Why ‘temporary’ income tax hike, retirement tax won’t fix Illinois pensions

Why ‘temporary’ income tax hike, retirement tax won’t fix Illinois pensions

A Chicago civic group suggests either increasing the state’s personal and corporate income taxes for 10 years or implementing a retirement tax to help pay for the state’s worst-in-the-nation pension debt. Here are the problems with that plan.

Illinois’ public pension debt is among the worst in the nation, reported to be $140 billion by state officials and up to $317 billion by independent analysts. The Commercial Club of Chicago, an organization representing senior leaders of the state’s business, education, cultural and philanthropic sectors, just released a report detailing their ideas to pay for that debt.

One of the suggestions made by the club’s Civic Committee is for the state to implement a “temporary” one-half of a percentage point increase in the personal income tax, from 4.95% to 5.54%, combined with a “temporary” increase of 0.7 of a percentage point hike in the corporate income tax rate, from 9.5% to 10.2%. The increases would last 10 years and be expected to generate $2.9 billion.

The other proposal, in lieu of the personal and corporate income tax hikes, would be to start collecting a state income tax on retirement income. The report estimates if the state taxed all retirement income on returns reporting annual gross income of $100,000 or more, a retirement tax would raise $1.8 billion annually. The organization would support adopting these measures under certain conditions.

Problem No. 1 is these revenue estimates are likely too high because they ignore the negative effects of tax hikes on the economy. Still, even if the Civic Committee’s estimates are accurate, neither plan comes close to generating enough to pay down Illinois’ pension debt.

Higher revenues are no guarantee the state’s pension problem can be fixed. The tax hike options outlined by the committee would still be short of the actuarially determined contribution necessary to pay for the state’s pensions in fiscal year 2024. The projected $2.9 billion from increasing the personal and corporate income tax rates is $1.5 billion short of the $4.4 billion needed to pay for pensions in 2024. The $1.8 billion projected from a retirement tax  would leaving the state over $2.6 billion short for pensions in 2024.

It would take imposing both the retirement tax and higher state income taxes to generate what the state needs to stop adding to its pension debt. That would come with even greater risks and damage, especially in a state already losing a record 104,000 residents, many over high taxes.

Illinoisans have seen proposals for temporary tax hikes in the past turn into permanent tax hikes. In 1989, the income tax was to be hiked from 2.5% to 3% until 1991 with the promise that extra revenue would be dedicated to education and cause local governments to lower property taxes. Lawmakers first voted to extend the tax hike and then voted to make it permanent in 1993.

In 2011, citing fiscal pressures caused by the Great Recession, then Gov. Pat Quinn and lawmakers hiked the income tax from 3% to 5%, with state leaders giving many reasons why they needed the money. They wanted to raise enough money to pay the state’s bills, pay off debt, deal with structural budget deficits, pay for pensions without borrowing and put Illinois on sound fiscal footing to ensure a strong economy.

The rate was set to partially sunset in 2014 to 3.75% and fall farther to 3.25% in 2025.

Lawmakers only allowed the partial sunset for two years and then voted to bring the rate almost all the way back to its highest-ever level in 2017. The increase to 4.95% was the largest permanent income tax hike in Illinois history.

Not only did Illinois politicians break their promise that the tax hike was temporary, but the tax increase failed to deliver on the promises to fix state finances and pay down pension debt.

The Commercial Club is right about addressing the state’s out-of-control pension debt, but the idea of raising taxes in a state bearing the highest tax burden in the nation is poor one.

The report claims increasing the personal income tax rate “would likely not have a major effect on the State’s tax competitiveness.” It goes on to cite the Tax Foundation’s 2022 State Business Tax Climate Index ranking Illinois 13th for income tax and Indiana 15th despite it having a lower income tax. According to the report, this shows “that there is room to increase the State’s income tax rate without substantially changing Illinois’ position relative to other states.”

The report fails to mention Indiana currently ranks 9th overall for its business climate in the latest rankings from the Tax Foundation while Illinois is 36th for how it treats job creators. Most of Illinois’ neighboring states are ranked much higher and have been improving since 2018.

Only structural reforms, which require a change to the Illinois Constitution, can fix the state’s broken pension system. Only ending state leaders’ poor spending habits can alleviate the stress on Illinois’ finances without placing further strain on taxpayers. Suggesting higher taxes during a time when Illinoisans are struggling with rising costs and potentially face a recession is a bad idea. It would likely make the state’s problems worse.

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