Progressive income tax: Money grab disguised as tax reform

The problem

by Ted Dabrowski, Vice President of Policy and Lawrence J. McQuillan, PhD Chief Economist Oct. 10, 2012*

In an interview with Huffington Post, Gov. Pat Quinn said that Illinois needs a progressive income tax.1 Thats one of my goals before I stop breathing and I sure hope we can get that done in Illinois. Sooner rather than later, he told the interviewer. The same forces that helped Quinn land the governorship in 2010 and raise income taxes in 2011 are laying the groundwork for his progressive tax initiative. A progressive income tax (also called a graduated income tax) taxes individual income at ever-higher marginal tax rates as income rises. State Sens. Michael Frerichs (D-Champaign), Kwame Raoul (D-Chicago) and Toi Hutchinson (D-Chicago Heights) have attended events in support of a progressive income tax.2 Also in favor of a progressive income tax are Senate President John Cullerton (D-Chicago) and Rep. Naomi Jakobsson (D-Urbana). Keith Kelleher, president of the Service Employees International Union (SEIU) Healthcare Illinois and Indiana, and Henry Bayer, executive director of the American Federation of State, County and Municipal Employees (AFSCME) Council 31, the largest union representing state government employees, also support a progressive tax.3 Both the Illinois Education Association and the Illinois Federation of Teachers ask political candidates who take their 2012 candidate questionnaires if they would support a constitutional amendment on the ballot to implement a graduated income tax. And in January 2012, the liberal activist group Citizen Action/Illinois posted a job advertisement that read: Illinois major progressive forces, including its leading citizen activist groups, human services advocates and labor unions, are combining efforts to wage a multiyear battle for tax justice, culminating in a constitutional amendment referendum in 2014. We are seeking a . . . director of [a] statewide, threeyear legislative and referendum campaign to amend the Illinois Constitution and enact a graduated state income tax.4 This job position was filled in April 2012. A union-funded group in Chicago, the Center for Tax and Budget Accountability (CTBA), has formalized a plan for a progressive income tax. In February 2012, the CTBA released a report titled The Case for Creating a Graduated Income Tax in Illinois, which claims a graduated income tax rate structure could reduce taxes for 94 percent of Illinois taxpayers and raise at least $2.4 billion more in revenue than the current five-percent flat tax.5 But the truth is that a progressive income tax will mean higher taxes for middle-class Illinoisans and destroy needed jobs for the poor and working families.
*This paper was updated on October 16, 2012 to compare the CTBAs progressive-tax scheme to both the sunset and a repeal of the 2011 tax hike.

Before Illinois flat income tax could be converted to a progressive tax, the Illinois Constitution would have to be amended. This is because its Revenue Article states: A tax on or measured by income shall be at a non-graduated rate. Currently, Illinois has a flat tax on personal income of 5 percent, which was increased by 67 percent in 2011 from the previous rate of 3 percent. Under current law, the increase will begin to sunset on Jan. 1, 2015 by falling to 3.75 percent, and then fall again to 3.25 percent on Jan. 1, 2025. The CTBA and its allies are hoping to get approval for a progressive tax by three-fifths majorities in both chambers of the Illinois General Assembly 36 senators and 71 representatives to put the question to voters in a general election. Lawmakers would have to approve a progressive tax amendment by early May 2014 to be included on the November 2014 ballot. The earliest that a progressive tax could go into effect, therefore, would be 2015. But supporters are already laying the groundwork and beginning the campaign to get this measure on the ballot in 2014 and approved by either 60 percent of those voting on the question or a majority of those voting in the election. The CTBA progressive tax plan circulating around the state would impose eight ever-higher marginal tax rates, topping off at 11 percent (see Table 1 below). This would tie Illinois with Hawaii for having the highest top income tax rate.
Table 1. The CTBAs progressive tax structure Illinois would tie for highest top marginal rate in the U.S.

Marginal tax rate 0.0% 5.0% 7.5% 8.5% 9.5% 10.0% 10.5% 11.0%

Base income range <$05,000 $5,001100,000 $100,001150,000 $150,001200,000 $200,001300,000 $300,001500,000 $500,0011,000,000 $1,000,001 and above

Percentage of returns that will pay each marginal rate 14.54 72.42 6.87 2.36 1.69 1.01 0.63 0.48

Source: Table developed by Lawrence J. McQuillan from data in Center for Tax and Budget Accountability, The Case for Creating a Graduated Income Tax in Illinois (Chicago: Center for Tax and Budget Accountability, 2012), p. 10

Supporters of the progressive tax are doing everything in their power to increase state spending now to justify no sunset of the 2011 tax hike and to be able to argue for even steeper progressivity in the future. These suggested marginal tax rates are only conversation starting points. In fact, the CTBA already favors state spending increases in excess of the $2.4 billion they hope to raise with the progressive income tax, meaning these marginal tax rates are only their starting points and will likely increase.6 There are many myths underlying the CTBA scheme that will be exposed in this report, but a central myth is its claim that the plan would cut taxes for 94 percent of Illinois taxpayers. In reality, the CTBA scheme will increase taxes on 85 percent of filers because the plan assumes the 2011 income tax rate hike will not sunset as scheduled under current law. It is scheduled to fall to 3.75 percent in January 2015. But notice that the CTBAs tax rates, which could not go into effect until 2015, use the current 5 percent rate, not the sunset 3.75 percent rate. CTBAs tax rates also are higher than the rate in House Bill 175, a bill supported by 41 legislators in the 97th General Assembly that would repeal the 2011 tax hikes and return the personal income tax rate to the 2010 level of 3 percent.
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As a result of the 2011 temporary tax hikes being made permanent, the CTBA plan will actually raise taxes by $6.4 - 8.64 billion annually instead of the $2.4 billion they advertise (see Figure 1 and 2 below).
Figure 1. Higher annual taxes with the CTBAs progressive tax scheme As compared to sunset of 2011 tax increase.

$6.4 billion
$4 billion

Total higher annual taxes Higher taxes in 2015 due to not sunsetting the 2011 income tax hike as scheduled current law (CBTA assumes hike will not sunset)

$2.4 billion

Higher taxes in 2015 from the CTBAs progressive rates

Source: Graphic developed by Lawrence J. McQuillan from data in Center for Tax and Budget Accountability, The Case for Creating a Graduated Income Tax in Illinois (Chicago: Center for Tax and Budget Accountability, 2012); and Commission on Government Forecasting and Accountability, Revenue Bill Analysis P.A. 96-1496 (SB 2505), Jan. 13, 2011.

Figure 2. Higher annual taxes with the CTBAs progressive tax scheme As compared to repeal of 2011 tax increase.

$8.64 billion Total higher annual taxes

Higher taxes in 2015 compared to the 2010 tax rate of 3 percent

$6.24 billion

$2.4 billion

Higher taxes in 2015 from the CTBAs progressive rates

Source: Graphic developed by Lawrence J. McQuillan from data in Center for Tax and Budget Accountability, The Case for Creating a Graduated Income Tax in Illinois (Chicago: Center for Tax and Budget Accountability, 2012); and Commission on Government Forecasting and Accountability, Revenue Bill Analysis P.A. 96-1496 (SB 2505), Jan. 13, 2011.

No state can tax itself to prosperity. A progressive income tax would be disastrous for the people of Illinois and the states economy because it would slow economic growth, kill jobs and make state budget deficits larger. It would be yet another anti-growth money grab to plague the state.
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This report exposes the myths underlying the progressive tax and highlights its problems and pitfalls in three main sections: (1) The national tax environment and competitiveness A progressive tax will send Illinois already high taxes even higher A progressive tax is being rejected by other states in favor of low, flat rates (2) How the progressive tax hurts you A progressive tax will creep into the middle classes A progressive tax punishes success at ALL income levels (3) How the progressive tax hurts the economy and state budgeting A progressive tax hurts job creation and economic growth A progressive tax is morally unfair, predatory and punitive A progressive tax is a recipe for budgeting disaster

(1) The national tax environment and competitiveness

A progressive tax will send Illinois already high taxes even higher
The purpose of taxation is to finance constitutionally-prescribed government activities. In a free society, taxes should influence private-sector decisions as little as possible. Today, however, taxes influence every major family decision from when and where to buy the family car and home, to which job to accept, to how much money to save for childrens education or parents retirement, to whether one can afford health insurance. The CTBA wants to increase taxes on hard-working Illinoisans. But Illinois is already a high-tax state. Table 2 shows that Illinois has the 13th highest combined state and local tax burden nationally. The Tax Foundation, a Washington, D.C.-based tax research group, arrived at the ranking by calculating the total amount of state and local taxes paid by residents in each state, and then dividing those taxes by the states total income to compute the tax burden. A typical Illinoisan pays $4,596 each year in state and local taxes, or 10 percent of income. No neighboring state pays more taxes per person, and only Wisconsin residents pay a larger share of their income to taxes (11 percent). Illinois is 8th highest when considering just total taxes paid to the state of residence (the home state).
Table 2. Total state and local taxes paid per person in Illinois and neighboring states, 2009 Illinois ranks 13th highest Percent of Income
(1 is heaviest burden nationally)

Rank

State

Indiana Iowa Kentucky Missouri Wisconsin

Illinois

10.0 9.5 9.5 9.3 11.0 9.0

25 24 30 34 4

13th
th th th th th

Taxes paid to home state per capita

$3,418 $2,501 $2,657 $2,227 $2,378 $3,418

Taxes paid to other states per capita

$1,177 $1,031 $1,047 $1,009

Total state and local taxes paid per capita

$895 $833

$4,596 $3,396 $3,688 $3,059 $3,425 $4,427

Income per capita

$46,079 $35,767 $38,688 $32,959 $37,853 $40,321

Source: Tax Foundation, most recent data available

Because Illinois total state and local tax burden is greater than all its neighbors except Wisconsin, from 1992 to 2009 Illinois has lost more income to its neighbors than it has gained.7 People and other income-generating assets have left Illinois in search of higher after-tax returns. The 2011 income tax hikes made Illinois income tax burden greater compared to the other states. Illinois ranking of total state income taxes paid measured either by per capita or as a percentage of personal income worsened by 10 places from fiscal year 2010 to fiscal year 2011.8 This sharp 10-place fall occurred even though the tax hikes were in effect for only half of the 2011 fiscal year, from January 2011 onward. Illinois is a high-tax state. The progressive tax increase in 2015 would burden Illinois taxpayers even more and make the state a less attractive place to live, work and start a new business.
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A progressive tax is being rejected by other states in favor of low, flat rates
Table 3 shows the nine states that do not tax personal income. They are scattered around the country.
Table 3. States classified by personal income tax, 2012 No tax (9) Flat tax (7) Flat tax percentage rate Progressive tax (34) Top marginal tax rate Number of tax brackets

Wyoming

Washington

Texas

Tennessee*

South Dakota

New Hampshire*

Nevada

Florida

Alaska

Massachusetts

Utah

Illinois

Colorado

Michigan

Indiana

Pennsylvania

5.30% Maryland Ohio Virginia

5.00% Oklahoma

5.00% Mississippi

4.63% Alabama

4.35% New Mexico

3.40% Arizona

3.07% North Dakota

California Hawaii
Source: Tax Foundation, most recent data available *New Hampshire and Tennessee do not tax wage income but do tax capital gains and dividends.

Oregon

Iowa

New Jersey

Vermont

New York

Maine

Minnesota

Idaho

Wisconsin

North Carolina

South Carolina

Arkansas

Montana

Nebraska

Delaware

Connecticut

West Virginia

Kansas

Missouri

Louisiana

Kentucky

Georgia

Rhode Island

5.925% 9 6.00% 6 5.99% 3

5.75% 4

5.75% 8

5.25% 7

5.00% 3

5.00% 3

4.90% 4

4.54% 5

3.99% 5

10.30% 7

9.90% 4

8.98% 9

8.97% 6

8.95% 5

8.82% 8

8.50% 4

7.85% 3

7.40% 7

7.75% 5

7.75% 3

7.00% 6

7.00% 6

6.90% 7

6.84% 4

6.75% 6

6.70% 6

6.50% 5

6.45% 3

6.00% 10

6.00% 3

6.00% 6

11.00% 12

Seven states tax personal income, but at a uniform statutory rate (a flat tax). Pennsylvania has the lowest flat rate at 3.07 percent; Massachusetts has the highest at 5.3 percent. Illinois currently has a flat rate of 5 percent after increasing the rate by 67 percent in 2011, up from the previous rate of 3 percent. Before the tax hike, Illinois had the lowest flat income tax rate in the country. Thirty-four states impose a progressive personal income tax. Hawaii has the most marginal tax brackets with 12, followed by Missouri with 10 brackets, and Iowa and Ohio with nine. Hawaii also has the highest top marginal income tax rate at 11 percent, followed by California at 10.3 percent and Oregon at 9.9 percent. Encapsulating what typically happens in progressive tax states, California Gov. Jerry Brown wants California voters to increase the Golden States top rate to a highest-in-the-nation 13.3 percent this fall. The most common number of brackets is three (seven states have three brackets). Six states have six brackets and six other states have five brackets. The CTBA and its allies want Illinois lawmakers to enact a progressive personal income tax with eight ever-higher marginal tax rates, topping off at 11 percent. If enacted, this would move Illinois from having a uniform tax to a steeply progressive income tax, which is ironic since some progressive tax states are considering scrapping their income tax altogether. In 2012, Kansas, Missouri and Oklahoma considered measures to abolish the personal income tax. Each of these states borders a no-tax or a flat-tax state, thus competition is pressuring progressive tax states to scrap their uncompetitive income tax. Oklahoma Gov. Mary Fallin has proposed cutting and ultimately eliminating the income tax. Her plan would lower the state income tax to 3.5 percent from 5.25 percent in 2013, and then phase it out completely by increments of 0.25 percentage points a year over 14 years. Illinois tax lobby wants to impose a steeply progressive income tax when other states are trying to escape their progressive tax.

(2) How the progressive tax hurts you

A progressive tax will creep into the middle classes
Supporters of a progressive tax always claim they only want to tax the Paris Hiltons of the world. But eventually, they come after the middle classes by creeping down the income ladder with higher tax rates. California is a classic example. It has steeply progressive and exceptionally high personal income tax rates. The Golden State taxes personal income at seven increasingly-higher rates including a top rate of 10.3 percent, second only to Hawaii. But Californias second-highest marginal rate of 9.3 percent kicks in at only $48,000 for single taxpayers. To show how higher tax rates have crept down the income ladder by lowering the income threshold, when Californias income tax began in 1935, this tax rate applied to people earning more than $838,000 in todays dollars.

This is how progressivity works start with the 1 percent but come after everyone else later by creeping down the income ladder with higher tax rates. Progressive tax supporters want to take more money by unleashing the Grim Creeper progressive tax. A progressive tax also allows the government to collect more tax revenue through inflation. A incomes rise over time with inflation, people are pushed into higher marginal tax brackets. This is called bracket creep. For example, a 1 or 2 percent increase in income to keep pace with inflation can push a person into a higher marginal tax bracket that is 10, 20 or 30 percent higher, resulting in significantly more revenue for the state. The easiest way to see creep down in action is to look at how an Illinois household consisting of a married couple with two children having an annual base income of $58,200 and, thus, taxable income of $50,000, is taxed in Illinois versus the 34 states with a progressive tax.9 This example allows an apples-to-apples comparison across all states by removing complications of going from federal adjusted gross income to Illinois total income to Illinois base income. Illinois currently has a flat personal income tax of 5 percent. It was raised by 67 percent from 3 percent on Jan. 1, 2011. The increase will begin to sunset, falling to 3.75 percent on Jan. 1, 2015, the earliest a progressive tax could go into effect, too. Figure 3 shows that 31 of the 34 progressive tax states (those in purple) tax $50,000 at a higher marginal tax rate than Illinois will in 2015. All of the purple states are higher than Illinois 2015 sunset rate of 3.75 percent. Even at todays tax rate of 5 percent, Illinois is lower than 24 of the progressive tax states. Only three progressive tax states (the blue states) are less than or equal to 3.75 percent.
Figure 3. Marginal tax rate on $50,000 of taxable income in progressive tax states
Flat tax or no-tax states Progressive tax states equal or lower than 3.75 percent Progressive tax states higher than 3.75 percent
0.00 9.00 7.80 0.00 0.00 6.90 2.82 0.00 6.84 0.00 0.00 6.45 7.92 3.75 6.00 3.40 4.10 6.00 5.75 7.00 7.00 6.00 7.05 6.50 4.35 3.07 6.45 5.30 3.75 5.00 5.53 5.55 4.75 0.00 6.80 8.50

9.30

5.80 0.00 5.00

3.36

4.90

5.25

7.00 4.00 5.00

0.00

0.00

0.00 8.25

Source: Calculations by Lawrence J. McQuillan using the most recent data available from the Tax Foundation

A progressive tax means a higher tax rate for Illinois families. Its even worse for a hard-working Illinois family with taxable income of $80,000. This family would pay a higher tax rate in 33 of the 34 progressive tax states (only North Dakota is lower). If Illinois adopted Hawaiis progressive tax (which most resembles the CTBA plan both in terms of the progressivity of the marginal rates and the top rate), a family with taxable income of $50,000 would pay $881 more in income taxes every year, a 35 percent increase in this familys tax bill. The additional taxes instead could have paid for a month or two of groceries.10 Make no mistake, progressive tax supporters in Illinois are plotting to take what youve earned. First, theyll fight to spend more in Springfield. Then theyll cry for more revenue and work to make the temporary income tax hikes permanent. Finally, theyll push for a progressive tax to grab more of your money. And they wont index tax rates to inflation in order to take more of your money with bracket creep. Progressive tax supporters might say they are only targeting the North Shore or the country club set, but theyre coming after you next. A progressive tax ultimately means a higher tax rate for the vast middle class.

A progressive tax punishes success at ALL income levels

Income taxes take part of your earnings, reducing the monetary return to work and leading more people to work less and invest less because they get to keep less of what they earn. Progressive income taxes go a step further and magnify this disincentive to work. Progressive income taxes create an ever-increasing disincentive for work at each step in the marginal tax rate. The key driver is the effect that marginal tax rates have on incentives. All taxes punish success, whether its the guy just starting to make it or the guy who has already made it. But progressive taxes punish success more severely as one moves up the income ladder. There is an increasing tax penalty for those who work harder and save more than their neighbors. It sends a signal to people that if you are successful, the government will punish you more severely. Progressive taxes are contrary to sound tax policy because they penalize work effort, saving, investment, risk-taking, entrepreneurship and population in-migration the ingredients of self-sustaining prosperity. Studies show income taxes impose an efficiency cost on society up to five times more than consumption taxes the cost being lost output and foregone exchanges between two parties.11 Economists call these efficiency costs deadweight losses. The disincentive effect is clearly evident in California. The punitive progressive tax has forced motivated and entrepreneurial people at all income levels to flee California, taking their money with them. Laffer Associates data in Figure 4 show that from 1981 to 2005, hikes in Californias top income-tax rate overlapped almost perfectly with periods of flight from the state, while cuts in the top rate brought people back.

Figure 4. Top marginal income tax rates and California migration California domestic in-migration and out-migration as percentage of each years total population vs. personal income tax rates
12 11.5
Top personal income tax rate

1.0% 0.5% 0.0% 0.5% 1.0% 1.5%

Migration to/from other states

11 10.5 10 9.5 9 8.5

1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005

Source: Laer Associates8

Source: Robert P. Murphy, Ending the Revenue Rollercoaster: The Benefits of a Three Percent Flat Income Tax for California (San Francisco: Pacific Research Institute, 2008), p. 11

Perhaps most important, research shows that increasing tax rates only on high-income earners forces out people at ALL income levels.12 People view the top tax rate as a signal for the states willingness to raise taxes in the future by increasing tax rates on lower income levels the creep down. Also, some people anticipate earning higher incomes in the future and being subject to the highest tax rate. Either way, they flee. So attempts to soak the rich with progressive taxes backfires. Where do people go? Roger Cohen, Andrew Lai and Charles Steindel examined annual Internal Revenue Service state-to-state migration data from 1992 to 2008 to study how state marginal tax rates on personal income affect the domestic migration flows of taxpayers and income. After controlling for differences in factors such as housing prices, per capita income, distance of move, and state amenities, the statistical results show individuals have a strong preference for zero income tax states.13 Illinois poor governance and lack of fiscal discipline has already helped to push 1.2 million people net out of the state between 1991 and 2009, costing Illinois state government $1.8 billion in taxable income annually.14 A progressive tax would force out even more people. Faced with higher progressive taxes if more successful, many people will simply pick up and leave the state, taking their businesses, jobs and money with them. A progressive tax is the wrong signal to send if Illinois wants to be competitive and pro-growth.

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(3) How the progressive tax hurts the economy and state budgeting
A progressive tax hurts job creation and economic growth
If 34 states have a progressive income tax, shouldnt Illinois? If so many states have it, doesnt that prove its better? Actually a progressive tax hurts a states economy. In this case, its good that Illinois is an outlier. Many studies have examined the effect of increasing marginal tax rates on decisions regarding work effort, savings, investment and entrepreneurship. Some of these studies examine countries, while others examine U.S. states. A sampling of the studies highlights the negative affect that progressive taxes have on economic performance by discouraging productive behavior:15 Fabio Padovano and Emma Galli: Two studies by Padovano and Galli confirm that high marginal tax rates reduce overall economic growth.16 Their 2001 study relied on data for 23 member countries of the Organisation for Economic Co-operation and Development (OECD) from 1951 to 1990. The OECD is a group of 34 democratic, industrialized countries. They found that high marginal tax rates and progressivity were negatively associated with long-run economic growth. In a 2002 follow-up study, they found that a 10-percentage-point increase in marginal tax rates decreased the annual rate of economic growth by 0.23 percentage point. Elizabeth Caucutt, Selahattin Imrohoroglu and Krishna Kumar: Using data for the U.S. economy, they found that increasing the progressivity of taxes meaning increasing marginal tax rates reduced the economic growth rate by 0.13 to 0.53 of a percentage point.17 Christina Romer and David Romer: In 2007, they examined the effects of 104 separate quarterly postwar tax changes from 1947 through 2006 on gross domestic product (GDP) growth, and they concluded that tax changes have very large effects on output.18 A tax increase of 1 percent of GDP lowered output as measured by real GDP by roughly 2 to 3 percent. They also found that tax increases were linked to sharp declines in investment, which made the GDP reductions so large and persistent. John Mullen and Martin Williams: They examined U.S. state and local tax systems and compared them to state economic performance.19 Using state data from 1969 to 1986, they concluded that lowering marginal tax rates can have a considerable positive impact on growth. Eric Engen and Jonathan Skinner: They examined more than 20 studies looking at evidence on tax rates and economic growth in the United States and abroad.20 They concluded: A major tax reform reducing all marginal rates by 5 percentage points, and average tax rates by 2.5 percentage points, is predicted to increase long-term growth rates by between 0.2 and 0.3 percentage points. Howard Chernick: He examined U.S. state data from 1977 to 1993 and found that states with progressive taxes had significantly lower economic growth rates over the entire period.21 The result was driven by the high growth rates in states that benefited from their tax-haven status adjacent to progressive tax states. Barry Poulson and Jules Gordon Kaplan: They explored the impact of tax policy on economic growth in the U.S. states from 1964 to 2004.22 They found that higher marginal tax rates had a negative impact on economic growth. States that held the rate of growth in revenue below the rate of growth in income
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achieved higher rates of economic growth. Also key, states that imposed an income tax to generate a given level of revenue experienced lower rates of economic growth compared to states that relied on alternative taxes to generate the same revenue the comparative deadweight cost mentioned earlier. Arthur Laffer: He examined how states with the highest income tax rates performed relative to their zero income tax counterparts from 1999 through 2009.23 Figure 5 shows the results.
Figure 5. Comparing state economic performance High-tax states vs. no-tax states 1999-2009
61.23 Percentage growth rates 44.91 High-tax states No-tax states 7.78 6.48 13.75 Output growth

0.47 Job growth

Measures of state economic performance

Population growth

Source: Graphic developed by Lawrence J. McQuillan from data in Arthur B. Laffer, Stephen Moore and Jonathan Williams, Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index, 4th edition (Washington, D.C.: American Legislative Exchange Council, 2011), p. 25

Laffer found that the nine states with no personal income tax had, on average, cumulative job growth more than 15 times greater. Population grew 112 percent more in the no-tax states and gross state product grew 36 percent more. No-tax states outperformed high-tax states across all measures. Laffer, who moved his business from progressive tax California to no-tax Tennessee because of the tax savings, concluded: The extent to which the states with the highest tax rates have underperformed those states without income taxes is shocking. The statistical evidence is overwhelming. Over the long haul (which is the only fair way to measure economic performance), economies with high marginal tax rates, progressive tax systems and heavy tax burdens have slower economic growth, less entrepreneurship, and fewer new jobs because of disincentive effects and the less productive use of resources by governments compared to the private sector. Its possible to calibrate the Romer findings to the Illinois economy. Calibration is a technique used by economists to take general results from a statistical analysis and apply them to a specific case such as a U.S. state. Christina Romer was President Obamas chief economist and is a professor at the University of California, Berkeley, so shes certainly no conservative. Calibration reveals that the CTBAs progressive tax increase would cut economic output in Illinois by a staggering $13 billion to $26 billion total over time.24 To put this into perspective, a $26 billion loss in output is comparable to losing Illinois entire construction industry and more. This plunge in output will, at a minimum, kill between 65,000-88,000 Illinois jobs.25
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Any reduction in economic activity typically hurts the poor most. Research shows that states with higher taxes and less economic freedom have higher poverty rates.26 A progressive tax hurts the poor and middle class most by destroying needed jobs. If the CTBA were honest, it would say: Well cut taxes on the poor and middle class by killing their jobs. No income, no income taxes! 27 Illinois shouldnt follow the losers and adopt a progressive income tax. Instead, Illinois ultimately should join the nine states with no income tax, sending a strong message that it rejects the harmful effects of the income tax and stands for strong growth and jobs for the poor.

A progressive tax is morally unfair, predatory and punitive

Supporters of a progressive income tax always say it is more fair, and makes the rich pay their fair share. But Illinois flat tax already is fair. Currently, Illinoisans with an annual base income more than $1 million pay an average tax 47 times higher than the average non-millionaire resident.28 Everyone pays the same rate, and the rich pay more because they are taxed at the uniform rate on higher incomes. Equal treatment under the law is fair and one measure of a moral society. But in California for example, the tax code is punitive and predatory. The average state income tax bill for millionaires is $277,000. The typical Californian pays $2,017, meaning high earners pay about 137 times more taxes each year than the average tax-paying Californian, and at rates up to 10 times higher.29 How much is enough? 150 times, 200 times, 1,000 times? A progressive tax allows income groups to prey on each other imposing higher taxes on others while sparing themselves. John Stuart Mill called the progressive tax a mild form of robbery.30 And when you rob Peter to pay Paul, you can always count on Pauls support, to paraphrase George Bernard Shaw. A progressive tax encourages widespread class envy, class warfare, anger among groups and moral decay as people use the progressive tax to steal from their neighbors. Tax thy neighbor not thyself becomes the collective thinking. In contrast, a pure flat tax system doesnt allow class warfare because when a flat tax is hiked, everyone in all income classes gets hit. Everyone is hurt by a tax hike. Equal treatment is fair. Also in California, for every millionaire there are more than 14 people who are asked to pay little or no taxes. This skewed system creates a permanent lobby for ever-larger state spending by people who dont shoulder much of the cost. This drives deficits skyward. The lopsided California tax system is fundamentally unfair and distortionary. It concentrates the tax burden among a small subset of people, which results in dangerous budget instability (more on this in the next section). In California, the top 1 percent of filers pays 45 percent of all personal income taxes. In flat-tax Illinois, the top 1 percent pays 25 percent a more balanced approach. Supporters of a progressive tax also argue that its needed because after accounting for all state and local taxes paid in Illinois, the poorest 20 percent pays 13.7 percent of their income on state and local taxes, on average, while the richest 1 percent pays 5.3 percent.31 Progressive tax supporters argue that income taxes should be more progressive to offset other taxes in the state that are regressive. But this argument is upside-down.

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The best way to help the poor would be to eliminate the income tax altogether so they can keep what they earn and decide for themselves when, and to some extent, how much money they sacrifice to the government under a consumption-tax system. Under the CTBA plan, someone earning a base income as little as $5,001 a year gets hit with a 5 percent income tax. They should be able to keep what they earn and not be taxed on it at all. Abolishing the income tax establishes the principle that an individual owns the fruits of his or her labor and they decide if and when the government gets any of it by choosing how much to spend. People who like the government targeting groups for special punishment and special favors, and want the government to discriminate and engage in predatory class warfare, will love a progressive income tax. A progressive tax is discriminatory by its very nature because it purposefully taxes some people, and some dollars, at a different rate than others. People who believe in equality under the law and that everyone, and every dollar, should be treated equally by government taxation, support the flat tax or no income tax at all. The choice is clear. Illinois has a long tradition of flat tax equality in its personal income tax. A progressive tax will codify discrimination, which is wrong.

A progressive tax is a recipe for budgeting disaster

A progressive income tax exaggerates booms and busts in state revenue. During good times, revenue surges both because incomes increase and people are pushed into higher marginal tax brackets. Flush with cash, lawmakers cant resist the temptation to spend more with new permanent programs. When the inevitable downturn occurs, the process reverses. Revenue drops are magnified and deficits explode because it is always much easier to expand government spending than to rapidly contract it.32 Poor people, who come to count on government programs, are often first to be harmed by any belt tightening, hardly a model of fairness. Ultimately, tax rates are ratcheted up to fix the deficit and the cycle repeats. This revenue rollercoaster is extreme in progressive tax California (see Figure 6). U.S. Census data shows Californias income tax revenues rise more quickly during good times, and fall more severely during bad times. Alan Auerbach, a professor of tax economics at the University of California, Berkeley, and longtime observer of California state finances, sums it up: The problem of volatility is particularly severe in California, which relies more strongly than many states on the individual income tax a relatively unstable source of revenue . . .33 This volatility, now conceded by California Gov. Jerry Brown, makes accurate state budgeting impossible because peaks, troughs and turning points in the business cycle are impossible to predict.

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Figure 6. Californias revenue rollercoaster Progressive taxes are volatile

30% 25%

Annual growth in income tax receipts

20% 15% 10% 5% 0% 5% 10% 15% 20% 25% 1997 1998 1999 2000 2001 2002 2003 2004 2005

Figure 3 plots the annual growth in in tax receipts for California versus the of all the states. It is clear that durin times, California revenues rise more quickly in Ca than in other states, and during bad tim fall more states Average of U.S. severely.

Source: Robert P. Murphy, Ending the Revenue Rollercoaster: The Benefits of a Three Percent Flat Income Tax for California (San Francisco: Pacific Research Institute, 2008), p. 9

Nationally, states with a higher reliance on personal income taxes for their revenue have greater budget deficit problems. On average, a 10 percentage point increase in a states reliance on personal income taxes for its revenue increases the states budget deficit by 3.7 percentage points because of the rollercoaster effect. The more reliant tax revenue becomes on income taxes from a smaller group of people, the more volatile tax revenues are and the more frequent major budgetary adjustments are necessary. If a progressive income tax was the magic bullet, Californias finances would be stable today rather than facing a $16 billion deficit and calls for more tax hikes. Taxifornia should not be Illinois role model. The experience of the U.S. states teaches that a progressive income tax would only make Illinois budget deficits larger. Illinois, already plagued with persistent overspending problems, shouldnt help lawmakers spend more with a progressive income tax. A progressive income tax causes wild swings in tax revenue, both during good times and during bad times, exploding deficits and cuts in services for the poor when belt-tightening becomes inevitable.

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2006

30%

e situation is even worse than Fi indicates. It is not merely that Cali income-tax receipts are more volatil the average; indeed they are among th volatile in the nation. Table 1 lists most volatile states, measured by the st deviation in the growth rates of their in tax receipts. Californias rank of fourth (i.e., fourth worst) in the nation i misleadingly optimistic. (Alaska and Florida) tax corporate b personal income, while the third-ranke (Tennessee) taxes corporate income as dividends and interest income for indi

Gov. Quinns objective is to impose a progressive income tax on Illinois workers. Quinns ally in this effort, who also helped him pass the 2011 income-tax hike, is Ralph Martire, executive director of the CTBA. Martire was featured recently at a forum in Springfield on how Illinois massive budget deficit is caused by lack of revenue and ineffective tax system, not because of spending. . . . [and] how the state can solve its fiscal mess by enacting a . . . graduated state income tax.35 The position of the CTBA is that the states budget problems are not caused by the Great Recession, excessive public pensions, too much Medicaid spending or growth in overall state government spending. Rather, the blame lies with too little tax revenue and a progressive income tax would help. In reality, the states budget mess is caused by rapidly increasing spending and a drop in revenues due to the Great Recession. Figure 8 shows this clearly.

Figure 8. Illinois state operating expenditures and revenues, 2003-2011

Total operating expenditures plus transfers out Total operating revenues plus transfers in Pre-Great Recession trend line for revenues 38% increase 2003-2011 22% increase 2003-2011

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Dollars in billions (actuals*)

30

25

20

2003

2004

2005

2006

2007

2008

2009

2010

2011

Fiscal years * For fiscal year 2011, the expenditure figure is a preliminary number

Note: For fiscal years 2003 and 2004, pension obligation reimbursement transfers-in were $300 million and $1.49 billion, respectively. For fiscal years 2010 and 2011, the amounts were $843 million and $224 million, respectively. Transfers-in also includes money from the federal government. Sources: Graphic developed by Lawrence J. McQuillan from data in Governors Illinois State Budget, Fiscal Years 20052013; and Commission on Government Forecasting and Accountability, State of Illinois Budget Summary Fiscal Year 2012, (August 2011), pp. 29 and 64

Illinois spending (the black line) increased a hearty 38 percent from 2003 through 2011. State revenues (the solid green line) increased 22 percent during this period. The difference between spending and revenues is the budget deficit, and it has clearly been caused by annual spending far exceeding revenues the past four fiscal years. But the deficit doesnt tell the whole story because the state has accrued $8 billion in past due bills.

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Notice that if revenues had continued growing since 2008 at the pre-recession trend (the dashed purple line), there would be a smaller budget deficit today. Contrary to the claims of the CTBA, a low flat tax would have provided sufficient revenue, if not for the Great Recession and overspending. A progressive income tax is not needed because of a shift in income distribution over time, as the CTBA claims. But even if revenues were at the long-term trend line, the budget is still in trouble long-term because of overspending. As mentioned above, there are $8 billion of unpaid bills, and these dont show up in the spending numbers until the bills are paid. There is $2 billion worth of unpaid Medicaid bills alone. Since 2000, Medicaid enrollment in Illinois nearly doubled to 2.7 million people from 1.4 million.36 And the unfunded liabilities for public employee pensions and retiree health care amount to a staggering $137 billion. There are no compelling reasons to adopt a progressive income tax. Moving to such a tax would be entirely a money grab to enable more government spending and to reduce urgency to reform public pensions, Medicaid and other programs that operate perpetually in deficit. Progressive tax supporters are using the recession as an opportunity to argue for a progressive income tax that is not needed. It would only feed a failed system.

Our solution
First, Illinois should discard any notion of enacting a progressive income tax of any kind. Instead, it should make its tax system more competitive by repealing the record 2011 income tax increase. On Jan. 1, 2011, the states individual income tax rate increased 67 percent to 5 percent, from 3 percent. This tax hike, along with the corporate income tax increase also passed in 2011, should be repealed, returning nearly $7 billion annually to hard-working Illinoisans. The repeal should be done in conjunction with major spending reforms in public pensions, Medicaid and other spending programs as detailed in Budget Solutions 2013.37 Long term, the state should start a discussion about how best to abolish its personal income tax joining nine states that do not tax personal income. For most of this nations history, income taxes were unconstitutional. The 16th Amendment to the U.S. Constitution, ratified in 1913, gave the U.S. Congress the right to levy an income tax. The first Illinois income tax was signed into law by Republican Gov. Richard Ogilvie in 1969. Before then most state funding came from a statewide property tax, abolished in 1932, and a subsequent sales tax. Abolishing the income tax doesnt mean a lack of government revenue. Over the past decade, tax revenues in the nine states without an income tax have grown two times more than the nine states with the highest income tax rates (an average of 124 percent versus 62 percent).38 Because productive economic activity is greater when there is no income tax, the tax base grows quicker to yield more tax revenue from the sales tax and property tax.

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Why this works

Pro-growth policies best incentivize work, investment and upward mobility for all. Illinois should repeal the 2011 income tax hike and start a discussion on abolishing its personal income tax long term. These pro-growth steps would be good for family budgets, good for the states economy and good for the poor. Good for families Repealing the 2011 income tax hike would save the previously mentioned Illinois household with $50,000 of taxable income about $840 to $960 per year, the equivalent of a month or two of groceries.39 Repeal would also jump-start the economy, helping to lower the states unemployment rate. Abolishing the states current 5 percent flat income tax completely would immediately save this Illinois household about $2,100 to $2,400 per year gross.40 People should be allowed to keep the fruits of their labor and invest in themselves or their businesses free from taxation. By not taxing labor income, Illinoisans would also bequeath a stronger economy to their children with more job opportunities. Good for Illinois economy States with low flat taxes or no income taxes have stronger economic growth and job creation and faster-growing populations. States with lower tax burdens, lower marginal tax rates, and less progressivity have more robust economies with strong incentives to live, work and start new businesses. Based on the results reported by Engen and Skinner discussed earlier, Illinois would boost its economic growth rate by between 0.2 and 0.3 percentage points if it scrapped its income tax entirely. This effect might seem small, but through compounding, it alone would cause living standards to double in 12 generations. By not adopting a progressive income tax, Illinois can avoid further economic and budgeting disasters like those plaguing California, New York and New Jersey. Since 2000, the data shows that 1.2 million more people left California than moved there, the second biggest net loss after steeply progressive New York.41 Illinois should not copy Taxifornias uncompetitive, volatile tax system. Instead, Illinois should start a dialogue about abolishing its personal income tax. Good for the poor The progressive tax hike proposed by the CTBA would cut economic output in Illinois up to $26 billion and kill as many as 88,000 Illinois jobs, not create jobs from more government and consumer spending as the CTBA alleges. This needless economic contraction would be devastating to the states poor, a group that has already suffered much during the Great Recession and would be first to lose their jobs from a progressive tax plan. Instead of a progressive income tax, Illinois needs to lower its flat tax or eliminate the income tax. This will pave the way for more job creation and allow the poor to keep the fruits of their labor. A robust economy with rapid job creation is the best way to help the poor, who typically have fewer marketable job skills and thus tend to be laid off first during downturns.

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Endnotes
1

HuffPost Interview with Illinois Governor Pat Quinn, July 12, 2012. Center for Tax and Budget Accountability, press release, February 28, 2012.

Greg Hinz, Wisconsin Gov. Walker Getting Mixed Reaction in Visits Here, Crains Chicago Business, April 17, 2012; Patrick Yeagle, Time to Graduate? Constitutional Amendment Would Ditch Flat Income Tax, Illinois Times, March 15, 2012; Keith Kelleher, A Fairer Tax, Chicago Tribune, June 19, 2012; and AFSCME Boss Spells Out Union Demands on Illinois Pension Crisis, May 30, 2012.
3 4

Job advertisement on NPO.net.

Center for Tax and Budget Accountability, The Case for Creating a Graduated Income Tax in Illinois (Chicago: Center for Tax and Budget Accountability, 2012), p. 8.
5

Center for Tax and Budget Accountability, Analysis of Proposed Illinois FY2013 General Fund Budgets (Chicago: Center for Tax and Budget Accountability, 2012).
6

Jacob Feldman, State Income Migration and Border Tax Burdens, working paper (Washington, D.C.: Americans for Tax Reform Foundation, 2012), p. 18.
7

The data come from U.S. Census Bureau, Annual Survey of State Government Tax Collections, published April 12, 2012; Federal Reserve Bank of St. Louis; and Federal Reserve Bank of St. Louis compiled from data from the Bureau of Economic Analysis.
8

Total taxable income in Illinois is called net income. Beginning in tax year 2012, the individual exemption is $2,050.
9

U.S. Department of Agriculture, Center for Nutrition Policy and Promotion, Official USDA Food Plans: Cost of Food at Home at Four Levels, U.S. Average, March 2012.
10

Robert P. Murphy and Jason Clemens, Taxifornia: Californias Tax System, Comparisons with Other States, and the Path to Reform in the Golden State (San Francisco: Pacific Research Institute, 2010).
11

Antony Davies and John Pulito, Tax Rates and Migration (Arlington, Va.: Mercatus Center at George Mason University, 2011).
12

Roger Cohen, Andrew Lai and Charles Steindel, The Effects of Marginal Tax Rates on Interstate Migration in the U.S., New Jersey Department of the Treasury, October 2011, p. 10.
13 14

J. Scott Moody, Leaving Illinois: An Exodus of People and Money (Chicago: Illinois Policy Institute, 2011).

This section borrows from the excellent literature review in Robert P. Murphy and Jason Clemens, Taxifornia: Californias Tax System, Comparisons with Other States, and the Path to Reform in the Golden State (San Francisco: Pacific Research Institute, 2010).
15

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Fabio Padovano and Emma Galli, Tax Rates and Economic Growth in OECD Countries (19501990), Economic Inquiry, vol. 39, no. 1 (January 2001), pp. 4457; and Fabio Padovano and Emma Galli, Comparing the Growth Effects of Marginal vs. Average Tax Rates and Progressivity, European Journal of Political Economy, vol. 18, no. 3 (September 2002), pp. 529544.
16

Elizabeth M. Caucutt, Selahattin Imrohoroglu, and Krishna B. Kumar, Does the Progressivity of Taxes Matter for Economic Growth? Institute for Empirical Macroeconomics, Federal Reserve Bank of Minneapolis, Discussion Paper 138 (2000).
17

Christina D. Romer and David H. Romer, The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks, NBER Working Paper 13264 (Cambridge, MA: National Bureau of Economic Research, 2007). Published as Christina D. Romer and David H. Romer, The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks, American Economic Review, vol. 100, no. 3 (June 2010), pp. 763801.
18

John K. Mullen and Martin Williams, Marginal Tax Rates and State Economic Growth, Regional Science and Urban Economics, vol. 24, no. 6 (December 1994), pp. 687705.
19

Eric Engen and Jonathan Skinner, Taxation and Economic Growth, National Tax Journal, vol. 49, no. 4 (December 1996), pp. 617642.
20

Howard Chernick, Tax Progressivity and State Economic Performance, Economic Development Quarterly, vol. 11, no. 3 (August 1997), pp. 249267.
21

Barry W. Poulson and Jules Gordon Kaplan, State Income Taxes and Economic Growth, Cato Journal, vol. 28, no. 1 (winter 2008), pp. 5371.
22

Arthur B. Laffer, Stephen Moore and Jonathan Williams, Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index, 4th edition (Washington, D.C.: American Legislative Exchange Council, 2011), pp. 2426.
23

According to Romer and Romer 2007, an increase in the tax burden of 1 percent of GDP results in a 2 to 3 percent reduction in GDP. Compared to a sunset of the tax hike, the CTBA plan will result in a $6.4 billion tax hike for Illinois. That would increase tax revenue as a percent of Illinois $651 billion GDP by 0.98 percent. The higher tax burden yields a fall in Illinois GDP of between 1.97 percent and 2.95 percent, or $13 billion to $19 billion.
24

Compared to a repeal of the tax hike, the CTBA plan will result in a $8.64 billion tax hike for Illinois. That would increase tax revenue as a percent of Illinois $651 billion GDP by 1.33 percent. The higher tax burden yields a fall in Illinois GDP of between 2.66 percent and 3.99 percent, or $17 billion to $26 billion. Keep in mind that this is the drop in output due only to the increased tax burden. There would be an additional drop in output and job losses due to progressivity and its greater disincentive effect. This estimate comes from applying Okuns Law to Illinois: The upper limit of the fall in Illinois GDP based on the failure to sunset the tax hike is 2.95 percent. Running this number through Okuns basic law yields an increase in unemployment of 0.98 percent, which multiplied by Illinois total civilian labor force of 6,592,300 yields 64,809 lost Illinois jobs.
25

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The upper limit of the fall in Illinois GDP based on the failure to repeal the 2011 tax hike is 3.99 percent. Running this number through Okuns basic law yields an increase in unemployment of 1.33 percent, which multiplied by Illinois total civilian labor force of 6,592,300 yields 87,677 lost Illinois jobs. These are conservative estimates because there would be additional job losses due to progressivity and its greater disincentive effect. Lawrence J. McQuillan and Robert P. Murphy, The Sizzle of Economic Freedom: How Economic Freedom Helps You and Why You Should Demand More (San Francisco: Pacific Research Institute, 2009), p. 17.
26

The CTBA is fond of saying that Adam Smith, the father of economic science, favored a graduated income tax. He didnt, and the pro-tax organization is misrepresenting his ideas from The Wealth of Nations (see authors blog post on this topic). Instead, the CTBA should quote another classical economist, Karl Marx. In The Communist Manifesto, written in 1848, Marx and Friedrich Engels list the 10 steps to overthrow Western capitalism without firing a shot and replace it with socialism. The second step says to adopt a heavy progressive or graduated income tax. This plank was no accident. Marx understood the negative impact that a progressive income tax has on capital investment and wealth accumulation.
27

Center for Tax and Budget Accountability, The Case for Creating a Graduated Income Tax in Illinois (Chicago: Center for Tax and Budget Accountability, 2012), p. 13.
28

Millionaires in California receive 11.8 percent of the states adjusted gross income but pay 24.2 percent of the personal income tax liability. All of these California tax statistics were calculated by the author using the most recent data available from the California Franchise Tax Board.
29 30

John Stuart Mill, Principles of Political Economy, vol. II (D. Appleton and Company, 1894), pp. 99, 401.

Center for Tax and Budget Accountability, The Case for Creating a Graduated Income Tax in Illinois (Chicago: Center for Tax and Budget Accountability, 2012), p. 2.
31

Mario Rizzo and Douglas Whitman write: Once the initial policy is in place where no policy existed before, it often becomes politically cheaper than before to propose extensions to that policy. See Mario J. Rizzo and Douglas G. Whitman, Little Brother is Watching You: New Paternalism on the Slippery Slopes, New York University Law and Economics working paper no. 126 (2008), p. 9.
32

Alan J. Auerbach, Consumption Tax Options for California (San Francisco: Public Policy Institute of California, 2011), p. 5.
33

Matt Mitchell, Does Progressive Taxation Make State Budgeting More Difficult? Neighborhood Effects blog, Mercatus Center at George Mason University, May 27, 2011.
34 35

E-mailed promotional flyer.

36

Ashley Griffin, Medicaids Cost: The Illinois Health Care System is Under Examination as Budget Woes Loom, Illinois Issues, April 2012.

21

Ted Dabrowski, Amanda Griffin-Johnson and Jonathan Ingram, Budget Solutions 2013 (Chicago: Illinois Policy Institute, 2012).
37 38

Arthur B. Laffer, Stephen Moore and Jonathan Williams, Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index, 4th edition (Washington, D.C.: American Legislative Exchange Council, 2011), p. 25. The tax savings in this section were calculated using The Quinn Income Tax Hike Calculator.

39

Depending on which, if any, taxes are increased to replace lost personal income tax revenue, the yearly tax savings could drop.
40 41

State to State Migration Data calculator, Tax Foundation.

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