In 2015 alone, Illinois state government redistributed more than $12 billion in income and other taxes to local governments. These financial shell games have created a needlessly complex system and make it difficult for local taxpayers to hold their governments accountable.
The Illinois Department of Revenue announced April 19 that the department erroneously made $168 million in overpayments to local governments and school districts across the state. The error occurred while the department executed its tax redistribution program, which sends certain state tax collections to local governments.
The error will soon be corrected; but the real issue is the state shouldn’t make these kinds of tax redistributions in the first place.
Here’s how it has worked for decades:
One unit of government imposes a tax, while another unit of government gets to spend the money. Illinoisans pay income tax to state government, but a part of those collections are redistributed to local governments. That’s precisely what happens under “shared agreements” between the state and local governments. The state government imposes and collects certain taxes and then redistributes them to local governments based on various formulas.
This setup makes it difficult for local taxpayers to hold their governments accountable. Local officials get to spend money they don’t raise locally, while state legislators gain control over billions of dollars that were never meant for the state coffers in the first place.
In a state with nearly 7,000 units of local government, this situation provides ample opportunity for politicians to shield themselves from accountability for levying taxes and spending that money.
In 2015 alone, Illinois state government redistributed more than $12.2 billion in income and other taxes to local governments. That total includes $6.6 billion in education funding for K-12 classrooms and another $5.6 billion the state sent back to local governments for their operations.
For education, the argument for redistribution is that those funds are based on need – that, in general, the poorest districts get a disproportionate share of state funds.
But the remaining $5.6 billion is simply reallocated back to localities based on either their share of the state’s total population or where the tax originated, with no true connection to need.
Under this redistribution practice, there are four major sources of tax revenue the state sends to local governments:
- The personal property replacement tax, or PPRT, is an income tax on businesses in addition to the general corporate income tax. In 2015, the state collected $1.4 billion in PPRT, and then redistributed that amount to local governments based on each locality’s historic (as of 1977) pro rata share of those collections.
- The local government distributive fund, or LGDF, is based on state personal and corporate income taxes, apart from what’s collected under the PPRT. Of the total 2015 income tax collections, $1.5 billion was deposited into LGDF for further distribution. Local governments receive LGDF funds based on their pro rata share of the state’s population.
- The third redistribution payment is based on a portion of the state sales tax. One percentage point of the statewide 6.25 percent sales tax is collected and sent back to the municipalities where those sales occurred. These distributions totaled $2.2 billion in 2015.
- Finally, the motor fuel tax resulted in $1.2 billion in revenues collected across the state. Just under 40 percent, or $471.3 million of net collections, was sent to municipalities and counties based on their pro rata share of statewide population.
If governments across Illinois are to be held accountable for how they use tax dollars, lawmakers need to stop the financial shell games that have plagued this state for decades. Illinois can start by eliminating the LGDF, the sharing agreement most targeted for reform in recent years.
However, as these agreements go away, so will the money. That means local governments will need to find savings through spending reforms or by prioritizing the services that warrant funding through local taxes.
A reduction in shared agreements should also be offset with other major reforms to reduce the costs borne by local government. These include:
- Reducing workers’ compensation costs
- Repealing Illinois’ prevailing-wage law
- Reforming the collective bargaining process
- Reducing unfunded state mandates
The state of Illinois’ financial shell games have created a needlessly complex system and make it difficult for local taxpayers to hold their governments accountable. If lawmakers are serious about fixing the state’s finances, they need to start by focusing accountability for local tax dollars back onto local governments.