January 12, 2012

The verdict is in The tax hike failed

Overview
One year after Illinois Democratic leaders pushed through a record tax hike, the grades are in. The tax hike flunked. It failed to put Illinois on sound fiscal footing. It failed at restoring confidence in governments ability to meet serious challenges head on. It failed to strengthen the states economy. It failed to create opportunity and prosperity. It failed families and the businesses that want to be a part of making Illinois great again. In January 2011, lawmakers raised income tax rates by 46 percent on businesses and a record 67 percent on individuals.1 The measure passed with the barest of majorities during the final hours of a lame duck session. It received the support of almost every legislator who retired a few hours later or was defeated at the ballot box the previous November. Gov. Pat Quinn, who had just run for election on a smaller tax increase, tossed his campaign pledge aside and seized the opportunity to transfer more money from Illinoisans to state government. At the time, advocates promised that the tax hike would usher in a new era in Illinois fiscal affairs and economy at large. Among their claims: We have some temporary tax increases that are designed to pay our bills, get Illinois back on fiscal sound footing and make sure that our state has a strong economy. Gov. Pat Quinn2 The purpose of this bill is to raise enough money so that we can continue to pay our pensions without borrowing the money, to pay off our debt, to have enough money to pay the interest on that debt, and for the first time ever, establish caps on how much we can appropriate. We even are going to change our rules to basically turn over to the minority party the right to dictate whether or not there will be an extra spending over that cap. And it is going to work. Senate President John Cullerton3 Remember the point of this income tax increase is not to expand programs, not to do brand new things in Illinois state government, it is only intended to pay our old bills and deal with the structural deficit. This is not about new spending. It is about trying to bring ourselves in line with the problems of old debt and of a structural deficit. House Majority Leader Barbara Flynn Currie4 One year later, its clear the tax hike was the solution to neither Illinois fiscal problems nor its continuing economic decline. Today things are worse: Heres why:
Ted Dabrowski is the Vice President of Policy with the Illinois Policy Institute.

Tax & Budget Brief

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1. Spending grew, bills went unpaid and pension reform stalled.

With a flood of new tax dollars, urgent pressure to pass lasting structural spending reforms deflated. The state is incurring more expenses in fiscal year 2012 than it appropriated for, pushing more than $2 billion in obligations to the future. The states backlog of unpaid bills and unaddressed obligations is now at $7 billion. The state has no plan to pay down this liability, let alone prevent it from growing again in the future.5

Illinois must reverse course. The solution? Repeal the tax hike. Its both good policy and good politics.

The tax hike allowed legislators to take a pass at resolving one of Illinois most urgent fiscal problems: the unsustainable state pension systems. Ballooning pension costs already are squeezing out spending on education and other vital services. By not reforming pensions, the fiscal crisis will only deepen. This was confirmed in January when Moodys rating agency downgraded Illinois, giving the state the worst credit rating in the nation. In justifying the rating, Moodys said Illinois took no steps to implement lasting solutions to its severe pension under-funding or to its chronic bill payment delays.

2. Illinois unemployment problem worsened.

Illinois unemployment rate is now the fifth highest in the nation. Unemployment jumped to 10 percent in just the last seven months, up from 8.7 percent in April. That increase contrasts sharply with a drop in the U.S. rate, to 8.6 percent from 9 percent, over the same time period.6 Had Illinois simply followed national employment trends since January, there would be fewer unemployed Illinoisans. During the past year, Illinois employment numbers have moved the wrong way while neighboring states and the national trend have improved. Those who supported the tax hikes want to ignore the consequences of their actions, but the hundreds of thousands in want of employment demand a better approach.

3. The tax hike made Illinois less competitive and forced businesses to leave the state.
The tax hike spurred a number of companies to leave or threaten to leave. The state resorted to handing out tax incentives to keep large businesses from leaving. This reinforced Illinois reputation of favoring the powerful and connected at the expense of everyone else. It is this perception grounded in reality that keeps many entrepreneurs from even considering Illinois as a place to found or grow their business. Illinois poor business environment is reflected in the Tax Foundations respected State Business Tax Climate Index. A forthcoming 2012 edition will show a precipitous fall for Illinois, thanks almost entirely to the personal income and corporate income tax hikes. Overall, Illinois fell to 28th place in 2012, from 16th place in 2011 (revised). In particular, Illinois fell 16 places in the corporate sub-index, dropping to 45th in the nation, from 29th prior to the tax hike. In passing the tax hikes, House Speaker Michael Madigan and Senate President John Cullerton along with the legislators who backed them ignored the many voices warning that increasing taxes was the wrong thing to do. Quinn proceeded to sign the bill. The cost to families has been high: dollars lost directly to taxes, employment prospects lost indirectly. Illinois must reverse course. The solution? Repeal the tax hike. Its both good policy and good politics. Illinoisans deserve better than being forced to feed a broken system.

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3 reasons why the tax hike didnt work

1. Spending grew, bills went unpaid and pension reform stalled.
Spending and deficits. The same people who passed the tax hike pledged fiscal austerity and restraint in the budgeting process. But the budget Gov. Quinn signed months after the tax hike did not deliver on that promise. Instead, the budget grew costs overall even as some individual line items were reduced. Medicaid expenditures will be more than what was appropriated to pay for them.7 More bills are being pushed into the future. The tax hike did not resolve the states fiscal crisis. Rather, it allowed for even more spending some of it hidden by accounting gimmicks. More importantly, the revenue from the tax hike fueled the unchecked spending habits that will make the sunset of the tax hike difficult. Unpaid bills. Promises to pay off the unpaid bills also fell short. In early January, Quinn outlined in his Illinois Economic and Fiscal Policy Report the amount of unpaid bills and unaddressed obligations he would like to restructure by borrowing. The amount totals an astounding $7 billion as of December 2011 (see Graphic 1).8

Graphic 1. Illinois $7 billion in unpaid bills and unaddressed obligations

The tax hike did not resolve the states fiscal crisis. Rather, it allowed for even more spending some of it hidden by accounting gimmicks.

Source: Governors Office of Budget and Management, Illinois Economic and Fiscal Policy Report, Jan. 3, 2012.

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If Illinois wants to protect funding for its core services, the state needs to align state employee pensions with the fiscal realities of the state.

No pension reform. Rather than eliminating unpaid bills, most of the new tax revenue went to make the states contribution to the unreformed government pension systems. The payment had been borrowed in recent years, and the influx of tax dollars allowed legislators to make the payment and put off worrying about the rapidly increasing payment schedule for the unreformed system to another day (see Graphic 2). This failure to act was recognized recently by Moodys, the credit rating agency, when it gave Illinois the worst credit rating of any state in the

nation. In its report, Moodys said Illinois took no steps to implement lasting solutions to its severe pension under-funding or to its chronic bill payment delays. The agency also added that Illinois has weak management practices. If Illinois wants to protect funding for its core services, the state needs to align state employee pensions with the fiscal realities of the state. Across the nation, states are implementing solutions that have reduced the burden on taxpayers and increased the security of state employee retirements. Illinois should do the same.

Graphic 2. Growth in state pension appropriations fiscal years 2008 - 2013 (in millions)

*Certified as of Nov. 15, 2011 Source: COGFA and the State Journal-Register

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2. Illinois unemployment problem worsened.

Illinois economy was on the way to recovery in 2010 as unemployment fell sharply from a high topping 11 percent (see Graphic 3). But that was before the tax hike. By November 2011, Illinois unemployment rate jumped to 10 percent from a low of 8.7 percent

seven months prior, according to the Bureau of Labor Statistics. Illinois upward unemployment rate is in sharp contrast to the national rate, which dropped during that same time period. Since the tax hike, 82,000 fewer Illinoisans are employed and 61,000 more have joined the unemployment rolls, according to the Bureau.

Graphic 3. Unemployment rates: Illinois vs. U.S., January 2010 to November 2011

In November 2011, Illinois unemployment rate jumped to 10 percent from a low of 8.7 percent seven months prior.

Source: Bureau of Labor Statistics

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Tax increases drain resources from the private sector, stealing the resources needed to expand businesses and hire new workers for the long haul.

Comparing Illinois to its neighboring states tells a similar story. Those states clearly are outperforming Illinois. Their unemployment rate as a group is just slightly above 8 percent (calculated as a weighted average based on each states respective labor force), almost two points below Illinois unemployment rate.

Tax increases drain resources from the private sector, stealing the resources needed to expand businesses and hire new workers for the long haul. What families need today are sustainable jobs that help put food on the table. The best long-term solution for Illinoisans, especially the poor and disadvantaged, is more employment through lower taxes and a better business climate.

Graphic 4. Unemployment rates: Illinois vs. neighboring states (weighted average), January 2010 to November 2011

Source: Bureau of Labor Statistics, Illinois Policy Institute

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3. The tax hike made Illinois less competitive and forced businesses to leave the state.

Thanks to the tax hike, Illinois now has one of the highest corporate tax rates in country.9 In 2011, it became evident that many businesses, large and small, had reached a breaking point with state government. Month after month, companies left or threatened to leave, while others hired lobbyists to seek relief. In reaction to the threats, Gov. Quinn and the legislature used some of the $700 million in new corporate income tax revenues to provide relief that overwhelmingly favored Illinois largest corporations. While these carve outs will ward off a few important departures, they will do little to help businesses without access to pricey lobbyists.

The totality of the business tax climate encompasses many factors, and the nonpartisan Tax Foundation has developed a comparative index that ranks the states. A special preview of their forthcoming 2012 State Business Tax Climate Index reflects the negative impact of the personal and corporate tax hikes. Illinois overall ranking dropped to 28th in the nation, from 16th in 2011 (1=best, 2011 score was revised). The corporate income tax sub-index component shows an even more dramatic drop in Illinois standing, to 45th place in 2012 from 29th in 2011. Bringing prosperity back to Illinois requires shedding our poor tax policies.

Bringing prosperity back to Illinois requires shedding our poor tax policies.

Graphic 5. Annual tax relief passed for major corporations:

$113.5 million

Source: Chicago Tribune and Crains Chicago Business

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Why repealing the tax hike is good politics

Voters want repeal. A January 2012 Pulse of Illinois poll (Graphic 6, page 9) found that 68 percent of voters oppose the income tax hike, and 65 percent are not confident that the tax hike revenue was used responsibly. More than 8 out of 10 of voters believe that the tax hike should be repealed immediately or allowed to expire as scheduled, while only 9 percent believe the tax hike should be made permanent. Serious policy challenges on pensions, Medicaid and other areas of spending are in Illinois immediate future. Those challenges must be met head on. The tax hike simply delayed the day of reckoning by taking $7 billion from taxpayers and propping up the status quo. Without that crutch, there is no alternative but to enact the necessary reforms that will put Illinois on a better path forward. Already more than 50 state senators, representatives and candidates for legislative office have signed the Repeal the Tax Hike Pledge. This is a commitment to voters that he or she will vote to repeal the income tax hikes of 2011 without imposing additional taxes on the people and businesses of Illinois. Repealing the tax hike is good policy and good politics. A full list of signers is available at illinoispolicy.org/repealthetaxhike. One year ago, Illinois politicians enacted a tax increase despite warnings that doing so would hurt the states residents and the economy. One year later, the verdict is in. The tax hike failed. Its time to undo the damage and to reignite Illinois. Repeal the tax hike.

A January 2012 Pulse of Illinois poll found that 68 percent of voters oppose the income tax hike, and 65 percent are not confident that the tax hike revenue was used responsibly.

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Graphic 6. Poll shows voters want repeal

Q1. In January 2011, state officials passed a 67 percent increase to the Illinois state income tax, raising the average household tax bill by approximately $1500.Do you favor or oppose this tax increase?
Favor

Q2. Has the tax increase put Illinois back on sound fiscal footing and strengthened the Illinois economy?
Yes, Illinois is back on sound fiscal footing and we have a strong economy No, Illinois isn't back on sound fiscal footing and the economy isn't strong

20% 68% 11%

7% 78% 14%

Oppose

Not sure

Not sure

Q3. How confident are you that revenue from the tax hike has been used responsibly?
Very or somewhat confident Not very or not at all confident

24% 65% 11%

Q4. According to current state law, the tax hike will be partially rolled back in 2015 and will fully expire by 2025.Should the tax hike be repealed immediately, should it be allowed to expire as scheduled or should the tax hike be made permanent?
The tax hike should be repealed immediately The tax hike should be allowed to expire as scheduled The tax hike should be made permanent

53% 31% 9% 7%

Not sure

Not sure

Q5. Generally speaking does the Illinois business climate make it more likely that businesses will leave Illinois or more likely that businesses will move to Illinois?
More likely to leave Illinois

71% 11% 18%

More likely to move to Illinois

Not sure

Source: Illinois survey of 500 likely voters, conducted Jan. 8, 2012 by Pulse Opinion Research. Margin of sampling error +/- 4.5 percentage points with a 95% level of confidence.

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Endnotes

1 Griffin-Johnson, Amanda. Fact Finder: Recent Tax Hike Is Highest in Illinois History. Rep. Illinois Policy Institute. Web. <http://articles.chicagotribune. com/2011-05-25/news/ct-edit-legis-20110525_1_ borrowing-2-percentage-point-income-tax-pension-system>. 2 Quinn, Pat. Speech. Post Tax Hike Press Conference. Press Room, Springfield.Youtube. com. 12 Jan. 2011 <http://www.youtube.com/ watch?v=U2kcieIEyfQ>. 3 96th General Assembly Regular Session Senate Transcript. State House, Springfield. 11 Jan. 2011. ILGA.gov. <http://ilga.gov/senate/transcripts/ strans96/09600144.pdf>. 4 96th General Assembly House of Representatives Transcription Debate. State House, Springfield. 11 Jan. 2011. ILGA.gov. <http://ilga.gov/house/ transcripts/htrans96/09600165.pdf> 5 Illinois. Governors Office of Management and Budget. Illinois Economic and Fiscal Policy Report. 3 Jan. 2012. 5 Jan. 2012 <http://www2.illinois.gov/ budget/Documents/2012%20Economic%20and%20 Fiscal%20Policy%20Report.pdf>. 6 United States. Bureau of Labor Statistics. Local Area Statistics. Http://www.bls.gov/lau/. Bureau of Labor Statistics, 20 Dec. 2011. Web. 10 Jan. 2012. 7 Ingram, Jonathan. Medicaid FAIL: Why cutting appropriations doesnt control costs. Rep. 8 Nov. 2011. Illinois Policy Institute. 5 Jan. 2012 <http://www.illinoispolicy.org/news/article. asp?ArticleSource=4503>. 8 Illinois. Governors Office of Management and Budget. Illinois Economic and Fiscal Policy Report. 3 Jan. 2012. 5 Jan. 2012 < http://www2.illinois.gov/ budget/Documents/2012%20Economic%20and%20 Fiscal%20Policy%20Report.pdf>. 9 The Tax Foundation - Tax Research Areas Illinois. The Tax Foundation - Educating Taxpayers Since 1937. 05 Jan. 2012 <http://www. taxfoundation.org/research/topic/26.html>.

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