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Fixing the Ongoing Illinois Budget Crisis

Posted on Feb. 17, 2020

Andy Daglas is a member of ONE Northside's Economic Justice Team; they thank the team at ONE Northside for research and contributions to their essay. John Bouman is president of the Shriver Center on Poverty Law in Chicago.

In this inaugural installment of From the Inside, the authors call for passage of a constitutional amendment to allow a graduated income tax (the Illinois Fair Tax), arguing that it would be pivotal in addressing the state’s long-standing structural deficit. In separate essays they posit solutions to address Illinois’s longstanding structural deficit.

Copyright 2020 Andy Daglas and John Bouman.
All rights reserved.

Andy Daglas

Illinois’s structural deficit is a direct consequence of its structural inequality. Under the constitutionally mandated flat tax system, all residents pay the same 4.95 percent income tax rate. This is one of the most significant ways that Illinois places a disproportionate tax burden on those who can least bear it: The poorest 20 percent of Illinois taxpayers carry double the tax burden of the richest 1 percent. Only eight states use a flat rate system, and only four states constitutionally mandate it.

The regressive flat tax not only takes already-extreme economic inequality and makes it worse, but also fails to adequately fund state government. This has pushed legislators to repeatedly cut funding for public services, including healthcare, education, environmental protection, housing assistance, childcare, legal defense, homelessness prevention, and domestic violence prevention. These cuts to vital services also exacerbate the strain on the low- and moderate-income residents who rely on them, further widening the gap between the wealthy few and everyone else.

Thanks to years of work by a wide coalition of organizers across the state, Illinois voters now have the opportunity to fix their upside-down tax system. This November’s election will include a referendum titled the Illinois Fair Tax to amend the state constitution and allow for a graduated income tax. By replacing the flat tax with a fair tax, Illinois would generate more revenue and do so more equitably.

The fair tax would raise annual revenues by $3.4 billion, making it by far the most effective single measure to repair the state’s structural deficit. With the flat tax still in place, addressing the deficit would require Illinois to either raise taxes on all residents by 20 percent or slash spending on critical programs by 15 percent. Schools, hospitals, and social service providers are only beginning to recover from the spending cuts imposed during former Gov. Bruce Rauner’s two-year budget impasse. Additional austerity measures would badly hamper this recovery and cause immense harm to communities statewide.

The fiscal pain inflicted by the budget impasse also forced legislators on both sides of the aisle to overrule Rauner and raise the state income tax in 2017. Because of the flat tax, all Illinoisans were hit with higher taxes. Had the fair tax been in place, legislators would have had much greater flexibility to make sure the richest residents pay their fair share without regressively raising taxes on the poor and working families.

Indeed, the fair tax would immediately rectify the state’s income tax inequality. The General Assembly has already voted on a new graduated income tax structure that would automatically take effect if the ballot referendum passes. It would lower the tax rate for 97 percent of Illinoisans, only raising rates on taxpayers with incomes above $250,000 per year. The vast majority of Illinoisans would pay lower taxes, freeing them to spend and invest more in local economies. Meanwhile, the state would gain sorely needed revenue to invest in education, housing, social services, and other programs to help all Illinois communities thrive.

The fair tax would reverse the state’s downward trend of strained services, fraying economic security, and growing inequality. The Rauner administration’s cuts to our education system, healthcare infrastructure, and other bedrock services spurred moderate- and low-income Illinoisans to flee the state for years. The fair tax would empower Illinois to ease the tax burden on these families and provide the full spectrum of public services they deserve. Conversely, and contrary to the alarmist claims of fair tax opponents, research shows no correlation between a state’s tax rates and the likelihood of high-income families leaving.

Even before voters weigh in on the fair tax, lawmakers can do a great deal to restore fairness and fiscal health in Illinois. Two measures introduced in Springfield would close corporate tax loopholes that benefit a small fraction of wealthy taxpayers at the expense of the entire state.

One measure (S.B. 1132/H.B. 2079) would modernize the retailers’ discount, which allows retailers to keep 1.75 percent of the sales taxes they collect from consumers. It also allows retailers that collect some selective sales and excises taxes to keep a percentage of those receipts.

This practice dates back to the 1940s, when the calculation of those taxes imposed additional time and costs on retailers. However, modern accounting methods have made it obsolete. Today it is a massive giveaway to big-box stores, which reap millions of public dollars for performing a task that costs them pennies. The retailers’ discount has cost Illinois more than $100 million annually in recent years.

The proposed reform to the discount would narrowly target the largest operators, holding 85 percent of retailers harmless. It makes no change to the 1.75 percent discount rate for sales tax and other collections discounts, but caps the total amount retailers can recoup at $1,000 per year. This both protects small businesses and removes an unfair advantage enjoyed by the largest and richest retailers. The Illinois Department of Revenue projects the reform would add at least $114.5 million to the general fund every year to pay for essential public services.

Reforming the retailers’ discount would not only modernize an antiquated law, but would also bring Illinois in line with most states; it is one of only 12 states to offer an uncapped discount. Of the 28 states with a retailers’ discount, 16 cap the revenue to which it can be applied. Twenty-two states do not offer it at all — including Minnesota, home to the country’s largest retailer center, the Mall of America.

Another unfair tax advantage exploited by large corporations — at the expense of both smaller businesses and Illinois taxpayers at large — is the use of offshore tax havens. This accounting sleight of hand costs the state $1.3 billion in revenue every year.

Because Illinois uses water’s-edge combined reporting, multinational corporations that do business in the state must report profits earned by their subsidiaries in other states, which are then figured into tax calculations. Corporations are not, however, required to report profits earned by subsidiaries abroad, allowing them to stash profits in foreign tax havens.

ONE Northside supports bills (S.B. 1115/H.B. 2085) that would end corporate tax dodging by making mandatory worldwide combined reporting the default method. This would require corporations to report profits earned anywhere in the world — thus neutralizing tax havens, making the playing field for Illinois businesses more level, and regaining hundreds of millions of dollars to fund vital services.

Importantly, this reform would not require mandatory worldwide combined reporting. Corporate taxpayers could still elect to use the water’s-edge method. However, the legislation would add 48 notorious tax havens to the water’s-edge group, thus requiring profits in those nations to be reported and calculated for tax purposes. It would further incentivize corporate taxpayers to select worldwide combined reporting by taxing future repatriated dividends as income for those that select water’s edge. The U.S. Public Interest Research Group estimates that this reform would generate more than $300 million in annual revenue for Illinois, which would go a long way toward both repairing the state’s structural deficit and restoring the level of public services that residents deserve.

There is ample evidence that this approach would work. Montana has had this exact law on the books since 2003 — and Alaska, Connecticut, the District of Columbia, Rhode Island, and West Virginia also have policies that mandate some sort of reporting for profits held in foreign tax havens. Also, Idaho, North Dakota, California, Massachusetts, and Utah provide an option for corporations to select worldwide combined reporting.

Illinois’s long-standing fiscal problems — not only its structural deficit, but also its recent legacy of underinvestment and disinvestment in public services — stem from the same cause. For too long, lawmakers have lavished huge yet invisible subsidies on the wealthiest individuals and corporations in the form of a regressive flat tax and corporate tax loopholes, such as those outlined earlier. Illinois voters must call upon their representatives to stop subsidizing powerful special interests and adopt tax reforms that ensure a fair and flourishing state for all.

John Bouman

The big story in Illinois this year on state finances, the budget, and the structural deficit will not play out in the annual budget process during the General Assembly’s spring session. Rather, the most important story will run throughout the year and climax on November 3, when the Illinois Fair Tax constitutional amendment will be decided in a binding referendum.

Democratic Gov. J.B. Pritzker’s fiscal 2020 budget message on February 19 will, as always, be the opening and framing moment for the budget process. It will contain revenue estimates for the state’s existing streams, including the important, but not reform-level new amounts from cannabis legalization and gambling expansion, enacted last session and just coming online in the current fiscal year (or, in some cases, the upcoming year). Dramatic changes are not expected on the spending side. It should be a fairly hold-even budget, in part designed to prompt a noncontroversial election-year accommodation. Pass it and go home to campaign.

A big part of the campaigning will be about the fair tax referendum, which is where substantial reform is possible toward resolving the state’s structural deficit, moving it toward fiscal responsibility and health, and reducing upward pressure on the property tax. Pritzker ran on his support for a graduated income tax (only possible if the Illinois Fair Tax amendment passes) and spearheaded the successful effort to pass the resolutions in both houses last year by the required 60 percent majorities necessary to put it on the ballot this November. The amendment deletes from the constitution the requirement that any income tax must charge the same rate to all taxpayers. Pritzker also championed passage of the graduated-rate income tax statute (the fair tax) that would take effect if the amendment passes. This new statutory model would produce $3.4 billion in new revenue while only raising taxes on the top 3 percent of taxpayers (tipping point at $250,000 of taxable income for a single taxpayer). The governor’s budget message and budget proposal for fiscal 2020 thus will also be important framing of the need for passage of the fair tax amendment and the alternatives that will arise if the amendment passes or fails.

Property taxes are high in Illinois precisely because the state-source taxes (mostly sales and income taxes) are poorly designed, and thus regressive and inadequate. Illinois is among the handful of most regressive states in the nation in state and local taxation, and it is, for example, lowest among the states in state-source contributions to public education. Fair tax opponents have sought to take advantage of the voting public’s confusion about taxes and tendency to conflate all types and sources of taxes into one unpopular concept of “high taxes.” And so the tactic of opposing the fair tax because it is about taxes has some political weight. As a result, Pritzker last year convened a property tax working group, and this year’s legislative session is likely to involve a proposal — perhaps multiple proposals — to control, cap, or reduce property taxes. These are local taxes, of course, so the outcome of these efforts will have little to do with the state’s fiscal condition or structural deficit, except to the extent that it bears on passing the fair tax amendment.

Illinois has long had a consensus on the spending side of the general funds budget, at least conceptually. Significant majorities expect the state to support preschool through college education, healthcare, human services, and public safety. There are substantial differences, of course, within those priorities and affecting the size of the investments. But in general, the commitments and promises affecting the spending side have strong support and, in any event, have been duly passed into law. The state is not a high-spending state, thoroughly in the middle of the pack by most measures.

The problem has been on the revenue side. The state has not developed a revenue system that can consistently support the commitments and promises on the spending side. A big part of that failure is in the design of the revenues. The system does not keep pace with natural growth on the spending side (cost of living, population). The sales tax is aimed mostly at manufactured goods — a shrinking part of the economy — and fails to target services, the booming part of the economy (it reaches 17 services, a fraction of those reached by Iowa or Wisconsin). And the constitutionally mandated flat income tax prevents the system from meshing sensibly with where the economy produces growth. For 40 years or more, income growth has been entirely concentrated in the top income stratum — the top 5 percent, or even 1 percent. The inability to be able to charge a reasonably higher rate for higher incomes and lower rate for lower incomes is not only a recipe for unfairness, but also for inadequacy, annual and regular inadequacy compared with the natural growth on the spending side — structural inadequacy.

The result of this poorly designed system, in addition to its basic unfairness, has been a constant struggle to balance budgets. This has resulted in choices driven not by evidence and values, but by the bald financial squeeze. With regularity, the state has adopted revenue measures to close the annual structural deficit and claim that, in the end-of-year momentary snapshot, the budget was “balanced.” This has included a wide range of devices, including the lottery, leasing the lottery, selling buildings, restructuring debt, moving bills to the following year, and especially pension holidays that have produced a large pension system funding need, among others. The state has also regularly shortchanged its services, providing low rates and falling far short of meeting needs, while also being unreliable in paying the bills. This unpredictability and instability have affected the state’s credit rating and led to substantial additional spending on debt service. The fractured nature of state finances also affects the business climate, as it makes it hard for businesses to plan. It causes uncertainty not only about state taxes, but also about property taxes, since the state’s weak performance so often prompts localities to have to consider local measures to address problems dealt with in other states by the state government.

It is worth focusing a bit on the property tax, since it is such a potent factor in the politics of the fair tax amendment. As of 2018, Illinois ranks 50th in the country in the proportion of K-12 education funding contributed by state government. State spending for education in Illinois contributes only 24.9 percent of overall education spending. In Minnesota, the state provides 66.7 percent of funding for public schools, Michigan provides 60.2 percent, Indiana provides 56.1 percent, Iowa provides 53.5 percent, Wisconsin provides 45.9 percent, Ohio provides 45.6 percent, and Missouri provides 32.5 percent.

Consistently, property taxes provide a greater share of education funding in Illinois than in any other state — a whopping 58 percent. The national average is only 36.4 percent. In the Midwest, every state with a graduated income tax relies substantially less on property taxes to fund schools than Illinois: Minnesota (13.6 percent of K-12 funding), Iowa (32.5 percent), Ohio (39.2 percent), Missouri (46 percent), and Wisconsin (42.9 percent).

Illinois’s excessive reliance on property taxes manifests in the funding of both K-12 education and public services generally. If the state cannot provide support to address crucial problems like community mental health or anti-violence programs, the problems do not go away. It is necessary for localities to fund the solutions or to deal with the consequences of leaving the problems unaddressed. According to the U.S. Census Bureau, Illinois ranks eighth in the country in percentage of total state and local revenues that consist of property taxes (22.9 percent). Every other state in the Midwest relies to a lesser degree on property taxes: Wisconsin (19.3 percent of all state and local revenues), Michigan (16.3 percent), Iowa (16 percent), Minnesota (14.9 percent), and Missouri (13.6 percent).

One of the most important things that Illinois can do to relieve upward pressure on the property tax, regardless of what might happen as a result of the governor’s property tax working group, is to pass the fair tax amendment and implement the graduated income tax system. This inverse relationship between state-source taxes and the locally levied property tax in Illinois is not well understood by the general public, and fair tax opponents rely heavily on this public misunderstanding when claiming that Illinois has high taxes already — a criticism that in fact applies only to the property tax and would be addressed by passage of the fair tax, which would modestly reduce taxes on many people while reducing pressure on the property tax.

The proposed graduated income tax would raise $3.4 billion in additional revenue above the current system. This is the number determined by the Governor’s Office of Management and Budget to be the current annual structural deficit. This is frequently misunderstood, because Illinois also has about $7 billion in unpaid bills, as well as a very large gap to make up in funding its pension system. The unpaid bills will be paid down much more quickly with the new revenues. The pension system is complicated by another state constitutional provision; it is a long-standing problem that is being negotiated, but meanwhile, the existence of new revenue from the fair tax would help keep the system under control. Importantly, the new graduated income tax not only would raise deeply needed additional revenue, it would also grow more readily in response to the economy. And of course, it would improve tax fairness in Illinois.

The Illinois Fair Tax amendment requires a 60 percent approval of those voting on it, or a 50 percent-plus-one yes vote of all voters in the election (whether or not they vote on the measure itself) in order to pass. It polls well across the state, especially in the wake of the disastrous two-year budget impasse under the previous administration. People learned what state government does, and learned to miss it when it was gone or threatened. State government has been hollowed out by the long-standing structural deficit, compounded by recessions and then the impasse. The passage of the resolutions to put the measure on the ballot was a politically safe vote for the legislators.

The measure’s chances for success are promising. It is supported by Pritzker and his campaign resources. The public, informed and activated by the budget impasse and years of the state’s embarrassing fiscal shortcomings, knows that Illinois needs to take this step. However, the measure faces a tough battle to pass, as most tax measures do. It is likely to be a national bellwether on the issue of progressive taxation and is attracting nationwide attention on both sides.

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