Green Taxes: Potential Revenue for Illinois?

Filed Under (Environmental Policy, Finance, U.S. Fiscal Policy) by Don Fullerton on Jul 1, 2011

In early January 2011, the State of Illinois enacted legislation to raise the personal income tax rate from 3% to 5% and to increase the corporate income rate from 4.8% to 7%.  Along with a cap on spending growth, these tax increases reduce the state’s projected budget deficit in 2011 by $3.8 billion (from $10.9 to $7.1 billion), according to the University of Illinois and their Institute of Government and Public Affairs (IGPA Fiscal Fallout #5).  The governor justified the tax increases on the grounds that the State’s “fiscal house was burning” (Chicago Tribune, January 12, 2011).  Dan Karney and I wrote a recent piece for the IGPA Forum, but we don’t debate the reasons for the underlying fiscal crisis in the State of Illinois, nor argue the merits of cutting spending versus raising revenue to balance the budget.  Instead, we just stipulate that politicians decided to raise revenue as part of the solution to the State’s deficit.  Then we analyze the use of “green taxes” as an alternate means of raising revenue that could mitigate or eliminate the need for increasing income taxes.

In general, green taxes are taxes either directly on pollution emissions or on goods whose use causes pollution.  In the revenue-raising context however, the basic argument for green taxes can be summarized by the adage: “tax waste, not work”.  That is, taxes on labor income discourages workers from engaging in productive activities and thus hurts society, while taxing waste discourages harmful pollution and thus benefits society.  In addition, the revenue raised from these green taxes can help the State’s fiscal crisis. 

While many green taxes could be implemented, we focus on four specific examples that have the potential to raise large amounts of revenue: carbon pricing, gasoline taxes, trucking tolls, and garbage fees.  Indeed, as we show, a reasonable set of tax rates on these four items can generate as much revenue as the income tax increase.  That is, imposing green taxes can completely fill the $3.8 billion difference between the projected baseline deficit ($10.9 billion) and the post-tax deficit ($7.1 billion). 

Yet we omit many other potentially high-revenue green taxes.  For example, the State could tax nitrogen-based fertilizers that contribute to nitrogen run-off pollution in streams, rivers, and lakes.  These omissions do not imply that other green taxes could not be implemented.  Also, the simple analysis does not include behavioral responses by consumers and businesses.  Rather, we apply hypothetical green taxes directly to historical quantities of emissions (or polluting products) in order to obtain an approximate level of potential revenue generation.  

In a short series of blogs, one per week, we now discuss each of the four green taxes and their potential for revenue generation.  This week: Carbon Pricing.

In 2008, electricity generators in the State of Illinois emitted almost 100 million metric tons of carbon dioxide (CO2) according to the U.S. Department of Energy’s Energy Information Agency (EIA).  See the State Historical Tables of their Estimated Emissions by State (EIA-767 and EIA-906).  While the United States has no nationwide price on carbon – neither a tax nor a cap-and-trade (permit) policy – some jurisdictions within the United States have imposed their own carbon policies.  For instance, a coalition of Northeastern states implemented the Regional Greenhouse Gas Initiative (RGGI) to limit CO2 emissions using a permit policy.  To date, RGGI’s modest effort has already generated close to $1 billion in revenue for the coalition states.

If Illinois were to adopt its own carbon pricing policy, then even a modest tax rate or permit price could raise significant revenue.  For instance, a $5 per metric ton CO2 price on emissions from electricity producers generates about $500 million in revenue (or 14.4% of the $3.8 billion raised from the state’s income tax hike).  By way of comparison, if the extra $500 million in emission taxes were entirely passed on to consumers in the form of higher electricity bills, then the average consumer’s bill would increase by 3.75%  (where $13.3 billion is spent annually on electricity in Illinois).

Table 1 reports the possible “revenue enhancement” from the $5 per metric ton tax, along with three other pricing scenarios.  Both the $5 and $10 rates are hypothetical prices created by the authors for expositional purposes.  In contrast, the $20 per metric ton price is approximately the carbon price faced by electricity producers in Europe’s Emission Trading System (ETS).  At the $20 rate, a carbon tax in Illinois generates almost $2 billion – over half of the tax revenue from the income tax increases.  Finally, the $40 tax rate (or carbon price) is from Richard S. J. Tol (2009), “The Economic Effects of Climate Change,” Journal of Economic Perspectives, 23(2): 29-51.  It is an estimate of the optimal carbon price that accounts for all of the negative effects from carbon emissions.  At this “optimal” price, the revenue from pricing carbon in Illinois by itself could replace the needed tax revenue from the State’s income tax increase.

It doesn’t matter what we CALL it!

Filed Under (Other Topics, U.S. Fiscal Policy) by Don Fullerton on May 8, 2011

In a recent Op-Ed in the NY Times, Martin Feldstein points out that the huge current federal deficit can be reduced without raising tax rates, but instead by reducing “tax expenditures” – provisions in the tax code to provide tax breaks (and thus extra money) for many special functions.  Martin Feldstein is a Harvard professor, and he is a former President of the National Bureau of Economic Research. His piece is well worth reading, so I hope you click on the link and read the whole article. 

For the moment, I’ll just use his thoughts to make an additional point – about the fact that a “tax expenditure” is equivalent to a particular kind of government spending.  If Congress wants to provide $1 billion for charities, for example, it can either (1) provide a special tax deduction for individuals who give to certain charities, in a way that costs the government $1 billion of lost revenue, or it can (2) add $1 billion to the spending side of the budget to provide the exact same funds to the exact same charities, in a program that would subsidize the same individual donations to the same extent.

Those two methods are equivalent in every respect.  Every existing “tax expenditure” is really the same as a particular government spending plan. 

Yet many politicians say they want to cut spending, not raise taxes.  Fine.  I would just point out that cutting a tax-expenditure could easily be characterized either way.  If any eventual deficit reduction plan were to eliminate certain tax deductions for special purposes, it would appear to raise additional tax revenue, but it is not from raising any tax rate.  And that effect on the budget is exactly the same as cutting some federal spending. 

So don’t make arbitrary distinctions between what we call a tax hike and what we call a spending reduction, as nice as those sound bite distinctions might sound to a politician.  Any Member of Congress who wants to cut federal spending should be equally happy about a plan to cut a “tax expenditure”.  It has the same effect!

Founding Fathers on the Social Security Trust Fund

Filed Under (Retirement Policy, U.S. Fiscal Policy, Uncategorized) by Jeffrey Brown on May 1, 2011

We found some amazing old footage of President George Washington and President Thomas Jefferson discussing the Social Security Trust Funds.  Enjoy!

Don’t be fooled . . .

Filed Under (Finance, U.S. Fiscal Policy) by Don Fullerton on Apr 15, 2011

 . . .  by proposals to cut taxes.  Fiscally, such proposals are dangerously irresponsible.  The U.S. debt is huge, and the annual deficit is adding to it daily.  Increasing proportions of our debt are owned by China and other countries.  We need to reduce the annual deficit, just to reduce the huge current interest payments on the debt, which crowd out other beneficial forms of government spending. 

As much as the taxpayers might wish for tax cuts, those tax cuts would only add to the nation’s future fiscal woes.  The claim that a tax cut might raise revenue is counterintuitive, pandering, and certainly not supported by any recent economic history.  President Reagan enacted the biggest tax cut in history at the time, and the deficit ballooned.  He also had to backtrack several times with tax increases to fix the problem.  President Clinton raised taxes, which was followed by one of the strongest sustained recoveries in our nation’s history (and years of U.S. budget surplus).  President Bush cut taxes again, which was followed by deficits that exceeded those of the Reagan Administration.   It’s only logical, face it, that tax cuts lead to deficits!

Given the current huge U.S. deficit, the only responsible course is some combination of spending cuts, continued borrowing during a period of deficit reduction, and selected tax increases.  We have choices to face, about who should suffer from those spending cuts and who should face the  tax increases, but none of THAT debate can deny the fundamental reality that somebody has to suffer from spending cuts, and somebody has to face tax increases.

Many gas taxes, but falling over time

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Apr 1, 2011

Per gallon of gasoline, are we paying more in taxes over the years, or less?   In my last post, I examined the Federal gas tax and inflation adjustments.  As it turns out, the overall price of gasoline adjusted for inflation just hasn’t changed that much over the past fifty years!  Regarding the Federal tax of 18.4 cents per gallon as a tool to collect revenue, however, the impact is significantly weakened by inflation.  It is a “unit tax” (fixed over time per unit of gasoline), and so it becomes a smaller fraction of price as the gas price rises.  In contrast, any “ad valorem” tax would be a fixed percentage of price (like an 8% sales tax).  When inflation increases the price, an ad valorem tax rises with it.

State and local gas taxes in Illinois are a bit more complicated. In 1990, the State of Illinois raised the gas tax from 16 cents to the current 19 cents per gallon – another “unit” tax.  The flat blue line in the figure below looks at that same fixed 19 cents per gallon since 1990.  The orange line shows its “real” value, adjusted for inflation, all in current 2011 dollars.  It shows that the 19 cents today is really the equivalent of 33 cents back in 1990.  So the real value of the state’s unit tax on gasoline has fallen from 33 cents to 19 cents per gallon.

In addition to the 19 cent per gallon state gas tax, we also pay 2 cents per gallon to the city of Urbana.  Furthermore, gasoline is subject to the general sales tax, which in Urbana is 8.75%.  (It is composed of 5% to the state, 2.25% to the city, 0.5% to the county, and another 1% to the school district). 

Here is how it all works.  Suppose the net-of-tax price of gas kept by the service station is exactly 3 dollars.  Then the combined state and local ad valorem sales tax (8.75%) applies to that $3.00 per gallon.  That tax would be $0.2625 (in other words, 26.25 cents).  Then the federal unit tax is 18.4 cents, the state unit gas tax is 19 cents, and the city unit gas tax is 2 cents.  The total of all those taxes is 75.65 cents per gallon.  These four major taxes per gallon are shown in the table.

Level of Tax

Tax in Cents per gallon

Federal unit tax

18.40

Illinois unit tax

19.00
Urbana unit tax

2.00

Combined sales tax

26.25

TOTAL TAX

75.65

 

That total 76-cent tax adds to the $3 per gallon price, and you pay $3.76 per gallon.   (And actually, a few other minor taxes are ignored here, such as the “Underground Storage Tank” fee and other environmental fees!)

 Yet only the ad valorem sales tax can keep up with inflation.  With every year that a unit tax on gasoline is not updated, the tax loses its value and fails to collect as much real revenue.   The State of Illinois revenue from the 19 cent gas tax is falling in real terms with inflation, as all the necessary expenditures by the State are rising.

What are the Policy Consequences of Delaying Social Security Reform?

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Mar 28, 2011

Much has been written about the financial consequences of delaying action on Social Security reform (click here for one such report, notable for the fact that it is genuinely bipartisan).  Most of what has been written deals with the straightforward “mathematics” of delay.  In short, the longer we delay, the bigger the changes that will be required when Congress finally does act.  Regardless of whether you prefer that we return Social Security to financial sustainability via benefit reductions or tax increases, the point is that the longer we wait to do so, the bigger those benefit reductions or tax increases will have to be.  This is well-documented by policy experts across the political spectrum (even if the facts are somehow ignored by many of those that must run for re-election).

Today, though, I want to focus not on the simple mathematics of delay, but rather on what delay means for the politics, and what those politics, in turn, mean for the policy outcome.  In recent years, I have heard two very different views on the subject.  I am not sure which will prove to be correct, so let me just set them out here and invite comments if you have strong feelings on the subject.

The first view, which I first heard in a conversation that I had with a well-known and well-respected policy expert on the Democratic side of the debate (whose name I will not use simply out of respect for the fact that this was a private conversation) who pointed out that the longer we wait to address Social Security, the more likely it was that solvency would be restored through tax increases.  His political calculus was that the bigger the benefit cuts required, the less likely that the political will would exist to make such cuts, particularly given the clout of organizations like the AARP.  This particular individual viewed this as a desirable outcome, as it made it more likely we would keep the current benefit structure in place. 

The second view was explained last week in an op-ed published in the Washington Post.  Chuck Blahous, who is one of two Public Trustees for Social Security (he is the Republican trustee who spent 8 years in the Bush White House, although he was nominated to this current post by President Obama), argues that delay could result in the undoing of the program.  He says:

“Faced with a choice between wrenching benefit cuts and/or payroll tax increases vs. tearing down the wall between Social Security and the rest of the budget, legislators will tear it down. And that would be the end of Social Security as we know it. No more special parliamentary protections. No longer would benefit payments be shielded from the chopping block by the rationale that they were funded by separate payroll tax contributions. Social Security would be financed from the general revenue pool, and its benefits would thereafter have to compete with every other federal spending priority. The irony would be that the program was done in by its supposed defenders.”

These are two very different views from two highly respected experts on Social Security politics and policy.  Sadly, given the reluctance of Congress and the Obama administration to make Social Security reform a priority, we may be given the “opportunity” to find out which view is right.  That is unfortunate, as the better outcome would be to fix the program sooner rather than later, and leave the “what ifs” as a purely intellectual exercise.    

I’d be interested in what the readers think (and you can post your comment by clicking the link below) — does delay make it more likely that we will shore up the program by raising payroll taxes, or does it make it more likely that we will have to desert the 75+ year history of having the program financed by a payroll tax, or does it make it more likely we will have to cut benefits?  Or something else?  Thoughts welcomed …

Gas prices are back in the news

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Mar 11, 2011

Gas prices are back in the news, simply because gas prices are rising.  Reporters like to discuss WHY gas prices are rising, but who knows?  The price of gasoline or crude oil can vary with any change, either in supply or demand.  We can always point to shifts in demand (like the growing economies of China and India), and we can always point to shifts in supply (like the shutdown of production due to unrest in countries of the Middle East and North Africa).  But it’s very difficult to sort out the net impact of each such factor, since the price is affected daily by so many different changes.

Instead of trying to answer that question here and now, let’s take a step back and look at whether any of the current changes are really that unusual.  Is the price of gas really high by historical standards?  And how much of that gas price is driven by energy policy, taxes, and factors under the control of policymakers?  In other words, let’s just look at the facts for now, and then try to analyze them later!

Here are the facts, for the fifty years since 1960.  The first figure below is from the U.S. Energy Information Administration (EIA).  Look first at the BLUE line, where we see what you already know:  the nominal price of gasoline has risen from $0.31/gallon to what’s now $3.56/gallon.  It’s driving us broke, right?

Well, not so fast.  The RED line corrects for inflation, showing all years’ prices in 2011 dollars.  So both series stand at $3.56/gallon in 2011, but the red line shows that the “real” (inflation-corrected) price of gasoline back in 1960 was $2.33/gallon.  In fact, compare the red line from 1960 to 2009: over those fifty years, the real price of gasoline only changed from $2.33 to $2.42 per gallon – virtually no change in the real price at all! 

From 2009 to 2011 the real price increased beyond $2.42, rising to $3.56/gallon, but that may be temporary.  You can see that the red line bounces around for the whole fifty year period.   In 1980, the real price was $3.35/gallon, so the current price is not much different from previous upward blips in the real price of gas.

Now look at the U.S. Federal Gasoline Tax Rate, in the next figure.  The red line in the next figure shows that the nominal statutory tax rate was four cents per gallon for years, and then it was increased in various increments to 18 cents per gallon today.  But of course, inflation has changed the real value of that tax rate as well.  Using 2011 dollars again, both real and nominal tax rates are 18 cents per gallon today.  But in 2011 dollars, the 4 cents per gallon back in 1960 was really equivalent to 29 cents today.  In other words, the real gas tax in the green line has fallen from 29 cents per gallon fifty years ago to only 18 cents today.

The gas price may be rising, but not due to any increase in the Federal gas tax.  That Federal gas tax is falling in real terms.  In the next entry, we’ll take a look at the various State gas tax rates, and we’ll look at how many of those taxes are fixed per gallon – so that they fall in real terms as inflation reduces the real value of those State tax rates.

A Modest Proposal to Reform Illinois Pensions

Filed Under (Finance, Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Jan 24, 2011

Illinois faces a challenging fiscal future.  Even with an enormous 67% increase in marginal tax rates (from 3% to 5%), Illinois does not have a sustainable long-run fiscal plan in place.  Decades of under-funding our pensions is part of the problem (though certainly not all of it).  And while we can argue all we want about who is to blame, it is an undeniable fact that the unfunded pension obligations are a substantial part of the fiscal mess that lies before us.

Most of the rhetoric on this issue has devolved into finger-pointing: “it is those lavish public pensions” versus “no, it is the irresponsible politicians who failed to fund them.”  Rather than adding to the argument about blame, I would like to suggest a way forward.  This is only a very rough conceptual outline – you will see there are no numbers attached.  And I should also be quite clear that what I am about to suggest does not “solve” our pension funding problem.  But it could help, so here goes:

First, three observations:

1.        We must begin by recognizing that there are two highly inter-related issues, both of which must be addressed.  The first issue is that we face a large fiscal challenge that, mathematically, almost seems to require that we find a way to reduce future pension obligations.  The second issues is that we face a human resources challenge – that at least in some parts of the public sector, we need to provide a compensation package that makes it possible to attract and retain the right kind of employees with the right kind of skills.  We cannot simply “cut pensions” without implications for our ability to compete in the labor market.  So the trick is to “fix” our budget problem while maintaining our ability to attract the professors, teachers, and other professionals that we want in the public sector.  Too often, the debate ignores this second part, implicitly (and mistakenly) suggesting that we can just slash pensions without any adverse consequences.

2.       The public defined benefit (DB) model, for all its strengths (e.g., inter-generational risk-sharing, retirement income security, cost efficiencies from pooled investments, etc.) also has some fundamental flaws, the most important of which is that it is far too easy to play financial games at the expense of future generations of taxpayers.  The list of budget gimmicks is far too long to enumerate here, but the gist of it is that we often end up growing our future liabilities in return for small short-term gains and then use accounting gimmickry (much of it blessed by the Government Accounting Standards Board) to hide the real costs to taxpayers.  Even if we did not face yawning budget chasms, citizens ought to be alarmed by the poor governance engendered by this system.

3.       The private sector 401(k) model – which is sometimes suggested as a replacement for public DB plans – is also deeply flawed.  As underscored by the recent recession and financial crisis, the existing 401(k) system is woefully inadequate when it comes to providing good tools for financial risk management.  There are mountains of empirical studies documenting the lack of financial literacy in the population and the resulting biases and mistakes that people make when forced into a “do-it-yourself” retirement system.  A few examples – inadequate savings rates, too little diversification, chasing past returns, failing to insure against the risk of outliving one’s resources, and many more.

So, what do we do?  Here is a modest proposal to get the conversation started:

1.        For future workers, we have already scaled back the public DB.  But I say we go even further.  For starters, let’s think about cutting the DB pensions in half.  But in recognition of the fact that we need to remain competitive in the labor market, please read on …

2.       Then, let’s supplement the DB pension with a fully-funded, income-oriented, Defined Contribution (DC) system.  I am not talking about a private sector 401(k).  I am talking about a sensibly designed, mandatory savings program that automatically diversifies people into low cost funds at appropriate savings rates, and that automatically convert into guaranteed retirement income as one approaches retirement.  For example, TIAA-CREF annuities, (DISCLOSURE:  since 2009, I have served as a Trustee of TIAA), which provide low cost investment options and opportunities to convert into lifetime income annuities.  This is akin to what Orange County California did last year – which you can read more about in Roger Ferguson’s op-ed in the WSJ last week.  They reduced their DB plan and supplemented with an income-oriented DC plan.  Importantly, this plan was supported by government officials and the unions.  Unlike the typical 401(k), this approach would manage risk more effectively, and thus would still provide valuable retirement benefits to public sector workers.

3.       For existing workers covered by the constitutional non-impairment clause:  since we probably cannot force them to take a lower benefit, we give them the voluntary option to switch to this same hybrid DB/DC pension.  But with two tweaks:  (i) We announce that the decision is voluntary, but that the default option is that they will be switched to the new system.  Those who wish to remain in the old system would be given a fixed period of time (say, 3-6 months) to fill out the paperwork (or the online form) to state their desire to stay in the old system.  A huge literature in psychology and economics suggests that many people will go with the default.  (ii) When determining the “price” at which we will convert future DB promises into DC contribution, we use a high discount rate that reflects the subjective political risk associated with the benefits.  This is key to this proposal saving the state any money, since the conversion of DB to DC, by itself, does not create any savings.  So let me say a bit more — in essence, we know that a lot of workers are concerned that they will never get their full DB benefit.  So this provides an opportunity to make a fair, voluntary trade – you get a guaranteed contribution to your DC account – which you will then own and which will be protected from the State – and in return, you accept a small “haircut” on the size of this contribution.  Yes, it would be a benefit “cut” relative to the currently promised but under-funded benefits, but numerous studies from the U.S. and abroad suggest that people would be willing to accept such a haircut in return for no longer having their future benefits reliant upon the ability of the State of Illinois to finance their DB pension.

4.       How do we deal with the “transition cost?”  To be clear, this approach would reduce the long-run obligations of the state.  But it would also require that – in the short-run – the state come up with more cash in order to fund the DC plans while still making good on DB promises to existing retirees.  How do we handle that?  A few ideas:

a.       Spread the contributions to the DC tier (that are payment for the reduced DB) over several years

b.      Don’t be afraid to issue debt to finance this.  Keep in mind that this would not represent a net increase in indebtedness – we would simply be exchanging implicit debt (to pensioners) with explicit debt (to bondholders).  Indeed, with the higher discount rate, the *total* debt (implicit plus explicit) would go down.

This obviously leaves a LOT Of details to be worked out.  But the system would have several advantages over the status quo. A few of the big ones are:

1.        It imposes funding discipline.  The state would be legally required to make its DC contributions going forward.

2.       It maintains a focus on the retirement income security of participants.  It is true that, with the “haircut”, the DC would not cover 100% of the reduction in the DB benefit.  But it is also true that the participant would no longer have to worry about leaving the entirely of their retirement income security in the hands of Springfield.

3.       If I am correct that many participants would be willing to accept a reduction in expected benefits (relative to the full DB benefits) in return for no longer being subject to the political risk that Illinois defaults on its DB obligations, then it has the potential to save money.  (But let’s be clear – there is no free lunch here!  The cost savings only come from people accepting a smaller expected benefit in exchange for reducing the political risk to their benefit).

Any takers?

The Illinois Tax Increase: Back of the Envelope Edition

Filed Under (Uncategorized) by Nolan Miller on Jan 17, 2011

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)

Care About the Economy? Ignore the Goldman Sachs Testimony, and Watch the Fiscal Responsibility Commission Instead

Filed Under (U.S. Fiscal Policy) by Jeffrey Brown on Apr 28, 2010

While the Goldman Sachs testimony yesterday made all the political headlines yesterday, there was a second event occurring simultaneously that is much more important for our long-term economic security.  You see, despite all the rhetoric about financial regulatory reform, the Goldman Sachs hearings are really all about the past. 

The bigger story is about our future.  President Obama formally kicked-off of the “National Commission on Fiscal Responsibility.”

This Commission has the most difficult and important jobs in Washington – to figure out how to restore U.S. fiscal policy to something akin to a sustainable course.  It won’t be easy.  After 50+ years of total government spending comprising about 1/5 of the U.S. economy, the three entitlement programs – Medicare, Medicaid and Social Security – are projected – all by themselves – to exceed this share of the economy in the lifetime our today’s schoolchildren.  Throw in continued expenditures on all other functions of government – national defense, homeland security, environmental protection, education, the court system, and more – government spending is projected to consume an ever larger share of our economy.  This, in turn, has the potential to raise interest rates, crowd-out private investment, and thus reduce our rate of economic growth.

The President was careful not to take anything off the table yesterday.  That is important because this is not going to be an easy problem to solve.  At the end of the day, there are only two solutions to our fiscal problem. 

Solution 1: Raise more revenue.  In political terms, this means raising taxes.  I doubt that the Republican members of the Commission will be fond of this.

Solution 2: Cut spending.  In political terms, this means reducing the growth rate and/or level of benefits from “sacred cow” programs with vocal constituencies – such as seniors.  Democrats proved in 2005 that they are unwilling to cut benefits.  And many Republican members of the House sought to “solve” the problem through free lunch gimmickry, arguing that personal accounts (which I support, albeit for different reasons) would generate high enough returns that no benefit cuts would be needed. 

Where does that leave the Commission?  I see it most likely pursuing one of three possible outcomes.

Outcome 1:  The D’s and R’s on the Commission are unable to find enough common ground, and thus the Commission issues a final report that offers a series of options, each with proponents and dissenters.  In other words, partisanship.

Outcome 2: The Commission agrees they need to have at least some options that most members agree to.  And, caving to political pressure, they throw intellectual honesty out the window, and use a combination of both time-tested and brand new gimmicks to make it seem like the problem can be fixed without serious revenue increases or spending cuts.

Outcome 3:  The Commission takes a brave political stand by pointing out the extraordinarily difficult fiscal challenges ahead of us, proposes politically earth-shattering reforms, and then disbands and watches its proposals wither and die in the backrooms of Congressional committees.

Given the composition of the committee (see list here), I am optimistic that option 2 will be discarded.  But I think 1 and 3 are equally likely.

If there is hope for real reform coming out of this Commission, it will be because the Commission actually includes many sitting members of Congress who control the key committees.  In this important sense, this Commission has more in common with the 1983 Greenspan Commission, which led to politically difficult Social Security reforms being passed by Congress, than with the 2001 President’s Commission to Strengthen Social Security, which had no members of Congress and which saw its recommendations soundly ignored.

I hope my skepticism is mis-placed.  I sincerely hope this Commission comes up with good options, and that those in power listen.  If this happens, the long-term implications for “good” are far greater than 99% of all other economic news …