Connecting state and local government leaders

Considering a ‘Progressive’ Income Tax in a Fiscally-Stressed State

Gov. J.B. Pritzker outlines his plan to replace Illinois' flat-rate income tax with a graduated structure, during a state Capitol news conference on Thursday, March 7, 2019 in Springfield.

Gov. J.B. Pritzker outlines his plan to replace Illinois' flat-rate income tax with a graduated structure, during a state Capitol news conference on Thursday, March 7, 2019 in Springfield. AP Photo/John O'Connor

 

Connecting state and local government leaders

What if Illinois scraps its flat tax structure and made higher earners pay more? A new study offers possible insights.

Switching to an income tax structure that applies stiffer rates to higher earners would allow Illinois to boost revenues and strengthen its finances, while also cutting taxes for most taxpayers, a new study says.

Gov. J.B. Pritzker, a billionaire Democrat elected last year, has proposed that the state adopt this sort of “progressive” income tax regime. Illinois’ constitution currently limits the state to a “flat” tax, with the same rate for all taxpayers regardless of their income.

That rate since 2017 has been 4.95% of net income for individual taxpayers.

Pritzker’s proposal calls for six different tax brackets that range from 4.75% to 7.95%. It would also up the corporate tax rate to 7.95%, from 7%. And it would expose so-called “pass-through” businesses, like “S Corps” and limited liability companies, to tax increases.

Illinois is one of eight states that has a flat income tax structure, while 33 have progressive systems, according to a study released Monday by the Project for Middle Class Renewal at the University of Illinois at Urbana-Champaign and the Illinois Economic Policy Institute.

The state is also well known for its massive pension debt and consistent budget woes.

The idea of scrapping the constitutional prohibition and adopting a graduated income tax structure has detractors.

Some warn it would clear the way for tax hikes on middle class households and businesses. Others argue this kind of change would make the state less competitive with its peers.

The Illinois Chamber of Commerce is among the groups that have raised concerns.

“Taxing businesses and business owners without restraining state spending nor taking measures that will spur economic growth sends exactly the wrong message to job creators who are already questioning their commitment to Illinois,” the Chamber's president and CEO Todd Maisch said recently.

But the new report says the graduated tax system could allow for income tax cuts for between 67% and 97% of taxpayers depending on how it’s designed. Lost state revenue from those cuts would be covered by higher taxes on the top 1% of earners, a group that includes taxpayers with net incomes above $500,000 each year.

Income inequality has grown during the past four decades in Illinois, according to the report. It says that income for the top 1% of earners rose 111%  between 1980 and 2018, while the median income in the state has increased just 8.5% during that time.

The study also found that adopting the progressive income tax structure would conservatively generate $3 billion to $5 billion of new revenues annually, helping the state to address a structural budget deficit that is in the ballpark of $1.2 billion.

Total general fund spending in Illinois in fiscal year 2017 was around $29.4 billion, according to figures compiled by the National Association of State Budget Officers.

A graduated tax system, the report also says, could provide enough revenue for the state to increase education spending, paving the way for reductions in local property taxes that school districts in Illinois now depend on heavily for funding.

Progressive income tax systems typically include brackets that set rates for certain levels of income.

With a “marginal” tax rate structure, earnings above the threshold for a bracket are taxed at that bracket’s rate. So higher earners pay higher rates only on a share of their income.

The report analyzes eight different possible progressive income tax rate structures, including one Pritzker released last month.

Pritzker’s initial plan includes marginal tax brackets that range from 4.75% for annual income up to $10,000, to 7.85% for income between $500,001 and $1 million, as well as a 7.95% flat tax rate applied to all income for those earning over $1 million.

Under the governor’s proposal, single taxpayers and married couples filing their taxes jointly would be treated the same

The report says that with this scenario 85% of tax filers—those with net incomes under $255,000—would see a tax cut, 12% would have no change in their taxes, and 2.8% would see an increase. About 20,600 taxpayers, it adds, would be subject to the top flat rate tax.

Pritzker’s blueprint would yield $3.12 billion in additional state revenue each year, the report says.

Four other scenarios the researchers analyzed feature four tax brackets that range from 3% to 10%. Two others are modified versions of the income tax systems used in Iowa and Minnesota.

Another scenario includes four brackets for both individuals and married couples. This is to avoid what’s sometimes called the “marriage penalty,” where the combined income of a married couple pushes them into a higher tax bracket.

Amending Illinois’ constitution to allow for a graduated income tax would require support from at least 60% of lawmakers in both chambers of the state’s General Assembly, as well as voter approval. The earliest the measure could appear on a ballot would be in 2020.

The specifics of the tax framework, such as how the brackets are structured, could be spelled out separate from the amendment.

Illinois Policy, a group that supports limited taxation, has argued that Pritzker’s proposal would depress job growth, result in tax increases on the middle class, and hurt small business.

They argue, among other things, that if individuals are taxed at a lower rate while less skilled and at a higher rate when they’re more skilled, it reduces incentives to acquire more skills. Higher taxes on top earners would make them less inclined to make investments, resulting in fewer jobs and weaker economic growth, the group also says.

Illinois Policy points to tax policies adopted by Connecticut in the mid-1990s, which it says are similar to what Pritzker has floated, and says these led to a 13% income tax increase on middle class households in the past 20 years and have not alleviated the state’s budget troubles.

The Tax Foundation has also criticized Pritzker’s plan, taking the position, for instance, that Illinois’ “relatively low" flat individual income tax has "historically been one of the few saving graces in a state with otherwise high and economically inefficient taxes.”

A full copy of the study released on Monday can be found here.

Bill Lucia is a Senior Reporter for Route Fifty and is based in Olympia, Washington.

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