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5 lessons for Illinois from Detroit’s bankruptcy

Published: Friday, Aug. 30, 2013 1:15 a.m. CDT
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Ted Dabrowski

Two weeks ago I took in the demise of Detroit with my own eyes. I was fortunate to be with my colleague, Detroit native Paul Kersey. As we embarked on the trip, he told me “Detroit is a story that must be told.”

He was right. 

I’d seen the pictures and knew the history, but I wasn’t prepared for what I saw: Each razed lot and burnt-out home represented a family’s dashed hopes and shattered future. Outside the small, but lively, downtown were parts of what is now 130 square miles of sadness. 

Ethnic neighborhoods no longer exist. Culture and arts are gone. There is no retail. Only one movie theater is left for nearly 700,000 people. As one city analyst told me, “Detroit is no longer a sustainable city.”

I’ve seen destitution in my many years of living in and traveling the developing world, but it was surreal to see it in America.

In the midst of it all, I had the good fortune to meet with three men who helped make sense of Detroit’s plight. These three men each are intertwined in the fabric of Detroit’s history and its bankruptcy. The first is a news reporter from one of the city’s major newspapers; the second, a Detroit native with decades of civic involvement in the Motor City; and the third, a municipal bond and legal expert who’s in the mix of the bankruptcy proceedings.

Their assessment of Detroit not only served to help me understand how we ended up with the Detroit of today, but also to heed the warnings of how failed government policies can destroy people’s lives.

Here’s the advice I came away with:

1.  First and foremost, respect the taxpayer. Start losing taxpayers and it’s a downward spiral from there. Detroit learned that the hard way. 

The city’s slew of bad public policies led to a surge in white flight in the 1950s, ’60s and ’70s, creating the first gaps in Detroit’s much-needed tax revenue. More than 1.1 million middle-class white residents left the city in that time period, and by 1990 only approximately 200,000 whites remained.

The exit of middle-class black residents followed.

Detroit lost the tax revenue needed to support core services, such as public safety. The city became unsustainable.

In Illinois’ largest city, Chicago, upcoming billion-dollar deficits at both the city and the Chicago Public Schools mean more tax increases are on the way. Add to that nearly insolvent pension funds and it spells chaos. 

In Chicago, the fiscal squeeze already is threatening the city’s ability to provide core services. CPS has laid off thousands of staff and closed nearly 50 schools, while the city’s crime rate is among the highest in the nation. When taxpayers stop receiving the services they are paying for, they’ll leave.

Taxpayers in Chicago, and all across Illinois, should be worried. They need to see big and bold reforms to know they’re not taken for granted.

2. Watch out for the financial markets – they’ll come after you. Over the past few years, investors have purchased Chicago and Illinois bonds despite their collapsing finances and multiple credit downgrades. These investors have assumed that government-issued bonds are a sure thing. They count on automatic tax increases if a city or state’s coffers dry up.

But Detroit’s treatment of bondholders under bankruptcy is changing the rules of the game. Since Detroit can’t raise more taxes (there aren’t many taxpayers left), the bankruptcy court is likely to dump bondholders into a pool with all other unsecured lenders. Bondholders will have to fight over the dregs and may be left with only cents on the dollar.

I’ve worked and traded in many fiscal crises that have been started by the bond markets. When bondholders no longer want to deal with financial deadbeats, they let you know in no uncertain terms. Chicago is getting dangerously close to that point.

3. Stop promising benefits you can’t afford, ... it’s immoral, and it will bankrupt you. Detroit is proving that no matter how many promises and constitutional protections a government makes, worker benefits will be cut when they’re no longer affordable. 

Detroit city workers and retirees are expecting cuts to their pensions as a result of bankruptcy. Under Detroit Emergency Manager Kevyn Orr’s bankruptcy plan, unfunded pension obligations will also be dumped into the unsecured creditor pool.

Again here in Illinois, Chicago’s pension plans are severely underfunded. These funds hold just 35 cents for every dollar they should have today. It’s been well documented how severe the state of Illinois’ pension crisis is for our state’s government workers, teachers and social service providers. Our public servants shouldn’t have to face the same fate as Detroiters. Illinois can take the lead nationally by championing major reforms that give workers full control over their retirement funds. Illinois already offers nearly 18,000 state university employees the option to self-manage their retirements in 401(k)-style accounts. Why shouldn’t all workers have that right? 

Reforming pension benefits before a crisis erupts, while politically difficult, is much preferable to indiscriminate cuts under bankruptcy. 

4. Small businesses and entrepreneurs matter. Some of Detroit’s leaders were openly hostile to the business community. It’s a complex story, but suffice it to say Detroit hurt its transition away from the auto industry. The city’s version of corruption and hostility stalled the vibrancy of small businesses and entrepreneurship needed to help Detroit evolve. Detroit lost companies to the suburbs, and scared away new ones from starting. Jobs and population began to disappear. The rest is history.

Illinois’ story is quite different, but the outcome could be eerily similar. Again, the state’s largest city, Chicago, has always been a hub for business. Witness the major companies that have come into Chicago, such as Boeing, and the city’s focus to build a high-tech community.

But its version of pro-business is the crony-capitalist type. The city, and other cities across the state, frequently offers tax-increment-financing packages that are nothing more than property tax slush funds in the hands of city leaders. Chicago spends big money to woo trophy companies and even more to make sure they stay. After threatening to leave Illinois in 2011, the Chicago Mercantile Exchange was granted a 10-year deal with more than $85 million a year in tax breaks to stay.

To pay those big sums, the city has to hit up thousands of little companies and entrepreneurs with higher taxes and more fees. 

That undermines the real job creators in Illinois – the ones who struggle to make profits by offering more basic services such as restaurants and retail stores.

Illinois  needs entrepreneurs to keep the state vibrant. They shouldn’t have to support crony capitalism.

5.  Don’t pass fake reforms, as tempting as it may be. Despite its ever-increasing plight, Detroit never took on real reforms. Instead, the city relied on state and federal subsidies to keep its broken programs afloat. Detroit is now all about reforms it could’ve and should’ve passed.

Illinois needs to avoid that ending. It has to avoid the temptation to pass fake and meaningless reforms that perpetuate its crisis. Instead, it needs to go for the big bold reforms that will keep our state great.

Kersey was right. “Detroit is a story that needs to be told.” Let’s not repeat Detroit’s story; let’s learn from it.

Ted Dabrowski is the vice president for policy at the Illinois Policy Institute, a free market think tank.

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