A Tax Code That Can't Keep Up: Why Revenues Don't Match Our Needs
By Andrea Kimpson
Ask any person how they feel about taxes and prepare yourself for a myriad of responses. Some people have strong opinions; others have no opinion. What is consistent is that most people do not enjoy paying taxes – in many cases, the process is onerous and expensive.
Here in Illinois, we are subject to relatively high tax rates compared to surrounding states, but we seem to be in a permanent budget crisis. Any news out of Springfield revolves around the ongoing budget shortfalls and consistent fights between lawmakers about what survives the budgetary process each session. Local governments are left to shift their tax structures in response to these state insufficiencies, often resulting in higher property taxes to keep local services operational. If we are paying so much in taxes, where is the money going? Why do social services continually need to be cut? The answer lies in a foundational issue – our tax structure is outdated and inadequate for generating revenues for robust public service provision. To make matters even worse, our tax system is also deeply unequal – we are the 8th most unfair in the country. Without rethinking Illinois’ tax structure, we will continue to get less than what we pay for and see the further erosion of services like behavioral health clinics and health programming.
The first culprit of tax insufficiency is our sales tax. First implemented in the 1930s, the state sales tax primarily taxes goods rather than services at a total rate of 6.25% on general merchandise. This means that products like shampoo, clothing, and furniture have sales tax applied, but services like cleaning services and landscaping do not.
What is the problem with this? Under our current structure, the items low- and middle-income earners spend most of their income on are taxed, but that is not the case for high income earners. Wealthy individuals spend more on services at a ratio of 5 to 1 compared to lower-income households. This has a two-fold effect for the wealthy: the services they spend greater proportions of their incomes on are protected from taxation and less of their income is impacted by taxation on goods because they are not paying taxes on all of the items they purchase. As a result, wealthy and high-income individuals are largely insulated from the tax burden while low- and middle-income individuals bear the brunt of the tax. It simply does not make sense that individuals who have more ability to spend on services are effectively exempt from paying taxes on these items; if we want an efficient tax structure, we need to align the types of items taxed with the spending habits of the entire tax base.
The wealth and income inequality generated from this sales tax structure is enough to warrant reform, but there is additional evidence pointing toward the insufficiency of this structure for the growing expenditure needs of the state. Between 1997 and 2023, expenditures on goods rose by 156 percent compared to a rise of 200 percent on consumer services in the same period. Our inefficient structure misses the opportunity to generate revenue from items that are becoming more common. We have only been able to generate about 20% of state general funds from sales taxes; and this is our second largest source of revenue. The state’s failure to capture potential revenues through sales tax creates our perpetual budget crisis.
To make matters worse, Illinois also has a flat 4.95 percent individual income tax rate. This means that regardless of income, every person is taxed at the same rate, ensuring that high income earners pay less in taxes proportional to their income. In other words, because everyone is being taxed at the same rate, low-and-middle income earners spend a greater amount of their income on taxes compared to high income earners. Not only is this structure unfair, it is also deeply inefficient as it misses out on potential tax revenues to be gained by a more progressive structure. A progressive structure, where the tax rate increases proportionally with income, would cut income taxes for at least two-thirds of taxpayers while growing the Illinois economy by $1 billion to $8 billion annually. Our current system is leaving money on the table, and reinforcing inequities, inequalities, and inefficiencies in the process.
The clear issues with our tax system require reform, however, the biggest challenge to an improved structure is the state Constitution. Article IX, Section 2 of the Illinois Constitution requires uniformity across non-property taxation to ensure that all subjects are treated equally. In 2019, Governor J.B. Pritzker introduced the Fair Tax Illinois proposal to introduce a graduated tax structure in the state. This proposal gained traction but faced significant political challenges in a year already strained by the pandemic. Its ultimate failure taught important lessons about the uphill battle facing the state regarding tax reform but demonstrated a significant appetite for change among a diverse coalition of stakeholders.
There are two key considerations for future tax reform:
Amending the Illinois tax code to introduce a 5% sales tax that applies to goods and services would generate nearly $2 billion in annual state revenues, as well as additional revenues for counties, municipalities, local governments, and transit agencies and allow us to reduce inequalities and inefficiencies.
Reform to the income tax system begins with a Constitutional amendment to remove the uniformity requirement from Article IX, Section 2, similar to the Fair Tax Illinois proposal. An amendment should open the conversation for what comes next by focusing on creating more options for Illinoisians at every income level.
Implementing new revenue streams for Illinois will present lawmakers at the local and state levels with an opportunity to freeze or lower property taxes, providing much needed relief to Illinoisians who pay the highest effective property tax rates in the country.
If Illinois wants to continue providing high quality services for its residents, tax reform is needed. With the ongoing chaos at the federal level, it will become more important for the state to be self-sustaining and able to meet the needs of an increasing number of people. The current system is deeply unequal and leaves revenue opportunities on the table. Reforming the sales tax and the income tax will create stability and new opportunities for the state. We can improve the status quo while building a better future. We must recognize the dire straits we find ourselves in and move toward new.