The Illinois Tax Increase: Back of the Envelope Edition

Posted by Nolan Miller on Jan 17, 2011

Filed Under (Uncategorized)

OK.  So we all know that Illinois is in a huge fiscal mess and that something has to be done about it.  Last week, Governor Quinn and state Democrats passed a package of tax increases that are expected to increase tax revenue by $6.8 Billion a year along with some limits on spending growth.  If you’re wondering what that means for your personal taxes, the personal income tax rate is going from 3% to 5%.  So, increase what you pay by about 2/3 and that will get you a rough answer.  Deductions and other provisions mean that taxes probably won’t go up by the full 2/3, but that will give you a rough answer.

Other states are very happy to hear of the tax increase in Illinois for two reasons.  First, Illinois’ path-breaking tax increase may make it easier for other states to follow suit.  Second, our friendly neighbors see our tax rate increase as an opportunity to poach our best and brightest businesses.  According to Indiana governor Mitch Daniels, “It’s like living next door to ‘The Simpsons’ — you know, the dysfunctional family down the block.”  Up in Wisconsin, politicians are reviving the “Escape to Wisconsin” tourism slogan as a way of attracting new businesses.  Of course, they don’t mention that Wisconsin’s top personal income tax rate is 7.75 percent and their state corporate tax rate is 7.9 percent, which is no free lunch.  (Frankly, anyone who even considers defection to Wisconsin this week is beyond redemption and we don’t want you anyway.  Go Bears!)  States from as far away as New Jersey are getting into the act, with Gov. Chris Christie saying he would go to Illinois to try and lure businesses away. 

All of this left me wondering what the effect of the tax increase will be on Illinois’ competitiveness in terms of the overall state and local tax burden.  According to the Tribune:  ”Corporations [in Illinois] also pay a 2.5 percent tax on income, called the personal property replacement tax, which is collected by the state and flows to local governments. The two rates taken together come to 9.5 percent, the third-highest rate in the U.S., according to the Tax Foundation, a non-partisan Washington-based research group.” So, the tax increase will push us into the upper ranks of states in terms of corporate taxes.  But, it seems like the real question is about the overall state and local tax burden, which includes things such as sales taxes, income taxes, property taxes, gas taxes, etc.  Before the tax increase, Illinois had the lowest income tax of states had an income tax.  On the other hand, our gas tax is in the top four, property taxes are in the top eight, and our sales tax is in the top 15.  So, until now, Illinois has been low in income tax and high in these other taxes.  The overall tax burden has fallen in the middle of states (ranked #30).

So, how will Illinois rank after the new taxes are imposed?  Surprisingly, I couldn’t find anything written on this.  The best piece, here, points out that it will be hard to really figure this out for a few years.  Of course, the nice thing about being a blogger and not a newspaper is that I can speculate.  So, I pulled out an envelope, flipped it over to the back, and started calculating.  According to the Tax Foundation, in 2008, Illinois was ranked 30th highest in terms of total state and local tax burden with a rate (total taxes paid divided by total income earned) of 9.3 percent.  This was the most recent figure I could find.  To figure out what the new taxes would do to this, I used Illinois’ estimated 2008 population of 12.9 million people, per capita income of $46,493 and per capita state and local tax burden of $4,346 to back out the total state income and total taxes paid by state residents.  I then added in the $6.8 billion in new taxes and recomputed the state and local tax rate at 10.4 percent of income.  (I know, I’m cramming together 2011 numbers and 2008 numbers, but that’s the best I could do.)  Comparing it to the Tax Foundation’s figures for the rest of the states, Illinois would have ranked 7th highest in terms of state and local tax burden, falling well below the highest-tax states of New Jersey, New York, Connecticut and Maryland and in a group with states like Hawaii, California, Ohio, Vermont, DC.  Wisconsin ranked 14th with a slightly lower total tax burden of 10.2 percent and Indiana and Michigan were well lower, each with a total state and local tax burden of 9.4 percent (which is basically in line with Illinois before the tax increase) and ranking around 27th.

So, back of the envelope calculations are just that, and I wouldn’t go betting the farm on these numbers.  In particular, the estimates above do not take into account behavioral changes by actors both within Illinois and in other states.  But, they’re a good starting point, and based on these numbers it doesn’t seem like the new tax rates make Illinois a total outlier.  Our taxes will be high, but we’ll be in the ballpark of other large states.  Sure, increasing our taxes will lead firms and individuals, on the margin, to move to other states.  But, the reactions both inside and outside of the state may be somewhat out of proportion.  One thing is certain, and that is that Illinois has to do something to right its fiscal ship.  (And, incidentally, that is going to involve meaningful spending reductions in addition to tax increases.  There are real questions about whether the 2 percent limit on spending growth is really going to be followed and, even if it were, if it would be enough to make significant progress on balancing the budget.)  The alternative is financial collapse, in which case individuals and firms will leave the state in droves.  So, maybe the right way to think of the current tax increases is not relative to today, but relative to what would have happened in the state in another few years if nothing were done.  Relative to that doomsday scenario, these tax increases might actually be job savers.

Interestingly, our state’s finances made the New York Times again today.  This time, instead of focusing on our financial woes, the editorial praises us – faintly to be sure – for taking the first steps toward righting our financial house. 

Note: if somebody knows of better projections of how the tax increase will impact Illinois’ rank in terms of total state and local tax burden, please send it along.

Some of the numbers and their sources:

Illinois population in 2008:  12.9 Million

Illinois per capita income in 2008:  $46,693

Illinois per capital state and local taxes 2008:  $4,346 

State and Local Tax Burden as a Percent of Income: 9.31%

Rank among states: 30 (1 is highest)

Total Income in 2008 = 46,693*12,901,000 = 602,386,393,000

Total Taxes Paid in 2008 = 4,346*12,901,000 = 56,067,746,000

Now, add in the $6.8 Billion that the new taxes are expected to generate:

New Total Taxes = 62,867,746,000

New Taxes Per Capita = $4,873

New Taxes as a fraction of income (*holding income constant!)= 10.4%

New Rank = 7th (1 is highest)