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April 30, 2014

Fiscal reality check: Illinois has an accumulated deficit north of $7.5 billion. That's roughly 30 percent of total spending on the core services of education, health care, social services and public safety, which collectively account for more than 90 percent of Illinois' annual service expenditures. Illinois has that huge deficit despite the new revenue generated by the temporary income tax increases (personal and corporate) that passed a couple of years ago, and the $4.7 billion in core service spending cuts made over the past five years.

And things are about to get worse, because those temporary tax increases are scheduled to phase out over the next couple of years, resulting in a net loss of $3 billion to $4 billion annually. Some contend that would be fine, in the belief that tax and spending cuts will stimulate private-sector economic growth.

But the evidence says they're wrong. In fact, a meta-analysis of all research on the issue by the University of Missouri found “tax cuts do not stimulate economic growth and/or development in a state, because the other side of the tax-cut coin is cuts in public services.”

So what to do? One thoughtful legislator — Sen. Don Harmon of Oak Park — has suggested a two-part strategy. First, amend the Illinois Constitution to allow state income tax rates to track ability to pay, by assessing lower rates on lower levels of income and higher rates on higher levels of income. Second, implement a legislative rate structure that reduces taxes for 95 percent of Illinois taxpayers from the current, flat 5 percent rate, while keeping the billions that would otherwise be lost from the scheduled phase-out of the temporary increases.

IT WON'T TANK THE ECONOMY

Why would this create fairer taxation? Because it would respond to how income gets shared in the modern economy. IRS data show that from 1979 to 2011, after adjusting for inflation, the wealthiest 10 percent in America realized 139.8 percent of national income growth — or more than all of it. That means, on average, 90 percent of all Americans had lower real earnings in 2011 than 1979. Which helps explain why it's textbook tax policy that to be fair, an income tax must vary based on ability to pay.

Hence, 33 of 41 states with an income tax have a fair, graduated structure — the kind prohibited by the Illinois Constitution. This Constitutional prohibition is a primary reason Illinois is one of the three most unfair taxing states in America.

Mr. Harmon's fair rate proposal won't scare millionaires out of Illinois or tank its economy. Indeed, there's no peer-reviewed study that has found tax policy has a statistically meaningful correlation to domicile choices by people generally or millionaires specifically. Housing costs, location of family members, weather and job considerations are what matter. So it's no surprise that four of the five states with the most millionaires per capita are high-income-tax states. Maryland, which passed a higher tax on top earners a few years ago, ranks first.

When it comes to the economy, the evidence again shows it's not tax policy that matters. For instance, the nine states in America with the highest marginal income tax rates had better growth in state GDP per capita and change in median wage over the past decade than the nine states that have no state income taxes at all — including Texas and Florida. Instead, things like investments made in education and infrastructure are what correlate strongly to growth.

Given Illinois' fiscal shortcomings, those investments won't be made if the revenue lost from the phase-out isn't replaced. Since Illinois has to replace this revenue, why not do it with a fairer tax system — one that's based on what the evidence says actually works?

Source: Crain's Chicago Business