How tax breaks are costing Illinois billions in lost revenue

Almost lost in the battle over how to close Illinois' $8 billion budget hole is the fact that the state effectively gives away even more than that amount each year in tax breaks.

A plethora of 257 separate categories of breaks - called tax expenditures by experts - cost Illinois $9.4 billion in revenue in fiscal 2015 alone, according to state records.

There are specially targeted breaks for business, breaks for the wealthy, breaks for the poor, breaks for mom and pop and breaks for grandma and grandpa - all jealously protected by deep-seated constituencies that can render any attempt at reform a minefield for political leaders. Together, they vastly complicate a tax system that in theory is simpler than most because the prime revenue generator, the income tax, imposes a flat rate of 3.75 percent for individuals and 5.25 percent for corporations.

Business tax breaks are fraught with the most controversy, but collectively they cost $1.8 billion in 2015, less than 20 percent of the potential revenue the state has chosen to forego. Indeed, the single-costliest break, worth $2.3 billion a year in lost revenue, is targeted for seniors.

In Illinois, all qualified retirement income - earnings from Social Security, pensions, 401(k) and IRA withdrawals and the like - is exempt from the state income tax. Such income is subject to taxation by the federal government and, either in part or in full, by most other states.

Advocates for some categories of tax expenditures would vigorously dispute any attempt to characterize them as giveaways. Indeed, some breaks have been added to the tax code over the years in attempts to compensate for double taxation of income, address inequities in the tax structure, and grant relief to low-income wage earners.

That latter program, the Illinois Earned Income Tax Credit, sliced $234 million off potential state revenues in fiscal 2015, according to the comptroller's office. The credit is modeled after a similar, and even more valuable, federal income tax credit for low-income workers.

Ralph Martire, executive director of the Chicago-based Center for Tax and Budget Accountability, said once tax expenditures are approved, their effectiveness and fairness are rarely if ever reviewed.

Martire argues the retirement income exemption "needs to go." However, low- and moderate-income seniors should continue to be exempt, he said. The issue, he concedes, is likely a non-starter now in Springfield.

Business tax breaks, while often controversial, also have proved difficult to upend once approved. Some were sold as mechanisms to keep businesses from being taxed twice on earnings or activity, while others were created by lawmakers as subsidies to promote economic development. Critics contend such subsidies are targeted deals that favor large companies and, in essence, let the state pick winners and losers.

Among big breaks available to business is the Economic Development for a Growing Economy tax credit, typically known by the acronym EDGE, which cost the state $137 million in fiscal 2015. Under EDGE, companies can qualify for state tax credits if they add jobs or, in some instances, simply don't downsize.

In 2013, the program came under the spotlight amid news that lawmakers had carved out special deals for some companies, allowing them to retain tax withholdings from employee paychecks rather than remit the money to the state, as is generally required.

Other big state tax loopholes for businesses include the Net Operating Loss Deduction, which allows for any losses to be carried forward for 12 years to mitigate or eliminate the tax consequences of future earnings. The deduction shrank the state's corporate income tax revenues by $48.7 million in fiscal 2015. It is similar to a federal loophole used by Republican presidential contender Donald Trump, who acknowledged avoiding tax payments for nearly two decades after claiming a $916 million business loss in 1995.

Illinois businesses can take advantage of a sales tax exemption for purchases of manufacturing machinery and equipment, costing the state $108 million. A similar exemption for farm machinery and equipment cost Illinois $109 million.

Sales tax breaks are also broadly available for individuals. While the state portion of the sales tax, 6.25 percent, is levied on the purchase of most retail goods, the rate drops to 1 percent on many foods, drugs and medical appliances.

With the state awash in red ink, many tax experts now argue for the repeal or modification of some tax expenditures - for example, imposing a means test to reduce burdens on low-income taxpayers. Some of those same experts also argue that the fastest, simplest and most transparent route to fixing Illinois' finances is to raise income and corporate tax rates, which were lowered at the beginning of 2015.

Norton Francis, a senior research associate with the Urban Institute's State and Local Finance Initiative, noted tax hikes can be political dynamite. To avoid them, Francis said, politicians groping for added revenue typically resort to workarounds like tinkering with deductions, further complicating the tax code.

• Alejandra Cancino can be reached at acancino@bettergov.org or @writeralejandra.

Breaking down tax breaks

Specially targeted tax breaks benefit businesses, the wealthy, seniors and others. Here are some common tax loopholes used in 2015 by Illinois taxpayers.

Business Source Cost to state

Manufacturing Sales tax $108 million equipment & machinery

EDGE, Economic Tax credit $137 million* Development for a Growing Economy

Net operating loss Tax credit $48.6 million deduction

Individual

Retirement income/ Tax credit $2.3 billion Social Security

EITC, Earned Income Tax credit $234 million

*Includes individual and corporate exemptions

Source: Illinois comptroller, Better Government Association