Neighbor states pursue real tax reform as Pritzker offers election-year gimmicks

While Illinois settles for Pritzker’s temporary relief that mostly expires after the November election, its neighbor states are making long-term changes to help grow their economies.

The pandemic left 33 states, including most of Illinois’ neighbors, pursuing real tax reform to give tax relief to desperate residents and businesses, but all Illinoisans got were temporary gimmicks designed to win votes.

Illinoisans needed more than gimmicks: A typical middle-class family in Illinois faces the highest tax burden of all 50 states.

Gov. J.B. Pritzker and the Illinois General Assembly adopted a budget this year with negligible tax relief that still leaves the average family with a net tax hike of $2,165 after four years of Pritzker. That’s thanks to 24 tax and fee hikes imposed earlier in his term, including a doubled gas tax.

Those 33 states are considering significant tax relief or restructuring of current tax codes this year, according to the Tax Foundation. Many of Illinois’ neighbors are among them, with most enacting or likely to enact structural tax changes that increase their competitiveness, lower tax burdens and take advantage of better-than-expected revenue growth.

Despite being among the states that beat pre-pandemic revenue trends, Illinois has taken no significant action to address its nation-leading tax burden. The brief relief offered in the new budget does almost nothing to address that burden or make the state more attractive to new residents or businesses.

The Tax Foundation’s 2022 State Business Tax Climate Index ranks Illinois 36th in the nation. Among Illinois’ neighbors, only Iowa has a worse ranking, two spots lower. That could soon change if proposed tax reforms in Iowa take effect. Among its regional neighbors, Illinois is the only state to see its position on the index decline, dropping 10 positions: from 26th to 36th during the past five years.

Indiana

Indiana passed legislation to reduce its income tax rate from 3.23%, already the third-lowest rate in the country, to 3.15% in 2023 and 2024. It is scheduled to drop to 2.9% by 2029 so long as certain economic and fiscal conditions are met. Despite their already competitive income tax rate, Indiana continues to pursue an even more competitive tax system.

Iowa

Iowa enacted sweeping tax reforms this year that make its tax system more competitive. The state has been transforming its tax code since 2018, when it had nine levels of income tax brackets with a top rate of 8.98%. It also had a graduated corporate tax with a top rate of 12% as well as alternative minimum taxes. That means some high-income filers have to calculate their tax liabilities twice, once using standard income tax rules and again under the alternative minimum tax rules, and then must pay whichever amount is higher.

Once the current reforms are phased in, Iowa will have a single income tax rate of 3.9%, less than half of what its top bracket rate was. The state will also boast a 5.5% flat corporate tax rate, no alternative minimum taxes, and the elimination of the state’s inheritance tax. These reforms are significant and will make Iowa’s taxation system much more competitive against its neighbors. Once these reforms are adopted, Iowa could improve its Business Climate Tax Index position from 38th to 15th, a huge shift in the right direction for the Hawkeye State and its business owners, workers and taxpayers. That shift would also leave Illinois with by far the worst ranking among its neighboring states.

Kentucky

Kentucky’s Republican legislature has recently passed tax reform proposals over the veto Democratic Gov. Andy Beshear. According to the Wall Street Journal, the reforms lower the current flat income tax rate to 4.5% from 5% in 2023. It also creates a trigger for automatic half percent rate cuts when state funding reserves are maintained and revenue exceeds spending. Like Pritzker, Beshear had proposed only temporary relief through a one-year reduction in the state’s sales tax rate from 6% to 5%. The reforms represent a policy shift in Kentucky, as prior proposals to reduce the state’s income tax received bipartisan pushback, but “intensifying tax competition” was cited as a major reason for the legislature’s willingness to change course.

Michigan

 Michigan’s legislature considered and passed reforms that would have moved the state into the top 10 on the Tax Foundation’s State Business Tax Climate Index. Unfortunately for Michigan residents, Gov. Gretchen Whitmer, a Democrat, vetoed the proposed changes, alleging they were “fiscally irresponsible.” The proposals would have set both the corporate and individual income tax rates to 3.9% while offering a $500 tax credit for qualified dependents. Michigan currently levies a flat 6% corporate income tax and a 4.25% individual income tax, with both becoming less attractive as neighboring states make significant changes to their tax codes.

Missouri

Missouri is considering several changes to its tax code as it looks to take advantage for significant long-term growth projections and a strong fiscal position. Missouri’s top individual income tax rate is currently 5.4% and tied to certain fiscal triggers for potential reductions. A new proposal would revise those current triggers to allow a 0.1% reduction for every $145 million over baseline collections the state takes in, while making an upward adjustment to the baseline amount after each cut to retain half of its future revenue growth. The current pace of the state’s collections would allow for the 5.4% rate to be cut to 4.6% for 2023. Other changes being considered include eliminating the corporate income tax and suspending the state’s gas tax for six months.

Wisconsin

Tax reform advocates in Wisconsin this year proposed a plan to lower and eventually eliminate the state’s progressive income tax. However, any significant tax reform proposal would likely receive opposition from Gov. Tony Evers, a Democrat, as he has issued dozens of vetoes just this year. One of Evers’ potential opponents in the upcoming election has said making “transformational income tax reform” is her top priority, along with ending the state’s tax on retirement income. She says those changes are necessary for Wisconsin to compete with neighboring states, adding the potential for even more serious tax competition for Illinois in the years ahead.

Conclusion

While its neighbors are proposing and passing serious tax reforms and increasing their fiscal appeal, Illinois will have to settle for one-year tax relief that amounts to little more than a reelection gimmick. Illinois has been struggling to recover jobs, still missing 178,300 jobs lost during the pandemic, and has the Midwest’s highest unemployment rate. The state’s hard-hit leisure and hospitality sector is still missing 77,000 jobs from pre-pandemic levels.

With its punishing tax system and lagging economy, Illinois broke a record for population loss last year, driven by people moving away. The Tax Foundation found people were largely moving to low-tax states in 2021, with high-tax states such as Illinois, New York and California among the states losing residents. Having a regionally competitive tax system is important and Illinois is in danger of falling out of the race completely.

With lagging job growth, declining population, high property taxes, and the nation’s worst pension crisis, Illinois cannot afford to simply maintain the status quo and hope to win the competition for attracting business growth and new residents. It will take more than a single year of temporary tax relief to keep residents and businesses invested in Illinois’ future.

Illinois needs to adopt its own reforms to move its finances forward and position itself to be able to offer the types of tax reforms being adopted in neighboring states. Without pension reform and other structural budget reforms, Illinois will remain a high-tax state and with an economy that lags its neighbors.