Illinois voters rejected a high graduated rate income taxA graduated rate income tax system consists of tax brackets where tax rates increase as income increases. Typically, this results in a taxpayer’s effective income tax rate, or the percentage of their income paid in taxes, increasing as their income increases. while Arizonans embraced a large income taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. rate increase for high earners, among the many attention-grabbing results from Tuesday’s elections—most of which, admittedly, weren’t about taxes. Coloradans, meanwhile, ratified an income tax cut in a year that many expected voters to instead be weighing in on a substantial income tax increase—and that was before the pandemic.
Voters, it turns out, still dislike income tax increases, and usually vote for the lower-tax position when the matter is before them on the ballot. The same usually holds true, though perhaps less rigorously, with sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. es. With both of these general taxes, however, and with local property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. increases when they are on the ballot, there is an exception: voters are considerably more willing to consider a tax increase if the revenue is tied to new or enhanced spending they support, often for education or transportation.
Between 2010 and today, when voters have weighed in on income taxes they have chosen the lower-tax option 14 out of 23 times, including 10 out of 17 votes directly on tax rates and levies. Of the seven times voters favored higher rates, four had language tying the increased revenue to education, health care, or transportation expenditures. Most of the failed measures lacked such provisions. Tying income tax increases to education, as was the case in Arizona Proposition 208, may have served to make income tax hikes more attractive to voters, even if doing so increases education funding’s reliance on a more volatile revenue source.
Arizona Proposition 208
Arizona’s Proposition 208 creates an 8 percent top rate on income above $250,000, up from 4.5 percent currently. This bracket will not be adjusted for inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. . This move reverses decades of reform which lowered the state’s top rate from a high of 7 percent and will undermine Arizona’s status as a destination for those fleeing California’s taxes, and for snowbirds looking for a state with mild winters and mild taxes.
Because the new bracket will not be indexed to inflation, this will also result in what is called “bracket creepBracket creep occurs when inflation pushes taxpayers into higher income tax brackets or reduces the value of credits, deductions, and exemptions. Bracket creep results in an increase in income taxes without an increase in real income. Many tax provisions—both at the federal and state level—are adjusted for inflation. ,” where income tax burdens increase even without an increase in real income. A person whose salary increases track with inflation could have the same amount of purchasing power year over year, while the change in the nominal dollar amount of earnings could push more of their income into the higher bracket. Because of this, the new Arizona bracket will capture progressively lower incomes as the value of the dollar decreases.
This subsequent tax increase will be a step backward from a system that has worked well for the state in the past: the income tax produced 185 percent more revenue in 2019 than it did in 1992 (inflation-adjusted) despite—or perhaps partly because of—substantial rate reductions. The state has seen a population boom, benefiting from outmigration from high-tax California, and inflation-adjusted collections have grown at nearly twice the rate of population increases. After this large income tax increase, “snowbirds” may still be attracted to the state for its warm temperatures, but those looking for a pleasant tax climate will be less likely to make Arizona home.
Colorado Proposition 116
Colorado was the only state to give the option to lower income taxes, and voters took the state up on that opportunity. Colorado’s Proposition 116 will permanently lower the state income tax rate from 4.63 percent to 4.55 percent, retroactive to January 1, 2020. In fiscal year 2019, actual tax collections exceeded the revenue cap by $428 million, which triggered a Taxpayer’s Bill of Rights (TABOR) refund in the form of a reduced income tax rate of 4.5 percent for tax year 2019.
While reducing the income tax rate to 4.55 percent for tax year 2020 and beyond would put the rate slightly higher than the rate in effect last year, it would give an estimated $203 million in relief in FY 2021 and $154 million in relief in FY 2022, compared to what would have been collected under current law. At a time when so many are facing economic challenges due to the COVID-19 pandemic, this change will provide some relief to individuals, families, and businesses across the state.
Although state forecasters expect an 11.6 percent decline in general fund revenue collections in FY 2021 compared to FY 2020, revenue collections have been strong in Colorado for some time, with the state expected to close the fiscal year with a nearly $2 billion reserve. State economists also anticipate that the General Assembly will have $2.9 billion more to spend or save in the FY 2022 General Fund than what is budgeted for FY 2021. Notably, Coloradans almost had two choices on the ballot, one of which would have been to raise income taxes substantially. That measure failed to secure enough signatures, though, and voters opted for the cut.
Illinois Allow for Graduated Income Tax Amendment
Meanwhile in Illinois, where Gov. J.B. Pritzker (D) strenuously advocated for Allow for Graduated Income Tax Amendment (the so-called “Fair Tax”), voters refused to bite. They rejected an amendment which would have opened the way to large changes in the state income tax code. The amendment would have removed the constitutional mandate for a flat-rate income tax and allowed the legislature to create a graduated system.
Neighboring Indiana, Iowa, Kentucky, and Missouri have all cut their income taxes in recent years, and, while blocking this amendment may not move the state in the same direction, it at least keeps Illinois from going further down the path to high taxes in one of the few areas where its tax code is not already at a competitive disadvantage with its peers.
The amendment itself did not set rates, but the legislature proactively adopted rate-setting legislation in 2019 that hinged on the passage of this amendment. Senate Bill 687 (Public Act 101-0008) would have established a six-rate personal income tax, with rates ranging from 4.75 to 7.99 percent. A recapture provision means that filers with income in the top bracket would have their entire income, not just their marginal income, subject to the top rate of 7.99 percent.
Meanwhile, the base corporate rate would have increased from 7 to 7.99 percent (10.49 percent counting the personal property replacement tax), in a misguided—and miscalculated—effort to match the new top rate on individual income. When Illinois lawmakers repealed the state’s taxes on tangible personal property 40 years ago, they created a second set of taxes on both pass-through income (1.5 percent) and corporate income (2.5) percent. Once combined with the new graduate corporate rate, the top rate on partnerships, S corporationAn S corporation is a business entity which elects to pass business income and losses through to its shareholders. The shareholders are then responsible for paying individual income taxes on this income. Unlike subchapter C corporations, an S corporation (S corp) is not subject to the corporate income tax (CIT). s, and trusts would have been 9.49 percent and the new rate on corporate income would have been 10.49 percent. The new system would have taken effect on January 1, 2021.
The rates passed by the legislature would only have been a starting point. The legislature could have adjusted rates as they saw fit, and there are compelling reasons to believe that they would have climbed higher and subjected more taxpayers to those higher rates. There were not, in voters’ minds, compelling reasons to make the change.
Voters’ views on income taxes do not cleanly map to partisan preferences. In Colorado, the Democratic governor gestured at support for a rate cut brought to the ballot by conservative groups, and in Illinois, voters who overwhelmingly chose Democratic candidates also rejected a tax increase championed by their Democratic governor.
It’s always dangerous to draw firm conclusions, but if you had to summarize the past decade worth of results on income tax-related ballot measures, it might look like this: voters are wary of tax increases, even when they largely fall on other taxpayers (at least initially), but their willingness to consider the proposed increases is much greater if they’re given a clear picture of what the additional revenue is for and can evaluate whether they think the trade-off is worthwhile. Observers may agree or disagree with voters’ evaluations of those trade-offs, but it says something good about the system that voters clearly care about both costs and benefits.
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