The Center's work on 'Taxes' Issues


In Illinois, a Chance to Fix a Constitutional Flaw

April 23, 2014 at 1:04 pm

Illinois’ constitution has a requirement that is quite unusual among states:  the state must have a single-rate income tax, meaning that middle-income taxpayers pay income tax at the same rate as the state’s wealthiest.  This provision has been a fiscal and economic failure.  Now lawmakers are considering a fix that would benefit the state’s middle-income taxpayers and economy for the long term.

When Illinois enacted the single-rate rule in 1970, the income gap between the wealthy and everyone else nationwide had been falling for several decades.  Since the 1970s, however, the top 5 percent of Illinoisans’ incomes have risen 123 percent — six-and-a-half times the rate for middle-income households (see chart).

In other words, most of the income benefits of the state’s economic growth since 1970 have accrued to the wealthy, and Illinois today has the nation’s ninth-highest level of income inequality.

The single-rate income tax is bad enough for middle-income households.  Other major revenue options, like sales or property tax increases, are even tougher on low- and middle-income families.  Indeed, accounting for all forms of state and local taxation, the Institute on Taxation and Economic Policy reports that Illinois’ tax structure is the nation’s fourth most lopsided in favor of those with high incomes, with the top 1 percent of taxpayers (with average income of $1.5 million) paying less than half as much of their income in taxes than the 80 percent with incomes below $93,000.

In part because of its limited revenue options, Illinois for many years did not raise enough tax dollars to cover its costs.  The state accrued nearly $10 billion in unpaid bills to doctors, child care centers, and other service providers, and it fell far behind on its pension payments. A temporary income tax increase enacted in 2011 has helped the state to slash the backlog of unpaid bills, but the state’s fiscal challenges remain large.

Nor has the flat-rate requirement helped Illinois’ economy.  Unemployment in Illinois remains well above the national average, and much higher than neighbors like Minnesota and Missouri that have multi-rate taxes.  (In fact, Minnesota last year raised taxes on its highest-income residents, with no economic harm, contrary to opponents’ predictions.)  A plethora of academic studies, as well as states’ direct experience, show that personal income tax rates have essentially no relationship to economic growth.

In the coming days, Illinois’ legislature will consider whether to give voters the option of fixing the flawed single-rate mandate.  A proposed constitutional amendment would enable Illinois to impose different rates on different levels of income, an option that all but a handful of other states already have.  This change could allow the state to fully pay its backlog of bills; better fund schools, parks, and roads; or meet other needs without imposing the greatest burden on middle-income Illinoisans.

The Top 5 (Okay, 6) State Tax Charts

April 14, 2014 at 1:51 pm

As we approach Tax Day, here are six charts focusing on state taxes.

More than half of state tax dollars go to fund education (K-12 and higher education) and health care, as the chart below shows.  State tax dollars also fund other critical services such as transportation, corrections, public assistance, care for residents with disabilities, police, state parks, and general aid to local governments.

State revenue losses from the Great Recession were both deeper and longer lasting than in previous recessions, as the chart below shows.  Not until the end of 2013 did revenues finally return to pre-recession (2007) levels, after adjusting for inflation.  But, the steady revenue increases of recent years offer states an opportunity to reinvest in education and other services that sustained unprecedented cuts during the recession.

While revenues have slowly recovered in most states, Kansas has moved in the opposite direction, as the chart below shows.  Kansas slashed income taxes, especially for businesses and wealthy Kansans, even as needs — like the number of K-12 students — have grown.  Revenues fell by more than 9 percent in Kansas in 2013.  Meanwhile, there is no evidence that the tax cuts have boosted the Kansas economy.

Five of the seven states that have made the deepest cuts to K-12 education since the beginning of the recession have also enacted major income tax cuts, as the chart below shows.  These tax cuts eliminated revenue that could have helped states reverse the deep funding cuts from the recession and invest in promising education reforms.

As the chart below shows, low-income families pay significantly more of their income in state and local taxes than very wealthy families.  State and local taxes push many families into — or deeper into — poverty.

A state Earned Income Tax Credit (EITC) is one powerful tool to prevent state and local taxes from pushing low-income working families deeper into poverty.  Twenty-five states and Washington, DC, have their own EITCs, as the map below shows.  A state credit builds on the federal EITC’s proven effectiveness in helping low-income working families make ends meet.  States looking to encourage work and reduce poverty, especially among children (the federal EITC lifts more children out of poverty than any other program), should considering enacting or expanding an EITC.

Just the Basics: Where Our State Tax Dollars Go

April 11, 2014 at 9:40 am

As Tax Day approaches, we’ve updated several backgrounders that explain how the federal government and states collect and spend tax dollars.  As policymakers and citizens weigh key decisions on how best to shape our future government, it’s helpful to examine where the dollars that comprise the budget come from and where they go.

The final installment in our series of revised “Policy Basics” backgrounders explains where our state tax dollars go.

In total, the 50 states and the District of Columbia spent a little more than $1 trillion in state revenues in fiscal year 2012, according to the most recent survey by the National Association of State Budget Officers.  (This figure does not include the federal funds that states also spent that year.)

By far the largest areas of state spending, on average, are education (both K-12 and higher education) and health care.  But states also fund a wide variety of other services, including transportation, corrections, pension and health benefits for public employees, care for persons with mental illness and developmental disabilities, assistance to low-income families, economic development, environmental projects, state police, parks and recreation, housing, and aid to local governments (see chart).

The figure above shows how states spend their tax dollars on average for the entire country.  But the specific mix of spending varies from state to state, depending on such factors as how the state and its localities share funding responsibilities for public services and how much state policymakers choose to invest in health care, education, and other areas.

Click here to read the full backgrounder.

“Tax Freedom Day” Analysis Can Give a Misleading Impression of Tax Burdens

April 7, 2014 at 5:01 pm

We explain the problems inherent in the Tax Foundation’s annual “Tax Freedom Day” analysis in a new paper.  Here’s the opening:

The Tax Foundation released its annual “Tax Freedom Day” report today that, once again, can leave a strikingly misleading impression of tax burdens — showing an average federal tax rate across the United States that’s likely higher than the tax rate that 80 percent of U.S. households actually pay (see chart).

To project the day when “the nation as a whole has earned enough money to pay its total tax bill for [the] year,” the Tax Foundation calculates the average tax rate by measuring tax revenues as a share of the economy (similar to estimates of total revenues as a share of Gross Domestic Product, or GDP).

In a progressive tax system like that of the United States, only upper-income households on average pay federal tax at rates that are equal to or above federal revenues as a share of the economy.  Estimates from the nonpartisan Urban-Brookings Tax Policy Center show that low- and middle-income households (about 80 percent of all households) will pay a smaller share of their income in federal taxes this year than the Tax Foundation’s average tax rate.

The Tax Foundation acknowledges this issue in a methodology paper accompanying its report, noting that its estimates reflect the “average tax burden for the economy as a whole, rather than for specific subgroups of taxpayers.”  Consequently, those who report on Tax Freedom Day as if it represents the day until which the typical American must work to pay his or her taxes are misinterpreting these figures and inadvertently fostering misimpressions about the taxes that most Americans pay.

Click here to read the full report.

5 Reasons Other States Shouldn’t Follow Kansas’ Tax-Cutting Lead

March 27, 2014 at 3:11 pm

One of the largest tax cuts any state has ever enacted took effect in Kansas at the beginning of last year.  The state sharply reduced its income tax rates and fully exempted certain business profits from taxation.  It also adopted a plan to cut income tax rates even further over the next few years.

Now, in a number of other states, proponents of tax cuts are saying that Kansas’ approach is a model for how to grow a state’s economy.  As we explain in our new paper, Kansas is anything but.  In fact, it’s a cautionary tale for five major reasons.

  1. Deep income tax cuts caused large revenue losses.  Kansas’ tax cuts this year are costing the state about 8 percent of the revenue it uses to fund schools, health care, and other public services, a hit comparable to a mid-sized recession.  State data show that the revenue loss will rise to 16 percent in five years if the state does not reverse the tax cuts.
  2. The revenue losses extended and deepened the recession’s damage to schools and other state services.  Most states are restoring funding for schools after years of significant cuts, but in Kansas the cuts continue (see chart).  Governor Sam Brownback recently proposed another reduction in per-pupil general school aid for next year, which would leave funding 17 percent below pre-recession levels.  Funding for other services — colleges and universities, libraries, and local health departments, among others — also is way down, and falling.
     
  3. The tax cuts delivered lopsided benefits to the wealthy.  Kansas’ tax cuts didn’t benefit everyone.  Most of the benefits went to high-income households.  Kansas even raised taxes for low-income families to offset part of the revenue loss; otherwise the cuts to schools and other services would have been greater still.
  4. Kansas’ tax cuts haven’t boosted its economy.  Since the tax cuts took effect at the beginning of 2013, Kansas has added jobs at a pace modestly slower than the country as a whole.  Average earnings fell more in Kansas in the year after the tax cut than in the rest of the country over the same period, while non-farm personal incomes rose less in Kansas than the nation as a whole. And so far there’s no evidence that Kansas is enjoying exceptional business growth: the number of registered businesses grew more slowly last year than in 2012, and the state’s share of all U.S. business establishments fell over the first three quarters of last year, which is the latest data available.
  5. There’s little evidence to suggest that Kansas’ tax cuts will improve its economy in the future.  No one knows for certain how Kansas’ economy will perform in the years ahead, but it isn’t likely to stand out from other states.  The latest official state revenue forecast, from November 2013, projects Kansas personal income will grow more slowly than total national personal income in 2014 and 2015.

Kansas’ tax cuts have meant big revenue losses and continued cuts in schools, colleges, and other services, with no noticeable economic gains.  That’s not a recipe that other states should want to follow.

Click here to read the full paper.