Misplaced Blame – Municipal Bankruptcy

Member Group : Lincoln Institute

Municipal and school taxes are increasing at an alarming rate. Community leaders and school district boards are feeling the heat from an angry and disaffected taxpayer and homeowner.

However, claims made against municipal and school budgets are most often outside the control of the very government leaders elected to supervise our local communities and schools.

Unfunded mandates from the Federal and State government are the rule rather than the exception.

The primary means of funding for education and state pensions has been the property tax although some communities permit taxation of both incomes and properties.

The increases in property taxes have had such a devastating impact on budgets of homeowners that continued ownership is in jeopardy. Since 2008, pay raises in the private sector have not kept pace with the rates of increase in property taxes creating this problem for those taxpayers on fixed incomes or modestly increasing pay.

Contrary to popular belief, the property tax system started in the United States dates at the time of the founding of our nation. The system of taxing property virtually guarantees that you will never own your own home.

Unfunded liabilities have precipitated a record number of bankruptcy filings of municipalities since 2010. The settlement of these bankruptcies will most certainly raise the level of debate of property taxes to unparalleled heights. The outcome of this battle will most decidedly determine whether or not American citizens have the right to own property.

These bankruptcy filings and the bankruptcy code is wherein lies the problem.

Municipal bankruptcy, Chapter 9 at the federal level, allows for reorganization of the community finances. States also have individual municipal bankruptcy statutes which are different than the Federal laws and cause creditors to "jockey" as to which court to file in to give the creditor greater standing.

It is important to note that bankruptcy is designed to protect the creditor not the debtor. The debtor in this case is the community and due to the property tax system that exists in our country, the property owner.

It is entirely within the purview of a judge to dictate that a community’s tax base and rates be increased to cover the community’s liabilities. It is a misnomer that bankruptcy will automatically discharge the obligations of the community.

Bankruptcy is also extremely expensive!

Detroit’s bankruptcy costs were over $178 million in legal fees and these bankruptcy fees are paid before ALL other obligations. It is possible that a community could file bankruptcy and have all of its obligations reaffirmed and then have to pay the legal fees on top of it. The principal means of paying for this is the property tax.

In a more simple analysis, it is appropriate to conclude that the individual property owner has a potential personal liability for the unfunded liabilities of their community.

In reality most bankruptcy courts will allow for the restructuring and reduction of the communities debt but not without great cost and potential substantial tax increases on the community.

For example, in the case of Chicago, the Mayor Emanuel had reached an agreement with 28 of 31 of its bargaining units to restructure the city’s pensions. Four of the bargaining units filed suit with the Illinois Supreme Court and were successful in overturning the agreement. The loss in the Illinois Supreme Court caused Chicago to have to pay over $560 million into the pension plan at a time when it did not have the funds to do so thereby necessitating a 40% increase in property taxes and giving Chicago one of the highest income tax rates in the nation.

It is essential to understand that unfunded mandates and deferred pension contributions and infrastructure spending will eventually cause the bankruptcy of either the city or the property owner. However, the moment the property owner goes bankrupt, the ability of the city to exist without bailout by other cities and communities is in jeopardy.

Should other cities and communities not want to bail out other communities, it is likely that the bankrupt community will cease to exist and become the ghost town of the 21st century with thousands of abandoned homes and properties as in Detroit, Baltimore, Philadelphia and legions of cities in our nation.

With the rapid rise in property taxes needed by most jurisdictions to cover their unfunded mandates and delayed infrastructure spending and with lower pay and higher unemployment of taxpayers throughout the nation, the property tax is now forcing millions of Americans to reassess where they live, how they live, and if they can ever retire.

The debate in the nation about property taxes should not be just about the method of taxation but it must center on government spending. It is the spending by government, not just the method of taxation that must be overhauled.

The American dream of home ownership and the foundation of our very communities are being shattered by those elected to serve us decades ago and now forcing current leaders to deal with the financially irresponsible behavior of those elected before them.

If we are to survive, government employees and our property owners must have compassion for one another and realistically deal with the financial problems at hand or the lack of a solution and compromise will destroy us all. Ignoring this problem is not a solution – it never was!

Col. Frank Ryan, CPA, USMCR (Ret) and served in Iraq and briefly in Afghanistan and specializes in corporate restructuring and lectures on ethics for the state CPA societies. He has served on numerous boards of publicly traded and non-profit organizations. He can be reached at [email protected] and twitter at @fryan1951.