The Bible doesn’t provide much guidance on tax policy, other than suggesting we ought to “give to Caesar what belongs to Caesar.” Fortunately, when it comes to designing a tax system, fiscal policy textbooks have identified three core economic principles that have to be satisfied for a tax system to work in a modern economy. It should be: fair to taxpayers; responsive to where the economy is growing; and stable during poor economic cycles.
Generally, the income tax is used to satisfy two of these core principles: that taxes be imposed fairly, and that they respond to the modern economy. The income tax is used to satisfy these two principles because it is the only tax that can be designed to track ability to pay, by assessing lower tax rates on lower levels of income and higher rates on higher levels of income. This is known as a “graduated” rate income tax.
Creating tax fairness by designing the income tax to correspond with ability to pay is a venerable principle that goes back to 1776 and Adam Smith, the father of capitalism. In The Wealth of Nations, Smith posited that in a capitalist economy, a “fair” tax should “remedy inequality of riches as much as possible, by relieving the poor and burdening the rich.”
Smith contended that would be fair taxation in a capitalist economy, because under capitalism, affluent folks would receive a disproportionate share of income growth over time. IRS data confirm Smith was right. Over the 1979-2016 sequence, the wealthiest 10 percent in America realized 108 percent of all income growth after inflation. If you’re math challenged, 100 percent would be all of it. This means fully 90 percent of all Americans on average earned less in real terms in 2016 than 1979.
So, to treat taxpayers fairly, Illinois needs the flexibility to tax lower levels of income at lower rates than higher levels of income–something the state Constitution prohibits. This makes Illinois a national outlier. Of the 41 states with an income tax, 33 have fair, graduated rate structures. Illinois doesn’t. According to a national study, that’s a primary reason Illinois ranks as one of the three most unfair taxing states in America–imposing tax burdens on low- and middle-income families which are more than double that of millionaires.
That’s not only unfair, but also makes no fiscal sense. Focusing taxes on low- and middle-income families, who are losing income in real terms over time, means tax revenue growth can’t keep pace with economic growth over time. Remember that to work, taxes have to respond to where the economy is expanding, not contracting. That’s why the lack of fairness in Illinois’ tax policy contributes to the state’s long-term structural deficit. A “structural deficit” exists when, adjusting solely for inflation and population growth and assuming a normal economy, revenue doesn’t increase at a rate sufficient to maintain current service levels from year-to-year.
As for deficit scolds who maintain Illinois has a spending not a revenue problem–there’s simply no data to support that canard. In fact, since FY2000, Illinois has cut spending on the core services of Education, Healthcare, Social Services and Public Safety by some $6.6 billion in real terms, and will be spending 21 percent less on those services in FY2018 than in FY2000.
Won’t taxing rich folks more scare millionaires out of Illinois and tank its economy? Well, no. Here’s why. No peer reviewed study has found that tax policy has a statistically significant correlation to domicile choices by people generally or millionaires specifically. Housing costs, location of family members, weather and job considerations are what matter.
There’s also no evidence it’ll kill the economy. Over the last decade, the nine states in America with the highest income tax rates on wealthy people had better growth in state GDP per capita and better change in median wage than the nine states that have no state income taxes at all–including Texas and Florida. In fact, the evidence overwhelmingly indicates there’s no meaningful correlation between state tax policy and economic competitiveness–other things matter far more, like public sector investment in education and infrastructure, or availability of natural resources and climate-based advantages (think palm trees and beaches).
Moreover, given that nine out of 10 workers earn less after inflation today than 30 years ago, using a fair rate structure to cut their taxes means they’ll likely spend their tax relief buying stuff. This’ll stimulate the economy, because around 68 percent of all economic activity is consumer spending. Meanwhile, increasing taxes on wealthier folks won’t diminish their spending, given the dramatic real income growth they’ve realized over time. The bottom line: Amending the state constitution to allow imposition of a fair, graduated rate income tax would be a positive step forward for Illinois.
Editor’s note: This article is the first in a series on taxation.
Executive Director of the Center for Tax and Budget Accountability and Arthur Rubloff Professor of Public Policy at Roosevelt University. CTBA is a bipartisan 501(c)(3) think tank committed to ensuring that state, federal and local workforce, education, fiscal, economic and budget policies are fair and just, and promote opportunity for all, regardless of race, ethnicity or income class.