Illinois 50 Years Later: Is it Time to Give Up the Flat Tax?
Ever since Illinois adopted its most recent state constitution in 1970, lawmakers have had to abide by strict rules about how they could structure Illinois’ income tax. The biggest restriction is that they have to charge all residents the same rate. Illinois legislators could not, for example, pass a millionaire’s tax like their counterparts in other states have done, because the constitution requires the rich to be taxed at the same rate as the poor.
Gov. JB Pritzker, a Democratic billionaire, wants to change that. He and the Democrats who control the General Assembly have asked voters to approve an amendment to the state constitution that would simply eliminate the flat-tax requirement.
But things are rarely simple in politics, and Pritzker’s efforts to allow a so-called “Fair Tax” have spawned a growing list of worries – some founded, some not – about what such a change would mean for people’s personal finances, for the state’s precarious financial position and for the balance of power in Springfield.
One of the biggest sources of confusion about the amendment is the fact that the General Assembly already passed the tax changes it would impose if the amendment passes. The Democrats who pushed through that law last year said they wanted to let voters know ahead of time how the tax law would change if voters approved the amendment.
That law slightly lowers the income tax rates for anyone who makes less than $250,000, which advocates say covers 97 percent of Illinois taxpayers. But the new tax law hits millionaires hard. Raising the rates on the very rich is how, after all, the law would generate what analysts last year said would be $3.4 billion in new revenue annually.
Lawmakers’ new millionaire tax cannot take effect without a change in the state constitution. But the constitutional amendment itself does not guarantee that the law Democrats passed last year will remain in effect. The legislature would still be able to change tax laws. They could tweak or entirely toss aside the tax law Democrats passed last year. The amendment just gives them more options for structuring Illinois’ tax regime.
Because the tentative changes have generated a lot of confusion, we are exploring some of the areas that have generated the most confusion or misinformation about the proposal.
What does the proposed constitutional amendment do?
As it is currently written, the Illinois constitution says, “A tax on or measured by income shall be at a non-graduated rate. At any one time there may be no more than one such tax imposed by the State for State purposes on individuals and one such tax so imposed on corporations.”
In essence, that means that Illinois has to have a flat tax, where every taxpayer, no matter how rich or poor, pays the same tax rate. (There are some measures, like the Earned Income Tax Credit, that reduce the tax bill for low-income taxpayers, though.)
Pritzker and legislative Democrats want to be able to charge richer taxpayers a higher income tax rate. Their amendment would replace the language about the flat tax above with this provision: “The General Assembly shall provide by law for the rate or rates of any tax on or measured by income imposed by the State.”
The constitution also prevents lawmakers from trying to raise taxes on businesses in order to keep taxes low for individuals. It does so by specifying that the corporate income tax rate cannot be more than 1.6 times higher than the personal income tax rate. With the changes Pritzker is proposing, though, there could be more than one personal income tax rate. So the amendment also specifies that the corporate-to-personal income tax rate limitations apply only to the highest personal income tax bracket.
What the amendment itself does not do is set any new tax policy. It does, however, give legislators more flexibility in how they can set that new tax policy.
So why do I keep hearing about tax cuts or tax hikes if the amendment passes?
Last year, Pritzker pushed lawmakers to adopt a new tax law that would only take effect if the constitutional amendment passes. The Democrats who hold lopsided majorities in both the House and Senate passed the law, which will take effect in January 2021 if voters approve the Fair Tax Amendment.
Illinois currently imposes a 4.95 percent personal income tax on everyone, regardless of income.
Under the new law, Illinois residents would pay a reduced rate of 4.75 percent for the first $10,000 they earn, 4.9 percent on any money they earn between $10,000 and $100,000 and the 4.95 percent on anything they earn between $100,000 and $250,000.
Beyond the first quarter million dollars, the rates jump significantly. The next bracket taxes people at 7.75 percent, up to $350,000 for people filing individually and up to $500,000 for those filing jointly. Beyond that, individuals pay 7.85 percent for income up to $750,000 and joint filers pay that rate for income up to $1 million.
Those tax rates apply to everyone below the highest tax bracket. So even if you make $749,000, the first $10,000 you earn would be taxed at 4.75 percent, not 7.85 percent.
In the highest bracket (above $750,000 for individuals or more than $1 million for couples), though, the 7.99 percent rate applies to ALL of the taxpayer’s income, from the first dollar on up.
The law also contains other provisions, such as new tax credits for children and larger tax credits to offset property taxes.
Does this allow for the taxation of retirement income?
Illinois remains one of a handful of states that does not tax retirement income, but that’s not because of the constitution. The Pritzker amendment does not change anything about taxing retirement income. In other words, Illinois lawmakers already had the option to tax retirement income but chose not to. They would still have that option, whether the amendment passes or fails.
The reason that this generated so much controversy is because Illinois Treasurer Mike Frerichs, a Democrat, told a group of suburban business leaders this summer that allowing progressive income taxes would make it more politically palatable to tax retirees who pull in six-figure incomes. “One thing a progressive tax would do is make clear you can have graduated rates when you are taxing retirement income,” he said, according to the Daily Herald. “And, I think that’s something that’s worth discussion.”
Once his comments caused an uproar, Frerichs backed away from them. “You’ve seen the ads that say the Fair Tax will tax retirement income. Well, that’s not true,” he said in a statement to the Center for Illinois Politics. “Because these misleading ads use my name, and in the spirit of General William Tecumseh Sherman, let me make this clear: I did NOT call for a tax on retirement income. There is NO plan for one. I will NOT vote for one.”
How would this affect small businesses?
It depends. Several factors, including the organizational structure of the business and how much income it receives, come into play.
Traditional businesses in Illinois pay two types of income tax: the corporate income tax and “personal property replacement taxes,” (PPRTs) which help fund local governments.
But many small business owners actually pay income taxes for their businesses through their own personal tax returns. Those so-called “pass-through” corporations are subject to the personal income tax, plus PPRTs.
The new tax law that would take effect if the Fair Tax amendment passes raises the corporate income tax rate – which applies to traditional businesses – from 7 percent to 7.99 percent.
But it could also raise the rates for shareholders or owners of “pass-through” corporations, if their income is higher than $250,000, because they are subject to the higher personal income tax rates for those brackets.
“Under the proposal, corporate income would be taxed at a flat rate of 10.49 percent, the third-highest rate in the nation, while the highest bracket for pass-through business income would be taxed at 9.49 percent, the fourth highest in the nation,” the Illinois Chamber of Commerce said on its website.
The chamber, which opposes the measure, also argued that “it is difficult, if not impossible, to install a progressive income tax that raises substantial new revenues, without significantly increasing the tax burden on the middle class.”
Would this affect property taxes?
Not directly. The new tax law increases the tax credit people can claim on their state income taxes for paying local property taxes from 5 percent of the property taxes they paid to 6 percent. But that only affects how much money the state receives, not local governments, which impose the property taxes.
Advocates for the Fair Tax say the new money generated by the graduated income tax could be used to better fund schools at the state level, which would allow local school districts to lower the property taxes they impose. In fact, Illinois’ new school-funding formula includes $50 million a year in property tax relief, as long as it is funded every year. Supporters say the Fair Tax amendment would make it more likely that Illinois lawmakers keep those commitments.
But that’s not a guarantee, especially with the state in dire financial condition because of its enormous pension liability and the pandemic-induced recession. In fact, Lieutenant Gov. Juliana Stratton said last week that lawmakers may have to raise taxes across the board by 20 percent if the Fair Tax amendment fails, because of projected revenue shortfalls.
Could legislators raise taxes again without voter approval?
Yes. But they can already do that. In fact, lawmakers last raised Illinois’ income taxes in 2017.
Very few states require voter approval for tax increases, because that job normally rests with the legislature. In Colorado, a 1992 law requires state and local governments to get permission from voters before raising taxes or exceeding certain spending limits. But Illinois has never had such restrictions.
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