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Given both the size and cause of the state’s fiscal shortcomings, at this point in time the greatest good policymakers can deliver for the public is to raise taxes. Here’s why.
First, there’s the sheer magnitude of the problem. At the end of fiscal year 2015 — the last year Illinois actually enacted a full budget — the accumulated General Fund deficit was $5.97 billion. That deficit ballooned to $9.5 billion in fiscal year 2016 — despite year-to-year spending cuts of $2.7 billion. Estimates are it will jump to $14.8 billion in the current fiscal year, which ends June 30. If that happens, over 68 percent, or more than two-thirds, of fiscal year 2017 service expenditures will be deficit spending.
That’s not good, given $9 out of every $10 of those service expenditures go to education, health care, social services and public safety. And no, the deficits weren’t caused by high or profligate spending. Indeed, Illinois ranked just 31st nationally in service spending per capita (39th in spending as a share of state GDP), while having the fifth-largest population and economy in the wealthiest nation in the world. Hence, despite its large relative wealth and population, Illinois’ huge deficits mean it can’t afford to rank in the bottom third in funding those four core services.
So if not spending, what’s really driving the untenable growth in Illinois’ deficit over time? Well, all the data show the primary culprit is state tax policy. It’s so flawed, it doesn’t generate enough revenue growth to continue funding the same level of services over time, adjusting solely for inflation and population changes — even during periods of normal economic growth. That’s a textbook “structural deficit.” The only sustainable way to eliminate a structural deficit caused by poor revenue growth resulting from flawed tax policy is to — you guessed it — raise revenue production by reforming tax policy.
The bad news is the longer politicians dither, the more expensive the tax increase has to be. Currently, the state needs to generate about $7 billion to $7.5 billion in new annual revenue to eliminate the structural deficit over time and fund services adequately into the future. Now, that sounds like a lot, but in context of Illinois’ annual state GDP of more than $777 billion, it really isn’t. Indeed, it amounts to taking slightly less than 1 percent of the state’s economic activity.
So what tax reforms are needed? First, Illinois has to increase its personal income tax rate to 5.3 percent — a relatively modest change from the current 3.75 percent. This goes a long way toward stabilizing the state’s finances, by generating roughly $5.1 billion in additional annual revenue. Moving to a graduated rate structure would be better — as in fairer — tax policy, but the Illinois Constitution doesn’t allow it. Still, some tax fairness can be gained by increasing the Illinois Earned Income Tax Credit, which targets tax relief to low- and middle-income folks.
Next, Illinois should bump the corporate income tax rate from 5.25 percent to 6 percent, while eliminating tax expenditures that don’t generate a public good. This raises over $740 million more annually. Finally, Illinois must expand its sales tax base to include the same consumer services taxed in Iowa and Wisconsin. The “base” of a sales tax is simply those items and services the tax applies to when sold. Currently, Illinois taxes less of the modern economy than any other state with a sales tax, because it misses most consumer services. This expansion would solve that problem and generate $2 billion in annual revenue. The kicker: Illinois would remain relatively low tax after implementing all these increases, ranking in the bottom half nationally in total state and local tax burden as a percentage of income.
Hey, life would be great if doing the right thing was always easy and popular. Experience, however, teaches us that it’s frequently neither. And while raising taxes isn’t politically popular or easy, it’s clearly the right thing to do.
— Ralph Martire is executive director of the Center for Tax and Budget Accountability, a bipartisan fiscal policy think tank. He can be contacted at firstname.lastname@example.org