Thursday, May 28, 2015

Is it a spending or revenue problem in Illinois? by Bill Barclay

(1)   If the State of Illinois was collecting a higher share of residents’ personal income and therefore spending more of its citizens’ money than other states, this would constitute a spending problem.  But, the reality is Illinois is low tax, low spending state when compared to surrounding states.  Nationally, Illinois ranks 19th in taxes (income, sales, property and miscellaneous taxes) to income comparisons. Minnesota (an important comparison to come back to), Indiana, Wisconsin and Kentucky all have a higher tax to income percentage and Michigan and Iowa are only slightly below Illinois. The State of Illinois is not “over-taxing” its residents.

(2)   However, many Illinois families are taxed too highly.  Illinois taxes are among the 10 most regressive in the country, taking a higher percentage of income from the bottom half of households compared to the percentage collected from the top 1% or 5%.   The bottom three income quantiles in Illinois all pay 10% or more of their household income in state income, sales and property taxes.  In contrast, the top 1% of households pays less than 5%, and the next 4% pay only 7.5% of their household income in these three taxes.

(3)   "Most of spending by the State of Illinois is on wages and salaries for public employees.  Maybe Illinois has too many such employees or pays them too much and that is the source of our budget problem." This is not true! Illinois ranks among the bottom 10% of all states in terms of public employees/capita.  While the average salary paid to public employees in the state is higher than in the private sector, this comparison forgets to take into account the level of education.  When educational level is factored in, Illinois public sector workers are paid more than 10% less than their private sector counterparts.  This pay discrepancy should be of concern since it makes it difficult to attract the top talent in a time when budgets are tight and needs are large.  

(4)   Overall, the State of Illinois does not have a spending problem, but the state does have a serious distribution and tax burden problem.  This can be highlighted by one simple comparison: if Illinois households in the top 1% of income receivers paid taxes – sales, property and state income – at the same rate as households in the middle quantile, the state would have over $5 billion more in revenue.  This would be enough to make the required pension payments and still have about $2 billion more to use for other purposes.  If the top 5% of Illinois households paid the same share rate as the middle quantile, there would be an additional $7.2 billion in revenueNote that this is not a progressive tax. It is simply the same overall flat rate.

If Illinois does not have a spending problem but it has a revenue problem, what are some possible choices?

While perhaps the State of Illinois is late to the game in thinking about this we do, as a result, have the advantage of assessing the choices made by other Midwestern states in dealing with budget, employment, and economic growth problems.  The best comparison is to consider the different policy choices and outcomes by Wisconsin and Minnesota over the past few years.  

The Wisconsin story:  Under the leadership of Governor Scott Walker, WI took several steps in response to the ravages of the Great Recession, which at the worst point left WI with a $3.6 billion budget deficit and an unemployment rate of 9.2%.  Specifically:
(1)   WI reduced spending on education.
(2)   WI shifted costs of health care and pensions to state employees.
(3)   WI reduced taxes on high income households in an attempt to stimulate investment and job creation.
(4)   WI became a “right to work” state in the belief that this would attract investment and increase job growth.
(5)   WI rejected the Medicaid expansion offered under the Affordable Care Act.
(6)   Governor Walker spent much time and political capital attacking unions, especially public sector unions.  While he survived a recall campaign, the state is now politically polarized.  

The Minnesota story: Under the leadership of Governor Mark Dayton, MN also took a series of steps in response to the ravages of the Great Recession, which at the worst point left MN with a $2.6 billion budget deficit and an unemployment rate of 8.3%. Specifically: 
(1)   MN increased state spending for education, especially at the post-high school level.
(2)   MN increased state spending on job training.
(3)   MN increased the tax rates for higher income households (for households receiving over $250,000/year, MN now has the 4th highest income tax rate of any state).
(4)   MN increased the corporate income tax rate.
(5)   MN took the Medicaid expansion offered under Affordable Care Act.
(6)   MN increased the state minimum wage to $9.00 (8/1/15) and then $9.50 (8/1/16) for businesses with $500,000 or more in annual sales and indexed it to inflation beginning in 2018.
(7)   Governor Dayton worked with both public and private sector unions.

What were the outcomes to these two very different approaches in making a state “great and compassionate?” 

(1)   Although WI’s labor force was a bit larger than MN’s (reflecting a larger population), MN has created more jobs over the past four plus years than WI.
(2)   WI still has a budget deficit. MN has a budget surplus of $1.2 billion.
(3)   WI's unemployment rate in March was 4.6% vs MN's 3.7%.
(4)   MN’s rate fell from by 41% while WI’s increased – and it is costing WI $150 million more to cover fewer people through “Badger Care.”
(5)   Manufacturing wages in MN are now $600/month higher than in WI.
(6)   WI's personal income growth since the official end of the Great Recession has lagged behind that of the US as a whole (ranking 44th in the country), while MN's personal income growth has been faster than the US as a whole.
(7)   WI’s state GDP has grown by less than 2%/yr. in each of the past four years. While MN’s state GDP has grown by over 2%/yr. and in 2010 by almost 4%.

In short, comparing WI and MN shows IL what to do – and what not to do.

Actions the State of Illinois should take:
(1)   Invest in education, especially education beyond high school.
(2)   Invest in job training.
(3)   Expand access to health care for the remaining Illinois residents who do not have adequate access.
(4)   Increase the state minimum wage to at least the $10 level and index to inflation.
(5)   Address the regressive nature of the tax burden in IL:  
a.       In the long run, this is most efficiently done through an amendment to the IL constitution removing the flat income tax requirement.  This would enable the state income tax to be reset in a progressive fashion, countering the regressive impact of the sales tax.
b.      In the short run, the state should increase the flat rate tax while (i) providing credits against the sales tax on a progressive basis and/or (ii) imposing a surcharge on households with incomes over a specified level, perhaps $250,000 -- an income that  puts an Illinois household in the top 5%.  There is political support for this as evidenced in the Nov 2014 referendum vote on a 3% surcharge for households with incomes over $1 million. This was supported by 64% of Illinois voters. (iii) End the EDGE program where the employer pays no state income tax and instead actually gets the money paid to the state by their employees.
(6)   Give serious consideration to a small tax on the trading of financial assets on the Chicago markets.

Actions the State of Illinois should not take:

(1)   Don’t waste time and effort fighting public (or private) sector associations.
(2)   Don’t pass out more tax breaks to businesses – especially those without any claw back provisions.

As Einstein is supposed to have said: continuing to do the same thing over and over and expecting a different outcome is the definition of insanity.  

--Bill Barclay


  1. A few critical facts regarding Minnesota seem to be missing here when attempting to provide a roadmap for IL:

    - Minnesota taxes all retirement income, including Social Security, at a minimum rate of 5.35%. Under a similar plan, using IL current flat rate, IL could collect $2B. And since every proposed progressive tax rate has essentially been an income tax hike on the majority of the workforce, a similar progressive rate on retirement income would bring in more needed revenue. Exempting an ever growing portion of the population from taxation makes any comparison difficult.
    - Minnesota has a predominantly white population (82% vs 63% for IL) with AA and Hispanic populations 2-3 times smaller by percentage than IL. So the social demographics, and related social costs, are considerably different for the two states.
    - Tax Freedom Day - the day when the nation as a whole has earned enough money to pay its total tax bill for the year - for IL and MN are the same today. Meaning, while IL has a lower income tax, the overall tax burden on IL citizens is the same as MN. Any raise in taxes will amount to a tax burden higher than MN.

    1. Do you have a name, citizen vs. machine?

      Re: Taxing Retirement Income

      Pensions and Retirement Accounts

      Nine states rise to the top when it comes to being tax-friendly for income. Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming have no income tax. Tennessee and New Hampshire only tax dividends and interest.

      Among the 41 states with an income tax, 35 states offer a tax break for at least some retirement income. State and local government pensions are fully exempt in Alabama, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Mississippi, New York and Pennsylvania (note, some of these states do tax out-of-state government pensions). Twelve other states, plus D.C., offer a partial exclusion for public pensions. In Michigan, taxpayers born before 1946 can fully exclude state and local government pensions, but that exclusion is gradually eliminated for Michiganders born in later years.

      Some states treat public pensions differently from private pensions. Illinois, Mississippi and Pennsylvania exclude all private retirement income, while Kansas and Massachusetts tax all private retirement income. Alabama excludes private pensions, but it imposes taxes on distributions from defined-contribution plans, such as 401(k)s, and IRAs. New York offers an exclusion of up to $20,000 of private pension income. Hawaii doesn't tax money from retirement plans funded by an employer, but it does partially tax money coming from retirement plans to which employees contribute.

      Retirement-income exclusions vary in size and often include age or income restrictions. For instance, New Jersey offers an exclusion of up to $15,000 of retirement income for single filers age 62 or older whose gross income for the year does not exceed $100,000. In Georgia, the retirement-income exclusion for those ages 62 to 64 is $35,000, but it is $65,000 for those 65 and older. Montana offers a pension and annuity income exemption of up to $3,760 per individual, subject to income limitations.

      Six states, though, provide no safe haven for retirement income: California, Minnesota, Nebraska, North Dakota, Rhode Island and Vermont. Connecticut offers a 50% exclusion for military pensions but no other retirement-income tax breaks.