McArdle: Next Chicago mayor to face crippling pension crisis

By Megan McArdle

The Washington Post

Chicago’s next mayor will be a black woman. Lori Lightfoot, a former federal prosecutor, and Toni Preckwinkle, the president of the Cook County Board of Commissioners, took the top two positions in the first-round election on Tuesday, beating 12 other candidates, and will advance to the April 2 runoff.

It’s a proud moment for a city with a not-always-proud history of racial tensions. But regardless of who wins, the next mayor will face a monumental challenge: Chicago’s crushing pension burden.

The city has been underfunding its pensions for decades, with dire results. Chicago’s pension plans collectively have only about a quarter of the assets they’ll need to pay benefits, one of the worst funding ratios in the nation. To put that hole in dollar terms, Chicago is about $28 billion short of what it needs, even under relatively favorable assumptions about future returns, or about $10,000 for every man, woman and child living in the city.

The problem could have been even worse. Mayor Rahm Emanuel, who chose not to seek a third term, has managed to halt what had been a free fall in funding levels. But while emergency action may have stabilized things, the patient is still on life support, with radical surgery still needed. Within a few years, pension contributions are projected to suck up more than 20 percent of the city’s budget. And Chicago can’t count on much help from the state, which is dealing with its own, equally severe case of pension underfunding.

From the moment the next mayor takes office in May, she will face fierce pressure. And the rest of the country will be watching, because what’s happening in Illinois is merely the earliest and most extreme manifestation of a quandary that will soon be dominating the public conversation in many states: how to pay for retirement promises to public employees without entering a fiscal death spiral.

Compared with the private sector, oversight for public-pension managers has been almost criminally lax, and the methods that many funds use to calculate their pension liabilities has been preposterously optimistic. The shoddy accounting allowed generations of politicians all over the country to curry favor with public-sector workers by offering them ever-fatter pension packages, gaining immediate benefit while deferring the political cost of paying for all those benefits until much later.

Later is now arriving. Cities and states have to figure out how to pay for all the promises made by their elected predecessors, and none of the choices are good.

Chicago isn’t a poor city like Detroit, unable to pay for its pensions (or much of anything else). It has a robust housing market, and both its per capita and median household income are within striking distance of New York City’s. Moreover, Chicago would seem to have plenty of unused taxing capacity, since the tax burden on its higher-income residents is relatively low compared with that of similar cities.

But Chicago lacks the thing that gives other blue-state behemoths nearly unlimited taxing power: a thick upper crust of ultra-affluent taxpayers sustained by a dominant position in a global industry such as tech, entertainment or finance. Los Angeles can effectively tell its wealthiest taxpayers “Pay up or try getting your movie produced in Omaha.” Chicago doesn’t have that many rich residents who are so thoroughly captive to geography.

Chicago has been losing lower- and middle-class residents for years, in part because of its heavily regressive tax burden. And when Chicago and Illinois both start raising the rates on upper earners — as they will have to, and soon — they run the risk that those people, too, will start trickling away, either to smaller cities without the burdensome pension-legacy costs, or coastal cities that can offer the economic benefits of living in a dense urban cluster.

Nor are the alternatives any better. The Illinois Constitution forbids both city and state from cutting pension benefits, and so far it has proved politically impossible to amend. The only remaining choice is cutting services: a good way to drive away taxpayers more interested in regular trash pickup than in paying for the workers of yesteryear, and bad for anyone who stays behind. And thus there’s a real danger that Chicago could find itself caught in a vicious circle, where any measures undertaken to pay the pensions actually make the pensions harder to pay.

This spring, either Lori Lightfoot or Toni Preckwinkle will make history in Chicago. And the next mayor will have a national impact if she can successfully address the city’s looming pension disaster. Because local governments across the country that will soon find themselves in similar straits desperately need a creative leader to show them how to square the vicious circle.

Megan McArdle is a Washington Post columnist. Follow her on Twitter @asymmetricinfo.