Evaluating the Proposed Tax Changes in Illinois Governor’s FY 2025 Budget

In his FY 2025 budget, Illinois Gov. J. B. Pritzker (D) outlined numerous proposed 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. changes. On net, these changes—mostly tax increases—would increase state tax revenues by nearly $900 million to help fill a projected budget deficit while increasing spending. Specifically, individual and corporate income taxes, state sales taxes, and sports betting excise taxes would increase, while the only substantial reduction (from a revenue standpoint) would reduce local, not state, revenues.

Modified Inflation IndexingInflation indexing refers to automatic cost-of-living adjustments built into tax provisions to keep pace with inflation. Absent these adjustments, income taxes are subject to “bracket creep” and stealth increases on taxpayers, while excise taxes are vulnerable to erosion as taxes expressed in marginal dollars, rather than rates, slowly lose value. of the Personal Exemption

Among the tax increases is a proposal to suspend the state’s standard procedure 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. indexing its personal exemption. Illinois’ personal exemption had been adjusted annually for inflation since 2013, but the FY 2024 budget suspended the 2023 adjustment, keeping the exemption at its 2022 level of $2,425. That budget also restored standard indexing practices for 2024-2028 instead of allowing the exemption to decrease to $1,000, as it was previously scheduled to do after 2023. Had standard indexing practices continued, the exemption would have been $2,625 in 2023, the largest inflation adjustment to date, since 2022 inflation levels were the highest the U.S. has seen since 1981.

Standard indexing procedures have resumed, bringing the exemption to $2,775 for 2024, but the FY 2025 budget proposes setting the exemption at $2,550 instead. This amount appears to have been calculated by adjusting for inflation that occurred between 2022 and 2023 only. By disallowing the standard adjustment for cumulative inflation since 2011, Illinois would, for tax year 2024, essentially “skip” accounting for inflation that occurred in 2022, treating taxpayers as if the record-breaking price increases they experienced that year did not occur. This would increase individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. collections by approximately $93 million.

Illinois is one of nearly two dozen states that typically indexes its personal exemption and/or standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. , and doing so is an important way to preserve the real value of these benefits over time. It is important to keep in mind that, to preserve the real value of Illinois’ personal exemption, inflation indexing must occur in perpetuity. Policymakers should therefore consider allowing a full adjustment to $2,775 for 2024, in addition to making Illinois’ personal exemption amount and standard indexing practices permanent to provide certainty to taxpayers beyond 2028.

Extending the Net Operating Loss Deduction Cap

Because corporate income taxes are designed to fall on net profits—or revenues less expenses—corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. codes account for the years in which companies do not turn a profit. They do this by offering net operating loss (NOL) deductions, whereby losses that occur in a given year can be carried forward and deducted from taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. in future profitable years.

NOL deductions help ensure corporate income taxes fall on a company’s average profitability over time. Without them, corporations in cyclical industries—with profits in some years and losses in others—would pay substantially higher taxes than those in stable industries, even assuming identical average profitability over time.

During the pandemic, the federal CARES Act provided aid to businesses by temporarily allowing more generous treatment of NOLs. In authorizing these provisions, including NOL carrybacks, Congress recognized that allowing businesses to deduct losses as soon as possible was one valuable way to help them stay afloat amid pandemic-related closures and uncertainty.

However, Illinois was one of two states—California being the other—that took the opposite approach, temporarily limiting NOL deductibility to boost short-term revenues to the state. Specifically, Illinois imposed a strict $100,000 cap on NOL deductions in tax years ending on or after December 31, 2021, and before December 31, 2024. By requiring businesses to wait in some cases many years to deduct past losses, this cap causes businesses to appear more profitable on paper than they are in reality, reducing their cash on hand while bolstering short-term revenues for the state. Now, to generate approximately $526 million in additional revenue, instead of allowing the cap to expire as scheduled, Gov. Pritzker has proposed extending the cap through 2027, while raising the annual limit slightly to $500,000.

Besides Illinois, New Hampshire is the only other state to impose a specific annual dollar amount limitation on NOL deductibility, but New Hampshire’s cap is 100 times more generous, at $10 million. California, the only other state that imposed strict temporary restrictions on NOLs during the pandemic, suspended NOLs entirely for 2020-2021 for corporations with taxable income of $1 million or more. That NOL suspension was originally scheduled to last three years, but Gov. Gavin Newsom (D) signed a bill to restore full NOL deductibility starting in 2022. Illinois should likewise act quickly to restore full NOL deductibility and put this economically harmful pandemic-era revenue raiser in the past. Failure to do so would make Illinois an outlier among states in its highly stingy treatment of business losses, including losses incurred during state-mandated business closures during the pandemic.

Raising the Sports Betting Excise TaxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections.

The governor’s budget also proposes increasing the excise tax on sports betting operators from 15 to 35 percent of adjusted gross sports wagering revenue. Currently, sports gambling revenue goes to the capital projects fund, but the budget proposes depositing revenue from the tax increase into the general fund.

At 15 percent, Illinois already taxes sports betting more heavily than most nearby states. Furthermore, excise taxes are most effective as a tool to address a specific issue related to the good or activity being taxed, such as funding public efforts to reduce problem gambling. The governor’s call for extra revenue to be sent to the general fund suggests no extra funds are needed for problem gambling. Absent a rise in problem gambling and a need for additional revenue to address such issues, increasing the sports gambling tax rate lacks economic justification and threatens to lure participants back to illicit markets.

Increasing the Corporate Franchise Tax ExemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax.

Illinois is one of 15 states levying a capital stock tax, also known as a franchise tax, whereby corporations pay an annual tax on the value of their property or paid-in capital. These taxes are economically harmful because they penalize investment in Illinois and are owed even when a corporation does not turn a profit. Additionally, Illinois’ franchise tax carries steep compliance burdens despite generating a relatively small amount of revenue.

In 2019, Gov. Pritzker signed a law phasing out Illinois’ franchise tax by increasing the exemption over time. The tax was scheduled to phase out altogether by 2024, but the FY 2022 budget reversed that phaseout, freezing the exemption at $1,000. The exemption has since increased to $5,000, and the governor’s budget proposes raising the exemption to $10,000, the level it would have been set to in 2022 had the phaseout proceeded as planned. Increasing the exemption is an important step toward removing this tax from the books altogether, as was intended in 2019.

Ending the State’s 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. on Groceries

Illinois levies a statewide sales tax on groceries at a preferential rate of 1 percent, substantially lower than the 6.25 percent general sales tax. While the sales tax on groceries is administered by the state, the revenue is distributed to local governments.

Many local officials have expressed concerns that the governor’s proposal would not offset the lost local revenue. A decision by state lawmakers to eliminate the tax would mean local governments would lose a substantial, and relatively stable, source of revenue. While some jurisdictions may be able to afford a tax cut, others would be left scrambling to raise taxes to recoup the lost revenue, which could leave taxpayers worse off.

Capping the Retailers’ Discount on Sales Taxes Due

Governing entities collect property taxes directly, but in levying sales taxes, governments rely on retailers to collect the appropriate taxes and remit them to the state. To partially offset compliance costs, states typically allow retailers to keep a portion of the sales tax revenues they collect. Currently, Illinois allows retailers to retain 1.75 percent of sales taxes collected, but the governor’s budget would impose a $1,000 per month cap.

This cap amount pales in comparison to actual sales tax compliance costs incurred by many retailers. In one survey, retailers who conducted their own sales tax compliance activities reported spending an average of over $24,000 per month on sales tax compliance. Capping the discount would increase retailers’ compliance costs at a time when sales tax complexity is especially high following South Dakota v. WayfairSouth Dakota v. Wayfair was a 2018 U.S. Supreme Court decision eliminating the requirement that a seller have physical presence in the taxing state to be able to collect and remit sales taxes to that state. It expanded states’ abilities to collect sales taxes from e-commerce and other remote transactions. .

Creating a Targeted Child Tax CreditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly.

Finally, the governor’s budget proposes creating a child tax credit for qualifying lower-income taxpayers with children aged two and under. The credit would equal 20 percent of the taxpayer’s Illinois earned income tax credit (EITC) amount, and, as a refundable credit, would result in some taxpayers receiving a net payment from the state instead of owing tax liability. Illinois already has a refundable EITC, so the proposed credit would be somewhat duplicative in increasing the total credit amount received by a subset of EITC recipients.

As Illinois lawmakers deliberate on the budget this legislative session, careful consideration should be given to the consequences of each of these proposed tax changes.

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