Income Tax

The Earned Income Tax Credit, or “EITC,” rewards work and reduces poverty by targeting tax relief to low-income families with children. The EITC has become one of the more effective anti-poverty programs in the United States. The reason the federal EITC is so effective is because it is designed as a “refundable” tax credit. When a tax credit is “refundable,” the taxpayer who qualifies to receive it gets the full dollar value of the credit, even if that dollar value exceeds the income tax liability said taxpayer owes. The EITC effectively boosts the earnings of workers who qualify to receive it, thereby increasing their purchasing power and alleviating poverty. And because lower wage workers tend to spend, rather than save any increase in income they receive—including income enhancements from tax credits—that additional spending creates the concomitant benefit of stimulating private sector economic growth. Even more, since the EITC is refundable, a lower wage worker who qualifies to receive this credit gets the full dollar value they qualify for, even if that dollar value exceeds her or his income tax liability. This excess monetary benefit effectively makes tax policy more progressive, because it helps offset the impact of many of the taxes, like sales, property and excise, low- and lower-middle-income workers' pay in addition to the income tax. That in turn makes their overall tax burden less regressive and hence fairer.

The Child Tax Credit (“CTC”) initially provided qualified taxpayers with a $400 per child nonrefundable credit and was intended to provide tax relief to middle-income families. In 2001, the CTC was made refundable, on a limited basis, with a maximum refundable benefit of $600. Its refundability feature also makes the CTC effective at making tax policy fairer, because like the EITC, the CTC functions to offset taxes other than income taxes—like sales, excise and property taxes—which place a disproportionate burden on lower income earners. Illinois currently does not have a CTC at the state level. In addition to alleviating poverty and stimulating the economy, the refundability feature of the EITC also creates a very effective, as well as administratively facile way to make tax burden fairer.

Under HB 4920/SB 3774 as introduced by Representative Carol Ammons and Senator Omar Aquino (the “Tax Equity Initiative”), eligibility to claim the Illinois state EITC would be expanded to include individuals over the age of 65 without children, childless taxpayers between the ages of 18-24, and taxpayers using a tax identification number (“ITIN”). The Tax Equity Initiative also creates an eligible dependent tax credit that is similar to, but not the same as the federal CTC. For instance, while the definition of a child ‘dependent’ contained in the Tax Equity Initiative is based on IRS criteria for federal tax purposes, the benefit a new state-level CTC would create is not contingent on the number of dependents a family has. Instead, the new state-level child tax credit would be made available at a flat rate to each qualified household with at least one child. The Tax Equity Initiative also provides that at a minimum, an unpaid caregiver of children ages 17 and under who is eligible to claim benefits under the state’s expanded EITC and new dependent child credit, shall receive a combined benefit worth at least $600 in any year. Additionally, unpaid caregivers of children who currently have no income—and thereby are ineligible for the EITC—will receive a fully refundable $600 credit if they have at least one dependent child ages 17 and under.

Read this report for more information about the economic impact of the proposed Tax Equity Initiative in Illinois as proposed in the 102^nd General Assembly.

This past November, voters failed to ratify an amendment to the Illinois Constitution that would have permitted replacing the state’s flat rate income tax with a graduated structure. That in turn killed the “Fair Tax” legislation, which was designed to raise around $3.6 billion in new, annual revenue (during a normal economy), by imposing higher income tax rates on the wealthiest three percent in Illinois, while reducing the income taxes paid by the bottom 97 percent of the state’s earners. This failure was unfortunate because the Fair Tax would have helped address key structural flaws in the state’s tax policy that both drive its long-term General Fund deficits, and make Illinois one of the most regressive, and hence unfair, taxing states in the nation.

As things stand today, the state’s General Fund deficit is large and growing. Illinois is suffering from a long-term structural deficit in its General Fund that cannot be eliminated without re-amortizing the Pension Ramp as detailed previously, and either raising taxes, or significantly reducing spending on core services like education, public safety, and human services. The better public policy solution is to raise taxes, given that: (i) Illinois is already low spending on services when compared to the rest of the nation; (ii) Illinois has been cutting its real investment in core services for decades; (iii) underfunding core services is harming communities across the state; and (iv) flawed tax policy which resulted in poor revenue generation is the primary driver of the structural deficit in the General Fund to begin with.

There are two primary revenue sources that most states rely on to fund current services, the income tax and the sales tax. Illinois is no exception, with roughly 54 percent of its General Fund revenue in FY 2020—the last complete fiscal year before COVID-19—coming from state level income taxes (individual and corporate, collectively) and another 22 percent coming from sales taxes.

If the goal is to raise revenue to help address the structural deficit, while also making tax burden incidence fairer, the amount of any such income tax increase that low- and moderate-income families would have to pay should be offset with targeted tax relief. Please read more about CTBA’s solution to increasing the income tax in Illinois in tandem with the utilization of refundable income tax credits in the short report “Increasing the Income Tax Rate: One Method for Addressing Illinois’ Long-term Fiscal Problems”.

In early August, the Illinois Chamber of Commerce issued a press release arguing against ratification of the proposed amendment to the Illinois Constitution that will permit the state to utilize a graduated rate structure for its income tax. According to the Illinois Chamber, such ratification, coupled with implementation of the specific graduated rate structure identified in P.A.101-0008, which is called the “Fair Tax” by proponents, would “somehow” shrink the Illinois economy, and disproportionately harm women and minorities. But the press release based these claims on largely unsubstantiated findings contained in an Executive Summary of the report, “Illinois’ Proposed Graduated Income Tax: Impacting Jobs and the Economy,” which the Illinois Chamber paid the Berkeley Research Group (BRG) to produce.

Unfortunately, the Executive Summary does not provide much in the way of support for the conclusions it reaches, nor does it regularly cite its sources, or even provide insight into the model BRG used to reach its conclusions which is particularly problematic in this instance, given that the main findings contained in the Executive Summary are contrary to prior research on migration, tax burden, and the economy.

CTBA decided to reached out to both the BRG and the Illinois Chamber to request a copy of the full report, however, neither the Illinois Chamber nor BRG was willing to make the full report available to either CTBA or the public. CTBA chose to respond to the BRG Executive Summary released by the Illinois Chamber anyway. To find out more about how, when compared to the body of research conducted by credible sources in the relevant areas, the Key Findings presented in the Executive Summary are revealed to be either inaccurate or misleading, please read CTBA’s new Issue Brief, “Analysis of Berkeley Research Group Graduated Rate Income Tax Impact Report.”

Do you still have questions about Illinois’ proposed amendment to the Illinois Constitution, often referred to as the “Fair Tax”? Over the past several months, the Center for Tax and Budget Accountability (“CTBA”) has been compiling some of the most frequently asked questions about the Fair Tax and has created this FAQ to help voters understand this ballot initiative.

On November 3, 2020, voters will have the chance to ratify an amendment to the Illinois Constitution which would allow the state to use a graduated rate structure for its income tax. Ratification of this amendment would  permit implementation of Public Act 101-0008 (“P.A. 101-0008”) which was signed into law on June 5, 2019. If implemented, this legislation which is frequently referred to as the “Fair Tax” by proponents, would replace the state’s current flat rate income tax with a graduated rate structure that: is tied to ability to pay; in normal economic times would raise around $3.5 billion in new revenue annually; and would effectively help eliminate some of the long-term structural flaws that have consistently made Illinois’ overall tax system one of the most unfair and poorly performing in the nation.

Many of those opposed to the Fair Tax have tried to mislead Illinoisans into voting against ratifying the proposed amendment to the state’s constitution this November, by relying on arguments that have emotional appeal but are not supported by either evidence or the vast body of research. One such specious argument consistently made against the proposed Fair Tax is that the change to a graduated rate income tax structure will cause a mass exodus of middle-income households and millionaires from Illinois.

This claim, however, is exposed for the baseless canard it is when evaluated against the body of research covering the relationship—or as it turns out lack thereof—between tax policy and migration, as well as the relevant data from the Internal Revenue Service (“IRS”), U.S. Census Bureau, and the Illinois Department of Revenue (“IDOR”).  People (including millionaires) move for many complicated, interrelated reasons, least of which is because of tax policy.

On November 3^rd, 2020, Illinois voters will have the opportunity to ratify the proposed amendment to the Illinois Constitution that would eliminate the mandate that state income taxes be assessed using only one flat rate.

This is a crucial moment for Illinois since it has historically been, and currently remains, one of the most unfair taxing states in the nation. From a textbook standpoint, an “unfair” tax system is a regressive tax system—that is, one that imposes a greater tax burden on low- and middle-income families than on affluent families, when tax burden is measured as a percentage of income.  It is unfair because such a system fails to allocate tax burden in a manner that correlates with ability to pay, thereby worsening the substantial growth in income inequality that has occurred in the private sector over the last four decades. But building fairness into a state tax system is difficult, given that every tax—or fee for that matter—which is available to fund public services provided at the state or local level is regressive except for one: the income tax.  The income tax is the only tax that can actually be designed to comport with ability to pay and hence create some tax fairness, because it is the only tax that can be designed to assess higher tax rates on higher levels of income, and lower rates on lower levels of income.

Unfortunately, Article IX, Section 3 of the Illinois Constitution mandates that the state income tax be imposed at one flat rate across all levels of income. Hence, Illinois is constitutionally prohibited from utilizing the income tax to play the essential tax policy role of offsetting the natural regressivity of every other tax and fee imposed at either the state or local level. In fact, Illinois’ inability to build some fairness into its tax system through implementation of a graduated rate income tax has played a major role in driving the ongoing deficits in the state’s General Fund, while also hampering private sector economic growth.  The good news is a genuine opportunity for meaningful reform of the Illinois income tax now exists. That is because on June 5, 2019, Governor Pritzker signed Public Act 101-0008 (“P.A. 101-0008”) into law. If implemented, this legislation will create a new, graduated rate income tax structure, frequently referred to as the “Fair Tax” by proponents, to replace the state’s current flat rate income tax.

To learn more about how the Fair Tax not only ties income tax burden to ability to pay, but also raises new revenue in a manner that will effectively help eliminate some of the long-term structural flaws that have consistently made Illinois’ overall tax system one of the most unfair and poorly performing in the nation, please read the new CTBA Report, “Implementing the “Fair Tax” Will Help the Illinois Fiscal System Respond Better to the Modern Economy While Promoting Tax Fairness.”

The state of Illinois faces a significant structural deficit into the future. The report highlights the nature of the structural deficit and identifies two key causes: the state’s historically flawed  tax policy and the plan devised for repayment of Illinois’ pension debt. CTBA proposes both the adoption of the Fair Tax and a reamortization of the pension debt as described in the report titled: Addressing Illinois’ Pension Debt Crisis With Reamortization. Doing so would allow the State to ensure full funding for the Evidence Based Funding Formula while also improving the status of Illinois’ public employee pension system and eliminating the State’s structural deficit by 2042.

The Center for Tax and Budget Accountability (CTBA) released a report, How a Graduated Rate Income Tax Would Help Reduce After-Tax Income Inequality in Illinois, which shows that the implementation of a graduated rate income tax can reduce the regressivity of Illinois’ state and local tax system while lessening after-tax income inequality, which imposes lower tax rates on lower levels of income and higher rates on higher levels of income,

The report notes that even as average income growth for the bottom 99 percent of households in Illinois has remained relatively stagnant for almost four decades, growing by an average of just 0.25 percent per year after inflation, the cost of many basic household necessities has increased. Between 2004 and 2017, median household income grew by 6.4 percent, while the average cost of consumer goods and services grew by 29.7 percent. As a result, most low- to middle-income families have a reduced capacity to save or maintain their standard of living.

Since 1979, the nation has seen a rapid and significant increase in income inequality between low- and middle-income Americans on the one hand, and the wealthiest one percent on the other. Over that time span, the bottom 99 percent of American households saw their incomes increase by an average of just 14 percent after inflation. Meanwhile, the wealthiest one percent saw their inflation-adjusted incomes balloon by 175 percent on average—or fully 12.5 times more than the income growth realized by everyone else.

Illinois not only followed this trend, but when compared to the other 49 states, experienced one of the greatest increases in income inequality over this sequence. In fact, between 1979 and 2015, the top one percent of households in Illinois realized a 177 percent jump in inflation-adjusted income on average – which is almost 20 times greater than the nine percent average income growth experienced by the bottom 99 percent of Illinois households. And that’s before the impact of Illinois’ regressive tax system is taken into account.

Because Illinois’ tax system is “regressive,” meaning lower- and middle-income people pay a larger proportion of their earnings in state and local taxes than do higher-income people, income inequality in the state is even greater on a net, after-tax basis. 

If properly designed, however, income tax policy can help lessen after-tax income inequality. In fact, the income tax is the only tax which can be broadly used to lessen net, after-tax income inequality, because it is the only tax that can be designed to correspond to ability to pay. This is best accomplished through the implementation of a graduated rate structure that imposes lower tax rates on lower levels of income and higher rates on higher levels of income – which is precisely what Governor Pritzker has proposed doing in Illinois. And in a state like Illinois, which has to increase tax revenue to address the multi-billion dollar long-term structural deficit in its General Fund, creating a graduated rate income tax is one of the few ways the state can generate new revenue without worsening income inequality.