Switching to a progressive income tax structure would drive Illinois even further behind Wisconsin

By Jay Miller for the Badger Institute

If states could declare bankruptcy, Illinois would be first in line seeking to shed its debts. The state’s total unfunded pension liabilities that are guaranteed to be paid have soared to $446 billion, according to the 2018 report, “Ranking the States by Fiscal Condition,” by the Mercatus Center at George Mason University.
 
Without bankruptcy as an option, the preferred solution might be to cut back on the metastasizing retirement benefits for its public-sector employees. But the Illinois Supreme Court has ruled that is forbidden under the state constitution. Amend the constitution? It turns out that Democratic Gov. J.B. Pritzker and his legislative allies want to do just that. Except they want to change the constitution to implement a graduated, or progressive, income tax structure.
 
Although right now, its state constitution requires a flat tax (currently at 4.95 percent), the Illinois legislature recently voted to put an amendment on the 2020 ballot to scrap that provision.
 
Wisconsin, on the other hand, already has a progressive income tax structure, with four tax brackets and top rate of 7.65 percent. That hasn’t worked so well, which is why the Badger Institute is now advocating for the state to reduce and broaden its brackets and cut back the progressivity built into its standard deduction.
 
One should not be misled by what a progressive tax rate usually signifies: open season for tax hikes.
 
In Illinois, for example, Pritzker is recommending (if the state constitution is changed) that the top rate be increased from the current flat 4.95 percent to 7.75 percent on income between $250,000 and $500,000 and then to 7.85 percent and beyond on income above that. Yet, lower-income earners only would see their tax rate fall from 4.95 percent to somewhere between 4.75 percent and 4.9 percent. This is not a matter of simply rearranging rates. Pritzker himself estimates that his plan would increase taxes in the aggregate by $3.4 billion.
 
Moreover, if Connecticut is any indication, the tax increases would not end there. Since abandoning a flat tax in 1996, the state’s top marginal rate has increased four times, and its brackets expanded to seven. To compound the pain, the higher tax rates keep being adjusted to apply to lesser amounts of taxable income.
 
If you think that these tax adjustments have enabled Connecticut to achieve financial stability, think again. Between 1991 (when an income tax on earned income was first applied) and 2017, its spending exceeded the rate of inflation by 71 percent. The Mercatus Center currently ranks Connecticut 49th among all states in terms of fiscal health. (Illinois is dead last.)
 
Maybe that’s why no state since Connecticut in 1991 has switched from a flat to progressive income tax. In 2018, Colorado voters rejected a constitutional amendment that would have allowed such a switch. On the other hand, North Carolina and Kentucky have gone the other way in recent years, from a progressive to a flat income tax.
 
Despite evidence to the contrary, Pritzker argues that a progressive income tax structure would enable Illinois to provide tax relief in other areas, such as its sky-high property taxes. While that might happen at the outset, Illinois will find that it must continue to feed the pension debt beast, driving up all sorts of taxes over time. Just like in Connecticut.
 
In a recent policy brief, “Leaving Illinois for Wisconsin,” the Badger Institute reports that Illinois in 2017 became the No. 1 state for outmigration. The reasons are several, but taxes played a role — and this is before a progressive income tax rate came into the picture. Based on 14 different business, economic and tax measures, Wisconsin fares better than Illinois in all but one of them. That one is the top state individual income tax rate.
 
But even there, if Pritzker and the Illinois legislature have their way with a progressive tax structure, they may move ahead of — or, er, behind — Wisconsin.
 
To help Wisconsin change places with Illinois, the Tax Foundation has proposed four different tax reform options for Wisconsin, a key piece of which would be revamping the state’s progressive income tax structure. A common trait under all of these different options is a reduction in the number of tax brackets.
 
Likewise, with three of its options, the Tax Foundation would have the state’s standard deduction conform with the federal one that has been recently expanded and make it available to all taxpayers. (The fourth option would eliminate the marriage penalty associated with Wisconsin’s standard deduction but otherwise keep the rest of it.)
 
Although state Sen. Duey Stroebel (R-Saukville) and others got a bill through the Wisconsin Legislature that would expand application of the standard deduction and shrink its progressivity, Gov. Tony Evers vetoed it. What that bodes for a future change in the law is unclear.
 
One thing is clear, however. There is nothing to suggest that a progressive tax scheme redounds to the state’s fiscal benefit. Quite the opposite, as evidenced by Connecticut and other states that lean heavily on a like structure. See, for example, New York and New Jersey. Perversely, it seems to provide a convenient vehicle for spending more and continuing to raise taxes, at least on higher-income folks. Which provides an additional incentive for them to move elsewhere, leaving a bigger tax hole in their wake.
 
Illinois is a mess right now. Its one saving grace is a flat income tax rate, which the powers that be are trying mightily to undo. If the November 2020 ballot referendum passes, that could represent another nail in Illinois’ fiscal coffin.
 
Wisconsin can and should move in the opposite direction, giving Illinois taxpayers and small businesses yet one more reason to migrate north.
 
Jay Miller of Whitefish Bay is tax attorney and a visiting fellow at the BadgerInstitute. Reposted with permission.