Illinois’s Mess II

by Dave Schuler on January 5, 2011

Much of the discussion of Illinois’s fiscal problems in response to my post yesterday dwelled on increasing Illinois’s personal income tax. Illinois can’t solve its problems by increasing its income tax. It can’t solve its problems by increasing revenues period. The numbers just don’t support it.

Illinois has a total budget of $26 billion and a shortfall of $13 billion. In other words to meets its obligations the state would need to double revenue. Here’s the breakdown of Illinois’s state tax revenue:

Sales tax 38%
Business taxes 18%
Fees 14%
Income tax 10%
Other 20%

Presumably, it’s obvious that you can’t double revenue even by doubling income taxes let alone by increasing them by 25 or 30%. Not mathematically possible. Can we double revenue at all? Very doubtful. Doubling the state’s revenue would mean that Illinois would have the highest ratio of taxes to personal income in the nation. The other states with very high ratios (Alaska and Vermont) are distinct cases with conditions that Illinois just doesn’t enjoy. If Illinois doubles its tax rates it won’t realize twice as much money—anybody who can will either leave the state or manage their income in such a way as to avoid the tax.

There’s a desperate problem on the expense side, too. Half of Illinois’s budget is devoted to healthcare and pensions. Not only are these two items the largest budget items, they’re also growing the fastest, expected to increase by 10% year-over-year for the foreseeable future. It can’t constitutionally reduce pensions. Suggesting that Illinois amend its constitution to allow it to cut pensions is dreaming: both houses of the Illinois legislature are dominated by Democrats and public employees are among their core constituencies.

If you need a reason for my continual harping on cutting healthcare costs, that’s a sufficient one.

{ 32 comments… read them below or add one }

michael reynolds January 5, 2011 at 9:10 am

I think you guys may be more screwed than we are in California.

Dave Schuler January 5, 2011 at 9:22 am

I don’t think there’s any doubt about it. It’s what the bond guys have been saying for some time.

IMO the whole debacle illustrates the problems of partisan politics at its very worst. Democrats control both houses of the legislature but Democrats can’t benefit by doing what needs to be done to bring Illinois’s fiscal house in order: increase taxes, change to a defined contribution plan for public pensions, hold public payrolls in line, reduce healthcare spending.

Additionally, Illinois has the problems that an inordinate number of safe seats (Democratic and Republican) bring. Nearly all of its federal representative are regular partisans and, consequently, Illinois’s problems don’t get a great deal of attention from the federal government.

Andy January 5, 2011 at 9:39 am

Just curious Dave, but what would it take to get you to leave the state?

PD Shaw January 5, 2011 at 9:55 am

Since the taxes will primarily be drawn from the bottom quintiles through cigarette, gambling and increases in the flat income tax rate, I’m not sure people or jobs are at serious risk of leaving. I think the bill to force Illinois consumers, primarily businesses, to pay for one or two unneeded coal plant is more hostile, that’s a tax on manufacturing, schools and sanitary districts.

There will be Republican support for an income tax increase, it will just be interesting to see what they get for it.

Dave Schuler January 5, 2011 at 9:56 am

It’s highly unlikely. Basically, my wife would need to get a job that would offer her the equivalent in pay and job satisfaction to the one she has now. And it would need to be somewhere we’d like to live. Given her pay level and how much she likes her job that’s pretty limiting.

I’ll never get another job. I’m just too old. For me to go out looking for a job would require total economic collapse. My clients are all local now (I used to have clients all over the world) and the ones I couldn’t handle remotely I could just drop without affecting my income or their service much.

Dave Schuler January 5, 2011 at 10:02 am

It’s amusing to me that a flat rate has been conflated with a flat tax. Even with Illinois’s single rate much of the revenue from the income tax is from the highest earners. The results of an increase in that rate will probably be to increase revenues a bit, cause some high earners to leave or change how they’re reporting their income, and make the income tax even more regressive than it is now.

But note that a 30% increase in the income tax only results in a 3% increase in revenues (or thereabouts). As I noted in the post, we’d need to double tax revenue to fill the gap and doing that would almost certainly have economic consequences.

Cuts to pensions and healthcare have got to be on the table. That’s just the way the numbers work out.

Dave Schuler January 5, 2011 at 10:05 am

PD does bring up a good point. In every state with casino gambling locals account for a hefty proportion of gambling revenues. I wonder if the powers that be realize how regressive a tax that is.

I have nothing moral against gambling. I just think it’s a losing proposition overall and probably injures the economies of the states that rely on it. I used to have a client that was a major game machine manufacturer. The house always wins.

PD Shaw January 5, 2011 at 10:21 am

Dave, I believe Illinois is the only state with a single flat income tax rate (3%), the effect of which is regressive because of the availability of tax credits and deductions to higher income earners. Neighboring states like Iowa have graduated rates, going from 0.36 % to 8.98%. Generally, Illinois’ taxes are regressive, but the poor and middle-class don’t leave, as long as there are jobs, which is why I think the coal plant issue is a big deal. Of course, higher earners have other options, but Illinois taxes are currently relatively benign to them.

Steve Verdon January 5, 2011 at 11:14 am

If you need a reason for my continual harping on cutting healthcare costs, that’s a sufficient one.

You are totally screwed. If you can’t deal with the pensions, just give up and let things collapse now. If the pension plan is growing at 10%/year it is only a matter of time before that is the entire budget squeezing out everything else…which we know wont happen.

You have two unsustainable growth trends, you cannot solve the problem by making only one sustainable. If one is impossible to fix then there is no solution. Blubbering on about income taxes and sales taxes, etc. is just a distraction.

Change you can believe in, eh?

Oh and my advice: leave the state.

PD Shaw January 5, 2011 at 11:17 am

This link (at page 4) is part of what I was getting at.

Compared with other states, the bottom quintile in Illinois pays the 4th highest percentage of their income in (all) taxes;
The top one percent pays the 40th highest.

Simply doubling the tax rate would probably place the bottom two quintiles into the worst state tax structure in the country; it would probably send the top quintile into the middle.

http://www.itepnet.org/pdf/iltestimony032007.pdf

john personna January 5, 2011 at 11:47 am

Jerry Brown has an interesting proposal for our mess.

Pushing tax-and-spend decisions to the counties would seem to solve the North California, South California problem.

PD Shaw January 5, 2011 at 12:02 pm

steve, Illinois did reform it’s pension system this year by creating a second tier for new hires that is much less beneficial than the existing one. The strategy going forward appears to be push early-retirement, try not to replace workers, if replaced consider using independent contractors, otherwise hire workers with lower salaries and benefits under the second tier. Perhaps long-term this will help.

The short-term problem is that by relying on not paying independent contractors, some of them are declining to continue their jobs or are starting to charge a premium for payment time delay.

Dave Schuler January 5, 2011 at 1:00 pm

jp, that’s an interesting proposal from Brown. Much in the direction that I’d prefer.

As an aside I think it’s worth mentioning that like me (and Iyad Allawi and Ahmed Chalabi), Brown is Jesuit-educated.

Dave Schuler January 5, 2011 at 1:13 pm

It’s a little bit hard to back out of that article, PD, but it can be done. The article is talking about taxes as a proportion of income. I’m talking about taxes paid by the highest earners as a proportion of revenue.

By my back-of-the-envelope calculations, Illinois income taxes account for about half of the revenue derived from the income tax and the taxes paid by the top 1% of income earners (those making more than $395,000) for about a third of that. What I’m suggesting that the top 1% are probably the most likely to either a) bail or b) find a way to avoid paying the increase.

PD Shaw January 5, 2011 at 2:36 pm

I think my linked piece probably works best in state-by-state comparisons since I don’t believe it reveals it’s modeling assumptions. Here by the way, is the report for all states:

http://www.itepnet.org/state_reports/whopays.php

PD Shaw January 5, 2011 at 2:43 pm

jp, I don’t know California well enough to know how that would work. It just appears to be an effort to bypass property tax caps.

For decentralization to work, I think “the people” have to want it to work. Otherwise, somebody unhappy with his city’s decision, will just go up the ladder and reverse it. This leads to attenuated responsibility and unfunded mandates.

john personna January 5, 2011 at 2:49 pm

It may be about the caps, but one interesting thing is that the biggest conservatives (and biggest politically contributing conservatives) are concentrated in one county. Why, this one right here!

Were it to happen, it would be interesting to see if The OC could actually cut their own services, in practice.

john personna January 5, 2011 at 2:54 pm

More, related

Dave Schuler January 5, 2011 at 3:08 pm

Yes, you’re right, jp. It is related. Although the rhetoric employed and the solutions suggested in Illinois might make one believe that Illinois’s problems are cyclic, e.g. borrowing, Illinois’s problems are primarily structural. Somewhere around here I’ve got a post that demonstrates that pretty conclusively using Cook County and its budget as an example. The short version is that if healthcare costs were just growing at the general rate of inflation Cook County wouldn’t have a budget problem and unless healthcare costs are controlled Cook County’s problems can’t be solved by tax increases.

steve January 5, 2011 at 4:44 pm
PD Shaw January 5, 2011 at 6:28 pm

steve, what’s the deal, your link is to a piece dated 2003, but it has comments from 2010. I really want to read about worse states, but Alaska has a cyclical economy and they’ll be fine unless jp gets the government to mandate bicycles and volts.

Sigh, I will always tell me children that 2003 were the salad years . . .

PD Shaw January 5, 2011 at 6:29 pm

I also look forward to an analysis of Illinois’ cyclical versus structural problems, but Dave I think you’re talking about future problems. That’s pretty optimistic.

steve January 5, 2011 at 6:44 pm

@PD- That is weird. The upper right date is Jan 5, 2011. Better, or at least more fun one here. Too lazy to go through my archives and find the best one.

http://www.creditloan.com/infographics/a-state-by-state-comparison-of-debt/

Steve

Dave Schuler January 5, 2011 at 7:16 pm

When you can’t pay today’s bill and at least 48% of the budget faces structural problems, it sounds pretty immediate to me.

john personna January 5, 2011 at 8:54 pm

Volts? Spit.

Drew January 6, 2011 at 9:06 am

Dave -

Heard on the radio today: 1) the votes are not there for an income tax increase, 2) given the schedule of payments, (and its borrowing capcity/bond rating) IL could face a cash flow debacle in 3 months.

Dave Schuler January 6, 2011 at 9:36 am

IIRC Illinois already has the lowest bond rating of any state, lower than California’s.

Democrats have majorities in both houses of the legislature and the governorship. Simple majorities are all that are required. The inability to increase the income tax is not a partisan issue other than that Democrats aren’t willing to take the responsibility (and, possibly, lose their sinecures) for doing it. Like I said, putting the “fun” in dysfunctional.

john personna January 6, 2011 at 9:39 am

Actually PD, you must skate!

http://feeds.boingboing.net/~r/boingboing/iBag/~3/htMVPkyS8Gg/video-of-people-enjo.html

(no, actually you must just pay 10c gas tax, ramping to 1$ in 10 years)

john personna January 6, 2011 at 9:53 am

Dave, I think for good pull you should play off the “California is the Lindsay Lohan of states” idea. Pick someone dead! “Illinois is the John Belushi of states”

That’s the ticket. There is a title.

I even pulled out of my subconscious that he was a native son.

john personna January 6, 2011 at 9:54 am

(Of course, sadly, California killed him)

Drew January 6, 2011 at 7:04 pm

That’s ghoulish, jp.

john personna January 7, 2011 at 7:26 am

It is less funny to me this morning. Though, the world isn’t being too kind to Lindsay either.

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