In addition to fairness, Illinois needs stability in tax system

By Ralph Martire

Guest columnist

Too often, major policy initiatives get framed as "either-or" propositions. This is understandable, given how politically driven the legislative process is. Portraying a potential reform as a stark choice between doing what's right, or supporting an alternative that's wrong, is a great way to instill party discipline and gain political advantage. It also ignores the reality that in most complex policy areas, following best practices usually incorporates more of a "both-and" approach, than the politically favored "either-or."

For a clear example of this dynamic, look no further than Gov. J.B. Pritzker's call for creating a fair state income tax by amending the Illinois Constitution to permit higher tax rates on higher levels of income and lower rates on lower levels of income. There's no question that - from a textbook tax policy standpoint - the governor is absolutely right: the best way to build fairness into a tax system is to have a graduated rate income tax.

The reasons for this are clear and compelling. After all, the income tax is the only tax that can be designed to comport with ability to pay, which is crucial to creating tax fairness, given growing income inequality. Indeed, after adjusting for inflation, since 1980 the wealthiest 10 percent have realized 108.4 percent of all income growth in America - meaning 90 percent of workers are earning less after inflation now than they did in 1980. So to tax people fairly, an income tax has to "respond" to this economic reality, by imposing higher rates on higher levels of income and lower rates on lower levels.

However, creating a fairer and more responsive state tax system is not the only crucial tax reform Illinois needs. Illinois also has to stabilize its tax system to have it function properly in the modern economy. See, designing a sound tax system is much like designing a sound long-term investment strategy for a family's savings portfolio. Just as different investments are needed to ensure a portfolio's long-term growth in varying economic situations, different taxes fulfill different core functions in ensuring a state fiscal system remains sound in different economies.

To accomplish that, tax systems should incorporate revenue sources that promote both: tax fairness, by responding to ability to pay; and fiscal stability, by ensuring revenues don't fall too precipitously during poor economic cycles. As already discussed, the income tax is the revenue source that creates tax fairness by responding to how the private sector distributes income growth over time. But because it is so responsive to the economy, during downturns, the revenue generated by an income tax tends to decline significantly.

To create stability in revenue generation - even during hard times - a state has to have a broad base for its sales tax. That means the sales tax has to apply to most of the transactions occurring in the consumer economy. This creates stability for two reasons. First, most economic activity - around 67 percent - is composed of consumer spending. Second, consumer spending doesn't decline much, even during recessions. So if a state broadly taxes consumer spending, it has added stability to its fiscal system. Unfortunately, of the 45 states with a sales tax, Illinois has the most narrow base, because its sales tax applies to very few services. That's no bueno, because services constitute both the largest and fastest growing segments of Illinois' economy.

Many advocates of tax fairness who support Gov. Pritzker's call for a graduated rate income tax oppose broadening the sales tax base. And while it's true sales taxes are regressive, the stable revenue a broad-based sales tax generates during recessions averts the need for significant spending cuts to core services predominantly consumed by low- and middle-income families. In other words, both reforms are needed for Illinois' fiscal system to be fair and sustainable over time, it's just a question of getting the balance right. This isn't a cause of "either-or," but rather "both-and."

Ralph Martire, rmartire@ctbaonline.org, is executive director of the Center for Tax and Budget Accountability, a bipartisan fiscal policy think tank.