Illinois’ tax structure should be built on stability, not emotion
Illinois lawmakers can learn valuable lessons from states that have protected essential government services from swings in the economy.
When tough times befall the U.S. economy, it’s important that state governments are able to keep their doors open. It’s also essential that states are financially prepared for this scenario, so politicians don’t resort to massive tax hikes on struggling residents.
Illinois is built to fail on both fronts.
As Illinois lawmakers search high and low for ways to raise taxes on residents, a report from Moody’s Investors Service highlights how to ensure financial stability in good times and bad. One key takeaway? Illinoisans were wise to fight back against a progressive income tax.
Moody’s “stress test,” released April 21, measures the ability of the 20 largest states to weather a potential recession. Texas took the No. 1 spot, meaning it is best able to stabilize state finances should a recession hit. At the bottom of the rankings are Illinois and California, meaning their state finances are most likely to be thrown into turmoil should another recession hit.
While many parallels can be drawn between the mismanagement of Illinois and California, each state is ill prepared for different reasons. The difference illuminates the paths Illinois lawmakers should avoid in trying to put the state on sustainable fiscal footing.
For one, California relies heavily on its progressive income tax to raise revenue from wealthy individuals. This results in massive year-to-year swings when the economy takes a dive. In 2000, when the tech boom was at its peak, California saw its revenues grow by more than 20 percent in a single year. But two years later revenues tanked by more than 17 percent. The state also saw a 12 percent decline in 2009 when another recession struck the state.
By contrast, Texas hasn’t seen a single year in recent history when revenue declined by more than 9 percent. And as Moody’s notes, “the greatest decline in Texas came not during the 1980s oil downturn, but during the 2009 recession.”
What’s the key to Texas’ even keel?
Instead of taking dollars directly out of residents’ paychecks, Texas gets a majority of its state revenue through a broad sales tax. These revenues are much less vulnerable to wild swings. The Lonestar State also empowers its governor with the flexibility to make midyear spending cuts in concert with the Legislative Budget Board.
Another important difference between California and Illinois is the portion of state revenue swallowed up by fixed costs: debt and pensions.
The less debt a state has when a recession hits, the easier it is to bounce back on the way up. Crippling debt and an irrational tax hike attempting to fix it were part of why Illinois experienced a tremendously painful recovery from the Great Recession.
According to Moody’s analysis, 28 cents of every state dollar in Illinois goes to two things: pensions and debt payments. That’s far higher than states such as Indiana (7.3 cents), Ohio (7 cents), Texas (8.5 cents), Florida (5.7 cents) and even California (12.5 cents).
Illinois spends 25 percent of all state revenue on pensions alone, which is a higher share than pension and debt payments combined in every other state measured.
When Illinois last hiked its income tax in 2011, 90 percent of the new money went to pay for pensions. It’s no wonder Illinoisans won’t stomach another tax hike without major spending reforms.
Changes that can save money, grow the economy and help the middle class are the smart way forward on the spending side. Moving away from the income tax and toward a broad sales tax are the smart moves on the revenue side.
The latter shouldn’t come before the former.