Back to state report | Introduction

Illinois Supplemental Report

Tax Environment

The cry for tax reform in Illinois failed to materialize into passed legislation in the recently completed 2003 spring legislative session. The state’s tax system is characterized by high property taxes, income taxes that hit at low income levels and significant exemptions to personal and corporate income taxes. In 2001, the state had the highest average property taxes in the country on homes with a value of $150,000.

The income tax structure is somewhat more complicated than in other states. The state constitution mandates a flat individual income tax, which currently stands at a comparatively low 3 percent. It is, however, levied on incomes as low as $8,000 for families of four. The corporate income tax can only be 8/5 of the individual tax, so it stands at 4.8 percent and can’t be raised without a corresponding hike in the individual income tax.

In 2001, the Education Funding Advisory Board, a panel appointed by then-Gov. George Ryan to improve the schools, recommended raising state income and sales taxes by $5.3 billion to provide $3.5 billion in lower property taxes and $1.8 billion in additional school spending.

Recent Tax Developments

• Lawmakers voted in 2003 to increase taxes from 50 percent to 70 percent on casinos’ adjusted gross receipts of more than $250 million; at the same time, they also voted to increase admission fees to the casinos. Along with these changes and the lowering of the threshold for existing tax rates for other boats, the state expects to raise $200 million.

• Illinois decoupled from the federal estate tax law. If Illinois remained coupled with the federal tax, it stood to lose $458 million annually by 2007, according to the Illinois Economic and Fiscal Commission. By decoupling now, Illinois essentially establishes its own estate tax, which re-institutes the tax as it stood December 31, 2001, before the phase-out began.

• Lawmakers approved a six-week tax amnesty program as part of the FY 2004 budget. The program is expected to raise $40 million and will run October 1 through November 15, 2003.

• Several sales tax exemptions for business-to-business purchases were ended, including machinery used for coal and oil extraction, graphic arts equipment, vending machines and noncommercial aircraft. Another bill amended the net operating loss carry-forward from 20 years to 12 years and cut the credit for corporate personal property taxes paid and the corporate standard deduction.

• In 2002, Illinois raised the cigarette tax by 40 cents per pack, gambling taxes by about $40 million and decoupled from the federal bonus depreciation being offered to corporations.

Budget Information

Illinois revenue estimates are not produced in a consensus process. Instead, the Office of Management and Budget and the Economic and Fiscal Commission produce estimates for the Governor’s office and the legislature, respectively.

FY2002 was the first year since 1955 that Illinois produced less general fund revenue than in the previous year. (The state had predicted growth of close to $900 million.) Revenues actually dropped $728 million compared with 2001, so the state brought in about $ 1.6 billion less than expected.

The state used myriad budget-balancing maneuvers in 2003. In addition to gambling and cigarette tax hikes, it cut $1 billion from the baseline 2002 budget, offered an early retirement plan to state workers, transferred $165 million from special funds into the general fund, used $226 million of the rainy day fund and borrowed $1 billion in short-term loans. In Illinois, that type of borrowing defers the pain for just a few months; state law dictates that any rainy day fund monies must be repaid within the same fiscal year. Short-term loans also must be paid back in that time-frame.

Budget problems persisted—and grew worse—for the 2004 budget. The 2003 tax hikes were less profitable than expected: they raised less than $250 million, compared to the projections of more than $350 million in additional revenue. The state faced a $5 billion budget gap for the 2004 fiscal year.

During the gubernatorial campaign, Rod Blagojevich, the state’s new Democratic governor, pledged not to raise income or sales taxes. The state eventually managed to balance the budget without raising those taxes, again through a variety of stop-gap measures. Casino taxes were once again hiked, some corporate tax exemptions were ended, state assets were sold and a host of higher fees — such as a $325 increase in the liquor license fee—were called upon to balance the budget. Blagojevich vetoed $22 million of the $52 billion budget.

Also approved during the 2003 spring legislative session was legislation that allows the state’s budget director to direct the state treasurer and comptroller to divert money from dedicated funds into the state’s general fund at any time. Due to the change, as much as 8 percent of a fund’s projected annual revenue or a quarter of the fund’s original balance—whichever is less—can now be transferred without legislative approval. State Treasurer Judy Baar Topinka may fight the move.

Moody’s has lowered the state’s bond rating from Aa2 to Aa3; Fitch lowered the rating to AA from AA+. Standard and Poor’s has issued a negative ratings outlook for the state.

Adequacy

Illinois’ tax system is comprised of the traditional three major taxes: income (both personal and corporate), sales and property taxes. Since 2002, revenues have fallen far short of projections; the state’s $5 billion budget gap for 2004 was the highest yet. Budget problems have been exacerbated by the same ills other states have faced, primarily a slowing economy leading to reduced income and sales tax receipts.

In 1998, the state changed the formula by which corporate income tax liability is calculated: businesses now pay only according to their sales in the state (commonly referred to as the single sales apportionment formula), as opposed to the more traditional calculation that takes property, payroll and sales into account. Gov. Rod Blagojevich supported a return to the three-factor approach, but the legislature did not approve his plan. One lawmaker estimates that the change has cost the state upwards of $96 million a year in tax revenue.

When state and local taxes are considered together, Illinois derives a larger portion of its tax base from property taxes than most states. The state over-relies on the property tax for school funding, a hot issue with many tax and revenue observers in the state. Reform of the system in the form of a tax swap or simple property tax reduction has not progressed beyond proposal stage.

The recent changes to the tax code that reduce or eliminate some business tax exemptions should help the state pick up at least $200 million in additional annual revenue.

Fairness

The system as a whole is regressive. In addition to the comparatively low level at which the individual income tax hits, groceries and prescription drugs are taxed, and the income tax is levied at a flat rate. When the impact of property taxes is factored in, the lowest income earners pay 13.1 percent of their salaries in taxes to the state, compared with 4.6 percent of the top 1 percent of income earners. http://www.itepnet.org/whopays.htm

The state’s general sales tax—considered the most regressive tax—is levied at 6.25 percent (though groceries and prescription drugs are taxed lower, at 1 percent). The problem with the sales tax stems from its significantly narrow base, which rests the sales tax burden on fewer consumers. The state taxes the fewest services nationwide and exempts items such as amusement park admission and movie rentals, which most other states—even those that tax relatively few other services—do tax, according to the Federation of Tax Administrators study of service taxation. http://www.taxadmin.org/fta/pub/services/rr147srv.pdf

Management

Illinois ran into a significant, though rare, problem last year: it ran out of money to pay back tax refunds. To fund refunds, the state takes 6 percent out of tax returns. But in years like 2002 and 2003, when tax receipts fell and refunds rose, there wasn’t enough money in that fund to pay out the returns. The state ended up following through on its individual income tax refunds through $150 million of its short-term loan. But corporate tax refunds were more of a problem; as of January, $524 million in refund payments were indefinitely on hold.

A fifth of the Revenue Department’s employees were eligible for the early retirement program offered by the state in 2002; the department estimated it would lose about 18 percent of its data processors to the program. That would leave sizable gaps in the workforce to complete processing of returns.

Processing speed is helped a great deal by the use of electronic filing. More than 50 percent of filers use some form of electronic filing, whether online or through 2-d barcode returns. The state doesn’t have an integrated tax system, however. It plans to build one for itself rather than purchase an off-the-shelf system, but a firm timetable for such a project has yet to be established. The Revenue Department does not use an imaging system along with the state’s 2-d barcode system, which would substantially improve tax return processing efficiency. Department officials indicated that an imaging program would top their “wish list” for new technology applications.

The state does not use a data warehouse. It was, however, one of the first four states to participate in the federal offset program, which offsets state tax debt with federal income tax refunds. The state estimates that it has collected more than $30 million from that program.

Illinois does an above-average job on tax policy accountability. The state prepares a tax expenditure report that itemizes the value of revenues foregone via tax breaks. The report is available on the web at http://163.191.177.7/ioc-pdf/TaxExpRptFY2002WEB.pdf. Illinois also analyzes the impact of state taxes or changes in the tax code on taxpayers of all income levels, according to the State Assets Development Report Card, Corporation for Enterprise Development, October, 2002.

Local Issues

The top local issue is the over-reliance on property taxes to fund education. As noted earlier, there has been some discussion of reducing the reliance on property taxes for public education funding by increasing income taxes and expanding the sales tax base, but such plans have not been approved. The state constitution does say that the state should pay 50 percent of school funding, but it is not a binding clause.

Counties and municipalities do have the option of levying local option sales taxes, but they must be on the same base as the state’s sales tax and approved by referendum. They are increased in quarter-percent increments; most stand now at 1 percent.

Noteworthy Programs

• In March, 2000, Illinois began a program—similar to ones operating in Maryland and Connecticut—to post the names of tax delinquents who owe more than $1,000 on the Web. The state gives delinquent taxpayers a warning 90 days prior to posting their names, to encourage taxpayers to satisfy the debt and avoid publication.

Copyright © 2003, Congressional Quarterly, Inc. Reproduction in any form without the written permission of the publisher is prohibited. Governing, City & State and Governing.com are registered trademarks of Congressional Quarterly, Inc.