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FLEXIBILITY LOST; By MARTIN J. BOURKE, Village Manager, Western Springs On the November 1994 General Election Ballot, voters in Cook County will be asked to vote on an advisory question about whether they would prefer that a property tax cap, similar to the cap previously instituted in the collar counties (DuPage, Kane, Lake, McHenry, and Will), be instituted by State legislation in their communities. Since the current cap legislation does not include home rule municipalities, the property tax levies of the City of Chicago, County of Cook and other home rule units would not be limited. The Property Tax Extension Limitation Law effects non home rule units of local government located in the collar counties and limits reassessment driven property tax levy growth to the lesser of five percent (5%) or the inflation rate. From my practitioner's point of view, the most onerous portions of the tax cap are included in this article. My purpose in writing this article is to provide officials in Suburban Cook County with a warning that if the Governor and the Legislature agree to extend the cap to your communities, you are headed for difficult times. Further, if the cap is successfully extended to Cook County, can Out State and Downstate areas be far behind? Officials in home rule municipalities should not be sleeping quietly either. There are many factions in and around the Governor and the Legislature who would be pleased to pass a law that would further erode home rule powers. In Suburban Cook County, I am assuming the advisory referendum will pass with flying colors, i.e., vote for mom, apple pie and tax caps! If it does, local officials will need to place great pressure on their local legislators to ignore the result of the advisory referendum as they ignored the results of the advisory referendum on State mandates. Before I began my duties in Western Springs, I was employed as Village Manager by a capped municipality in DuPage County. In coming to Suburban Cook County, I was struck by the lack of knowledge of many elected and appointed officials about the potentially catastrophic damage that would be done to their municipal budget and financing opportunities if this legislation was extended to Suburban Cook County. In addition to the lack of knowledge in Suburban Cook County, representatives of the IML believed that officials in municipalities located in Out State and Downstate Illinois were not fully aware of the ramifications of the tax cap since it is not in effect in their communities. The Tax Cap Limits Increases In All Levies Further Than Traditional Legal Limitations Before the adoption of the tax cap, State law set limitations on many non home rule levy rates, including: corporate, garbage, streets and bridges, police and fire protection, insurance, ambulance, capital improvements and others. The tax cap makes these traditional limitation rates irrelevant since municipalities cannot take full advantage of those limitations unless they can be attained by increasing this year's levy by the lesser of five percent (5%) or the inflation rate over last year's final extension. This year's inflation rate for tax cap purposes will equal 2.7%. In any other case, an attempt to increase levies to their legal limits can only be done after a successful referendum vote. Some currently capped municipalities do not levy property taxes for operating and pension obligations due to reliance on other revenues, consequently, creating a previous year's extension base of $0.00. Since the tax cap limitation is built on the previous year's extension base, these municipalities cannot levy for any dollars without referendum approval. If the other revenues currently relied upon by these municipalities are negatively affected by the general or local economy or other October 1994 / Illinois Municipal Review / Page 17 factors beyond municipal control, an infusion of property tax revenues is not possible without a successful referendum vote. The Tax Cap Eliminates The Use Of Important Financing Vehicles The tax cap legislation was deliberately designed to prevent non home rule municipalities from issuing debt without referendum approval. Most of the debt vehicles eliminated, however, were designed to have their yearly debt service payments funded by revenues sources other than property tax. As many of you will recall, the Legislature only recently gave non home rule municipalities greater debt issuance flexibility through the passage of the Local Government Debt Reform Act of 1988. The Debt Reform Act was prepared by experts in the municipal bond field as a way of saving tax payer dollars by encouraging the use of debt vehicles issued with lower interest rates and lower debt reserve. The clumsily constructed tax cap legislation has essentially voided the carefully crafted debt reform legislation that was less than four (4) years old when the tax cap was adopted. Eliminated from use were the following: (A) One-half of one percent (.05%) Non-Referendum Bonds; (B) General Obligation Bonds (Alternate Revenue Source); (C) General Obligation TIF Bonds (Back Door Referendum Petition Period); (D) Non-Referendum General Obligation Bonds issued to fund EPA mandated or court ordered projects; (E) General Obligation Bonds to fund Tort judgments or self-insured or joint self-insured risk financing activities; (F) Greater than ten (10) year but less than twenty (20) year Installment Purchase Contracts needing property tax backing; Page 18 / Illinois Municipal Review / October 1994 (G) General Obligation Tax Notes and Warrants. In my community, we recently issued $1.5 million dollars of General Obligation Bonds (Alternate Revenue Source) to pay for much needed water and sewer system improvements. Since the bonds were "backed" by the full faith and credit of the municipality, they were issued at an interest rate lower than what could be achieved by the issuance of a revenue bond. While property taxes must be levied each year to fund the debt service payments, they will not be extended since increases in water and sewer usage charges will pay the debt service. This vehicle allows much needed improvements to be built without burdening the property tax payers and at the most cost-effective interest rate for the utility customers. The Tax Cap Includes State Mandated Costs, But Does Nothing To Halt Them Officials in many communities mistakenly believe that police, fire and IMRF pension costs mandated by State legislation and traditionally funded by property tax increases were exempt from the cap. This is not true! If the State mandates any pension increases, those increases will be borne by the municipalities subject to the property tax cap. If the pension cost increases are significant, other levies may need to be lowered or frozen to "make room" under the cap for the pension increases. If lowering the other levies is still not enough, other revenues must be allocated to pay pension costs. State law was recently amended to demand full funding of local fire and police pensions by the year 2033. If a municipality fails to fund its local pensions on a yearly basis as recommended by the Illinois Department of Insurance, the Department will not hesitate sending a letter detailing your irresponsibility, regardless of a tax cap. Similarly, if property, liability, workers' compensation and/or group health insurance costs skyrocket, as they do regularly, there is no provision for an exemption from the cap. October 1994 / Illinois Municipal Review / Page 19 As you may not recall, one of the ways in which the framers of the tax cap legislation "sold it" to the Legislature, business interests and the local governments affected was a companion promise to eliminate unfunded State mandates. The companion legislation has never arrived. This spring, we all witnessed the miserable performance of the Legislature as they ignored the results of the State wide advisory referendum urging a constitutional amendment eliminating unfunded State mandates on local governments The Tax Cap May Cause A Drop In Municipal Bond Rating Or Force Municipalities Into Questionable Financing Techniques There are very few items in the arena of municipal finance that are more carefully monitored by local officials than the municipal bond rating. The bond rating is a reflection of municipal financial well-being. It is not only used by underwriters in preparing their bids to purchase municipal bonds, it is used by all financial and economic development experts in describing and symbolizing your community's economic health. In a publication prepared by Moody's Investors Services they state the following; "Legislation with the features of the property tax extension limitation act is likely to affect credit quality negatively, although Moody's expects the effects to be gradual and cumulative." It is not difficult to understand why Moody's makes such a statement. Since the tax cap restricts a municipality from one of its most significant sources of operating revenue, there is bound to be a ripple effect throughout the rest of the municipal budget and financial structure. Can growth in other revenues cover the loss of access to the property tax? This question can only be answered on an individual municipal basis. In the two (2) communities that I am most familiar, the sales tax bases are weak and the utility tax rates are at the maximum amounts, therefore, the answer to the question posed above is "no." If municipalities begin to "spend down" their fund balances due to the tax cap or their tax base is perceived to be eroding by bond rating agencies, both of these instances will negatively affect their bond rating. When municipalities in the collar counties were convinced that the tax cap was to become a reality, many issued new debt that could not be issued after the cap took effect. This "rush" was portrayed by the framers of the tax cap legislation and some of the press as a demonstration of municipal irresponsibility, consequently, confirming the need for a tax cap. What was really happening was municipal projects and debt issuance that were previously planned to occur in later years had to be accelerated before access to more cost- effective debt financing vehicles was eliminated. If the cap comes to any other area in the State, you can expect the same type of accelerated debt issuance to occur and the same people moving very quickly to chastise local governments for "reckless spending". An example of why it is an attractive idea to issue debt before the cap is placed in effect recently occurred in a collar county. A growing community of twenty thousand (20,000) people housed their police Page 20 / Illinois Municipal Review / October 1994 department in a sixty (60) year old single family house. The voters were asked to approve a twenty (20) year general obligation bond of $2.5 million. The voters rejected the issuance of the bonds, however, forcing the municipal officials to enter a ten (10) year lease purchase agreement to build the badly needed police station. Obviously, the debt service payments for a ten (10) year lease purchase will be much higher than for a twenty (20) year bond. In addition, the debt service payments will need to be funded by other general revenues placing further constrictions on an already constricted municipal budget. It is also likely that the interest rate to be paid on the lease purchase is higher than the rate that would have been obtained by a General Obligation Bond. Quirks In The Tax Cap Legislation That Were Not Expected In using the word "quirks" in the title of this section, I am using a term favored by the framers of the tax cap in attempting to explain away some of its many technical and legal flaws. Unfortunately for you as municipal officials, these "quirks" will become headaches that will have to be dealt with yearly. Keeping in mind the disastrous referendum result mentioned above, the framers of the tax cap legislation, took great delight in challenging local government officials not be afraid "to face" their electorate by placing tax increase and bond issue questions on referendum ballots. What was generally known by all municipal officials at that time, but was generally not acknowledged by the tax cap framers was that case law in Illinois has firmly established that local governments cannot spend public funds to convince voters to approve referendum questions. While municipalities can place taxing and financing questions on the ballot, they cannot spend any public funds to "sell" their attributes to the public. It is conceivable that the framers of the tax cap did not know of this restriction on local governments. It is also conceivable they knew it, but chose to ignore it. The tax cap eliminated many financing vehicles used to fund necessary, but not glamorous improvements. Since local governments can not spend public funds to convince voters to raise taxes or issue bonds, citizen groups have traditionally taken on this challenge. While it is very common to have referendum passage groups form such as "Friends of the Library" or "Citizens for Better Parks" or "Residents to Enhance our Schools", I have never encountered the "Friends of the Wastewater Treatment Plant" or "Citizens for More Jail Cells"! The tax cap uses the consumer price index (CPI) to determine the amount of tax increase allowed. The CPI included in the law is not calculated for the Chicago area nor even for Illinois as a whole, but the national CPI. I have never understood why the cost of living in Idaho or Hawaii should be used to determine property tax increases to fund vital municipal services in the collar counties of Northeastern Illinois. If municipalities have been acting responsibly in authorizing moderate property tax increases in the years prior to a cap, they will not be rewarded for prudence by the tax cap legislation; they will instead be penalized. The unfortunate lesson learned is that a mu- October 1994 / Illinois Municipal Review / Page 21 nicipality should raise levies to levels that would have never been contemplated just prior to the cap coming into effect. The excess funds generated each year can be invested and set aside for capital projects that can not be funded later because cost effective financing vehicles will not be available. Further, it would not be prudent to abate any portion of the levy because the initial dollars levied will never be recovered. Remember, next year's levy limitation will be based on this year's final extension, not last year's levy. Municipalities should also be aware that the tax cap legislation was supposed to allow for the capturing of extra property tax dollars from development, redevelopment or annexation; commonly referred to as "new growth". While the tax cap legislation does give additional credit for new growth, municipal officials must be very careful how their county assessment officials are determining new growth. If the county assessment system is not efficient as it should be, your municipality will be the loser. Rezoning of residential property to more valuable commercial/industrial property is not considered new growth, and therefore, a new growth credit is not allowed. The very successful economic development process of Tax Increment Financing (TIF) has also been negatively effected by the tax cap legislation. When a TIF district is created, the actual value of the property within the district will most likely increase but is frozen for the underlying districts until the TIF period ends. Under the tax cap law, TIF's in non home rule municipalities would not be as beneficial as TIF's in home rule municipalities. TIF's established by non home rule municipalities suffer because although the tax cap does recognize that new growth occurs from year to year, and that the gain in assessed value will be made available to the taxing bodies for one year and not subject to the cap calculation, upon dissolution of the TIF the new growth is not made from year 1 of the TIF creation, but only from the last year prior to the dissolution of the TIF. This makes TIF funding even less attractive to the underlying districts and creates an inequity between home rule TIF's and non home rule TIF's. (Village Library Problem) The idea that a village budget and levy is affected by the actions of an independently elected board is a Statutory problem that has never been adequately resolved. It has now been further exacerbated by the tax cap. Those villages who have a library created under the Illinois Local Library Act already know the problems this structure causes at budget and tax levy time. The village library is governed by an independently elected board, yet their budget and tax levy must be approved by a village board. It has always been questionable whether a village board has a right and/or obligation to alter or refuse to pass the library's budget or levy if they see fit to do so. Library interest groups will claim that village library budgets and levies are to be passed as presented without alteration by a village board. If the library's levy is to be passed as presented, but the library's levy must also be considered part of the village's levy for tax cap purposes, large levy increases by the library board may affect the village's levy. If the levies of both bodies are to be kept to a combined aggregate increase of five percent (5%) or less, one or both of the levies will have to be reduced to bring the aggregate down to fit within the cap. If you accept the position of library interests that the library's levy is sacrosanct, then the village's levy would have to be reduced. Most villages have held that the library levy has to be reduced at the same percentage as the village's levy to get down below the cap, but this is a pragmatic solution to the problem, and might not stand up to a legal challenge. Maybe the final indignity suffered by municipalities as a quirk of the tax cap legislation is that the cumbersome requirements of the Truth in Taxation Act are still in effect. Although your municipality is capped to five October 1994 / Illinois Municipal Review / Page 22 percent (5%) or less levy growth, you still have to follow the steps laid out in the Truth in Taxation process, which is ludicrous for a capped municipality. Restrictions On Other Non Home Rule Revenues Were Not Lifted With The Tax Cap As you know, non home rule municipalities have been restricted from utilizing some productive revenue sources that are currently available to home rule municipalities. Three (3) very productive sources of revenue available to home rule municipalities are still precluded from use by non home rule municipalities; unrestricted use and unlimited rate hotel/motel tax, real estate transfer tax and local sales tax. Non home rule hotel/motel tax is restricted to a maximum of five percent (5%) and revenues collected must be spent only to promote tourism. Lack of access to these more productive sources of revenue that are relatively painless to the electorate is unfair and makes the tax cap even harder to accept. In the collar counties, even the home rule municipalities have been adopting self-imposed property tax caps due to potential negative publicity and as a way to prevent the Legislature from finding a reason to place them under the cap. While this may be saving the property tax payers some dollars, it can be argued that if the home rule municipalities begin to use their authority to levy a local sales tax instead of raising property taxes, the average tax payer may not realize any savings. Local sales tax is no longer deductible from Federal income tax. On the other hand, property tax payments are deductible. Although the utility tax is available to all municipalities, elected officials have been reluctant to implement it since it adds costs to their residents' ever increasing and highly publicized utility bills. In addition, local utility taxes paid are not deductible from Federal income tax returns. In summary, municipal officials in Suburban Cook County and the other areas of the State should not want any part of the tax cap legislation that is currently on the Statute books. I am certain that many of your residents, businesses, and colleagues, and your local state legislators as well, do not understand the full ramifications of this law. If this article is of any assistance in your discussions concerning this issue, I will be gratified. If I can be of any further assistance, please do not hesitate to contact me.
October 1994 / Illinois Municipal Review / Page 22
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