Under current Illinois law, the income rates are the following: 4.95 percent for individual income and 7 percent for corporate income. The feature of the Illinois tax code is that it is a proportionate tax code. Illinois is currently one of eight states with a flat tax rate. The crux of Governor Pritzker's is to change the Illinois tax code to a progressive one (see individual income tax rates below, as well as a report arguing for graduated tax rate from the Illinois-based, Left-leaning Center for Tax and Budget Accountability). There are other features of the proposal, including a $100 nonrefundable child tax credit, raising the corporate income tax from 7 to 7.95 percent, and increasing the property tax credit from 5 to 6 percent. Pritzker claims not only that 97 percent of Illinoisans will pay less in income taxes, but that it will generate $3.4B annually (Reuters).
What Is Fair Taxation?
Before getting into the details of what Pritzker is proposing, I would like to briefly discuss fairness, particularly in the context of taxation. Truth be told, fairness is a subjective matter. The subjectivity of fairness can be illustrated by the three main types of taxation systems: regressive, proportional, and progressive.A regressive tax is assessed on the percentage of the value of a good or service (e.g., sales tax, sin tax, property tax). It can be construed as fair because it charges everyone the same amount, regardless of earnings or income level. On the other hand, it could be construed as unfair since poorer people pay a higher percentage of their income than richer folks.
The second type of tax is a proportional tax, which is also referred to as a flat tax. This tax could arguably be fair since this tax charges everyone the same tax rate, regardless of income. This is most commonly implemented for income and wealth taxes, although it can be implemented for gross receipt taxes, occupational taxes, and per capita taxes.
The third type of tax is a progressive tax. Under a progressive system, the tax scheduling is done based on an individual's income. With the accelerated tax schedule, higher-income earners pay a higher percentage than lower-income earners. The purpose of such a system is to reflect an assumption of fairness that the upper-class is more capable of paying a higher tax burden.
Why is this subjective? Any one of these systems could be argued as "fair." There is no objective formula to determine what is fair. Fairness is based on values, morals, and political philosophy. The idea of fairness is so subjective that one could argue that fairness shouldn't matter because "life is not fair," and it has no bearing on the tax code. I wouldn't necessarily argue that, but rather it is to reaffirm the point that what might be fair to one person might not be fair to another.
Why Governor Pritzker's Plan Goes Awry
Now we can return to the details of the plan. One of Pritzker's goals is to shift tax burden from the lower- and middle-class to upper-class individuals. Pritzker would like to raise the proper tax revenue to mitigate Illinois' fiscal woes. While his intentions might be good, we are here to determine whether the results would be.The first issue is that his figures are in dispute. The Illinois Policy Institute, an Illinois-based think tank focused on economic liberty and free markets, estimated that Pritzker's plan would only generate $1.4-$2.4B in new revenue, depending on whether you use static or dynamic scoring.
For argument's sake, let's give Pritzker the benefit of a doubt, and assume that his plan will generate $3.4B, which coincidentally is the projected budget gap for 2021. Even with $3.4B in generated tax revenue, his plan runs into problems, including the big problem that in his recent budget address. Last month, Pritzker proposed spending anywhere from an additional $14B to $19B in the 2020 Illinois state budget (a proposal, by the way, that credit rating agency Standard and Poor's said would weaken Illinois' credit trajectory). This additional spending includes paying down bills, funding a capital project, and investing in education. Setting aside the fact that this Fair Tax would be in effect in 2021 at the earliest, the last time I checked, $14B > $3.4B, which means that if both the Fair Tax and Pritzker's spending promises go through, the income tax rates would need to be even higher to close the gap. This brings me to my next point.....
Not Addressing Illinois' Spending Problem
In his Fair Tax proposal, Pritzker rightly points out there being a dire fiscal condition. You would think that Illinois had a tax revenue problem, but Illinois has collected more tax revenue per capita than the U.S. average (Tax Policy Center). But let's think about it for a second. Illinois has state-level debt of over $151B. If you look at the Mercatus Center's ranking of states' fiscal solvency, Illinois is at the bottom of the list. Illinois does not have enough cash to cover short-term liabilities. Its revenue is only 92 percent of its expenses. Looking at long-term solvency, it has a net asset ratio of 2.86, which means that for every dollar in assets it has, Illinois has nearly three dollars in liabilities. Illinois has a major issue with its pension and benefits system that continues to drive these fiscal indicators into the ground. If Pritzker throws in his additional spending to the mix, the situation in Illinois is only going to go from bad to the point where more than just the wealthiest will end up paying high tax rates.
Not Going to Solve the Issue with Fairness
It is not only Governor Pritzker that is making the argument of fairness. It is also coming from the Institute on Taxation and Economic Policy (ITEP), a national think-tank focused more on tax policy. Full disclosure: ITEP leans to the Left. Their argument for the currently unfair tax code in Illinois comes from their 2018 report measuring tax equality by state. In ITEP's report, it found Illinois being the eighth most unfair tax code amongst all the 50 states. Why? Because the bottom 20 percent pays 14.4 percent of their income in state taxes, whereas the top one percent pay 7.4 percent. That is a gap of 7.0 percent. There are two things to consider with ITEP's report.One is that with Pritzker's plan, the richest will pay 7.95 percent, whereas the poorest will only pay 4.75 percent. This creates a difference of 3.2 percent (7.95-4.75=3.2). If the current gap is 7.0 percent, this bill would close less than half of the gap (3.2/7.0=46%). Closing the gap would be nice if your goal is for everyone to pay the same percentage of income in taxes. If your goal is to have the rich pay a higher percentage in taxes, then this wouldn't close it on a state level. However, this doesn't take into account federal taxation.
The second is what happens when you look at what is driving the gap. When looking at personal income tax, the top 1 percent pay 4.1 percent of their income in state income tax, whereas the bottom 20 percent only pay 1.5 percent. That is a difference of 273%! When you look at what is driving the gap, it is two types of taxes: consumption taxes and property taxes.
Consumption and property taxes are more regressive in nature, and it should be no surprise that these taxes are causing the disparity. Another way of closing the gap would be to lower the consumption and property tax rates. If you want to talk about unfair, how about Illinois having the seventh highest sales tax rate of 8.74%, or that Illinois has the ninth highest per capita property tax collection? Given the regressive nature of these taxes, is it fair to burden lower-class citizens with these high tax rates? Why doesn't Pritzker address these taxes in his proposal?
Tax Competitiveness and Migration
Taxes have two main functions. The first is that it collects revenue for the government. The second is that it alters and distorts people's behavior. We cannot look at a specific tax increase in isolation. It is a question of how it affects the economy and people's behavior. That is what the conservative Tax Foundation does in its thorough analysis of Pritzker's Fair Tax proposal (also see the Illinois Policy Institute's analysis here). In the Tax Foundation's State Business Tax Climate Index, Illinois currently ranks 36th. What would happen if Illinois were to implement this Fair Tax? Tax Foundation projects that Illinois would fall to 48th place on its ranking. This ranking would fall to such depths because if passed, Illinois would have among the highest state tax burden in this country.Why should Illinois care about tax competitiveness? We live in an economy that is more capital-intensive than it was in the early- and mid-twentieth century. It is easier than ever for businesses to move. If the tax rates are too high, then companies will be incentivized to move elsewhere.
Looking at Illinois' historic trend, its individual income tax rate has been lower in the past (see below). Illinois is trending towards higher income tax rates.
What are Illinois' neighbors doing? The exact opposite. Missouri lowered its income tax rate from 5.9 percent to 5.5 percent last year. Iowa reduced their rate from 8.98 percent to 6.5 percent in 2018. From 2013 to 2017, Indiana phased their income tax from 3.4 percent to 3.2 percent. Even in the two states that have higher income taxes and are not looking to lower them (Wisconsin and Iowa), the states at least have balanced budget amendments. If this proposal passes, Illinois would be surrounded by states that would have better overall state tax competitiveness.
Postscript
I am not even going to get into such features of the Fair Tax proposal as the marriage penalty or its atypical "recapture" provision. What I am going to conclude with is the following. The flat tax is one of the only redeemable aspects of Illinois' tax and budgetary policy. Right now, Illinois' individual income tax is on the lower end compared to other states. It is nowhere near California's income tax rate of 13 percent. If this proposal passes, Illinois loses what little advantage it previously had.I do not have the power of clairvoyance, but I would take an educated enough of a guess as to what would happen. For one, job growth would be hampered further. Illinois' private-sector job growth is already sluggish (so sluggish that it is nearly half the growth rate of the rest of the country) because of tax and regulatory environment. I would also predict further capital flight and labor migration. And to top it all off, the Fair Tax would not help mitigate Illinois' dire fiscal state of affairs. Other states have graduated-rate income taxes, but the Illinois government has historically shown that it cannot keep its taxation or spending in check.
The way to enact this proposal is through a constitutional amendment, which thankfully, is not an easy process. After it passing three-fifths of both legislative chambers, the people of Illinois would then need to vote on it. That cannot happen any earlier than November 2020. I hope that the citizens of my former state are not blindsided by vague, yet ultimately harmful notions of fairness and vote for such foolishness.
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