PI Original Adam Doster Tuesday August 3rd, 2010, 2:30pm

Illinois' Income Tax Rate In Context

For those just getting caught up on Illinois' income tax debate, here are a few basic facts about the issue.

Since Quinn administration Budget Director David Vaught went off script last week, predicting that lawmakers will raise the state's individual income tax rate from 3 to 5 percent during the January lame-duck session, critics have spent the past week incessantly warning that a "66 percent" increase in the state's income tax rate will devastate families and the state's economy. Without any background knowledge on the issue, that seems like a reasonable claim; jacking up tax rates during a recession contradicts counter-cyclical fiscal policy.

But context is crucial to understanding tax policy. And politicians aren't always interested in providing it. During an interview with WIND's Big John and Amy this morning, House Minority Leader Tom Cross (R-Oswego), a new friend of Glenn Beck, could not cite how Illinois' income tax compares to those of other large states. Listen below (the full interview is available here):

This seems like an important piece of information for the House Republican leader to know. It's also important for voters to know. For those just getting caught up on Illinois' income tax fight, here are a few basic facts about the issue:

Is Illinois' income tax already high?

Of the 41 states that impose an individual income tax, Illinois' 3 percent rate is the lowest in the nation. ** It's also important to keep in mind that Illinois' constitution still mandates the state's income tax be flat, meaning everyone -- from Oprah Winfrey to your neighbor -- pays the same rate. (New York  and California, for what it's worth, both have progressive income tax structures where the wealthiest residents pay 7.85 and 10.55 percent in state income taxes, respectively.)

When looked at in full, Illinois' overall tax structure seems like it was designed specifically to burden low-income residents. The personal exemption an individual taxpayer can claim against the state income tax is just $2,000 per family member and is not indexed to inflation. (It was $1,000 when the state income tax was first enacted in 1969). The Land of Lincoln only matches 5 percent of the federal Earned Income Tax Credit, which is the second-lowest state credit in the country. Illinois offers no match for the federal Child Tax Credit, which is targeted more broadly than the EITC. Illinois levies sales taxes on food and clothes -- which poor people need to purchase --  but ignores discretionary consumer services like lawn care and health clubs. Illinois' income tax is too puny to fund schools properly, which forces local districts to raise property taxes to cover holes. (Illinois is in the top 10 in total property tax collections.) To top it all off,  the wealthiest individuals in Illinois are apparently shielding huge amounts of income from the state.

We've used this graph from the Insitute on Taxation and Economic Policy a few times before, but it's illustrative. Illinois' combined state and local tax burden ranks 30th nationally, just below the U.S. average. But the bottom 20 percent of Illinois taxpayers faces the fourth highest burden of any income-tax generating state in the nation. The wealthiest 5 percent? They make out just fine:

How much would the increase cost?

So if Illinoisans were asked to fork over 2 percent more of their income each year, what would it cost a family?

To give just one example, a family of four making $100,000 each year currently pays $2,760 in state income taxes. If the General Assembly increases the tax rate to 5 percent (and boosts the personal exemption to $3,000, as Gov. Quinn once supported), the same family would owe an additional $1,640 -- or $31.54 more per week. The government, meanwhile, would take in roughly $6 billion more per year.

To be sure, $30 per week is a significant amount of money, even for families that are financially comfortable. But if the state holds the line on income taxes, families statewide will likely feel pain elsewhere, whether it's reduced state services or infrastructure spending, higher local taxes, or increased long-term debt.

How would a tax hike impact the broader economy?

This is a difficult question to answer. Clearly, taking money out of people's pockets during a recession won't jumpstart consumer demand and could lead to job losses on the margins.

But there are a few other factors lawmakers and voters should consider. More state revenue, for example, will help prevent service cuts and layoffs at the 2,000 non-profits owed back payments by their lawmakers in Springfield, which would have a strong ripple effect statewide. Take spending on Medicaid. Earlier this year, Heather O’Donnell of the Center for Tax and Budget Accountability (CTBA) tried to assess the detrimental effects cuts on the public health program would have on the state's overall economy. Aside from stripping away coverage for the growing number of enrollees demanding the government-run coverage, reducing Medicaid payments by $10 million would result in a loss of $16.2 million in federal matching funds (using the higher matching rate facilitated by the stimulus package). In turn, reducing provider payments by $26.2 million translates into an estimated loss of $80.4 million in business activity and $27.6 million in lost wages. That's a significant hit for a state slowly crawling out of the recession.

While no business wants to pay more in taxes, there's also reason to think that solving the state's budget crisis as soon as possible, thereby avoiding another session or more of instability regarding regulations and tax rates, would do a lot to calm the nerves of Illinois' business owners and bond investors.

Nobody should forget the long-term health of the state, either. The key reason state government "spends beyond its means," as Bill Brady likes to say, is because the tax system is inefficient. Indeed, the state has been starving its human services infrastructure for years while consistently ignoring its required pension payments. A few simple changes to the tax code, as the State Senate passed last spring, could help ease the mountain of debt while eventually improving the state's education funding structure and providing high-quality services to the nation's fifth largest state.

**UPDATE (4:10 p.m.): Voices for Illinois Children has produced a useful map comparing Illinois' income tax rate with those of its neighbors. Check it out here (PDF).

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