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Last month, a bipartisan compromise in Washington led to a payroll tax cut for all working Americans. But residents of Illinois can be forgiven if they do not notice. This is because, at 1:30 am on Wednesday of last week, just hours before their terms ended, Illinois's lame duck legislature passed a $7 billion tax increase on individuals, corporations and estates--the largest, as a share of gross state product, of any state in the wake of the recession.
Individual taxpayers face a 67 percent increase in their state income tax--the flat rate will rise from 3 percent to 5 percent. And Illinois corporations will see a 46 percent tax increase, to 9.5 percent--the third highest rate in the country. Combined with the federal burden, the Land of Lincoln will now have some of the highest business taxes in the industrialized world, according to the Tax Foundation.
For typical Illinois families, this tax increase will wipe out the effect of the payroll tax cut--and unlike the payroll tax cut, which will last only for 2011, Illinois' new tax increase is likely around for good. While the tax increases are scheduled to sunset in 2015, leaders in Springfield have not shown a commitment to the spending cuts that would be needed to make expiration possible.
Some kind of drastic action was needed to fix Illinois's budget gap. Illinois was on pace to enter the 2012 fiscal year with a deficit of almost $13 billion. As a percentage of Illinois's $32 billion general fund budget, this was the largest deficit in the country. Unfortunately, the legislature made the wrong choice to close the gap with a combination of huge tax increases and big bond issuances.
For more than a decade, Illinois has been an unsustainable spending path. If Illinois lawmakers had simply grown all general spending at the same rate of inflation and population growth since 1997, the state would currently enjoy a multi-billion dollar budget surplus. Instead Illinois not only faced a $13 billion deficit but has an $8 billion backlog of unpaid bills and $27 billion in bonded debt.
In the days leading up to the tax hike vote, lawmakers claimed that every state function--education, roads, healthcare--was jeopardized by keeping taxes at their previous levels. Unfortunately, there was no serious discussion of how those services could be provided more cheaply and effectively.
For example, while Illinois's education spending per pupil is close to the national average, it is high for the Midwest. Instead of asking taxpayers for more money, why weren't lawmakers asking school districts why we must spend 17 percent more per pupil than Indiana?
But the real elephant in the room is Illinois's underfunded and largely unreformed pension plans. The new tax hike is projected to raise about $7 billion per year. The state had to borrow cash to make its $4.6 billion payment to the pension funds in Fiscal Year 2011. By 2015, the annual state obligation to its pension funds will be nearly $8 billion, and by the end of the decade some predict that figure will reach $14 billion. Rather than funding essential public services, the whole tax hike will be swallowed up by unsustainable pension costs.
There is real pension reform on the table in Springfield, including a solid plan proposed by the Civic Committee of the Commercial Club of Chicago and backed by Tom Cross, the Republican Leader in the Illinois House. But so far, interest from the majority Democrats has been scant.
The next few months will be telling. If lawmakers fail to tackle spending and pensions in a meaningful way, they will be setting up a spending cliff in 2015 that will make extension of the tax hikes fiscally inevitable--and Illinoisians should plan to pay more in perpetuity.
That is, unless they move--and some will. Indeed, Illinois was already failing to attract and retain residents. A new Illinois Policy Institute study by Scott Moody shows that since 1995 saw a net loss of 750,000 people moving to and from other states. (Birth rates, longer life spans, and international immigration are the only factors keeping the state's population stable.)
This isn't just a matter of long-term population trends away from the Midwest toward the South and West. In fact, Illinois suffered a net loss of taxpayers to 40 states and the District of Columbia over that period--including all of its neighbor states. This tax increase risks turning that slow drip of taxpayers into a gusher.
Neighboring governors Mitch Daniels (R) and Scott Walker (R), of Indiana and Wisconsin, respectively, are already promoting their states as havens for Illinois businesses looking to escape higher taxes. As Daniels put it, "We already had an edge on Illinois in terms of the cost of doing business, and this is going to make it significantly wider." Walker put out a fact sheet contrasting his program of tax and spending cuts with the huge tax increases to his south.
Illinois can stop the bleeding, but only by taking immediate action to make this tax hike short-lived. The Democratic leaders who sped the bill through the legislature are claiming that the increase is temporary, and that Illinois taxpayers need not flee. If that's really true, it's time for them to undertake a serious spending reform agenda
Collin Hitt is a policy director at the Illinois Policy Institute. He can be reached at firstname.lastname@example.org.