Over The Horizon: Increase in the State Income Tax From 3 Percent to 5 Percent Expires in 2015

Nov 1, 2013

Although the search for a way out of the state’s public pension mess has been the focal point in Springfield for the past two years, it’s not the only fiscal question mark looming over Illinois’ political landscape.

But unlike the years-long build-up that led to the slow-motion pension train wreck, this potential debacle has a timeline that’s crystal clear. On January 1, 2015, the first phase of the state’s temporary 2011 income tax increase will expire, potentially blowing a projected $2.2 billion hole in the state’s revenue stream.

Plenty of people are gearing up for a fight over whether to extend the temporary tax hike or allow it to expire.

 

In one corner are groups representing organizations and agencies that provide public services to the state, ranging from education groups to public sector unions. “This would be devastating to human services,” says Tony Paulauski, executive director of the ARC of Illinois, which represents organizations providing services to developmentally disabled Illinoisans. “It’s almost unimaginable. Right now, it’s really spooky.”

In the other corner are those who say the state needs to rip the financial Band-Aid off the wound and move on. “This will be a truly painful period. But we have no choice. If we keep our high taxes, we’ll continue to drive jobs out of this state,” says state Rep. David McSweeney, R-Barrington Hills.

In January 2011, Democrats who control state government pushed through a law that increased the individual income tax from 3 percent to 5 percent. Without action from the governor and the General Assembly, it will decrease to 3.75 percent in 2015, and to 3.25 percent in 2025.

The corporate tax rate increased from 4.8 percent to 7 percent but will decrease to 5.25 percent in 2015 and finally to the original 4.8 percent in 2025.

Eric Noggle, the senior revenue analyst at the Commission on Government Forecasting and Accountability, which provides fiscal data for the General Assembly, says projections show the state will get $19 billion in the next fiscal year if the tax increases stay in place. With the reduction, the state will receive $16.8 billion, he says. It is the $2.2 billion drop that has lawmakers and other stakeholders in state government wringing their hands.

At COGFA, analysts aren’t confident the legislature will find ways to cut the budget. Rather, they predict lawmakers will look for other solutions to keep spending at current levels.

“Without a permanent revenue source to replace this funding, the state will most likely be looking to one-time, short-term revenue solutions to balance the budget,” the commission stated in a recent analysis. Under one scenario, if the income tax increase expires and the state’s growth rate for spending is left at normal levels, the state’s deficit would explode to $15 billion within three years.

What makes all of this talk of fiscal pain even more complicated is that it will come against the backdrop of the 2014 election season. New lawmakers and the state’s next governor will be sworn in just days after the tax hike expires.

Rather than float ideas on how to deal with the potential bombshell, House Speaker Michael Madigan and Senate President John Cullerton, both Chicago Democrats, have said the future of the tax hike rests largely on the results of the 2014 gubernatorial election.

Steve Brown, spokesman for House Speaker Michael Madigan, says the speaker is waiting to hear from the gubernatorial candidates about what they plan to do. “Probably the most interesting debate in the primary season will be that exact topic: Who will have plans to reveal on how to deal with that issue?” Brown asks.

Cullerton spokeswoman Rikeesha Phelon is sending a similar message: “What is clear is that the combination of ballooning pension payments — without reforms — and the loss of tax revenue in 2015 will make budgeting for a full fiscal year almost impossible,” she said in a recent email.

But getting the candidates for governor to talk about the politically toxic issue of massive cuts to education, public safety and other state services remains a tough sell.

Part of that reluctance is by design. Candidates do not want to commit at this early stage to a plan they believe would keep the state from going over a fiscal cliff. And their handlers say much could happen between now and January 2015 that could change the game.

Gov. Pat Quinn, who won election in 2010 despite his support of the income tax increase, has been playing coy about the situation for months. The Chicago Democrat, who only recently learned he won’t be facing any major opposition in the March primary election, continues to say his priority is solving the puzzle that is the states’ underfunded retirement systems. “The governor is focused on pension reform,” says Abdon Pallasch, assistant director of the Governor’s Office of Management and Budget.

 

The four Republicans seeking to take on Quinn in the November 2014 election are similarly lacking in specifics when it comes to the retirement system riddle.

State Sen. Bill Brady of Bloomington, who narrowly lost to Quinn in 2010, disagrees that the loss of the money from the income tax hike would be a disaster. Rather, the conservative real estate developer says that because the decreased revenue will be spread over two budget years, it will lessen the pain.

Instead of listing what cuts he’d make, Brady says a combination of pension and Medicaid reforms would go a long way in making up for the revenue loss. “Those two things would easily bite into it,” Brady says.

He says the money would be spent in the economy, generating economic growth. He also supports abolishing the lieutenant governor’s office and combining the treasurer and comptroller to save about $12 million annually.

Venture capitalist Bruce Rauner, a political newcomer from Winnetka, says he wants to overhaul the tax code so that it is fair to all taxpayers, but he isn’t getting more specific about his plan if he wins. “We’re not yet rolling out our budget plan,” says spokesman Mike Schrimpf.

Schrimpf says Rauner would veto an extension of the tax hike and look to make up the loss of revenue through pension savings and better management of state government. And he promised he’d fill in voters with more information as the campaign season rolls along. “I think you will certainly see more by Election Day,” Schrimpf says.

Of the GOP candidates, state Treasurer Dan Rutherford is the only one who has not ruled out vetoing an extension of the tax hike. The former lawmaker from Chenoa says his avoidance of committing to the veto pen is not because he supports the tax hike. Rather, he says, from a tactical standpoint, the tax hike serves as a bargaining chip.

“I don’t want to keep it. I don’t want to keep it. I don’t want to keep it,” Rutherford says. “But it may have to be on the table for negotiating purposes.”

He says Quinn made a mistake in 2010 when he failed to link the tax increase to pension reform.

State Sen. Kirk Dillard from Hinsdale also isn’t getting specific about what he’d cut to accommodate the drop in revenue. He says he’d call on state agencies to give back a percentage of their budgets, freeze new programs, further reform Medicaid and try to grow the economy.

“There will be pain,” says Dillard, who served as chief of staff to former Gov. Jim Edgar. “But I have managed difficult budgets before.”

Some groups say the vagueness of the candidates is understandable at this point.

Ben Schwarm, deputy executive director of the Illinois Association of School Boards, says it may be too early to determine what’s going to happen.

“There are these pieces out there that are not resolved,” Schwarm says, pointing to pension reform and ongoing attempts to reduce Medicaid costs. “The effect of all of this is going to depend on a number of different factors.”

He says opponents of extending the tax hike eventually will have to spell out how the state will grapple with the reduction in revenue. “Certainly, they are going to have to say what’s the plan to fill the gap,” Schwarm says.

The possibilities range from the vague cuts floated by the Republican governor candidates to the possibility of a sea change in Illinois tax policy, courtesy of a possible constitutional amendment being touted by unions and others.

The American Federation of State, County and Municipal Employees union is among at least 100 groups backing a proposed amendment to the state Constitution that would scrap the state’s flat tax system and replace it with one that would essentially impose higher taxes on wealthier Illinoisans and lower the tax burden for lower-income residents. Supporters say the added revenue it could generate would offset the loss of revenue when the current income tax increase expires.

To change that, both chambers of the legislature would have to pass a resolution by a three-fifths vote to place a measure on the ballot asking voters to amend the Constitution. That ballot question would then need to be approved by either three-fifths of those voting on the measure or the majority of those voting in the election.

But timing is key. To get a constitutional amendment on the ballot, the legislature must act by the first week of May.

AFSCME says cutting state spending more is “unthinkable” at a time when the state already has a hard time paying its bills for things like education, health care, public safety and human services.

“The state has already made draconian cuts in all those areas,” AFSCME Council 31 spokesman Anders Lindall says. As an example, Lindall points to the state’s overcrowded prison system, which does not have enough employees to provide inmates with education or job training before they return to society. “The picture is already grim,” Lindall says.

Among the other groups backing the amendment is the ARC of Illinois. “It’s certainly our top priority as an organization,” Paulauski says.

Supporters say a graduated tax system — already used by the federal government and 34 of 41 other states that charge an income tax — is fairer than the state’s current flat tax. They say most Illinoisans would see their taxes cut from the current rate, but the state would rake in more cash because the wealthiest earners would pay more.

Under one proposal outlined by the union-financed Center for Tax and Budget Accountability, a graduated income tax would bring in about $2.4 billion more in revenue per year — a move that would erase the loss if the temporary tax hike expires.

Opponents, led by McSweeney, are pledging a fight. “I think it would be the final nail in the coffin,” the freshman lawmaker says. “I think it’s going to be a major fight.”

Although it is unlikely to be called for a vote, a resolution sponsored by McSweeney opposes the graduated income tax. He has rounded up 46 co-sponsors.

Rather than approve a so-called “progressive tax” in Illinois, McSweeney says the state could absorb the loss of revenue from the expiration of the temporary tax hike if the legislature rolled back an additional $2 billion in spending that was added to last year’s budget.

Savings from pension reform also could be rolled into the savings. Other potential savings could come from a laundry list of possibilities, including further reforms of Medicaid, eliminating the lieutenant governor’s office and combining the treasurer and comptroller into one office.

“We need to cut spending,” McSweeney said. “It’s not going to be easy.”

If the graduated income tax gambit doesn’t pan out, lawmakers also could try to raid income tax dollars normally sent to local governments and schools. Agencies that have already been cut also could see fewer dollars.

The state also could expand gambling in hopes of filling any budget gaps with additional revenue from new casinos and slot machines at race tracks.

And, for good measure, both Republicans and Democrats hope the state can somehow pull itself out of its fiscal quagmire by benefiting from the end of the recession.

“The improving economy could be an element,” says Brown, Madigan’s spokesman. What’s more, the federal government could always pitch in, Brown adds. “You won’t have to spend as much on the wars as you have in the past decade.” 

Kurt Erickson is Statehouse bureau chief for Lee Enterprises newspapers in Illinois.

Illinois Issues, November 2013