October 2017 | The bill for underfunded pensions of local governments in Illinois will be delivered via higher real estate taxes. Laws restricting increases in tax levies will provide limited protection to taxpayers.
On August 29th the Illinois Senate passed an education funding bill (SB 1947). It was signed by Governor Rauner two days later and became law. A property tax hike was authorized for the Chicago Board of Education that is expressly to be used to fund pensions.
With regard to the funding of local pensions, provisions in this bill raise a number of interesting questions.
- What is the process for local taxing bodies to levy taxes to fund pension obligations
- Why is the State of Illinois involved in determining tax levies for the Chicago Public Schools’ pension funds?
Where will the tax revenue to fund local pensions come from?
Local governments with pension obligations have no choice but to increase real estate taxes. The following table shows the sources of state and local tax revenue in Illinois from 2013 to 2015. (2016 property tax information is not yet available.)
If a local government entity has unfunded pension obligations, there really isn’t any option other than to increase real estate taxes.
What is the process of taxing real estate?
The levy process
Total real estate taxes to be paid by property owners are determined through a budgeting process at local taxing districts.
Local taxing districts estimate revenue from non-tax sources. These include fees and federal and state revenue sharing.
The taxing districts also estimate expenditures. The difference between non-tax revenue and expenditures is the amount the taxing district will attempt to raise from property taxes. This is referred to as a levy.
The revenue and expense information is built into a budget which is subject to public oversight. After that is done, the budget must be certified and given to the county clerk.
The extension process
Real estate taxes are referred to as ad valorem taxes. This means they are assessed based on value, usually fair market value.
County clerks are the ones who aggregate the levies of taxing bodies within their respective counties and allocate the total to properties. The key figure used in this process is the aggregated tax base. This is the total fair market value of all properties in the taxing district.
Determination of value
County assessors are required to estimate the fair market value of individual properties. This can be done based on market data, cost, or income (for income producing properties). Notices of assessed value are sent to taxpayers and are subject to appeal.
Equalization is a statistical massaging of the assessment information the county assessor’s database to arrive at a better estimate of fair market value of individual properties.
The assessed value of properties in the database is compared against actual sales. The difference between the two figures is referred to as an Equalization Factor. Call it a fudge factor.
What happens here is that the effect of a small number of transactions is applied to the all the properties.
Tax base calculations for individual properties
Calculations for different counties vary, but the approach winds up being the same. Here is a hypothetical example of tax base and tax calculations for Cook and DuPage Counties in Illinois.
- A different percentage of the values of the property goes into the tax base.
- DuPage County does not use an equalization Factor.
- The tax rates are different because the tax bases are computed differently.
Are there restrictions on the ability of local goverments to raise real estate taxes?
The Property Tax Limitation Law
There are limitations on the ability of local taxing districts to raise their levies. In Illinois, the Property Tax Extension Limitation Law (PTELL) limits increases to the lesser of 5% or the change in the Consumer Price Index for the year. PTELL limitations apply unless approved by voter referendums, something that politicians generally try to avoid.
The decision to adopt PTELL is made on a county-by-county basis. Over 20 years ago, PTELL was adopted in Cook and the Chicago collar counties (Lake, Kane, DuPage, and Will).
The CPI used in PTELL calculations has been low since 2010.
The big loophole – Home rule
As noted above, the Property Tax Limitation Law (PTELL) limits increases in property tax levies in Cook and the collar counties. How then do the City of Chicago and Cook County manage to increase taxes above the inflation rate?
Cook County Section 74-38
PTELL allows municipalities with populations greater than 25,000 to elect home rule and get an exemption from its application. Both Chicago and Cook County are home rule entities, but both have adopted language in their codes that reflect the PTELL limitations.
(b) Except as otherwise provided in Subsections (c) and (d) of this Section, the County Board shall not increase the aggregate real estate tax levy . . . . . for any year over the prior year’s aggregate levy by an amount greater than five percent or the percentage increase in the Consumer Price Index during the 12-month calendar year preceding the levy year, whichever is less.
(c) The County Board may adopt an Aggregate Levy for any year in excess of the limitation set forth in Subsection (b) of this Section if approved by a two-thirds vote of the members of the County Board then holding office.
Chicago 3-92-020 Definitions
(b) “Aggregate levy” means the annual levy of property taxes by the city for all purposes, with the exception of (i) amounts levied for the specific purposes of special service areas or pensions.
Chicago 3-92-030 Limitation.
The city shall not certify to the county clerks of Cook and DuPage Counties an aggregate levy in one year that exceeds the aggregate levy of the prior year by more than the lesser of (a) five percent; or (b) the percentage increase in the annualized Consumer Price Index during the 12-month period most recently announced preceding the filing of the preliminary budget estimate report.
Both of these ordinances give the appearance of conforming to the PTELL limitations without really doing so. In the case of Cook County, a referendum is not required to allow tax increases to exceed the limit. In the case of Chicago, levies for pensions are exempted from the calculations. Given the size of Chicago’s unfunded pension, this is like having no limit at all.
So, if the City of Chicago has a home rule exception to the Property Tax Limitation Law, why did the Illinois legislature find it necessary to approve a property tax hike to fund Chicago Public Schools pensions? See . . . Chicago gets adult supervision
Here comes the bill. What has happened to Chicago property taxes since 2009?
Psychologically, increasing property values make higher real estate taxes easier to bear. The tax rate can remain the same, but owners feel better off because their net worth is going up. What really irks property owners is getting tax increases while property values are decreasing.
After the real estate bubble burst in 2009, Equalized Assessed Valuations decreased for four years. The tax rate increased to offset the decline in value, so taxes actually went up during the period. (If you are looking for justice, look elsewhere.)
When EAVs recovered in 2015 and 2016, there was no commensurate reduction in the tax rate. The net result was that property taxes increased at a rate that was 23% above the increase in the inflation index used Property Tax Extension Limitation Law (PTELL CPI).
The following tables shows how tax increases compare to the PTELL CPI both an annual and a cumulative basis since 2009, and how the annual rate of increase compares to the increase in the PTELL CPI.
Increases in taxes that are over double the CPI clearly illustrate the ineffectiveness of the Property Tax Extension Limitation Law. As noted above, Chicago and Cook County are well equipped to skirt any restrictions on property tax increases under their local codes.
These are a huge burden on property owners, with taxes doubling every 16 years. This will throw a brick at price appreciation.