Civic Fed: Raise income taxes but lower sales tax to fix Illinois

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Laurence Msall, president of the Civic Federation: “Why wouldn’t they be making sure they’re receiving the benefits?” | Rich Hein / Sun-Times

A report released Friday says Illinois’ financial situation is so bad that the state would have to slash spending by more than 26 percent to balance next year’s budget through cuts alone.

Civic Federation President Laurence Msall says Gov. Bruce Rauner and legislators “need to take action immediately.”

The nonpartisan government-watchdog and policy-analysis organization recommends Illinois limit spending growth and increase the individual income tax rate from 3.75 to 5.25 percent, as well as increasing the corporate tax rate. It also calls for lowering the state sales-tax rate.

The group says lawmakers’ delay in passing a balanced state budget means fixing the problem will take longer and require more dramatic measures.

Republican Rauner and the Democratic-majority Legislature have gone almost two years without approving a budget, causing Illinois to rack up $11 billion in overdue bills.

Here is the full text of the Civic Federation news release:

In a report released today, the Civic Federation’s Institute for Illinois’ Fiscal Sustainability proposes a comprehensive five-year plan that addresses the State’s ongoing financial crisis and budget impasse with painful but necessary spending limits and revenue enhancements.

While Illinois has gone more than 19 months without a comprehensive, balanced budget, state government has continued to function because of court orders, consent decrees, statutory requirements and full-year spending bills for primary and secondary education. However, many areas of government, including higher education, human services, agency operations and group health insurance, have gone entirely or partially unfunded. A stopgap package for the first half of FY2017 provided only partial relief for some of these areas of government but the appropriations expired on December 31, 2016. The State’s backlog of bills is expected to reach $14.5 billion by the end of FY2017, and there is no clear end in sight to the standoff.

“Illinois is in the unenviable position of having by far the worst rated credit in the United States and the most notoriously dysfunctional state government,” said Civic Federation President Laurence Msall. “Governor Rauner and Illinois legislators on both sides of the aisle need to take action immediately to put Illinois back on the path toward sound financial footing. Ending the impasse is the right thing to do for Illinois taxpayers, the State’s vendors and especially our most vulnerable citizens, who have been irreparably harmed during the last 19 months.”

As part of a comprehensive five-year plan, the Federation proposes the following recommendations to begin stabilizing Illinois’ financial position:

• Limit State Spending: Illinois should limit spending growth to 1.7% through at least FY2022, using the Governor’s estimated maintenance FY2017 spending level as a base. The State should also stop paying hundreds of millions of dollars in unnecessary interest penalties on its overdue bills. Ending the budget impasse is the only path to reducing the state’s highest-in-the-nation interest costs, including an estimated $700 million in penalties if bills on hand are paid at the end of FY2017.

• Increase Income Taxes: The State should retroactively increase the income tax rate to 5.25% for individuals and 7.0% for corporations as of January 1, 2017. If the Civic Federation’s proposals are implemented, the State should be in a position to lower the individual tax rate to 5% on January 1, 2022. The burden of the increase on low income residents should be alleviated by expanding the earned income tax credit by 50%.

• Eliminate Tax Exemption for Federally Taxable Retirement Income: Out of the 41 states that impose an income tax, Illinois is one of only three that exempt all retirement income. The State can no longer afford to provide this generous benefit, which is out of line with most other states.

• Expand Sales Tax Base and Lower the Rate: The State should enact a new service tax including a broad-based definition of consumer services and a firm exemption for business-to-business transactions and medical services. In conjunction, the State should lower the general sales tax rate for goods and services from 6.25% to 5.5%. This would reduce the effective rate in Chicago to 9.5%, down from 10.25%, which is the highest of any major metropolitan area in the nation.

• Limit Business Tax Expenditures: Illinois should cap the retailer’s discount, eliminate the E-10 ethanol incentive, decouple from the federal domestic production activities deduction and eliminate the continental shelf exemption, because these expenditures do not provide sufficient public value to justify their cost.

• Merge the Chicago Teachers’ Pension Fund with the Teachers’ Retirement System: There is no good public policy reason for Illinois to maintain two separate funds for public school teachers’ pensions. The Chicago Teachers’ Pension Fund and Teachers’ Retirement System should consolidate, providing more equitable pension funding for all teachers and helping to stabilize Chicago Public Schools’ finances.

• Consolidate and Streamline Government Units: The multiplicity of Illinois’ highest-in-the-nation 6,963 units of local government is often cited as a reason for high property tax rates in Illinois.

Borrow to Clear the Bill Backlog: In conjunction with a balanced budget and credible plan to maintain fiscal sustainability, borrowing to eliminate the backlog would save on interest penalties and restore confidence in the State’s finances.

• Make Supplemental Pension Payments: Beginning after backlog bond debt service ends, the State should make supplemental payments to bring all five State retirement systems to 100% funded.

Establish a Rainy Day Fund: The State of Illinois should work toward building a rainy day fund equal to 10.0% of State-source General Funds revenues to cushion the budget from the next economic downturn.

The delay in acting on the State’s fiscal problems means that measures taken now need to be more dramatic than those previously proposed, and the resolution to the crisis will take longer. The Federation’s plan would substantially reduce, but not eliminate, the FY2017 operating deficit. Beginning in FY2018, the State would have budget surpluses that would cover debt service for bonds issued to pay off the backlog of bills.

Added Msall, “There are no politically easy choices left for the State of Illinois and, unfortunately, none of the shared pain from spending restrictions and increased revenues will go toward better or additional services for Illinoisans. Rather, this will only settle many billions of dollars in obligations we have already incurred. Despite the pain, such measures are absolutely necessary to secure Illinois’ financial future.”

The State should also consider some of the following measures that could give Illinois’ finances more long-term sustainability:

• A constitutional amendment limiting the pension protection clause to accrued benefits;

• A constitutional amendment allowing a graduated individual income tax;

• A reduction in the interest Illinois pays on overdue bills under the Prompt Payment Act;

• A return of the lapse period to two months from six; and

• A phase-out of Section 25 liabilities and other practices that allow prior year’s costs to be paid from current year’s appropriations.

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