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To respond to reality, state needs to fix structural tax deficit

Last weekend the state enacted a $55.2 billion General Fund budget for its upcoming 2026 fiscal year. A sizable chunk of that budget, $16 billion, covers mandatory spending obligations required to be paid either by law, such as debt service owed to bondholders, or contracts, like health insurance for state workers. That leaves around $39 billion for services. Over 94% of those service expenditures go to education, health care, social services and public safety, the core services families rely on across Illinois.

Some of the commentary since the budget passed has focused on what didn’t get addressed, like the $771 million fiscal cliff facing the Regional Transit Authority. Much of the remaining analysis has focused on incremental changes, like the year-to-year $307 million bump for the state’s school funding formula, which is welcome, but still some $2.7 billion less than what the evidence shows is needed for every school to provide an adequate education to its students, or the $330 million cut to funding health care for non-citizens (aka “people”) between 42 and 64 years old. In fact, while spending will increase slightly year-over-year, total FY 2026 General Fund appropriations for the four core services are 12% less in real, inflation-adjusted dollars than they were way back in FY 2000.

Unfortunately, most budget commentary doesn’t provide enough context to understand why Illinois, which has an economy of over $1 trillion, the fifth largest of any state, has been cutting spending in real terms since Republican George Ryan was governor.

The data, however do. Illinois’ General Fund has a structural deficit. That means over time, tax revenue growth fails to support the inflationary cost of maintaining the same level of public services from year-to-year. The data also show that flawed tax policy is why this structural deficit exists. See, neither of Illinois’ two primary revenue sources — the income and sales taxes — is designed to respond to the modern economy, resulting in a tax system that’s both unsound and unfair.

Start with Illinois’ sales tax, which applies primarily to purchases of goods, not services. That’s a losing proposition, given that the sale of goods accounts for just 17% of state GDP, while the sale of services accounts for 74%. Failing to assess sales taxes on most of the largest and fastest growing segment of the economy means the revenue it generates can’t grow with the economy. Fixing that requires assessing Illinois’ sales tax to the purchase of all consumer services, like neighboring Iowa and Wisconsin do. That reform would generate over $2 billion in new revenue.

Then there’s the income tax, which is supposed to create some tax fairness, and respond to how income growth is actually shared among taxpayers over time. Since 1979, the real incomes of the bottom 10% of earners has declined. Folks in the middle realized a modest 8% growth in income, while the wealthiest 10% saw their incomes jump by 30%. So to respond to reality and tax people fairly, the income tax should vary with ability to pay, by imposing higher tax rates on higher levels of income and lower rates on lower levels of income.

Except Illinois’ income tax can’t, because the state Constitution requires utilization of only one flat rate. To fix this, the state’s flat income tax rate should be increased by 1.5 percentage points to 6.45%. That’s enough to generate about $3.7 billion in net new revenue, after covering the cost of implementing a new, refundable tax credit to offset the impact of the aforesaid tax increases on low and middle income families. Collectively, these reforms would eliminate the structural deficit, while simultaneously making state tax policy fairer for people.

• Ralph Martire, rmartire@ctbaonline.org, is Executive Director of the Center for Tax and Budget Accountability, a fiscal policy think tank, and the Arthur Rubloff Professor of Public Policy at Roosevelt University.

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