As Illinois lawmakers stare down their final weeks in Springfield, the state is staring down its own fiscal realities: $6.5 billion in unpaid bills, a $130 billion pension shortfall, and credit ratings still barely teetering above junk-bond status despite an income-tax hike last summer. That makes it an anomaly within the Midwest, a state that can never seem to manage its money while surrounding ones thrive. But its tax system is also strikingly different than theirs, a fact members of both parties have long bemoaned but not changed.
J.B. Pritzker's campaign is the latest to propose aligning the state's revenues with that of its neighbors, and it would be a considerable shift. After years of non-serious discussion of the issue, he's pushing to change the state’s constitution to permit a graduated income tax instead of the mandated flat tax. If that happens, it would bring Illinois closer to the tax structures of surrounding states.
But there are two other types of taxes employed by our neighbors—ones brought up again and again—that still seem too poisonous to consider.
All of Illinois’ neighbors tax retirement income in some form (as does the federal government). And of the 41 states that have an income tax, Illinois is one of just three that does not extend that tax to public and private pensions, 401(k) withdrawals, annuities, Social Security payments, and IRA withdrawals. If it did, a new report out last week from the nonpartisan Chicago-based Civic Federation recommended that Illinois adopt a tax on retirement income, which the organization projects could bring in over $2.5 billion next year.
Civic Federation president Laurence Msall stressed that the organization’s recommendation isn’t a stand-alone proposal “in the abstract,” and would have to be implemented in conjunction solid budget.
“Nobody wants to add any new taxes if you didn’t have to,” he said. But he added that the decades-old idea that exempting retirement income from taxation seems to be outdated. “Is the argument that not taxing retirement income is keeping people in Illinois?” Msall said. “The Census tracts seem to show that people are leaving the state of Illinois.”
Indeed, census data shows the state has lost over 88,000 net residents in the last four years, with over a third of that loss counted in the last year alone.
But Bob Gallo, the state director of AARP Illinois, said that serious discussion of a tax on retirement income would drive even more retirees out of the state.
“Our concern when this comes up… is not to solve the state’s fiscal problems on the backs of one group of individuals, who basically did not create this problem in the first place, and in their retirement did not plan for this to be coming out of their retirement income and do not have the opportunity or elasticity in their income to make up the difference,” Gallo said.
AARP polled state residents over 50 on the subject in 2015. Nearly 90 percent opposed the idea. The Simon Institute at Southern Illinois polled the question in 2013, and 74 percent of respondents were opposed—but 60 percent favored a tax on retirement income over $100,000, compared to just 39 percent favoring service taxes.
When Illinois initially adopted an income tax in 1969, retirement income was included. But just two years later, retirement income was partially exempted, and then fully exempted in 1972. Though there had been warnings of missing out on revenue in the early days of the exemption, serious considerations of switching back quickly became politically unpalatable.
Senior citizens are a notoriously reliable voting bloc, and an important group to appeal to. On this point, both Gov. Bruce Rauner and candidate Pritzker agree: neither are open to a discussion of taxing retirement income, no matter the potential revenue boost.
The Civic Federation’s recent report also suggests Illinois expand its sales tax to a list of 14 service categories, the same group of services taxed by Wisconsin. Illinois currently taxes a very small group of services, though most—12 out of 17, according to the Federation of Tax Administrators—are considered utilities, and are thus taxed under different statutes. Of the five states touching Illinois’ borders, only Indiana does not currently tax services.
Jason Stein, research director for the nonpartisan Wisconsin Policy Forum, said he understands that proposing new taxes on services is difficult—in 2006 a “tax swap” was proposed to lesser the property tax burden, but it ultimately failed—but once the sales tax is in place, “14 cents on a latte” tends to “fl[y] under the radar.”
“If you ask a homeowner what he or she paid in property taxes last year, they can probably tell you that right away,” Stein said. “If you asked how much they paid in sales taxes, unless they’re keeping track, they wouldn’t know.”
The argument for taxing services is one that accounts for the changing nature of the economy: More household spending goes to services, or services that deliver goods, rather than in the past, when spending was mostly on goods. The Tax Foundation, a nonpartisan think tank based in Washington, D.C., has repeatedly suggested states adopt a wider tax base by expanding sales taxes to services.
As recently as last spring, the question of taxing certain services like laundry and dry-cleaning, pest control, security services, tattoos and piercings were on the table as leaders in the Illinois Senate attempted to broker a deal that would end the two-year political stalemate where Illinois operated without a proper budget. But the services were cut from the so-called “Grand Bargain” midway through negotiations, and the deal fell through anyway.
In his first gubernatorial campaign in 2014, Rauner was open to taxing “non-necessity” services like charter airplane flights, interior decorating and marina towing. But Rauner has soured on any kind of upward tax tweak since Democrats and some within his own Republican party pushed through a tax hike to end the budget impasse.
Meanwhile, a Pritzker spokeswoman said that any time the candidate talks about opposing “regressive” taxes, an expanded sales tax on services is included.