COUNTERPOINT: Changing Illinois’ income tax from a flat tax to a graduated tax

Progressive income tax proposals could weaken Illinois’ recovery and inhibit economic growth

    The Land of Lincoln is faced with a major debate about how to tax income. In the last few years, the debate about progressive income taxes has been hashed out in states as diverse as Colorado and Washington, where voters have rejected progressive income tax plans by wide margins, and North Carolina, where a landmark tax reform flattened the income tax to one rate, similar to Illinois’ current system.
    These states recognized that higher, more progressive income taxes can be economically disadvantageous as they squeeze household budgets and hurt small businesses.
    Illinois’ current debate, however, has a larger context. Illinois significantly raised taxes in 2011 in an attempt to address its $8.5 billion backlog of unpaid bills and other financial difficulties. The state raised its flat individual income tax from 3 percent to 5 percent and increased the corporate income tax from 7.3 percent to 9.5 percent, one of the highest in the nation. The 2011 tax increases have generated between $7 billion and $8 billion in added tax revenue each year.
    In 2015, the tax increases are scheduled to partially sunset, with the individual income tax dropping from 5 percent to 3.75 percent, and the corporate income tax dropping from 9.5 percent to 7.75 percent. In 2025, a further drop to 3.25 percent and 7.3 percent (respectively) is scheduled.
    Despite the added revenue from the 2011 tax increases, the state’s backlog of unpaid bills grew to $9 billion by 2013 before dropping at the end of the year to $7.6 billion. Additionally, interest payments have more than doubled and the state’s credit and economic outlook remains weak. The corporate tax increase has led to several instances of high-profile businesses preparing to move operations out-of-state before the state stepped in to mitigate the increased tax burden with targeted incentive packages, leading to a proliferation of business tax incentives.
    With mounting fiscal difficulties, and taxes scheduled to return to their historically normal levels, Illinois legislators are scrambling to find new revenues. Some policymakers are considering doubling down on bad tax policy by implementing a progressive income tax.
    Exact details on progressive tax proposals vary, but the versions with the most public discussion and legislative backing include top rates of 9 percent and 11 percent, about double the current income tax rate. In particular, the plan with a 9 percent top rate, proposed by Rep. Naomi Jakobsson, would raise taxes on all income over $18,000 relative to current law.
    Raising income taxes, and making them more progressive, will not help Illinois’ already weak economic recovery. Illinois’ neighbors who cut taxes, like Indiana, are competing for business investments and, in the last few years, appear to have been winning, exhibiting faster job growth. According to the Bureau of Labor Statistics’ Quarterly Census of Employment and Wages, Illinois has fewer businesses of every size than it had before the recession, with the exception of businesses with zero employees. With high-employment businesses dying off or leaving and unemployment among the highest in the nation at an alarming 8.6 percent, Illinois would be well-served by tax policies focused on growing the economy more than growing the budget in Springfield.
    Progressive income taxes will do the opposite. While advocates of progressive income taxes suggest these taxes will only affect the rich, the fact of the matter is that, of the 34 states with progressive income taxes, 19 of them set their highest tax rate on a bracket that hits middle class households. Even the proposed plans for Illinois would raise taxes on the middle class, with Rep. Jakobsson’s plan raising taxes on all income over $18,000.
    These additional taxes matter. The extra tax bill for an average Illinois family, relative to current law for 2015, is not negligible. For example, in a family with two working parents and a child and $56,000 in income, the extra tax bill of the Jakobsson plan would be $91, which could have been a cell phone bill, or school supplies, or part of a utilities bill, but instead will go to Springfield to cover unpaid bills and state debt. These are real costs for real people, and a real diminishment in the economy of Illinois and the standard of living of Illinois residents.
    The tax increase would be even more severe for small businesses. Most small businesses don’t file their taxes as corporations, but file on individual income tax returns, and thus are subject to individual income tax rates. Thus, higher personal income taxes means higher small business taxes.
    For a small business owner with $500,000 in taxable income, taxes could increase by as much as $17,000. For $17,000, that small business could have hired a new cashier or server, or offered more hours to those they already employ. That higher tax bill means less jobs for Illinois residents. For a larger business filing under the individual income tax, say one with $2 million in revenues, the tax bite is even bigger: possibly as much as $95,000, which could have been a new computer programmer, or manager, or new equipment to modernize the business.
    These higher taxes will increase the burden of taxation on Illinois families and businesses, and can be a significant drag on the economy. Increasing, and in some cases for the proposals in Illinois actually doubling taxes does not help to promote economic growth.
    Indeed, contrary to the claims of its supporters, there is nothing fair about a tax that threatens Illinois’ economic recovery, decreases employment, and makes it harder for families to pay their bills. There is nothing fair about a tax that asks different people to bear hugely different tax burdens disproportionate to income. A fair tax plan, and a pro-growth tax plan, would mean low, flat, broad-based taxes.
    Lyman Stone is an economist with the nonpartisan Tax Foundation, and author of a recent analysis of progressive income tax proposals in Illinois. Joseph Henchman is the vice president of State and Legal Projects at the Tax Foundation.