How to make income taxes more fair in Illinois — even after the demise of the ‘Fair Tax’

A flat tax combined with a flat cash grant effectively creates a progressive income tax.

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A propose amendment to the Illinois Constitution to allow for a graduated income tax — called the “Fair Tax” by proponents — was voted down on Nov. 3.

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Last week, Illinois voters rejected the Fair Tax. Had it passed, it would have amended Illinois’s constitution, which currently requires the state income tax to be at “a non-graduated rate” — a flat tax — to allow for graduated tax rates.

Almost immediately after it became clear the Fair Tax would not pass, Gov. J.B. Pritzker warned that without the ability to enact a graduated tax, the state would face both budget cuts and across-the-board tax increases. These cuts and tax increases that would reach every taxpayer in the state.

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There may, however, be a way the legislature can amend its income tax so that all Illinois taxpayers face the same tax rate but high-income taxpayers still pay a higher percentage of their income in taxes.

Before getting into the how, though, it is worth looking briefly at the why. Why would the governor want the ability to enact a graduated income tax? In short, because this type of progressive income tax is fairer than a flat tax.

And why is it fairer? The fairness question comes down to what tax policy people call “ability to pay.” Tax increases — even when they are proportionate to income — fall harder on low-income individuals than high-income individuals.

People with less income spend a higher percentage of that income on food, clothing, housing and other necessities than a higher-income individual. As a result, an increase in taxes is more likely to cut into the necessary spending of a lower-income individual than the spending of a higher-income individual. A flat tax makes tax increases painful to low-income taxpayers. (This unfair burden also makes raising taxes politically unpalatable to legislators, a result that anti-tax advocates approve.)

But the Illinois constitution prevents the state from imposing non-graduated tax rates. So how can the state create a fairer tax though the constitutional amendment failed?

The fix would require two steps. First, the state would raise the tax rate. Second, it would transfer cash to all taxpayers. This cash transfer would be the same amount, irrespective of income.

While it may not seem intuitive, a flat tax combined with a flat cash grant effectively creates a progressive income tax and can be designed in a way that roughly mirrors the goals of Fair Tax proponents.

Fair Tax proponents proposed that lower-income taxpayers would get a tax cut and that nobody earning less than $250,000 a year would pay more in taxes than they currently do. They also aimed at a top marginal tax rate of 7.99% for unmarried taxpayers earning at least $750,000 and married taxpayers earning at least $1 million.

We can design a flat tax with a cash grant that approximates these proposed rates. Imagine that the state raised the individual tax rate to 8.5%, a tax increase of about 3.5 percentage points. At the same time, the state would give taxpayers $7,500.

In that case, a taxpayer earning $100,000 would pay $8,500 in state income tax. The $7,500 payment from the state offsets all but $1,000. Effectively, then, the taxpayer would pay state taxes at a 1% rate, which represents a tax cut from the current 4.95% rate.

Meanwhile, a taxpayer earning $250,000 would pay $21,250 but would get the same $7,500 from the state for a net payment of $13,750. While both taxpayers would face the same non-graduated rate of tax — required by the state constitution — this taxpayer has an effective rate of 5.5%.  And with the 8.5% tax rate and the $7,500 grant, a taxpayer earning $1 million would pay an effective tax rate of 7.5%.

There is no reason why the rate has to be 8.5% or that the cash grant needs to be $7,500. Those numbers merely illustrate how a flat tax with a cash grant works. The legislature could adjust both the tax rate and the cash transfer to target the revenue and effective tax rates it wanted to achieve.

This type of tax clearly meets Illinois’ constitutional requirements: every taxpayer would pay taxes at precisely the same rate. But the cash grant means that effective tax rates rise as income goes up. Even without the Fair Tax, Illinois could increase its revenue.

This type of tax has an additional benefit: taxpayers at lower income levels would actually receive cash from the state. These cash transfers would not necessarily cost the state anything: they could substitute for some social safety net spending that the state already does.

Of course, that the Legislature can raise taxes more easily using a progressive income tax does not mean that a progressive income tax should allow them to become profligate and wasteful. Voters would have to remain vigilant, holding the Legislature responsible for its spending.

But the risk of wasteful spending — something equally plausible with a flat tax — should not prevent the state from creating a modern progressive income tax system for Illinois.

Samuel D. Brunson is the Georgia Reithal Professor of Law at the Loyola University Chicago School of Law.

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