U Of I Study Looks At Potential Impact Of Graduated Income Tax On Illinois

A report issued by the University of Illinois Institute of Government and Public Affairs indicates that Illinois could raise more tax revenue, with a serious change in residents’ economic behavior, if it used a graduated income tax structure similar to those in neighboring states.

The report was issued in reply to questions from State Senator Andy Manar.

The Macoupin County Democrat wanted to know how the graduated state income tax structures used in the neighboring states of Wisconsin, Minnesota, Iowa and Missouri would play out if implemented in Illinois.

Manar voted for the graduated tax amendment that passed the Illinois Senate on May First. And one big question about the proposal is, could such a system really raise more revenue for the state?

Illinois Public Media’s Jim Meadows talked with Prof. David F. Merriman at the University of Illinois Chicago campus, who researches economic policy for the Fiscal Futures Project at the Institute of Government and Public Affairs, about the results of the study, (which he co-authored with three professors from the U of I at Springfield: Public Administration Prof. Kenneth Kriz and Prof. Patricia Byrnes and instructor Glenn Cassidy of the Dept. of Economics). The transcript that follows has been edited for clarity:

Meadows: This report came from a request made by made by a lawmaker (State Senator Andy Manar, D-Bunker Hill). What were the main points he was trying to get information on?

Merriman: I think he wanted to know how the Illinois personal income tax system compared to other states in the Midwest. But he was also interested in how that might change over time as the distribution of income changed.

Meadows: Changes in income inequality over the years, is that what you were referring to?

Merriman: That's correct.

Meadows: And also the other states that you compared to, I think it was Wisconsin, Minnesota, Iowa and Missouri. Are those states that have graduated income taxes?

Merriman: Yes, they do. Although Missouri's graduated tax tops out at very low income. I think it's $10,000. And after that, it's basically a flat rate system.

Meadows: So we're comparing some sort of graduated income tax to Illinois' flat tax.

Merriman: That's correct.

Meadows: What does the report say about a potential graduated income tax in Illinois in the future and what impact that might have?

Merriman: Well, we a set of data that looks a lot like Illinois taxpayers. And then we say, how much revenue would that generate if we run it through these other state tax systems? So that the revenue that you generate depends not only on what the rates are, but also what kind of income is exempted; whether, for instance, retirement income is exempted, whether their personal exemptions or credits in the system. So we looked at that kind of thing, not only that, how the rates differ but also how the tax base differs.

Meadows: And what did you find out as far as what the difference would be, if you were to essentially apply the tax systems of those other states to Illinois?

Merriman: Wisconsin, Minnesota, Iowa would all generate 10 to 15% more revenue with the same taxpayers as Illinois, and Missouri would generate just about the same amount of revenue. And the tax would be distributed a little bit differently. Higher income tax payers, particularly those with income over $100,000 would pay more under any of those state systems than they do under Illinois'. And low income taxpayers would generally pay less; those with an income, say, of $50,000 or less, would pay less if we adopted other states’ tax systems

Meadows: Are these changes which would be seen as validation by the supporters of a graduated income tax in Illinois?

Merriman: You should really ask the supporters of graduated rate taxes, whether or not they see them as validation. I think these are just facts that we have about the system. We don't come down with any position about whether a graduated rate tax is a good idea or not.

Meadows: You were looking at specific tax systems in those states, which might not be quite the same as what's being debated in Springfield right now?

Merriman: Yeah, they almost certainly would not be the same. This is what the senator asked us to look at. And that's what we did look at. One thing we also looked at: when you change the tax system, we expect that people might change their behavior and reaction to that tax system. For example, if you raise tax rates, some people might move out of state, or they might work less, or they might change the form of their income. And so, we tried to look at what the literature said about that and take that into consideration in some of the estimates that we did. And although there's quite a bit of evidence that there are behavioral changes, they don't change the fundamental conclusions that we reached when we take them into account.

Meadows: The fundamental conclusion being that these systems, except for Missouri would raise more revenue in Illinois.

Merriman: That's right.

 

Meadows: You also talked about income inequality and how that had been a rising phenomenon, but you're forecasting that the rate of that rise might slow and even start to change.

Merriman: Well, the forecasting tools that we have allow us to go out only about five years. So these are really short term changes. To look back over 100 years or so, you see definitely a big increase in the share of income going to the highest income categories. Now, the top 1% of taxpayers have about 20% of the income of the state. We don't see any evidence that that will change in the short term.

Meadows: Okay. It's going to stay around 20%. But, the rate of the rise in income inequality might slow down a bit?

Merriman: Yes.

Meadows: And it also sounds like you're not making any predictions as to what that would mean for what happens beyond the next five years.

Merriman: Right. We didn't try to do that kind of analysis. We don't really have the tools or the evidence to know what's going to happen to the income inequality. There's, as you might guess, been a lot of discussion in the economics literature about what's causing this change in income inequality and I'd say it's an unsettled question. We don't have strong models that explain what happened in the past. And we don't have the ability to make long term predictions about the future.

Meadows: Well, the question of a graduated income tax is one that could very well be coming to Illinois voters in the next year or two, if this amendment is sent to them to ratify. Short of saying what decision voters should make, what data in your report do you think it's useful for voters to pay attention to, as they try to decide?

Merriman: Well, I think the most important thing is, how much will this change the behavior of people, particularly people with high income? And might there be a tendency for those people to leave the state or to change their behavior in a way to work less? And what our report is relatively reassuring on, we think that the behavioral changes that might come about as a result of relatively modest increases in the tax rate from, say, five to eight percent, for the top group, in other places, haven't been associated with very large changes in behavior. And, and so that I think that's the most important information in this report.

Meadows: Now, that's in the context of an Illinois where I understand the population has been under decline.

Merriman: That's certainly true.

Meadows: And do you know if the decline is among a particular income group or is it spread all across the board?

Merriman: I have not looked at that. If you look at the tax records, where is Illinois getting its revenue from, more and more revenue is coming from upper income groups, a larger share. And that's a combination of the fact that those groups have been gaining over time, and of the share of income that they have. And it doesn't really say that much about how many people in those groups have left the state.

Meadows: You're saying the data suggests that if a graduated income tax does become reality in Illinois, it's not going to have a dramatic change in whatever is happening?

Merriman: Yeah, the best evidence we have suggests we won't have a dramatic change.

Meadows: Are there any other important points that you think should be noted in the report?

Merriman: I guess one other point I'd make is that when the income tax system changed, when we raised the rate from three to 5%, and then it went down to 3.75%, and then back up to 4.95%*: the evidence from that experiment is that revenue increased in tandem with the tax rate changes. So when the tax rate went up substantially, revenue also went up substantially. When the tax rate went down, revenue went down. And we didn't see dramatic changes in migration or economic activity as those rate changes happened.

*Legislators voted to raise state income tax rates, with the personal rate going up to 5%, effective 1/1/2011; a sunset clause automatically dropped it to 3.75% on 1/1/2015. New legislation raised it up again, to its present rate of 4.95%, effective 7/1/2017.- JM

You can read the full report below: