Study looks at introducing graduated State income tax in Illinois
June 1, 2018

Graphs courtesy CBTA
With Illinois having a flat tax, middle income earners actually pay a higher percentage than some of their richer counterparts.

By Igor Studenkov

A study by the Loop-based Center for Tax and Budget Accountability (CTBA) found that the State of Illinois could raise as much as $2 billion more in income tax revenue and, if it does it right, reduce taxes for the majority of the State’s population if it takes a cue from neighboring Minnesota and changes how it taxes income.

Under the Illinois state constitution, the State taxes all residents’ income at the same rate. Most states with income taxes follow a graduated income tax model similar to the federal income tax model, where the tax rate goes up along with the income.

The CTBA study argued that Illinois’s current tax model benefits high income earners and puts a disproportionate tax burden on everybody else. Not only is the arrangement unfair, but it hurts working class and middle class residents’ ability to spend money, which hurts the State economy.

CTBA evaluated two graduated income tax scenarios. One would keep the lowest tax rate the same but introduce a tax credit to offset the tax burden for lower-income residents, and the other would lower the tax rate for residents earning $100,000 or less while keeping the rate the same for residents earning between $100,000 and $300,000 and increasing them for those earning more.

While the center readily acknowledged neither scenario provides a silver bullet for all the State’s financial woes, members believe it would go a long way toward putting the State on a better financial footing and making it more a attractive place to live and do business.

The proposal is not without detractors, however, with opponents arguing it would hurt the State’s ability to attract businesses and push more people to leave Illinois.

Out of 43 states that have a state income tax, eight have a flat income tax. In the Midwest, that includes Illinois, Indiana, and Michigan. Wisconsin, Minnesota, Iowa, Missouri, Kentucky, and Ohio, however, have graduated income taxes.

Earning more, paying less

According to CTBA, the problem is that, while everybody pays the same rate, in practical terms, this means that, the more money one earns, the less of his or her income goes into paying taxes.

“In Illinois, the top one percent of income earners pay just 4.6% of their income in State and local taxes, while the middle 20% of workers pay more than double that, coming in at 10.8% of income, and the bottom 20% of earners have almost three times the tax burden of the wealthiest, coming in at 13.2%,” the report stated.

By comparison, according to the Institute for Taxation and Economic Policy data used in the report, in Indiana, the top earners pay 5.2% of their income in taxes, while the middle 20% earners pay 10.8%, and bottom earners pay 12%. In Wisconsin, the top percent pay 6.2% of their income in taxes, while the middle 20% pay 10.2%, and the bottom 20% of earners pay 8.9%. In Minnesota, which has a graduated income tax, top earners paid 7.5% of their income in taxes, while middle 20% earners paid 9.6% and bottom 20% earners paid 8.8%.

The report notes the perception that Illinois is a high-tax state is not baseless, if you are middle class or lower.

While “Illinois is in the bottom half of all states when considering total state and local tax burden as a percentage of personal income, because its system is so regressive, it is in fact a high-tax state for middle- and low-income residents—and hence for most taxpayers,” the report stated. “Indeed, for the middle 20% of earners, Illinois has the third highest state and local tax burden as a percentage of income nationally, while for the bottom 20% of earners, Illinois is second highest. Meanwhile, for the wealthy few, Illinois is truly a low-tax state: Illinois’s total state and local tax burden for the top one percent of earners is lower than all but 16 other states.”

Graphs courtesy CBTA
With a graduated income tax, richer people would carry a higher percentage of the tax requirements than those less well off.

Tax burden hurts consumers

The study notes that, according to a Jan. 24, 2012, report by the U.S. Congress Joint Economic Committee, consumer spending accounts for 66% percent of all economic activity. Because low  and middle class families shoulder so much of the tax burden, they have less money to spend, which hurts the State economy in general and the companies that depend on customer spending for revenue specifically.

By “focusing its tax burden on low- and middle-income families, Illinois harms their capacity to purchase goods and services in the local economy, thereby diminishing consumer spending and impeding private sector economic growth,” the study stated.

Another consequence of the flat income tax: when the economy improves and Illinois residents earn more, the State can get only so much from residents who earn the most. That, in turn, limits the State’s ability to pay for education, healthcare, and other social and public services even under the best economic conditions.

“Illinois has for generations suffered from a ‘structural deficit,’ that is, adjusting solely for inflation and population changes, and assuming a normal economy and no changes in law, the cost of providing public services has grown with the economy and population over time, but State revenues have not,” the study stated. “Hence, even when Illinois does not add or expand any public services from year to year, its fiscal system nonetheless generates a deficit.”

The report argues the issue is further compounded because, when the State does not get as much revenue as it needs to maintain services, teachers, social workers, healthcare professionals, and correctional officers wind up getting laid off. As many of them are part of middle-class families that account for much of the aforementioned spending, the study argues that, by hurting their ability to spend money, the State is making a bad situation worse.

“The research shows that for every dollar the State cuts in General Fund spending on current services, the private sector loses an average of $1.36 in economic activity,” the study stated.

More revenue generated

The graduated income tax would not only make the tax burdens more equal, but bring in more revenue to the State.

The study looked at two theoretical scenarios. In Scenario 1, the State would create five tax brackets. Residents earning $300,000 or less would pay taxes at the current rate of 4.95%. Residents earning between $300,000 and $400,000 would have a 7.5% tax rate, residents earning between $400,000 and $500,000 would have an 8% rate, residents earning $500,000 to $1,000,000 would have a 9.25% rate, and residents earning $1,000,000 and more pay at a rate of 9.85%. All taxpayers also will get a $300 tax credit.

The study projects that, under this scenario, 98% of Illinois residents would see their taxes reduced or eliminated entirely, and the State would generate an additional $2 billion in income tax revenue.

CTBA research director Daniel Hertz told Gazette Chicago that the organization based the tax brackets on Minnesota’s, because it’s a Midwestern state where officials raised taxes, leading to a budget surplus. The study notes the tax brackets under Scenario 1 are more generous toward residents earning less than $1 million, as Minnesota’s top tax bracket starts at $160,020.

The second scenario also would create five tax brackets but structure them differently. The top two tax brackets would be same as in Scenario 1, but the lowest tax bracket would be for residents earning $100,000 or less, with the rate reduced to 4.5%. Residents earning between $100,000 and $300,000 would pay at the current tax rate, while residents earning between $300,000 and $500,000 would pay 8%.

Under this scenario, the study estimates 98% of Illinois residents would see their taxes reduced by up to $450, and the State still would get $2 billion more in tax revenue.

Under such an approach, 49 out of 50 Illinois taxpayers would see a reduction in their income tax burden,” the study concluded. “Meanwhile, top marginal income tax rates would be no higher than rates that already exist in the Midwest.”

David Merriman, a professor at the University of Illinois at Chicago College of Urban Planning and Public Affairs’s Department of Public Administration, told Gazette Chicago those tax brackets and rates were “within the bounds” of what other states have set.

“I think the general comment at that would be [that] it’s not radically different from what other states have successfully done,” he said.

Merriman said that, generally speaking, switching from a flat tax to graduated tax had both advantages and disadvantages.

The advantages he cited were similar to what was outlined in the study, including greater fairness and more revenue when the economy is growing. As for negatives, Merriman said revenues would be less predictable.

“Some of the income gains for high-income groups—returns on capital, stock returns—those tend to vary a lot.” he said. “And the State would have to be able to deal with it. The revenue may jump around more.”

Merriman also noted the flip side of the fairness argument is that higher income residents may argue they are “being taken advantage of.”

Graphs courtesy CBTA
A graduated income tax could create a tax rates that are extremely low for low-income earners, and average 4% for all taxpayers.

Tax resolution

The CTBA study originally was released April 30. Four days earlier, Illinois State Representative Barbara Flynn Currie (D-25), introduced HR 1025, a resolution supporting the concept of a graduated income tax. Several State Representatives have signed on since then. In Gazette Chicago’s coverage area, that includes Theresa Mah (D-2), Julianna Stratton (D-5), Melissa Conyears-Ervin (D-10), and Christian Mitchell (D-26).

Conyears-Ervin said, “I cospon-
sored this legislation because I believe hardworking, everyday people shouldn’t pay the same tax rate as millionaires and billionaires. Illinois is one of only eight states with a regressive income tax. If we want to pay our debts, uphold our promises to our public workers, and educate our children, then we cannot have a flat tax anymore. Illinois families deserve better.”

“When we put more dollars in the pockets of working families it will improve our local economies, support small businesses, and create jobs in our communities,” Mah said.

“The fair tax is a win-win for our state,” Mah continued. It will help provide tax relief for the middle class and help spur the state’s economy.

“Our current, regressive tax system burdens working families and gives a free pass to ultra wealthy,” Mah asserted, who added that billionaires “have not been paying their fair share, and the middle class has had to pick up the tab.”

Gazette Chicago contacted Governor Bruce Rauner’s and JB Pritzker’s gubernatorial campaigns. While the former did not respond, Pritzker campaign spokesperson Jason Rubin noted Pritzker supports a graduated income tax and the CTBA study.

“JB believes we need a progressive income tax system that asks those who can afford it to pay more, while providing a tax cut for the middle class and those striving to get there,” he stated. “This study shows examples of how a progressive income tax can raise additional revenue and provide a tax break to almost all Illinoisans.”

Gazette Chicago also contacted the Chicagoland Chamber of Commerce and the Illinois Chamber of Commerce. The former declined to comment.

Sadie Schwarm, the spokesperson for the Illinois Chamber, sent a statement saying the Illinois Chamber of Commerce was “adamantly opposed” to a graduated income tax and HR 1025.

“A stable flat tax is one of the few advantages that allows Illinois to compete with other states that have much better overall tax and regulatory systems,” stated Todd Maisch, the chamber’s president and CEO. “When Illinois already leads the nation in out-migration, punishing the job creators we need to restore our economy is a disaster in the making.”

Maisch also argued that whatever tax cut residents would see would be temporary, as $2 billion would not be enough to cover the $14.6 billion Illinois deficit.

GOP opposition

In response to HR 1025, State Senator Jil Tracy (R-Quincy) sponsored a resolution backed by many Republicans opposing a graduated income tax.

“Illinois’s focus right now should be drawing in new business and job opportunities, not introducing a graduated income tax that will hurt Illinois-based companies and residents and cause them to look to our neighboring states,” said Tracy.

Hertz said he was skeptical of the idea that the graduated income tax would drive away residents, at least in significant numbers.

“There’s not very much evidence that tax policy is what is really driving migration,” he said. “It’s not that nobody moves because of taxes, but the overwhelming majority of research suggests that people move because of jobs, people move because of families.”

Hertz also noted that, even though Illinois has a flat tax, it already has “one of the worst out-migration statistics in the region and the country.” He added that major destinations for out-migration for higher-income residents are New York City and major cities in California, which have graduated income taxes that are higher than that of Illinois. Hertz noted having more money for the State to spend on higher education and human services ultimately would make Illinois more attractive.

Merriman said one thing to bear in mind was Chicago’s unique niche in the Midwest, which makes it a draw.

“Chicago is a relatively unique place in the Midwest in terms of being a center of commerce, finance, law,” he said.

Merriman also said he was skeptical a graduated income tax would lead to significant out-migration.

“We could lose some of the very high-income folks,” he said. “We’re dealing with a tiny, tiny share of the population. For 99% of households, this is not a concern.”

As for criticism that the graduated income tax wouldn’t generate enough revenue to close the deficit, Hertz said CTBA was well aware of that.

“The plan was not meant to be the ‘how we close the deficit plan,’” he said. “It’s a step in the right direction. We’re going to need other measures to completely close the deficit. This is no silver bullet. But it does show the way that the State can generate a substantial amount of revenue while giving a substantial tax cut to 98% of Illinois taxpayers.”

When asked about other ways Illinois can increase revenue, Merriman mentioned two major potential sources.

“Taxing retirement income, which we aren’t doing, which is unusual for a state,” he said. “This is certainly something we should look at.”

The other is broadening the sales tax base. Services play an increasingly important role in the economy in Illinois, Merriman said, and the way the sales taxes are structured should reflect that.

For more about the CTBA, go to ctbaonline.org. For the College of Urban Planning and Public Affairs at UIC, go to https://cuppa.uic.edu. State Rep Barbara Flynn Currie’s website is www.barbaraflynncurrie.org. For the Illinois Chamber of Commerce, go to https:ilchamber.org. State Senator Jil Tracy’s website is www.senatorjiltracy.com.