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Illinois Issues: Taxpayers Should Brace Themselves For Increases

Income tax space on a Monopoly game board

Commentary — Let’s be blunt: Illinois needs higher taxes.

That statement might come as a shock to citizens under the illusion that all would be well, if state leaders would just cut all the wasteful spending out of the state budget. 

Better-informed folks won’t be surprised, though, when at some point — one would hope sooner rather than later — Gov. Bruce Rauner and the legislature’s majority Democrats hash out a budget deal for the current fiscal year involving some cuts, but also major tax increases.

The need for additional revenue long has been a recurring theme among knowledgeable observers of the state’s financial picture. In an August analysis, for example, Moody’s Investors Services suggested “a combination of spending cuts and revenue increases including reinstating higher income tax rates” as a way to offset a roughly $5 billion deficit projected for the current fiscal year. 

Charlie Wheeler headshot
Credit WUIS/Illinois Issues
WUIS/Illinois Issues
Charles N. Wheeler III is director of the Public Affairs Reporting program at the University of Illinois Springfield. He has been writing his Ends and Means column for Illinois Issues since 1984.

Similarly, in February The Civic Federation, a Chicago-based fiscal watchdog, unveiled a comprehensive proposal to stabilize state finances, starting with tight spending controls, but also calling for more revenue. Relying only on spending reductions to balance the budget, while mathematically possible, “would come at the cost of eliminating entire areas of state services or completely restructuring how Illinois government functions.”

The federation’s 58-page “budget roadmap” came on the heels of a January study by the Fiscal Futures Project of the University of Illinois’ Institute of Government and Public Affairs entitled “Apocalypse Now?” The academics’ conclusion: “Illinois’ fiscal problems are huge, structural, and escalating quickly. The state’s deficits cannot be eliminated by quick, temporary fixes, or by waiting for the economy to grow. Solving Illinois’ problems means that the state must use all the fiscal tools it has available. This means a combination of cuts in spending and increased revenue.”

While the economists, finance experts, and professors offered clinical examinations of the state’s fiscal condition, state Comptroller Leslie Munger has been battling on a daily basis with the real-world consequences of no budget and inadequate revenues.

Thanks to laws requiring automatic payments to state bond holders and public employee pension systems, court orders covering state employees’ paychecks, and consent decrees for many human service programs, roughly 90 percent of the state’s bills are being paid, Munger said a few weeks ago. But none of the dollars going out are helping pay higher education costs, including scholarships for students with financial need, or health insurance claims for state workers and retirees, or even folks who win big in the Illinois Lottery, all expenses a future budget agreement will have to cover, at least partially.

“The problem is, the spending is based on FY 15 levels while revenue is based on FY 16 levels, which is running considerably lower due to the sunset of the temporary tax increase in January,” Munger said. In concrete terms, Illinois is spending at a $36-billion-a-year clip, while taking in only about $32 billion. The mismatch means the state’s backlog of unpaid bills could hit $8.5 billion by the end of the calendar year, Munger warned.  Absent a budget agreement, Illinois could literally run out of cash next spring to cover even court-ordered and automatic payments. 

Credit www.StockMonkeys.com

The political combatants themselves recognize the fiscal reality. Legislative Democrats conceded the spending plan they sent the governor in May was short billions of dollars that would require painful cuts and politically difficult tax hikes to make up. Rauner vetoed all but funding for local public schools, citing what he said was a $4 billion shortfall in the Democrats’ plan. But rather than flatly rule out tax increases, the governor insisted that Democrats need to approve his pro-business, anti-union initiatives before he’ll talk about revenue. Indeed, as a candidate, Rauner spoke favorably of raising income tax rates on a temporary basis and slapping the state sales tax on some services. 

Also contrary to popular belief, the state does not tax its citizens more heavily than its neighbors. While Illinois ranks near the top nationally in property tax collections — all of which go to school districts and other local governments — the state is more middle-of-the-pack for state income and sales taxes as a percentage of personal income, according to the Federation of Tax Administrators. 

Unlike many states, Illinois does not tax retirement income.

What does that mean in dollars-and-cents terms? As Senate President John Cullerton has argued for years, Illinois would be in much better financial shape if it had the exact same tax laws as some of its neighbors. For example, if Illinois had Wisconsin’s revenue structure — higher income tax rates, a tax on retirement income, sales tax on services — the Prairie State would collect almost $10 billion a year more than with its current taxing provisions, more than enough to cover Monger’s projected shortfall.

With that in mind, when a revenue package finally is forged, what might it look like? Almost certainly, higher income tax rates and an expanded sales tax base will be included. Not only are they the ideas most often discussed by both political leaders and outside budget experts, but also income and sales taxes also largely underpin the state’s checkbook account. Together, they produced almost 80 percent of general fund revenues in FY 2015, making them the only sources capable of raising enough new dollars to make a difference.

Here’s a closer look at what might be in store for both revenue sources:

• Income taxes: In its February roadmap, The Civic Federation proposed increasing the individual income tax rate to 4.25 percent from 3.75 percent and the corporate income tax rate to 6 percent from 5.25 percent. The rates then would drop permanently in 2018 to 4 percent for individuals and 5.6 percent for corporations. The plan also called for taxing the pensions and retirement income of those who make more than $50,000, excluding all Social Security income. (*Correction: A previous version of this column said The Civic Federation's plan called for taxing pensions and other retirement income — but not Social Security — of more than $50,000. But the plan actually would not exclude the first $50,000 of income. It would, instead, only apply to those who make more than $50,000 in retirement, not counting Social Security benefits.)  

By raising income tax rates now, then gradually reducing them, “The state can mitigate a large portion of the current financial crisis and begin paying down a larger portion of the state’s unpaid bills in the near term giving relief to vendors and local governments,” the federation said.

“Illinois has the economic capacity to absorb higher income tax rates,” Moody’s noted, as one of only eight states that don’t impose graduated rates, with a flat rate that’s comparatively low, 3.75 percent compared to the 4.4 percent average among flat-rate states. Raising the individual rate to 4.75 percent and the corporate rate to 6.75 percent starting January 1 would generate approximately $2.4 billion of additional revenue, the Moody analysts said. 

Also advocating higher income tax rates is the Center for Tax and Budget Accountability, a Chicago-based think tank. Setting the individual rate at 4.75 percent would bring in an additional $3.9 million a year, the center estimated, while moving the corporate rate to 6 percent would generate almost $400 million more. Including retirement income of $50,000 or more would bring in another $1 billion.

Taxing retirement income might not make the final cut, but whatever new rates are negotiated, the package is likely to include provisions to lessen the impact on low- and middle-income families, such as increasing personal exemptions and expanding the earned income credit.

• Sales taxes: With few exceptions, the state’s 5 percent sales tax applies only to transactions involving tangible items, in which someone pays someone else for a physical object, such as a customer paying sales tax on a new refrigerator. Eighty some years ago, when the state sales tax first was imposed, most sales involved goods. Now, however, more than 70 percent of the state’s economic activity involves services — someone paying someone else to do something, often not involving any exchange of physical objects. Think getting a haircut. 

Credit Kristine Paulus
If the state sales tax applied to services, Illinois residents might pay it on dog walking.

In contrast, all neighboring states include more services in their sales tax bases. Iowa, for example, taxes 90 of 168 possible services enumerated by the tax administrators, while Wisconsin hits 76. Illinois’ tax base included just 17 — 12 of them involving utility bills.

As a candidate, Rauner proposed expanding the base to 32 additional services, many of them professional like legal or advertising, to bring in $600 million more. Rather than cover professional and business-to-business services, though, a better approach might be to include only consumer services, such as lawn care, health clubs, and pet grooming, as the Center for Tax and Budget Accountability has been recommending for years. The center’s plan would generate some $2 billion in additional revenue. In fact, a broad enough base might allow a reduction in the current 5 percent state rate with no revenue loss.

Other ideas have been floated, such as a new tax on sugary soft drinks or a franchise tax on satellite TV 

Credit David Wilson
Haircuts are another service that could be taxed under a sales tax expansion.

  service. Neither idea has gained much traction in the past, and the new revenue either would produce is relatively small, so lawmakers aren’t likely to see either idea as a game-changer. On the other hand, a so-called transaction tax, essentially a sales tax on trades of stocks, bonds, options, and similar financial activity, would generate huge revenue at minuscule rates. But fierce opposition from Chicago’s exchanges all but guarantees no legislative future for the idea.

Instead, Illinoisans should brace themselves for higher income tax rates and a broader sales tax base, necessary evils if the state is to balance the budget while preserving the education, health care and human service programs folks routinely tell pollsters they want spared from the austerity ax.

The former director of the Public Affairs Reporting (PAR) graduate program is Professor Charles N. Wheeler III, a veteran newsman who came to the University of Illinois at Springfield following a 24-year career at the Chicago Sun-Times.
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