Tax Decoded | Summer 2018
Grappling With Graduated Income Taxes
Let’s decode the math behind proposed graduated income tax plans.
Keith Staats, JD
Executive Director, Illinois Chamber Tax Institute
The Illinois Constitution currently forbids the imposition of a graduated income tax, but
calls for constitutional amendments authorizing one continue to come forward in the Illinois
General Assembly. The opportunity for inclusion on the November 2018 ballot has expired
but, depending on the Illinois General Assembly’s composition following the November
election, we could see such an amendment on the 2020 ballot.
Proposed constitutional amendments authorizing a vote on a graduated income tax on
individuals and corporations were introduced in the General Assembly over the past two
years but lacked the support needed to advance. Non-binding resolutions, from both sides
of the aisle and both sides of the issue, were filed during the spring. HR 975, sponsored by
Republican Leader Jim Durkin and most House Republicans, opposes a graduated income
tax. HR 1025, sponsored by Speaker Mike Madigan and most House Democrats, urges a
“progressive” (graduated) income tax.
The House Revenue Committee even held a subject matter hearing in Chicago on May 2
to hear testimony from HR 1025 proponents and opponents. In full disclosure, I testified
on behalf of the Illinois Chamber of Commerce, expressing our opposition. Although I have
strong feelings on the issue, I’m not writing this column to argue for or against a graduated
income tax — I want to decode the numbers.
In particular, the Center for Tax and Budget Accountability’s (CTBA) recent report,
“Cutting Taxes for the Middle Class and Shrinking the Deficit: Moving to a Graduated
State Income Tax in Illinois,” illustrates the inherent difficulty in imposing a graduated
income tax that raises substantial new revenues, without significantly increasing the tax
burden on the middle class.
The CTBA, a clear proponent of a graduated income tax, offers two proposals that it
claims could raise an additional $2 billion in general funds revenues, while providing
a tax cut to 98 percent of taxpayers. While that sounds enticing at the surface level,
let’s look at the numbers.
The first proposal recommends leaving the current tax rate of 4.95 percent in effect for all
taxpayers earning less than $300,000 in taxable income. Those with taxable income over
$300,000 would see their rates balloon to 7.5 to 9.85 percent. The “tax cut” for 98 percent
of taxpayers is in the form of a $300 tax credit for those earning less than $100,000 (single)
or $200,000 (jointly) in taxable income. In other words, a tax reduction of about $11.50
per paycheck for employees paid bi-weekly.
The second proposal would reduce the tax rate to 4.5 percent on taxable income up to
$100,000, maintain 4.95 percent on taxable income from $100,000 to $300,000, and raise
rates to 8 to 9.85 percent on higher taxable income levels. Again, the tax cut under this
proposal is also minimal — $225 for someone earning $50,000.
Now, the $2 billion revenue increase projected in these proposals is close to what some
have indicated is the current state budget structural deficit. However, many proponents of
a graduated income tax are not proposing the tax just to close the perceived structural deficit — they’re seeking additional funding for programs they
contend are inadequately funded. Therefore, assuming there’s no
political will to cut state spending, the CTBA numbers demonstrate
that obtaining significant amounts of new revenue over and above
$2 billion would require raising the current 4.95 percent income
tax rate on taxpayers earning less than $300,000 in taxable income.
Regardless of your judgment on the programs seeking additional
funding, the fact of the math is there just aren't enough “rich”
people to tax at higher rates under a graduated income tax to
provide all the additional revenues.
The CTBA proposals would impose a graduated rate structure only
on individuals, but recently proposed constitutional amendments to
authorize a graduated income tax would also authorize a graduated
rate on corporations. If revenues from a graduated rate structure on
individuals prove to be inadequate for those who seek additional tax
revenues, they will likely turn to graduated rates on corporations.
One rationale behind the call for a graduated rate structure, in
addition to the “fairness” argument, is that the tax base has been
eroded because of “corporate loopholes” that need to be closed. Let’s
review that assertion. Over the years, there has been significant tax
base erosion via enactment of exemptions, credits, and deductions.
However, the tax base erosion stems overwhelmingly from
exemptions, credits, and deductions provided to individual taxpayers
— not to corporations. The two biggest exemptions are the $1.8
billion exemption for federally taxed retirement income and $1.98
billion state sales tax exemption for food and drugs. In contrast, the
Economic Development for a Growing Economy (EDGE) Tax Credit
and Research and Development Tax Credit provided $82.4 million
and $27.2 million in tax relief to corporations. Those are FY 2016
figures; with the tax rate reinstated to 4.95 percent, it’s estimated that
the retirement income exemption will increase to approximately $2.7
billion for the current fiscal year. Again, I’m not making a judgment
as to the value of the exemptions and credits, but the numbers
demonstrate where tax base erosion has occurred most.
Further, even in the face of the state’s budget crisis, the General
Assembly enacted additional individual tax credits, including the
Invest in Kids Scholarship Tax Credit Program ($75 million), a new
Natural Disaster Income Tax Credit, a new tax credit allowing
teachers to claim up to $250 in deductions for supplies, and an
increase to the Education Expense Credit.
In my estimation, the proponents of graduated income tax rates are
mistaken if they think they can solve state spending imbalances
without taxing the middle class. It’s equally unrealistic for
opponents to such a plan to argue that taxes can be reduced if only
cuts are made. There’s no political will among current members of
the General Assembly to make those kinds of spending cuts or tax
rate changes. And, despite rhetoric from candidates of both political
parties, nobody, once in office, seems to be able to discover and
eliminate enough “waste, fraud, and abuse” to make material
changes to the spending side of the state’s ledger.
The Illinois General Assembly and the governor will continue to have
difficult budget choices ahead. There will be continued discussions
about changing the state’s tax structure to capture additional
revenues. As the CTBA states: “No silver bullet exists that will entirely
resolve all these challenges.” It’s essential to get beyond the rhetoric
of both sides and carefully evaluate the numbers.
Author’s Note: This column includes my personal observations and
are not necessarily the views of the Illinois CPA Society or the Illinois
Chamber of Commerce.