While its neighbors have undertaken positive tax reforms, lowering rates for businesses and individual taxpayers, Illinois has been moving in the opposite direction and is now considering moving from a flat-rate income tax to a progressive tax.
Only a few years ago, Illinois’ tax competitiveness compared well to those of its neighbors and other states. In 2011, however, the state increased the personal income tax rate from 3.75 percent to 5 percent and hiked the corporate tax rate by 30 percent. As a result, the Tax Foundation’s State Business Climate Index now ranks Illinois as having the 31st most competitive tax climate for businesses, far down from its 17th place ranking 2010. Since these temporary tax hikes were implemented, state spending has continued to skyrocket, growing by more than 17 percent. Illinois still has one of the nation’s worst fiscal deficits, the highest pension liability, a shrinking population, and the worst bond rating.
The most popular progressive tax proposal under consideration is the so-called Fair Tax championed by For a Better Illinois, which would require an amendment to the state constitution to allow a graduated or progressive income tax. This change would have several major effects on taxpayers and the state’s economy.
First, a progressive tax would cause a significant increase in taxes for Illinois’ middle-income taxpayers. According to the Illinois Policy Institute (IPI), one version of the Fair Tax, proposed by state Rep. Naomi Jakobsson, would impose higher tax rates at an annual income of just $18,000, with the average Illinois family projected to expect a tax increase of $781 a year. Another Fair Tax proposal, sponsored by state Sen. Don Harmon, would apply an increased rate of 4.9 percent to annual income earned above $12,500. According to IPI, under this plan any taxpayer with a taxable income of more than $22,000 will see his or her overall state tax bill increase, thus making Illinois a less-attractive place for employees and employers.
Progressive taxes also drive wealthy taxpayers out of the state, and their income, capital, and tax revenues go with them. The Tax Foundation found the proposed progressive income tax plans would drop Illinois’ business tax climate ranking to 44th in the nation.
Under a progressive tax system, tax rates increase as taxable income increases. Progressive taxes are a form of income redistribution, with the taxes paid by higher-income earners used to cover government services for lower-income people. Supporters of the progressive tax argue this is both fair and an example of social justice, but these taxes violate democratic tax principles by placing an undue burden on certain groups of people. Even under a flat tax, those who earn higher incomes pay more in taxes, achieving the “social justice” progressive tax proponents claim to seek.
Tax revenues are more volatile under progressive tax systems than with flat taxes, making budgeting more difficult. Relying on a small percentage of higher-income taxpayers for a larger percentage of revenues generates revenue windfalls and spending free-for-alls during economic booms, followed by massive budget gaps during economic recessions. Scott Hodge at the Tax Foundation has found high income status is both temporary and fluid. Many taxpayers achieve millionaire status only once in their lifetime, and the number of millionaires fluctuates based on the business cycle.
The Fair Tax is anything but fair: It increases taxes for most taxpayers, increases the burden on small businesses, and enables the rampant growth in spending that is already crippling the state. Illinois legislators should focus on making the state a more attractive place for businesses and workers by restraining spending, lowering taxes, and reducing unnecessary regulations. Illinois’ tax rates are steadily climbing higher than most states’, and increasing them any further risks greater harm to the state’s economic competitiveness.
The following articles examine progressive income taxes and the Illinois Fair Tax proposals.
Ten Principles of State Fiscal Policy
The Heartland Institute provides policymakers and civic and business leaders a highly condensed, easy-to-read guide to state fiscal policy principles. The principles range from “Above all else: Keep taxes low” to “Protect state employees from politics.”
Illinois Considers Further Income Tax Increases as Temporary Tax Nears Expiration
Lyman Stone of the Tax Foundation examines Illinois’ 2011 tax hikes and the proposed switch to a progressive tax system. Stone argues moving away from the current flat tax could have dire effects on the state’s economy: “Extending what was meant to be a temporary tax increase, or significantly increasing the state’s income tax still further, would sidestep these fundamental issues while worsening the state’s already shaky economic footing.”
Five Illinois “Fair Tax” Myths
The Illinois Policy Institute outlines five myths about the proposed progressive tax proposals for the state, touted by their supporters as the Fair Tax. The article outlines the possible negative consequences of a switch from the flat tax.
Progressive Income Tax Money Grab Disguised as Tax Reform
In this article from the Illinois Policy Institute, Ted Dabrowski dispels several myths underlying the progressive tax. Dabrowski argues a progressive income tax will mean higher taxes for middle-income Illinoisans and destroy needed jobs for poor and working families.
Tax Foundation: Progressive Income Tax would Destroy Illinois’ Businesses Climate
Benjamin VanMetre of the Illinois Policy Institute examines an analysis from the Tax Foundation of the proposal to dump Illinois’ fair, flat tax in favor of a progressive tax that would force people to pay higher taxes as their income increases: “The conclusion was unsurprising: a progressive income tax would deliver a devastating blow to Illinois’ already struggling business climate.” A Heartland Daily Podcast with Mr. VanMetre is available here.
Long-run Macroeconomic Impact of Increasing Tax Rates on High-Income Taxpayers in 2013
This report from Ernst & Young conducted on behalf of the Independent Community Bankers of America, National Federation of Independent Business, S Corporation Association, and United States Chamber of Commerce examines the long-term impact of an increase in top income tax rates.
Progressive Income Tax would Deliver Devastating Blow to Illinois’ Already-struggling Economy
Kristina Rasmussen of the Illinois Policy Institute argues against progressive tax proposals in Illinois and outlines several facts illustrating the negative effects of a progressive tax system.
The U.S. Tax System: Who Really Pays?
Writing for the Manhattan Institute, economist Stephen Moore examines popular conceptions and misconceptions about the impact of tax rates on economic productivity and fairness, addressing these statements and debunking attendant myths. He provides useful information on how the rich are taxed and how much they contribute.
Does Progressive Taxation Make State Budgeting More Difficult?
Matt Mitchell discusses the effect of a progressive tax system on state budgeting in this Mercatus Center report. Mitchell notes states with a progressive tax system have found it increasingly difficult to forecast tax revenues and set budgets. “In sum: it appears that progressive taxation seems to be a recipe for rapid revenue growth when the economy is expanding (even tepidly). But it also seems to lead to larger budget gaps during recessions,” he writes.
The Inequity of the Progressive Income Tax
Kip Hagopian of the Hoover Institution contends the most compelling argument against the use of the progressive income tax to redistribute income is that it is inequitable: “Under a progressive income tax, the welfare of one group in a society has been increased at the expense of the welfare of a different group.” Hagopian dismantles arguments for the progressive income tax and proposes a new doctrine of tax fairness.
The Effect of Progressive Tax Codes
Bill Ahern of the Tax Foundation discusses the effect different kinds of progressive taxes can have on taxpayers and the economy.
Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Tax News Web site at http://news.heartland.org/fiscal, The Heartland Institute’s Web site at www.heartland.org, and PolicyBot, Heartland’s free online research database, at www.policybot.org.
If you have any questions about this issue or The Heartland Institute, contact Heartland Institute Senior Policy Analyst Matthew Glans at 312/377-4000 or [email protected].