Monday, May 14, 2007

Now is the time for Tax Fairness in the General Assembly

The debate on implementing tax fairness just opened up.

I think there's a fairly firm consensus in the General Assembly that our tax system is unfair. We tax people in poverty too much and we do not tax our state's largest corporations and wealthiest individuals nearly enough. Middle-class people probably are taxed a bit too much as well, particularly those in low-wealth communities.

The Governor has put tax fairness at the center of this year's session, rightfully pointing out that the corporate income tax is essentially broken as it lets the biggest corporations off the hook.

He hasn't pointed out that our 3% state income tax with a low personal exemption and a low earned income tax credit means that people who make six figures pay a smaller percent of their income in state and local taxes than people who make 40 grand or less. That's backwards and this is the month to change it.

The question before each Member of the General Assembly is how to change it.

The Governor's proposal to implement a tax on the gross receipts of the largest businesses in Illinois has largely been rejected as, in the Speaker's words, a “regressive” tax. The House, by the way, deserves credit for taking the Governor's proposal seriously with an eight-hour hearing before the entire House. That high-level policy debate is the crux of transparent governing and we should have more of it. Why can't the Governor appear before a joint session of the General Assembly every month for a British-style Question Time? That would be fun.

One of the most illuminating exchanges was between Representative David Miller and Governor Blagojevich, after the Governor said that any income tax increase – no matter how progressive -- is “off the table” as he would veto it, Representative Miller matter-of-factly reminded the Governor that the General Assembly could simply override the veto. The Governor's response: I'll campaign against any income tax increase next year! Why? Because “it's wrong.”

Here is the worst aspect of the Governor's position: he rejects, vilifies and obfuscates the existence of a progressive income tax. The absolute best way to reverse our regressive taxes is to raise income taxes on high incomes (personal and corporate) and lower taxes on low incomes. This is not difficult to do.

Our state Constitution does require a non-graduated income tax rate, which is why we have a flat rate of 3%. The Governor's position has been that this provision of the Constitution precludes any sort of progressive income tax – but that's just not true.

It would be great if we could have a federal-style income tax where the first $15,000 of income isn't taxed at all, and the next $40,000 of income is taxed at 15%, and the next $60,000 of income is taxed at 28% and then income above $250,000 is taxed at 35%. But, we don't.

What we can do, however, is raise the rate on all income to 5%. That would raise the revenue from the people who have it the most, won't miss it at all, benefit from the Bush tax cuts and (crucially) can write-off the higher state income tax they pay off of their federal returns so that the state as a whole will pay less in federal taxes.

What about people who make less than $50 grand – or people who make less than $15 grand? If we raise the income tax rate to 5%, they will pay more too, and that's the reason why the Governor thinks it is wrong to raise the income tax. There is an easy way, however, to make sure that the middle class and the poor do not pay more in income taxes in order to satisfy the Governor.

That's to raise the personal exemption to $10,000. It's current $2100. Or in other words, cut a $500 check per exemption to every taxpayer instead of what we do now which is cut a $63 check per exemption to every taxpayer (3% of $2100). That exemption is essentially meaningless.

For people with not a lot of money, $500 off of taxes is a lot. And it's probably enough to wipe out any tax they might owe: you have to earn $10,000 per person in order to owe anything (since 5% of $10,000 is $500). So a family of four wouldn't pay any state income tax at all if they earn less than $40,000. And lots of legislative districts have an median family income of less than $40,000. That is about the average family income in our state.

Compared to our current state income tax which hits people as soon as they earn $2100, a $10,000 personal exemption even with a 5% income tax would make most people better off, particularly as they have more exemptions to take (that is, kids).

Here's how it works with one exemption (look for the blue highlight to see the break-even point):

Gross family income Number of exemptions Deduction Value of exemption Adjusted income Rate Tax
$10,000.00 1 $2,000.00 $2,000.00 $8,000.00 0.03 $240.00
$20,000.00 1 $2,000.00 $2,000.00 $18,000.00 0.03 $540.00
$30,000.00 1 $2,000.00 $2,000.00 $28,000.00 0.03 $840.00
$40,000.00 1 $2,000.00 $2,000.00 $38,000.00 0.03 $1,140.00
$50,000.00 1 $2,000.00 $2,000.00 $48,000.00 0.03 $1,440.00
$60,000.00 1 $2,000.00 $2,000.00 $58,000.00 0.03 $1,740.00
$70,000.00 1 $2,000.00 $2,000.00 $68,000.00 0.03 $2,040.00
$80,000.00 1 $2,000.00 $2,000.00 $78,000.00 0.03 $2,340.00

and now here is with a higher income tax rate (5%) and a $10,000 personal exemption.

Gross family income Number of exemptions Deduction Value of exemption Adjusted income Rate Tax
$10,000.00 1 $10,000.00 $10,000.00 $0.00 0.05 $0.00
$20,000.00 1 $10,000.00 $10,000.00 $10,000.00 0.05 $500.00
$30,000.00 1 $10,000.00 $10,000.00 $20,000.00 0.05 $1,000.00
$40,000.00 1 $10,000.00 $10,000.00 $30,000.00 0.05 $1,500.00
$50,000.00 1 $10,000.00 $10,000.00 $40,000.00 0.05 $2,000.00
$60,000.00 1 $10,000.00 $10,000.00 $50,000.00 0.05 $2,500.00
$70,000.00 1 $10,000.00 $10,000.00 $60,000.00 0.05 $3,000.00
$80,000.00 1 $10,000.00 $10,000.00 $70,000.00 0.05 $3,500.00

For people who earn less than $20,000 – that's $10 an hour with a full-time job, and remember our state's minimum wage is only $6.50, and remember, about a fifth of the entire state's population earns less than $20,000 a year – they are better off under a 5% state income tax with a $10,000 exemption than they are under a 3% state income tax with a $2,000 exemption. This is about the break-even point, so anyone who makes more than $20,000 as a single filer would pay more under the change.

Let's skip ahead to people with two exemptions and watch the break-even point rise dramatically. People with two exemptions include married couples and single parents with one kid.

Here is the status quo:

Gross family income Number of exemptions Deduction Value of exemption Adjusted income Rate Tax
$10,000.00 2 $2,000.00 $4,000.00 $6,000.00 0.03 $180.00
$20,000.00 2 $2,000.00 $4,000.00 $16,000.00 0.03 $480.00
$30,000.00 2 $2,000.00 $4,000.00 $26,000.00 0.03 $780.00
$40,000.00 2 $2,000.00 $4,000.00 $36,000.00 0.03 $1,080.00
$50,000.00 2 $2,000.00 $4,000.00 $46,000.00 0.03 $1,380.00
$60,000.00 2 $2,000.00 $4,000.00 $56,000.00 0.03 $1,680.00
$70,000.00 2 $2,000.00 $4,000.00 $66,000.00 0.03 $1,980.00
$80,000.00 2 $2,000.00 $4,000.00 $76,000.00 0.03 $2,280.00

And here is a more progressive income tax at a 5% rate and a $10,000 exemption.

Gross family income Number of exemptions Deduction Value of exemption Adjusted income Rate Tax
$10,000.00 2 $10,000.00 $20,000.00 -$10,000.00 0.05 $0.00
$20,000.00 2 $10,000.00 $20,000.00 $0.00 0.05 $0.00
$30,000.00 2 $10,000.00 $20,000.00 $10,000.00 0.05 $500.00
$40,000.00 2 $10,000.00 $20,000.00 $20,000.00 0.05 $1,000.00
$50,000.00 2 $10,000.00 $20,000.00 $30,000.00 0.05 $1,500.00
$60,000.00 2 $10,000.00 $20,000.00 $40,000.00 0.05 $2,000.00
$70,000.00 2 $10,000.00 $20,000.00 $50,000.00 0.05 $2,500.00
$80,000.00 2 $10,000.00 $20,000.00 $60,000.00 0.05 $3,000.00

Now we're at $40,000 of family income for a family of two (where just under half the population lives). That's a $20/hour job. Not bad and getting tougher to find as our manufacturing jobs are disappearing and service jobs rarely pay that much.

Here everyone with two exemptions who makes less than $40,000 is better off with a higher tax rate (raising taxes!) and a higher personal exemption than they are today. Anyone who makes more than that will pay more.

Let's skip to the comparison for four exemptions (a married couple with two kids or a single parent with three kids):

Gross family income Number of exemptions Deduction Value of exemption Adjusted income Rate Tax
$10,000.00 4 $2,000.00 $8,000.00 $2,000.00 0.03 $60.00
$20,000.00 4 $2,000.00 $8,000.00 $12,000.00 0.03 $360.00
$30,000.00 4 $2,000.00 $8,000.00 $22,000.00 0.03 $660.00
$40,000.00 4 $2,000.00 $8,000.00 $32,000.00 0.03 $960.00
$50,000.00 4 $2,000.00 $8,000.00 $42,000.00 0.03 $1,260.00
$60,000.00 4 $2,000.00 $8,000.00 $52,000.00 0.03 $1,560.00
$70,000.00 4 $2,000.00 $8,000.00 $62,000.00 0.03 $1,860.00
$80,000.00 4 $2,000.00 $8,000.00 $72,000.00 0.03 $2,160.00
$90,000.00 4 $2,000.00 $8,000.00 $82,000.00 0.03 $2,460.00

Now, with a more progressive income tax (even with the Constitutional flat rate)

Gross family income Number of exemptions Deduction Value of exemption Adjusted income Rate Tax
$10,000.00 4 $10,000.00 $40,000.00 -$30,000.00 0.05 $0.00
$20,000.00 4 $10,000.00 $40,000.00 -$20,000.00 0.05 $0.00
$30,000.00 4 $10,000.00 $40,000.00 -$10,000.00 0.05 $0.00
$40,000.00 4 $10,000.00 $40,000.00 $0.00 0.05 $0.00
$50,000.00 4 $10,000.00 $40,000.00 $10,000.00 0.05 $500.00
$60,000.00 4 $10,000.00 $40,000.00 $20,000.00 0.05 $1,000.00
$70,000.00 4 $10,000.00 $40,000.00 $30,000.00 0.05 $1,500.00
$80,000.00 4 $10,000.00 $40,000.00 $40,000.00 0.05 $2,000.00
$90,000.00 4 $10,000.00 $40,000.00 $50,000.00 0.05 $2,500.00

90 grand! That's the break-even point!

Everyone who makes less than $90,000 in family income with four exemptions pays less with a 5% income tax rate and a $10,000 exemption than they do today.

That's a lot of middle-class (and upper-middle-class) families in both D and R districts.

This is just to show that a progressive income tax is very possible and can cut taxes for lots of low-income and working people who are paying too many taxes now because we don't tax high incomes and corporations enough.

That's how it should be.

There are other important ways to make our tax more fair -- increasing the earned income tax credit and either closing corporate tax loopholes or instituting an alternative minimum corporate income tax or even perhaps a gross receipts tax that only affects the highest grossing corporations.

But for those of us who believe in a more progressive tax, we have a challenge that so far we have not really met and that is to explain to each Member of the General Assembly exactly how each of these low-income tax cuts (a higher personal exemption of the earned income tax credit) actually works to deliver tax cuts to the people who need it most.

Tax policy is not intuitive or obvious and unless we do a better job showing Members exactly how taxes are not progressive now and how to make them more progressive, we are unlikely to overcome legislators' natural inclination against raising taxes. And ultimately, our task is to convince voters that they stand to benefit from raising taxes on incomes above their own as it is often too much to ask Members to get ahead of their voters.

This is the crux of the communications challenge: we need to convince lower-income voters (who usually have less education) that raising taxes on high incomes while cutting taxes on lower incomes is good for their bottom line. We need to convince voters that progressive tax policy is the best rural economic development and inner-city economic development the state can possibly offer – because it is.

750, the twin bills in the House and Senate that raise the income tax to 5%, expand the sales tax to include services and invest the revenue in education, human services and pension payments, also holds harmless lower incomes from the higher taxes. This is a great step and right now 750 must be considered the leading proposal before the General Assembly.

One problem, however, is that the low-income tax cuts in 750 (the Family Tax Credit) are neither obvious nor simple to explain. The Family Tax Credit is, as I understand it, a tax credit off of the higher state income tax that compensates for both the expected higher sales tax and the higher income tax that lower-income residents would pay. There is a worksheet that calculates the size of the credit based on income and exemptions which will result in everyone making less than $50,000 or so paying the same amount under 750 than they do today with a 3% income tax and a non-service sales tax.

The concept is sound and deserves to be at the center of the debate, but there are two potential improvements worth considering. One is that the bill essentially asks legislators to trust that the Family Tax Credit will work, as the mechanism is not clearly explained (for every $2,000 of income, how much is the Family Tax Credit worth?). The second is that instead of cutting taxes for those earning less than $30,000 or so, 750 keeps the tax burden the same. 750 makes our tax more progressive by raising taxes on people making more than $50,000 or $60,000 or so, which is good (since our state's long-term economy is suffering from a low-tax and thus low-investment status, particularly in education and transportation), but does not make progress on the other side to cut taxes on low-income people which would do the most good to our economy (as low-income people spend locally almost all the money they save unlike high-income people who invest their money in global vehicles like mutual funds or second homes).

This is the month to build on the Governor's campaign for Tax Fairness in the General Assembly. Let's seize it!


x said...

Bam! Great post!

Extreme Wisdom said...

Where is the petition to get people to turn off their engines at long lights and trains?

Where is the petition to replace income taxes with a tax high enough to reduce demand? (this would require some sort of "rebate" for EITC recipents)

Where is the sanity here? The idea that the oil companies and refiners play around with the market to goose prices wouldn't surprise me, but hearing after hearing has shown that they aren't "gouging."

Chinese growth is exploding, and Americans LOVE their Escalades and Navigators.

You want to look at who to blame for gas prices, look in the mirror.

Extreme Wisdom said...

Oops, wrong post!

I tend to agree with this one, provided property taxes are permanently and substantially reduced.