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 The economic effects of the current COVID-19 outbreak and
measures to contain it are massive. Experts are predicting national declines in
gross domestic product ranging from 24% to 50% in the second quarter of 2020,
which would translate to a contraction between $54 billion and $113 billion for
the state of Illinois.
The massive reduction in economic activity and skyrocketing number of
Illinoisans who now find themselves unemployed will also put a massive dent in
income tax revenue for the state. In fiscal year 2020, Illinois collected $19.7
billion in individual income taxes, its largest source of tax revenue. However,
if current projections hold, Illinois could see a reduction in income tax
revenues ranging from $2.9 billion to $6.6 billion (see Appendix).
Historically in Illinois, a 1% change in GDP has been associated with a 2.4% to
2.7% change in taxable income. Current economic projections indicate the severe
contraction expected in the second quarter of 2020 to translate into a 6% to
12.5% decline in GDP for the year. This decline in GDP would indicate Illinois
taxable income, and therefore income tax collections, would drop anywhere from
14.7% to 33.8%.
Total revenue decline
Illinois was already facing a $1.7 billion budget shortfall for the upcoming
fiscal year, prior to the onset of the COVID-19 pandemic. Now that large swaths
of the economy have been shut down, revenues are expected to fall drastically,
with researchers at the University of Illinois’ Institute of Government and
Public Affairs estimating total revenues could decline anywhere from $4.3
billion in one year to $28.4 billion over three years, depending on the severity
and duration of the downturn and the subsequent recovery.
Normally when states experience sudden downturns in revenue, they use their
budget stabilization, or “rainy-day,” funds to cover budget shortfalls. Experts
recommend states take advantage of economic expansions to maintain reserves that
could cover state expenses for about a month.
Unfortunately, Illinois has virtually no rainy-day fund. The state’s budget
stabilization fund currently has $1.19 million, enough to cover just over 15
minutes of state spending. The state has also become increasingly reliant on
volatile sources of revenue in recent years, making the state budget more
susceptible to downturns.
 The current administration’s progressive income tax proposal could not offset
the coming decline in personal income tax revenues
A large reason for why the state is likely to suffer such a massive dip in
revenues is the heavy reliance on income taxes. Federal Reserve Bank economists
have pointed out that income taxes are often subject to the largest swings,
offering robust growth during good times but also severely contracting during
downturns. Meanwhile, consumption-based taxes generally provide both growth in
tax revenues and stability.
As noted by economists and observed during the last recession, income taxes tend
to be the most volatile source of revenue. An increase in the income tax, while
bringing in greater revenues, would also mean larger dips in revenue during
economic downturns. The increase in Illinois income taxes during the past decade
is already one of the reasons revenues are more volatile now than in the past.
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Not only would increasing the state’s reliance on
income taxes threaten the stability of tax revenues, but changing
the income tax from flat to progressive would generate added
volatility. Progressive income taxes are more volatile than flat
income taxes because they rely on smaller segments of the population
for large portions of revenue, and the income for these earners is
far less stable than most. Had Illinois had a progressive income tax
during the last downturn, income tax revenue would have fallen by
$613 million more than it did under the state’s flat tax, generating
a total decline of $2.16 billion in income tax revenue.
While it remains to be seen what the final effects of the COVID-19
outbreak will be on GDP and therefore income tax collections, one
thing is certain: the decline in revenue would have been larger if
the state had a progressive income tax. As the state stares down a
massive budget hole, it is important to recognize that (1) adopting
a progressive income tax means larger swings in state income tax
revenue and (2) the governor’s estimated revenues from the proposed
progressive income tax – barring any changes in revenue forecasts
because of the downturn – would cover less than half of the current
projected budget deficit.
If the proposed progressive tax amendment is not withdrawn by the
General Assembly, voters approve it on Nov. 3 and the progressive
income tax rates already passed by the legislature take effect,
Illinoisans will face income tax rates ranging from 4.75% to 7.99%
starting Jan. 1, 2021.
While state leaders previously estimated this plan would bring in an
additional $3.7 billion in income tax revenue, their estimates were
not factoring in an economic contraction of the current magnitude.
The currently proposed rates are not even enough to offset the
anticipated decline in income tax revenues. In order for the
progressive income tax, as it is currently structured, to offset the
decline in personal income tax revenue, tax rates would have to be
far higher for all Illinoisans (see Appendix B).
Marginal income tax rates would have to range from 5.16% to 8.68% in
order for the progressive income tax to offset the low-end estimate
for the decline in income tax revenue. In the worst-case scenario,
tax rates would have to be far higher, ranging from 6.08% to 10.23%.
This tax increase would represent a $286 to $1,056 income tax hike
for the typical Illinois family, who made $81,313 in 2018.
In any scenario, using the progressive income tax to offset the
decline in personal income tax revenue would result in a tax hike
for all Illinoisans. With the total decline in all tax revenues for
the state potentially growing to over $28 billion, it is clear that
a progressive income tax would not be able to solve the state’s
budget woes.
As the state battles with economic fallout from COVID-19, the
anticipated income tax revenue from the current progressive income
tax would likely be far less, prompting the state to raise income
tax rates to cover part – or all – of the shortfall. Instead of
pushing a progressive income tax hike in the midst of an economic
crisis, lawmakers should provide certainty and stability to
taxpayers and remove the question from the ballot.
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