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 Some states are more prepared to weather the next recession
than others, two of the nation’s largest credit rating agencies are finding. And
one key factor is the structure of a given state’s income tax.
Two separate analyses conducted by Standards & Poor’s Global Ratings and Moody’s
Analytics found that states with a graduated, or “progressive,” income tax are
especially susceptible to “wild revenue swings” during recessions, according to
Governing magazine.
This matters especially for residents reliant on core government services, which
can be compromised when a state isn’t prepared for a dip in revenue during an
economic slowdown. For example, the reports estimate a revenue decline of at
least 9 percent if Illinois encountered even a “moderate” recession. Moody’s
estimated a shortfall of more than $4 billion assuming the state experiences a
moderate recession and $6.8 billion in a “severe” recession. That would place a
serious strain on available resources, as the automatic increase in Medicaid
payouts alone in a moderate recession would grow expenditures by between 2 and 3
percent, the reports estimate.
 Moody’s includes Illinois among the 17 worst-prepared states. S&P puts Illinois
in the bottom 18 – states which have less than 70 percent of the cash reserves
needed to weather a recession comfortably.
While the U.S. overall will be better prepared for the next recession compared
with the last, Illinois’ position has only deteriorated since 2008.
There are a few variables that determine the preparedness of states in managing
fiscal shocks brought about by recession periods. Much of this has to do with
the varying levels of volatility between states’ primary revenue source. A
progressive income tax, relying heavily on a smaller tax base of higher earners,
includes more income from investment, or capital gains, which is highly volatile
during economic downturns.
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Findings from these reports should command the
attention of state lawmakers, a majority of whom voted in May to
pass a resolution filed by House Speaker Mike Madigan declaring
their endorsement of a progressive income tax. One progressive tax
proposal filed by state Rep. Robert Martwick, D-Chicago, in the
General Assembly would hike taxes on Illinoisans earning as little
as $17,300 per year.
In both studies, the ratings agencies found that while many states
will be better positioned to brave the next recession compared with
the previous crash, a striking number of states would still find
themselves perilously unprepared. Moody’s found that the number of
states with sufficient protection against recession actually
increased to 23 from 16 since 2017. Unfortunately, the Land of
Lincoln remains severely exposed.
Even with its flat tax, decades of poor policy choices have made
Illinois among the worst-prepared states in the nation.
Rather than taking steps to reverse a pattern of wasteful spending,
for example, the state has instead found revenue by dipping into
special funds. As a result, Illinois’ emergency, or “rainy day,”
fund is only capable of covering a mere 81 seconds of state
spending.
Some economists predict the next recession could arrive as early as
2020. By coincidence, that’s the next year Illinois voters would
have the ability to approve an amendment to the state constitution
at the ballot box, which is necessary to scrap Illinois’ flat-tax
protection.
Illinois is ill-prepared for the next recession – and a progressive
income tax would only leave the state worse off. If state lawmakers
are serious about restoring the state’s fiscal heath, they would be
wise to keep such a measure off the table.
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