Illinois “Index Analysis”: The Potential Impact of HB 750

February 7, 2005

Fiscal Fact No. 20

As Illinois state lawmakers consider changes to their tax system in 2005, they should pursue those changes that will make their state more attractive to business investment, and eschew those changes that will drive labor and capital to other states and countries.

The Tax Foundation developed its State Business Tax Climate Index to rank the features of a state’s tax system that are most helpful in seeking and attracting new investment in the competitive international economy. A rational, competitive tax climate is essential to a state’s fiscal health and is therefore a crucial component of a state’s overall business climate.

This analysis explores Illinois House Bill 750, a bill introduced last year in the Illinois Legislature, and it’s potential impact on Illinois’ ranking in the Index.

HB 750 would raise corporate and individual income taxes as well as state sales taxes. According to the Index, these tax increases would make Illinois’ business tax climate more hostile to business investment, less competitive in attracting new jobs, and would harm Illinois’ ability to keep jobs currently located there. If the provisions of HB 750 had been in effect when the latest Index rankings were calculated, Illinois, which ranks 23rd best in the Index and third-best compared to surrounding states, would have dropped to 38th and fourth-best compared to surrounding states.

Index Analysis Illinois House Bill 750 would make significant changes to Illinois’ tax system, including:

  • increasing the individual income tax rate from 3 percent to 5 percent;
  • increasing the corporate income tax from 7.3 percent to 10.5 percent;
  • raising the individual income tax on retirees making over $75,000 per year;
  • extending the state sales and use tax bases to services that are currently not taxed; and
  • expanding the corporate tax base.

These tax increases would generate approximately $7 billion per year in additional revenue for the state, to be used for additional school funding, closing the state’s “structural deficit”, tax credits for low income individuals, and property tax relief.

Table 1:HB 750’s Impact on Illinois’ Top Tax Rates and Index Ranking Compared with Neighboring States

State

Top Corporate Tax Rate

Top Individual Tax Rate

Overall Index Ranking

Illinois (with HB 750)

10.5% (up from 7.3%)

5% (up from 3.0%)

38 (up from 23rd)

Indiana

8.5%

3.4%

12

Iowa

12%

8.98%

28

Kentucky

8.25%

6%

44

Missouri

6.25%

6%

11

Wisconsin

7.9%

6.75%

41

Source: Tax Foundation

These policy changes were assessed using the State Business Tax Climate Index. The Index ranks five key features of a state’s tax climate: the corporate income tax; the personal income tax; the sales tax; the unemployment insurance tax; and the state’s overall fiscal balance. These five subindexes tier up to a national ranking.

Corporate Income Tax Currently, Illinois’ corporate income tax ranks 23rd in the corporate income tax subindex. HB 750 would raise corporate tax rates and expand the base by eliminating corporate tax “loopholes.” This causes Illinois’ ranking on corporate taxes to fall drastically to 47th.

Individual Income Tax Illinois’ personal income tax currently ranks 11th in the individual income tax subindex. Among those states that tax wages and salaries, Illinois has the second-highest rated state income tax in the Index. HB 750 would raise personal income taxes by increasing the rates and by including retirement income (e.g., pensions and social security) in the tax base for retirees with adjusted gross incomes in excess of $75,000 per year. These changes would cause Illinois’ ranking on personal income taxes to fall to 18th, and allow neighbor Indiana to have, among those states that levy it, the best rated personal income tax in the Index.

Sales and Gross Receipts Tax The current ranking of Illinois in the sales and gross receipts tax subindex is 42nd. HB 750 would change the sales tax by expanding the tax base to include personal services like repair and cleaning. This would entail a major cost increase for businesses that use these services, and these costs will be passed on to consumers in the form of higher prices. This causes Illinois’ ranking on sales taxes to fall to 46th.

Overall, these tax changes would significantly alter Illinois’s standing in the Index relative to other states. HB 750 causes Illinois’ final Index ranking to fall fifteen spots from 23rd to 38th.

Table 2: HB 750’s Impact on Illinois’ Current Ranking in the State Business Tax Climate Index*

Corporate Income Tax Subindex

Individual Income Tax Subindex

Sales and Gross Receipts Tax Subindex

Overall Index

Original Rank

23

11

42

23

Final Rank

47

18

46

38

Rank Change

-24

-7

-4

-15

*Note: No changes to UIT or Fiscal Indexes.Source: Tax Foundation

Policy Analysis and Conclusion HB 750 disguises painful tax increases as revenue enhancements designed to support the public infrastructure necessary to maintain a healthy business climate. While some public infrastructure improvements can help a state economy, the economic damage inflicted by the tax increases in HB 750 would far outweigh any contemplated benefits. These negative impacts are quantified in the fact that HB 750 would lower Illinois’ ranking in the Index to 38th from 23rd.

State lawmakers will always face higher spending demands. Raising taxes, particularly in an era of mobile labor and capital, is not the right way to meet those demands. Lawmakers who want to maintain quality schools, roads and health systems in the 21st century must first create a business tax climate that attracts business investment and jobs. A healthy Illinois economy is the surest source of stable revenue to support necessary public infrastructure.


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