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POINT: SHOULD ILLINOIS ADOPT A GRADUATED INCOME TAX? The need for a graduated income tax

Ralph-Martire-Point-Sept-13   What do people want from state government? According to polling data, pretty much what you’d expect. A significant majority want a quality public education for children, vulnerable members of society cared for, infrastructure investments that promote economic growth and safe, clean communities. The catch is, taxes pay for the services residents demand. This is a significant catch indeed, since no one really likes paying taxes. And for that reason, elected officials tend to avoid dealing with the subject.
   In Illinois, this neglect has been anything but benign. As it turns out, flawed tax policy is the common denominator behind many of the most vexatious challenges confronting Illinois state government today -from its recurring General Fund deficits to its outsized, $100 billion-plus unfunded pension liability and woefully inequitable and inadequate education funding system.
   Ah, but there’s hope. Two forward-thinking state legislators – Sen. Don Harmon and Rep. Naomi Jakobsson – have introduced identical resolutions in their respective chambers of the General Assembly that call for amending the Illinois Constitution to reform, of all things, tax policy. This reform would remove the current restriction that state income taxes be imposed at one flat rate across all income levels, and instead allow tax rates to correspond to ability to pay. Hence, higher income levels would be taxed at a higher rate than would lower income levels. This is known as a “graduated” or “progressive” income tax. It is also sound, fair, modern tax policy.
   Indeed, if the proposed constitutional amendment becomes law, for the first time in state history the Illinois income tax could be designed to: tax people fairly; respond to the modern economy and thereby help alleviate the state’s deficit, pension and education funding problems; and actually help spur economic growth.  
   First, consider fairness. It’s textbook tax policy that a fair tax is a tax that varies based on ability to pay – imposing a greater tax burden on more affluent than on low or moderate income individuals, when tax burden is measured as a percentage of income. This venerable principle goes all the way back to 1776 and the work of Adam Smith, the father of capitalism. Smith, in his seminal work, The Wealth of Nations, posited that tax policy in a capitalist economy should “remedy inequality of riches as much as possible, by relieving the poor and burdening the rich.”
   Smith believed that the affluent should have a greater tax burden in a capitalist system than other income classes because they’d receive a disproportionate share of income growth over time. An analysis of IRS data from 1947 through 2011 performed by Professors Piketty and Saez shows Smith was right.  After adjusting for inflation, the wealthiest 10 percent in America realized 34.1 percent of all income growth from 1947-1979, while the bottom 90 percent got 65.9 percent. Since then, things have worsened.  From 1979-2011, 139.8 percent of national income growth – or more than all of it – went to the wealthiest 10 percent. That means fully 90 percent of all income earners in America on average earned 39.8 percent less in real terms in 2011 than in 1979.  
   Obviously to respond to reality and be fair to taxpayers, Illinois needs the flexibility to tax lower levels of income at lower rates and higher levels of income at higher rates – something the state Constitution currently prohibits. This makes Illinois a tax outlier. Thirty-four of the 41 states in America with an income tax, or 83 percent, have a fair, graduated rate structure. Illinois is one of only seven that does not.  According to a national study, that is a primary reason Illinois ranks as one of three most unfair, regressive taxing states in the country – imposing tax burdens as a percentage of income on low and middle income families that are more than double the tax burden imposed on millionaires.
   That’s not only unfair, but it makes no fiscal sense. Focusing taxes on low- and middle-income families, a demographic that is losing income in inflation adjusted terms over time, means tax revenue growth won’t keep pace with economic growth over time. To work fiscally, taxes have to respond to where the economy is expanding, not contracting. That’s why the lack of fairness in Illinois’ tax policy contributes to the state’s long-term structural deficit.
   A “structural deficit” exists when, adjusting solely for inflation and population growth and assuming a normal economy, revenue won’t increase at a rate sufficient to maintain current service levels from year to year. Illinois has had a structural deficit since at least the late 1970s.That means without adding or expanding one service, Illinois’ General Fund nonetheless generates annual deficits that grow over time.  
   As for those deficit scolds who claim Illinois has a spending not a revenue problem, there’s simply no data to support that claim. Since 2009, the state has cut General Fund spending on the core services of education, health care, social services and public safety by some $4.7 billion in nominal dollars, and will be spending almost 30 percent less in real terms on those services in FY 2014 than it did in FY 2000.  Illinois ranks dead last in the nation in state workers per capita, despite having the fifth-largest population. The only budget increase has been in repaying debt service – which the state incurred primarily to the pension systems over the last three decades – to avoid fixing tax policy and thereby disguise its structural deficit.
   And no, raising taxes won’t scare millionaires away and won’t tank the state’s economy. In fact, it will probably help it. Here’s why: No peer-reviewed study has found that tax policy has a statistically significant correlation to domicile choices. Housing costs, location of family members, weather and job considerations are what matter. California, which has some of the highest personal state income tax rates in the nation, actually has net immigration of millionaires into the state. As for killing the economy, well, the Institute of Tax and Economic Policy in D.C. found that from 2000-2010, the nine states in America with the highest marginal state income tax rates had better growth in state GDP per capita and better change in median wage than, and identical unemployment rates with, the nine states in America that have no state income taxes at all – including Texas and Florida.
   In fact, given that nine out of 10 workers are earning less today in real terms than 30 years ago, using a graduated rate structure to cut their taxes means they’ll likely spend what they get in tax relief buying stuff in the local economy, since their income-based purchasing power has been declining and they don’t have the capacity to save. This should stimulate the economy. That’s because around 68 percent of all economic activity is consumer spending. Meanwhile, focusing an income tax increase on wealthier folks won’t diminish their spending, given the dramatic real growth in income they’ve realized over time.
   The bottom line here is clear: Going to a fair, graduated rate income tax will be a positive step forward for Illinois.
   Ralph Martire is executive director of the Center for Tax and Budget Accountability.

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