States with a progressive income tax more vulnerable to fiscal shocks

Despite finding favor among some politicians and political candidates in Illinois, states with a progressive income tax are more vulnerable during recessions than flat-tax states.

Some states are more prepared to weather the next recession than others, two of the nation’s largest credit rating agencies are finding. And one key factor is the structure of a given state’s income tax.

Two separate analyses conducted by Standard & Poor’s Global Ratings and Moody’s Analytics found that states with a graduated, or “progressive,” income tax are especially susceptible to “wild revenue swings” during recessions, according to Governing magazine.

This matters especially for residents reliant on core government services, which can be compromised when a state isn’t prepared for a dip in revenue during an economic slowdown. For example, the reports estimate a revenue decline of at least 9 percent if Illinois encountered even a “moderate” recession. Moody’s estimated a shortfall of more than $4 billion, assuming the state experiences a moderate recession, and $6.8 billion in a “severe” recession. That would place a serious strain on available resources, as the automatic increase in Medicaid payouts alone in a moderate recession would grow expenditures by between 2 and 3 percent, the reports estimate.

Moody’s includes Illinois among the 17 worst-prepared states. S&P puts Illinois in the bottom 18 – states which have less than 70 percent of the cash reserves needed to weather a recession comfortably.

While the U.S. overall will be better prepared for the next recession compared with the last, Illinois’ position has only deteriorated since 2008.

There are a few variables that determine the preparedness of states in managing fiscal shocks brought about by recession periods. Much of this has to do with the varying levels of volatility between states’ primary revenue source. A progressive income tax, relying heavily on a smaller tax base of higher earners, includes more income from investment, or capital gains, which is highly volatile during economic downturns.

Findings from these reports should command the attention of state lawmakers, a majority of whom voted in May to pass a resolution filed by House Speaker Mike Madigan declaring their endorsement of a progressive income tax. One progressive tax proposal filed by state Rep. Robert Martwick, D-Chicago, in the General Assembly would hike taxes on Illinoisans earning as little as $17,300 per year.

In both studies, the ratings agencies found that while many states will be better positioned to brave the next recession compared with the previous crash, a striking number of states would still find themselves perilously unprepared. Moody’s found that the number of states with sufficient protection against recession actually increased to 23 from 16 since 2017. Unfortunately, the Land of Lincoln remains severely exposed.

Even with its flat tax, decades of poor policy choices have made Illinois among the worst-prepared states in the nation.

Rather than taking steps to reverse a pattern of wasteful spending, for example, the state has instead found revenue by dipping into special funds. As a result, Illinois’ emergency, or “rainy day,” fund is only capable of covering a mere 81 seconds of state spending.

Some economists predict the next recession could arrive as early as 2020. By coincidence, that’s the next year Illinois voters would have the ability to approve an amendment to the state constitution at the ballot box, which is necessary to scrap Illinois’ flat-tax protection.

Illinois is ill-prepared for the next recession – and a progressive income tax would only leave the state worse off. If state lawmakers are serious about restoring the state’s fiscal heath, they would be wise to keep such a measure off the table.