the Fire and Police Pension Funds is only four years instead of five: “The 2018 budget proposal increases the City’s base property tax levy to $1.41 billion, which includes $900 million for required pension payments by the City. This includes the final year of the four-year property tax increase committed to funding the City’s police and fire pension obligations codified in Public Act 99-0506“ (emphasis added). Public Act 99-506 specifies that the ramps are five years.

****The property tax is the main source of revenue for its pension contributions. In 2015, after the new funding law for the Fire and Police Funds was approved by the General Assembly, the City Council passed several ordinances that set the property tax levies for the pension contributions to those funds for most years of the ramp period (here are links to the 2015, 2016, 2017, and 2018 levy ordinances). However, only the levies for years 2015 through 2018 were set (meaning just four of the five ramp years). This means that the Mayor and Aldermen are going to have to vote on a 2019 property tax levy increase or come up with an alternative revenue source to make that year’s required payments. The 2019 budget has to be finalized in the fall of 2018 as the fiscal year starts on January 1. The 2019 election takes place on February 26, 2019. In other words, the Mayor and Aldermen likely need to approve a tax increase before the 2019 mayoral election. As such, this may also become an important election issue. In total, the 2019 contributions are about 10% more than the 2018 contributions.