Illinois is one of the very few states that exempts all retirement income from taxation. It is the state’s most expensive exemption, costing Illinois more than $2 billion in foregone annual revenue. From a tax policy standpoint, this makes no sense—all types of income should be treated equally and taxed according to ability to pay.
In Illinois, the political challenge to reforming the retirement income exclusion starts with potentially angry seniors. But the state’s tax structure is so flawed that it’s also difficult to argue that taxing retirement income should come before other changes, such as a graduated income tax and broader sales tax that encompasses services.
The Center for Tax & Budget Accountability proposal exempts $50,000 of a retired individual’s adjusted gross income, slowly phasing out the exemption at higher income levels. In retirement, $50,000 is quite a bit of taxable income to be drawing from Social Security and retirement accounts. For example, Medicare tacks on a high income surcharge to premiums for seniors with incomes starting at $85,000. The CTBA plan would raise about $1 billion annually—half of what the Civic Committee and Civic Federation plans generate. But it is a much more balanced, fair approach.