The state of the State

This year's gubernatorial race offers an interesting role reversal on the key issue of the extension of the income tax surcharge. Neil F. Hartigan, the Democratic nominee, has proposed abolition of the tax that was imposed in 1989 with generally Democratic votes. Jim Edgar, the Republican candidate, has supported reimposition of the tax that was passed in 1989 over widespread Republican opposition. Both candidates supported the surcharge in 1989. Both candidates will face severe fiscal problems if they follow their campaign pledges. Hartigan's problems will come sooner, Edgar's later.

Voters are weary of taxes and wary of politicians who raise them. Accordingly, both candidates have crafted anti-tax stands. Democrat Hartigan's anti-tax position is his pledge to allow the two-year 20 percent income tax increase to die when it expires on June 30. He will not rule out subsequent tax increases. Republican Edgar, who wants the temporary tax extended, has carved out his anti-tax position by promising no new taxes for his first term.

Given their positions, both candidates will have difficulty governing if elected. The Hartigan proposal will create massive problems with the budget for fiscal year 1992, which will begin six months after the new governor takes office. Edgar's surcharge extension position would allow him more flexibility in dealing with short-run budget crises. Both plans will cause problems in the longer term because state revenues rise at less than the rate of inflation.

Hartigan's says that his detailed "getting-your-money's-worth-from-state-government-for-a-change" budget plan would result in $600 million in spending cuts. In reality it calls for $386 million in reduced spending ($330 million in the general funds) and $187 million in new revenues. Hartigan's cuts would include:

•  $50 million from the Department of Commerce and Community Affairs, the only specific cut that he has proposed.

•  $113 million from an across-the-board 10 percent reduction of administrative budgets.

•   $105 million ($49 million in the general funds) from elimination of waste and duplication following completion of a detailed analysis of state spending.

•  $53 million from reform of the budget process: limiting supplemental appropriations and phasing down lapse-period spending. This will be a true cut only if the state spends less money in some areas.

•  $65 million from using bond proceeds to pay for capital spending now covered by current revenues. The spending remains, only the funding source is switched.

The balance of Hartigan's program is new revenues that are somewhat shakier. He believes that more diligence and better collection procedures could produce $100 million in taxes and other payments due state government from the $1.8 billion now carried on the state books as uncollectible. He may have trouble meeting that target in the general funds because less than half the $1.8 billion listed as uncollectible on December 31, 1989, ($690 million) was due the general funds.

Finally, he proposes to evaluate existing loopholes and to raise $87 million in new tax revenues by closing them. Most of the loopholes ($119 million of the $173 million) are sales tax exemptions for business

10/November 1990/Illinois Issues

machinery and equipment. Removal of the tax exemption constitutes a tax increase to those who pay the tax. Closing the loopholes will require a vote by lawmakers who are just as tax-shy as gubernatorial candidates.

His fallback position, too, is a revenue increase. Hartigan says that if some cuts prove unwise or impossible to make, the state can work to improve what it receives from the federal government. Federal budget pressures will make that a difficult task.

To summarize, Hartigan proposes spending cuts in the general funds that total $265 million. His specific cuts are $50 million from the Department of Commerce and Community Affairs. His nonspecific cuts come in administration, waste elimination and budget reform measures that would total $215 million.

Add the $65 million in the bond fund switch to Hartigan's others cuts and he has reduced general funds spending by $330 million, thus freeing up money for real-location. And he has whatever he can raise by collecting the $690 million owed the general funds and whatever loopholes he can close.

Hartigan will need at least some new revenues, or deeper budget cuts, to make good on his pledge to let the income tax surcharge expire without taking money away from schools, colleges and universities. To fulfill that pledge Hartigan must find $375 million to replace what education would lose in fiscal year 1992.

In total, the elimination of the surcharge would take $900 million out of state revenues of which about $500 million would be from general funds revenues. (The other $400 million goes to local government on a per capita basis.) From the $500 million in the general funds about $375 million goes to education. Another $90 million in surcharge receipts subsidizes the double deduction for property taxes on the state income tax, the portion of the original surcharge package that Hartigan has pledged to retain. Another $40 million or so raised by the surcharge simply flows into the general funds where it is earmarked for no particular purpose.

The $500 million total general funds share of the income tax surcharge represents just about the natural growth in state revenues (it is slightly higher than Hartigan's $450 million figure for natural revenue growth). For simplicity's sake assume that the discontinuation of the surcharge exactly offsets the normal natural revenue growth.

To cover his pledge to replace education's loss from expiration of the surcharge with cuts elsewhere, Hartigan must come up with $375 million in spending reductions. His cuts and switch only produce $330 million.

That leaves his revenue increases to cover the shortfall and all other new spending: the $100 million in collectibles and the $87 million from broadening the taxes —if he can get them passed — to cover all the increased costs of government.

In the long term, the centerpiece of Hartigan's commitment to education — his pledge to give schools, colleges and universities one-quarter of all new revenues in fiscal year 1992 and half of all new revenues thereafater — may prove unsatisfying, unless he raises taxes. Education will see little new money in fiscal year 1992 because the elimination of the surcharge will limit revenue growth. Education's new money would be about $110 million in fiscal 1992.

Later on, education will see larger dollar increases but nothing extraordinary. By fiscal year 1995, the increase will be about $300 million: $200 million for elementary and secondary education and $100 million for higher education under the current unwritten formula. Over the course of four years, for example, the $650 million increase that Hartigan's budget would allow for elementary and secondary education would be comparable to most of the four-year increases over the last decade, without the large fluctuations.

Similarly, Hartigan's commitment to earmark half of all revenue growth to education produces no spectacular change in the state's share of education spending during the four-year term that ends in fiscal year 1995. In fiscal year 1991 education accounts for 37 percent of projected general funds spending. By 1995, if half of all revenue growth went to education and if revenues grew at 4 percent annually, that share would rise to 39 percent. A tax increase mid-term would increase education's percentage share more rapidly.

An Edgar administration would have far fewer problems in the initial years, but his no-tax-increase pledge will put pressure on state spending in later years. Leaving the surcharge in place produces $900 million in state revenues, $500 million of that to the general funds and the other $400 million to local governments. Edgar has suggested reallocating local government's share to support property tax relief, schools and other uses, but local governments are guaranteed about $100 million of the surcharge as their one-twelfth share of all state income taxes that was established when the state income tax was enacted in 1969.

To compare the two positions, Hartigan would start fiscal year 1992 with a $500 million reduction in general funds revenues from loss of the surcharge. By continuing the surcharge and promising re-allocation, though not being specific, Edgar retains that $500 million and has an extra $300 million in potential general funds revenues.

Edgar's "extra" $300 million could disappear in a hurry. The next governor will inherit the $120 million deficit in the fiscal year 1991 budget and will face $100 million in unpaid bills for medical care to the poor, senior citizens' property tax relief and state employees' group insurance. He also inherits a budget based upon relatively optimistic revenue forecasts

November 1990/Illinois Issues/11

The state of the State

made before developments in the Middle East and other signals of economic downturn.

Edgar's pledge of absolutely no tax increases for four years will present problems later in his term. Edgar says that he recognizes that problem and will reprioritize spending. Like Hartigan, he promises to make cuts in other spending to find money for priorities like education and child abuse caseworkers. Edgar puts no number on his cuts, although he does target middle-level managers for termination or reassignment.

Edgar will have to make cuts to sustain programs because state general funds revenues grow at a rate slower than inflation or even general economic growth. The performance of state taxes leaves governors and lawmakers to choose from spending reductions or revenue increases. Edgar's pledge leaves him no choice.

The problem is with the state tax structure. Income taxes provide about one-third of state tax revenues; sales taxes provides another third; an assortment of minor taxes — cigarettes, liquor, utility — provide the remaining third. Historically income taxes have grown with the economy and inflation and have been Illinois' most consistent growth revenue sources. There is also growth in sales tax receipts, although the removal of food and medicine from the base has made them more volatile. The balance of the sources do not grow. With growth in two-thirds of the tax base and no growth in the other third, Illinois revenues trail inflation. That leaves state government to do things more cheaply or to do fewer things.

The Taxpayers' Federation of Illinois did a study in 1988 of the first 10 years of the Thompson administration (from fiscal year 1978 through fiscal year 1987) that showed general funds spending increased $4.8 billion or 76.5 percent over the period. Adjusted for inflation, however, general funds spending declined $101 million or 1.6 percent over the period.

Revenues have followed the same trend. Between 1978 and 1990 general funds revenues increased from $6,343 billion to $12,841 billion, an increase of $6,498 billion or 102 percent. Adjusted for inflation state revenues rose from $6,343 billion to $6,364 billion, an increase of $21 million or 0.3 percent. Remember that 1990 was the first year of the state's largest tax increase ever. Before that increase, general funds revenues in constant dollars had declined 0.3 percent between fiscal year 1978 and fiscal year 1989.

Richard Kolhauser, a visiting research professor at Sangamon State University and former deputy state budget director under Gov. James R. Thompson, illustrated the structural problem differently at a conference on state tax structure in April. Kolhauser took the percentage change in general funds tax receipts and subtracted from that the percentage change in Illinois personal income. During the 1970s the trend was for general funds tax growth to exceed personal income growth. The trend reversed in the 1980s. In only two years, the tax increase years of fiscal 1984 and 1990, did state tax revenues grow faster than personal income.

Kolhauser told those attending the conference that the sluggish revenue system caused three problems for state finances. First, it is difficult to maintain programs. Second, tax increases are more frequent. Third, the depressed revenues and tax increases contribute to feast-or-famine cycles for state funding.

'The performance of the revenue system is lackluster in most years'

Kolhauser offered this view of state finances: "The performance of the revenue system is lackluster in most years. Funding for state programs gradually falls behind. State taxes are increased at some point. The new revenue is fully allocated, and there are very large funding increases for state programs. Thereafter the ratcheting down starts again."

State revenue growth will be constrained by Hartigan's no-surcharge pledge and by Edgar's no-other-taxes pledge. By keeping the surcharge, Edgar keeps the $500 million in the base for general funds spending. In fiscal year 1995 he will have $370 million more than Hartigan for general funds spending (see table on page 11). Edgar would also have whatever is reallocated from local government's $300 million share.

The demands for new spending far outstrip those resources. Overall, Edgar's proposals would see a $2.2 billion increase in spending between fiscal year 1991 and fiscal year 1995. Hartigan's proposals would allow $1.8 billion in new spending over the period. Both increases will almost certainly be less than the rate of inflation.

Identifiable needs dwarf both those figures. Take education. Hartigan has criticized the decline in the state share of public school funding from 48 percent of school spending to 38 percent. To have the state provide 50 percent of the cost of elementary and secondary education would cost $1.0 billion annually.

A second education issue looms, the threat of a lawsuit challenging Illinois' school aid formula that permits variations from $2,500 to $10,000 in the amount of money school districts spend per pupil. The legal action may or may not be completed during the new governor's first term, but there will be pressure to close disparities to avoid the lawsuit. The cost could be extreme. In New Jersey, a smaller state, the courts found the school funding mechanism unconstitutional, and the state allocated $1 billion in new state spending to education.

State spending on mental health services has come under severe fire. A year ago the Governor's Commission to Revise the Mental Health Code looked at what other states do and developed a model system. Total cost, $0.5 billion.

State prisons are undeniably overcrowded. The Department of Corrections estimates that it would take 10 900-bed prisons to eliminate current overcrowding. Total cost: $0.5 billion to build and $0.1 billion in annual operating costs.

Property taxes in Illinois are high, while income taxes are low, and property taxes are drawing ever more voter complaints. Total property taxes, which are collected by Illinois' schools and local governments, are about $8 billion per year. To reduce property taxes by 20 percent and replace them with income taxes would cost $1.6 billion in new state taxes, nearly twice what is raised by the surcharge.

The difference between the identified spending needs and available state resources is striking. Neither candidate has championed a program that would ease Illinois' chronic fiscal problems. With Hartigan the crisis will come soon. With Edgar the problem will not become apparent until later.

12/November 1990/Illinois Issues