Why Pritzker’s ‘fair tax’ fails 3 of 4 basic tests
The progressive tax’s structure fails to account for inflation and includes a marriage penalty for 4 million Illinoisans. It is designed to creep farther into taxpayers’ wallets.
If you are going to design a tax, it needs simplicity, transparency, neutrality and stability, according to the experts at the nonpartisan Tax Foundation.
Gov. J.B. Pritzker’s proposed progressive tax amendment fails three of those four tests. Those design flaws are aside from the folly of hiking taxes in the middle of an economic downturn as well as the problems with progressive taxes as general policy.
Simplicity means tax codes should be easy for taxpayers to comply with and for governments to administer and enforce. Transparency means tax policy should be clear, including with respect to amounts owed, timing of payments and any changes to the system. Moreover, governments should not hide tax burdens in complex structures. Neutrality means taxes should neither encourage nor discourage personal or business decisions. Stability means tax policy should aim at consistency and predictability in the tax code.
Pritzker’s progressive income tax violates the principles of transparency and neutrality, and progressive income taxes will come into conflict with the principle of stability.
The governor’s progressive tax amendment and its accompanying statutory rates do not account for inflation, virtually guaranteeing invisible tax hikes on the middle class as the years go by. The rates target certain married couples for tax hikes while giving other higher-earning couples a break. There is no limit on the number of tax brackets in the amendment, allowing lawmakers to target small populations of increasingly lower income levels without risking a widespread backlash. These basic errors in drafting are still more reasons Illinoisans should oppose the “fair tax.”
Under Pritzker’s rates, inflation will raise taxes on more middle-class earners
Pritzker has offered his progressive tax not only as a way to collect $3.6 billion more in revenue, but to offer tax relief to the poor and middle class in Illinois. But the brackets in the current proposal would enable lawmakers to quietly raise taxes on the poor and middle class as the years go on. That is because as inflation rises each year, the tax brackets remain unchanged.
For example, $163,000 in January 2000 would be the equivalent of around $250,000 today. In 1980, a little over $75,000 would be worth $250,000 now. As the buying power of a dollar decreases, the increased rates begin to affect those earning less and less when looking at the actual value of their income.
This phenomenon is known as “bracket creep,” and it means taxes rise on more and more people year over year as their nominal incomes increase due to inflation. This outcome is entirely predictable and would have been easily fixed by pegging the tax brackets to inflation, so the level of income taxed rises as its purchasing power decreases. It clearly violates the principle that taxation should be transparent but setting up the brackets this way gives the state an easy means of quietly raising more revenue from more people. According to the left-leaning Institute on Taxation and Economic Policy, these invisible tax hikes usually fall heavily on low- and middle-income taxpayers. It recommends indexing taxes to inflation out of basic fairness.
According to the Tax Foundation, in 2019 most states with progressive tax schemes indexed their brackets for inflation. States with a flat income tax rate do not need to adjust their rates for inflation, because the single rate always remains the same, automatically accounting for inflation.
Pritzker’s rates punish some married couples
Under the proposed progressive tax most married Illinois couples will see a higher tax rate than they would as single filers. This “marriage penalty” is caused by tax rate brackets that do not increase proportionally from single to joint filing. Most states solve this problem by doubling the amount of income that would be covered by a particular bracket or by allowing couples to file separately for state tax purposes on the same form. Only 15 states’ income tax schemes include a penalty for filing jointly, according to the Tax Foundation.
Pritzker’s tax thus fails on the principle of neutrality. Under the rates passed by the Illinois General Assembly, more than 4 million married Illinoisans would be penalized. Meanwhile, couples who earn more than $1 million would not face a marriage penalty at all, and many couples earning between $350,000 and $1 million would actually see a marriage “bonus,” where they would pay less tax filing jointly than filing separately.
Aside from running afoul of basic principles of sound taxation, there are other vulnerabilities that will encourage lawmakers to work their way down the income ladder rung by rung. Just as the currently enacted rate structure is subject to change, the number of tax brackets is not set in stone, either. Nothing limits the number of income brackets the General Assembly can create under the progressive tax amendment. Legislators could add more and more brackets, targeting smaller fractions of the population for tax hikes. Dividing taxpayers makes it difficult for them to mobilize against any individual increase as Springfield takes more taxes out of an increasing number of Illinoisans’ pockets. Tax hikes would slowly eat away at the paychecks of those making less and less, much of it going to unsustainable public pension benefits.
Also, there is no limit between the lowest and highest rates, allowing lawmakers to expand that gap as far as they want, dividing and targeting brackets as they go. The current Illinois Constitution, for example, requires the rate for corporate income taxes cannot exceed the rate for individual income taxes by more than a ratio of 8 to 5. That provision was likely designed in recognition of the tendency for lawmakers to target businesses for tax hikes given that only individuals can vote. Similarly, taxpayers should be protected from being targeted with marginal tax rates that greatly exceed the marginal rates of lower brackets, if only to avoid losing more jobs and economic growth than the state already has.
Lawmakers will be looking for ways to squeeze more money where they can. Spending on many services has dropped during the past 20 years in real terms, and will continue to drop as spending on pensions crowds outspending on other priorities. That was before COVID-19 and the accompanying shutdown’s effects on the economy caused massive losses in revenue. Now, the failure to cap the number of brackets is an invitation for lawmakers to carve out additional revenue wherever they can. That will assure more tax hikes on middle-class Illinoisans on top of the recent gas and vehicle taxes, not to mention online sales tax expansion, parking garage tax and vehicle trade-in tax hikes.
These basic errors show too little thought and care went into drafting the progressive tax amendment and its accompanying rates. Pritzker’s “fair tax” strikes out on transparency, neutrality and stability.
As far as simplicity, it is simply a bad design for taxpayers and simply brilliant for state leaders wanting more money without the political cost of being open about taking it.