The Policy Shop: Chicago’s accelerating wealth flight

The Policy Shop: Chicago’s accelerating wealth flight

This edition of The Policy Shop is by policy advisor Paul Vallas.

Chicago Mayor Brandon Johnson’s promises are colliding with his problems, which will be on full display today when he delivers his budget address to the City Council.

There’s a $538 million projected deficit. There are over 17,000 migrants expected to cost the city $345 million by the end of 2023. There is rampant crime and a diminished police force. Then there are his progressive promises and the $800 million in tax schemes he hopes will fund them, mostly on the backs of the city’s backbone businesses.

Those new taxes could drive away the folks he’s hoping to tax, leaving residents as the next sources of revenue.

CME Group Inc. CEO Terry Duffy told Bloomberg he met with Johnson in April and wants to help him, but “we don’t agree on anything.”

So the company founded in 1898 that became the Chicago Mercantile Exchange is preparing its exit plan from Chicago.

“I liquidated every piece of real estate in the state,” Duffy told Bloomberg last week. “I have leases where I am in an advantageous position, because now I can renegotiate. They’re all coming due. We like Chicago. There’s no reason for us to want to leave. But at the same time, if the atmosphere gets to the point where it’s intolerable, we have no choice.”

Johnson introduced his budget forecast with this statement: “On my inauguration day, I told the city that I wanted to re-route the rivers of prosperity to the banks of disinvestment so that no one in the greatest city in the world goes thirsty.”

But Johnson is getting ready to turn a dry spell into a drought.

He plans to impose his “mansion tax” to raise $400 million for his homelessness alleviation efforts. It would restructure the Real Estate Transfer Tax but would mainly impact commercial property owners whose property values are already plummeting.

As far as how these higher taxes will help homeless people? The details appear to be missing.

Johnson’s tax is likely to fall well below his expectations because it relies on dwindling commercial property sales that have already plummeted by 51% in the first half of this year as owners find it hard to dump largely vacant and overtaxed properties. Menashe’s recent Loop office tower purchase was the first commercial property sold downtown in almost a year – and at a 63% discount.

The mansion tax would exacerbate this trend.

For more evidence Johnson wouldn’t be taxing residences of the rich, look at Crain’s Chicago Business’ analysis of property sales over $1 million from April 2021 to April 2022 showing more commercial property sales than residential property sales by a rate of 9 to 1 or $7.5 billion to $841.8 million. If this isn’t about hitting commercial property tax owners, why not remove them from the proposal in City Hall?

Chicago has the second-highest commercial property taxes in the nation at 3.78%, according to a study by the Lincoln Institute of Land Policy and Minnesota Center for Fiscal Excellence. That’s more than double the U.S. average for the largest cities in each state. Only Detroit has higher commercial property taxes at 4.21%.

Unlike Detroit, which dealt with low property values post-bankruptcy in 2013, Chicago’s high property tax rate is because of high local government spending. Chicago’s commercial property taxes have been rapidly rising in recent years, increasing by 93% from taxes payable in 2012 to taxes payable in 2022.

Retailers in the Loop have suffered tremendously since the pandemic, and many have shuttered or are close to failing. Office vacancy escalated to a record 23.7% by the end of September; it had been 13.8% before the pandemic.

Imposing taxes without a concrete plan in place to relieve homelessness nearly guarantees Chicago will suck the revenue into its general budget or the new money will displace the old money the city spent on the homeless.

Better to unleash the potential of the housing market and remove obstacles, including converting unimproved spaces to garden units, securing the tens of thousands of unoccupied homes and apartments, and streamlining the process for securing permits and zoning approval for new housing.

Right after the city’s business leaders worry about new taxation, they next talk about crime. Duffy’s wife was carjacked in the middle of the afternoon, and he said crime is keeping some of his employees from returning to the office.

Chicagoans are already highly taxed, paying some of the nation’s highest taxes for some of the poorest city services. Police protection is an expectation for that taxation, but Chicago has 1,700 fewer police than before Lori Lightfoot became mayor and there are 1,000 vacancies that Johnson inherited with no plans for how to fill them. Those vacancies are costly, with police overtime expected to hit a record $250 million by the end of the year.

Fewer officers is a major factor in why there’s been an over 50% drop in annual arrests since 2019. The lack of officers is directly to blame for the dramatic increase in the number of high-priority 911 calls for which the Chicago Police Department did not have a squad car available to respond. The major crimes are up 54% over five years ago, but car theft is up 228%.

Crime impacts corporate leaders, but it also damages small businesses. Imagine being a Chicago restaurant owner worried customers may not venture out for fear of crime, or to find their car is missing after dining. Then the city decides it knows best how to run the restaurant by dictating compensation for waitstaff and bartenders.

Johnson and aldermen just passed a schedule of hikes in the wages for tipped workers until the $9.48 an hour subminimum wage matches the Chicago minimum wage in 2028. Tipped workers are worried customers will tip less, because the reality is tips mean they make much more than minimum wage. Illinois’ statewide median is $28.48 per hour for waitstaff at full-service restaurants.

About 7,000 restaurants in Chicago – still recovering from the pandemic and operating on very thin profit margins – will be impacted by needing to raise prices, cut staff or close, according to the Illinois Restaurant Association. “In San Francisco, after it was mandated that the minimum wage be $15 for both tipped and un-tipped workers, restaurant closures reached an all-time high,” the association stated.

CME’s Duffy was asked what he’d do if he were in Johnson’s place: “I’d be doing things a lot differently. You can’t walk outside and not have commerce in one of the largest cities in the world. Who’s going to pay the taxes on these large buildings that are now vacant? You need to figure out ways to get people back into the cities.”

“I’d like to see us go away from some of the taxes that we already have in place…. But let’s think logically about how we’re going to get people back into work and into a society. We don’t have a society right now.”

If passed, Johnson’s hike in the Real Estate Transfer Tax will just be the first of many to come. As commercial property values fall, the tax burden will inevitably shift to homeowners.

This budget may not be when Johnson pursues his $100 million financial transactions tax, but Duffey and the other leaders of Chicago’s $75 billion finance industry are worried he’ll make good on his campaign promise. Gov. J.B. Pritzker opposes risking Chicago’s position as the global pipeline for trillions a year in trading everything from crop futures to stock options, but Pritzker might have other ambitions and some other governor might go along with Johnson.

“We don’t want to leave,” Ed Tilly, the chief executive officer of Cboe Global Markets Inc. told Fortune. “But we cannot be in a position where we are disadvantaged in the most competitive markets in the world, where our competitors don’t face the same economics that we would.”

Johnson faces a $538 million budget hole, a hole in the police department and potentially more holes in the financial sector at the foundation of Chicago’s economy. It’s pretty hard to reroute the rivers of prosperity with so many holes in the bucket.

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