With an increase in personal income and corporate taxes officially signed into law on Thursday by Gov. Pat Quinn, many in the state are still wondering if the new rates go far enough toward solving the budget crisis in Illinois.
Daniel McMillen, an economist with the Institute of Government and Public Affairs at the University of Illinois, discusses how the new tax increases will affect the increasingly dire state of the Illinois economy in an interview with News Bureau Business & Law Editor Phil Ciciora.
Does the new 66 percent increase in the individual state income tax go far enough toward solving the state's long-term fiscal problems? In other words, will this tax increase work?
The tax increase does not solve the state's fiscal problems by itself, whether short-term or long-term. The state has an enormous deficit that took years to build. It wouldn't be a good idea to try to cure the problem all at once, but at the same time, the deficit has reached a critical point where something has to be done about it. The tax increase does make a dent into the deficit. IGPA projected that the state's deficit would be $12 billion for fiscal year 2012. Now we are projecting that the deficit will be closer to $6 billion.
Four things are needed to eliminate Illinois' long-term deficit problem - tax increases, expenditure reductions, economic growth, and sufficient funding to cover long-term pension and Medicaid expenses. The tax increase by itself isn't large enough to eliminate the structural deficit that Illinois has been running for years.
At some point, the state has to make a serious effort to match its spending to its revenues, and that is going to require cutting expenditures.
Where does this put Illinois in relation to other states and their tax rates?
Illinois previously had a relatively low personal income tax rate and a moderate corporate rate. If the tax increases were any larger, Illinois would move into the ranks of very high-tax states. Sales and property tax rates are also as high as they can go before Illinois is a clear high-tax state.
The corporate income tax would temporarily increase from 4.8 to 7.0 percent. How would that affect job creation in Illinois? Would it be better to keep tax rates low in order to spur economic growth?
The increase in the corporate tax rate certainly is not going to make it easier to attract companies to Illinois. At the same time, the enormous deficit has led to a lot of uncertainty about the future of the state, and businesses prefer to locate in places where future tax rates are predictable.
Illinois missed the opportunity during two decades of sustained economic growth to cure its structural deficit problem and match its expenditure levels to its fiscal capacity. Now it is paying the price by needing to both raise taxes and reduce expenditures to get out of virtual bankruptcy.
Low tax rates don't attract business when combined with a chronic deficit, but a smaller deficit and higher tax rates are not attractive either. Illinois lost its chance to be attractive to business through years of poor choices by the state government.
Democratic lawmakers have said that a tax increase would actually help the economy when the money is eventually re-invested back into the economy. Others, including Chicago Mayor Richard M. Daley, have said it's unwise to raise taxes during a slow economy. Who's right?
Neither one. The money is already in the economy, so having the state take it away to spend it will have, at best, a small impact on the economy. Mayor Daley is right that it usually is not a good idea to raise taxes during a slow economy, but in this case the deficit problem is so serious that tax increases are necessary to avoid near bankruptcy. Illinois' bond rating is currently the worst in the country, and it is not clear how much longer the state will be able to borrow more money.
Four years from now, the individual state income tax rate will go back down to 3.75 percent, slightly higher than its previous rate. In the past, whenever there has been a temporary income tax increase, the higher rate has been renewed. Do you foresee the personal rate staying at 5 percent four years from now, after the current legislation expires?
I'd be very surprised if the rate is reduced when the current legislations expires. I'll also be surprised if Illinois does not still have a large deficit in 5 years; it will just be smaller than it would have been without the tax increase.
What will this tax increase mean to the average citizen of Illinois?
The average citizen is going to end up paying more for fewer services than they get now. The state government has been living beyond its means for years and the bill is coming due.
Hopefully, the end of the recession and a period of fiscal restraint on the part of the government will spur growth and reduce the burden of the taxes.