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PROGRESSIVE TAX COULD COST NEARLY $1,800 A YEAR IN HOME EQUITY
Illinois Policy Institute/Orphe
Divounguy, Bryce Hill
Gov.
J.B. Pritzker promises his $3.7 billion “fair tax” would only hit those
making over $250,000, but it also threatens to cost more than 3.2
million Illinois homeowners an average of $1,800 a year in home equity. |
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 If
voters approve the state income tax increase, it could eventually cause
Illinois’ home price appreciation rate to fall by 34.8% (see Appendix), if the
state has the same experience as the last state to enact a progressive income
tax: Connecticut in 1996. If the median homeowner, with a home value of
$203,400, were planning on selling their house in 10 years, a progressive income
tax would cost them $17,937 in foregone equity. The average annual cost of the
progressive tax for these homeowners would be nearly $1,800 in home equity.
Because lower home prices are a hidden cost that will impact
homeowners at all income levels, it is disingenuous for proponents of the
progressive tax to claim it will only affect the rich. Less housing wealth will
be a concern even if state lawmakers could be trusted not to abuse their new
taxing powers to spread tax hikes to the middle class or retirees, as
Connecticut also did.
INTRODUCTION
Lawmakers are asking voters to approve a $3.7 billion income tax increase on
Nov. 3, promising the tax increase will only harm those making more than
$250,000. However, the financial damage would also spread to Illinois’ 3.2
million homeowners. The 2011 state income tax hike previously reduced housing
prices in Illinois, according to the Harvard Joint Center for Housing Studies,
which added a caveat because housing prices were already declining prior to the
tax hike. The same study found the 2007 Washington, D.C., income tax cuts led to
a significant increase in housing prices.
Even if the tax rates as currently proposed were to remain in place – which is
increasingly unlikely amid declining state revenue from the COVID-19 related
downturn and the state’s growing fiscal imbalance – house prices would
appreciate by 1.5% to 4.9% less (see Appendix).
It is much more likely the progressive income tax hikes would be extended to
middle- and low-income earners, taking even more income tax dollars from them.
Without real reforms, Illinoisans could face far slower housing appreciation as
income taxes and the nation’s second-highest property taxes continue to increase
– as happened in Connecticut after it switched from a flat tax in 1996 and
phased in a progressive income tax over three years.
Connecticut’s results were disastrous. A decade after the tax hikes, housing
prices had appreciated 46% less when compared to similar nearby states such as
Massachusetts, Rhode Island and New Jersey. By 2019, the gap was even larger:
average housing prices in Connecticut had appreciated by 70% relative to 144%
housing appreciation – less than half – the growth in housing values in similar
nearby states.
The damage to the housing market should caution Illinois homeowners voting on
the progressive tax issue in November.
If Pritzker’s tax hike is enacted, land values and home equity growth are likely
to suffer, stripping wealth from Illinois homeowners and causing property tax
burdens to increase. Again, those were the impacts seen in Connecticut when it
implemented a progressive tax.
Pritzker’s argument for the progressive tax relies on the same myths used to
persuade Connecticut voters: that a progressive income tax will allow for
middle-class tax relief, that it will lower property taxes and that it will
shore up the state’s finances. On the contrary, if Illinois ditches its
constitutionally protected flat income tax, history shows Illinoisans will
likely face the same fate as Connecticut – higher taxes for everyone, fewer jobs
and an even more sluggish economy – all at a time when Illinois’ economy is
trying to recover from COVID-19 shocks.
THE IMPACT OF THE PROGRESSIVE INCOME TAX HIKE ON HOUSING PRICES
Using the “synthetic control method” as in Abadie and Gardeazabal (2003), we
investigated the impact of Connecticut’s tax hikes on house prices. We learned
that the switch to a progressive income tax in Connecticut permanently lowered
housing prices. By 2019, average house price appreciation rates in Connecticut
were lower by 34.8% relative to housing values in similar nearby states such as
Massachusetts, Rhode Island and New Jersey because of the state’s income tax
hikes (see Appendix).
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The evidence also suggests those nearby
states likely benefitted from Connecticut’s policy misstep. This was to be
expected. The increase in the cost of housing in Connecticut, relative to other
states, likely led to a decrease in demand for housing services in Connecticut,
dragging down housing prices.
Similarly, a progressive income tax increase in Illinois is likely to harm
homeowners and renters in Illinois when compared to neighboring states that
offer similar amenities. Income tax hikes cause demand for housing services to
decrease. The result is vacant units take longer to sell (time on market
increases), housing prices fall and the number of vacancies increases relative
to the number of potential buyers.
Higher income taxes also have a negative impact on the labor market prospects
and incomes of homeowners and renters in Illinois relative to other states. This
is especially true now that a federal cap on state and local tax deductions
increases tax burdens on those who live in high-tax states. As a result, land
values decrease and so do housing prices.
Owning a home in Illinois becomes less rewarding than in states where homeowners
face much lower costs. On the supply side, constrained homeowners with little or
no equity could walk away from rising costs by opting to sell. On the demand
side, a declining working-age population with stagnant income growth means
fewer, already risk-adverse buyers dragging down housing prices.
The negative effect on housing prices is exacerbated by the fact houses are
illiquid assets – meaning they cannot be sold quickly for what is considered the
market price. A decrease in demand could mean time on the market for vacant
units increases, prices fall and housing sales decline.
For those reasons, even small negative shocks can have lasting negative effects
on the housing market.
LOWER GROWTH IN HOUSING VALUES WILL IMPAIR THE RECOVERY
If a progressive tax were adopted in Illinois, the resulting decrease in housing
appreciation would have negative implication for mortgage delinquency as well as
the economic recovery. This is because growth in home equity is negatively
associated with mortgage delinquency.
As of February, Illinois had the second-highest foreclosure rate in the country.
COVID-19 worsened the situation. First, rental income dried up and now data
released by the Mortgage Bankers Association shows Illinois delinquent mortgages
increased by 79% in the second quarter of 2020 versus a year earlier.
Unfortunately, that makes sense: substantial home equity fends off delinquency,
and housing wealth increases the likelihood that you spend more freely and
support the economy. A decline in housing wealth is associated with lower
consumer spending, thus harming Illinois’ economic recovery.
A BETTER PATH FORWARD
Rejecting a progressive income tax would spare Illinoisans from Connecticut’s
sorry fate. Changes to the state tax code will not fix the structural flaws with
the state’s finances or reform the main cost-drivers, pensions and government
employee health care costs. By eating nearly one-third of the dollars taxpayers
will send to Springfield this year, state spending on pensions has crowded out
the delivery of core services, including social spending on the disadvantaged as
well as important public investments that would raise the incomes and home
values of Illinois taxpayers.
So long as the state continues to prioritize government workers over everyone
else, Illinoisans will be forced to endure tax hikes regardless of the structure
of the state income tax. A progressive income tax will only make it easier for
politicians to gradually raise middle-class taxes and to levy a tax on
retirement income, just like Connecticut did.
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