Fiscal Fact No. 20
As Illinois state lawmakers consider changes to their 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. 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 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. rate from 3 percent to 5 percent;
- increasing the 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. 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 baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. .
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 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. 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 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. ; 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 TaxA gross receipts tax, also known as a turnover tax, is applied to a company’s gross sales, without deductions for a firm’s business expenses, like costs of goods sold and compensation. Unlike a sales tax, a gross receipts tax is assessed on businesses and apply to business-to-business transactions in addition to final consumer purchases, leading to tax pyramiding. 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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