By CHARLES N. WHEELER III

Thompson's tax hike: the reasons and the politics

Support for schools and universities, for medical care for the working poor, for mental health and child care, for prisons and transportation. The "whys" of Gov. Thompson's tax proposals are easy to articulate. "How" the governor must sell his program to wary legislators is somewhat more complex. And "whether" he can do it is the toughest test of all

"THROUGHOUT seven years and three campaigns for the office of governor, I have always promised you that if the day ever came when I believed that we could not maintain services without an increase in taxes, I would come to you and openly and plainly tell you so. That day has come. . . ." Gov. James R. Thompson, State of the State address.

With those words, Gov. Thompson formally acknowledged what students of state finance had suspected for months was inevitable: Illinois, like its Midwestern neighbors before it, had finally succumbed to the unrelenting battering administered its governmental matrix by the nation's worst economic decline in half a century.

And now Thompson, fresh from election to an unprecedented third consecutive term by a scant 0.14 percent margin, had no choice but to violate one of the most potent taboos of Illinois political folklore and urge higher income taxes.

No more betrayed faith in a will-o'-the-wisp recovery, always just around the corner.

No more bookkeeping stratagems, nor creative accounting, in the name of cash flow.

No more speeding up tax collections and slowing down bill payments, piling up IOUs against the hope of a better future.

No more taking dollars from school children, the handicapped, the mentally ill and the poor, and euphemistically calling it belt-tightening.

True, those nostrums had afforded temporary relief, but like a pernicious cancer, recession continued to eat away at the state's financial well-being until at last only the unthinkable remained.

And so, live on Chicago TV and via a statewide radio network, the governor declared:

"It is my duty to tell you my fellow citizens, that I believe that we can no longer save and cut, stretch and borrow, nor put off until tomorrow the pressing human needs of today. . . .

"The same cruel recession which has been punishing so many of our citizens has taken its toll on the ability of your state government to maintain a standard of decency in the delivery of human services, of excellence in education, and a new standard of achievement in economic development. . . .

"For a number of urgent and compelling reasons, I believe we ought to raise the income tax. . . in Illinois."

Thus, the central issue has been defined for the 83rd General Assembly, the first elected in the wake of the 1980 legislative Cutback Amendment and the first ever in which the presiding officers in both chambers are Cook County Democrats.

In themselves, those historic firsts may have rated a footnote in state annals. Addressing the income tax issue, however, this legislature now seems fated to become the stuff of political legend, like its predecessor that first gave Illinois its income tax 14 years ago.

In even more dramatic fashion, the outcome of Thompson's bold revenue initiative may well define for all time the quality of his leadership and the character of his administration. Merely daring to propose an income tax increase, no matter how relentlessly compelled by the course of events, bespeaks political courage of the sort some critics have found wanting so far in Thompson's six-year stewardship. Similar doubts about gubernatorial tenacity and toughness likewise would be answered if Thompson's package passes.

More importantly, the new revenues would enable the governor to reshape state government, its services and its finances, to his vision of its destiny; to leave, as it were, a legacy richer than Class X and a string of triple-A bond ratings.

Failure, on the other hand, could usher in a governmental dark age of chronic fiscal crises and never ending reductions in essential services below minimal levels of decency. Without increased taxes, Thompson cautioned, Illinois faces "massive new budget cuts that would risk the health and safety of the people. . . and seriously threaten our ability not only to recover recession but to move the economy of this state forward.

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"Taxes are," he said, "the price we pay for living in a decent, compassionate and educated society, the goal of which is the spiritual and economic progress of all. I am only asking that we pay enough to accomplish this, and no more."

Of the governor's tax plan (see box), neither the highway funding package nor the liquor tax increases he proposed were new initiatives for the governor. Since his first campaign in 1976, Thompson has pressed for increased highway funding, but to no avail; most notably, his suggested tax on oil companies' gross receipts was a spectacular failure two years ago. As for the stiffer levies on alcohol, twice last year lawmakers scotched similar Thompson requests.

Breaking new ground

But, he called for an income tax increase, and that was no mere recycling of his past failures. With that call, he broke new ground, compelled by the bleak arithmetic of today and a confortless glimpse at the state's future.

Key to his decision to propose the income tax increase were three factors:

1. With less than half the current fiscal year remaining, Illinois faced a $300 million general funds budget gap.
2. Already, the state is committed to about $650 million in additional general funds spending next year, even though available revenues are not expected to exceed 1983 levels.
3. Fundamental changes are occurring in the state's population and economy, with ominous implications for future revenue growth and service demands.

The most obvious cause of the state's immediate financial distress is the recession, with its attendant crushing unemployment levels. Thompson made the point: "It is plain that people who are out of work do not pay income taxes to the state of Illinois. It is plain that people out of work, or who fear the loss of their jobs, cut back sharply on their spending, with the result that millions of dollars in sales taxes are lost forever."

Largely because the longed-for recovery had yet to occur, at State of the State time the Thompson administration's revenue estimate for the fiscal year ending June 30 was about $500 million less than the one made when the governor first unveiled his fiscal 1984 budget recommendations almost a year earlier. And the shortfall would be even greater, were it not for one-time bookkeeping maneuvers expected to swell this year's take by some $94 million --- $62.5 million borrowed from other earmarked funds and about $31 million in accelerated collection of utility taxes.

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Measuring estimated revenues of about $8.3 billion against projected spending of about $8.6 billion neatly defines the immediate problem — the $300 million gap.

To plug the hole, Thompson said he would make further budget cuts, dip into general funds reserves and engage in short-term borrowing. The latter two options, of course, merely delay the ultimate day of reckoning without addressing the basic problem — more outgo than income.

Thompson cannot avoid those off-the-top obligations of $650 million, which to some extent represent IOUs from bygone efforts to balance the budget premised on "next year's" revenue surge that would accompany the economic recovery "right around the corner." But the recovery remained elusive; no surge occurred.

For example, the state by law must budget an extra $118 million school aid payment in fiscal 1984, to catch up for one skipped in June 1982 in order to end fiscal 1982 in the black. Another example, a scheduled switchover of the $40 million price tag for state police salaries to general funds from the Road Fund was delayed until fiscal 1984.

And whatever short-term borrowing is needed to keep the state afloat through June 30 must be repaid within a year; Thompson, in a background paper for his State of the State address, suggested $202 million as a possible amount.

The IOUs go on. Principal and interest payments for long-term bonds will grow by some $40 million. The federal government has socked the state treasury with a $50 million bill, payable October 1, for the interest on the huge amounts Illinois has borrowed from Washington to keep benefit checks going to jobless workers. In addition, recent changes in how the state calculates corporate income tax liability might require an added $200 million next year in refunds to businesses that paid too much in the past.

And Thompson's $650 million list doesn't include any effort to catch up on below par state pension contributions or to meet the cost of settling accounts with hospitals for treating welfare clients, an amount that could be considerably higher than usual because of an agreement forged last year between the hospitals and the administration.

What about economic recovery as a solution to pay the $650 million in IOUs? "Under no circumstances will natural growth in our economy bring in anywhere near that amount," said the governor. In fact, Thompson's budget director, Robert L. Mandeville, argues there will be "almost no growth" in revenues visible next year, even with a modest recovery, because of the $100 million revenue loss from abolition of the state inheritance tax and the absence from next year's base of the $94 million boost provided by this year's one-time accounting sleight of hand.

In addition, even if national recovery finally arrives sometime in 1983, the Illinois economy will lag behind; in briefing reporters on the State of the State, Mandeville envisioned Illinois unemployment averaging 12 percent over the next 18 months. In fiscal 1979, the rate was only 5.6 percent.

The basic imbalance between workers and jobs that unemployment figures try to measure can result from several causes, some more devastating to state finances than others. For example, the labor force may be growing faster than new jobs are available, and unemployment rises.

To the extent that some new jobs are created, though, the impact on state finances can be blunted. During the 1970s, for example, the "baby boom" generation came of age. The state's labor force grew by 18 percent, stimulating revenue growth as most found work and became taxpayers.

On the other hand, unemployment also may reflect a net loss of jobs available to the same work force, dealing a much more acute blow to state revenues. During the last 18 months, since July 1981, the number of persons working in Illinois has been declining. In the first 11 months of 1982, for example, the state's level of employment dropped to 4.8 million from 5.1 million, a net loss of some 300,000 jobs. That dip, Mandeville estimates, cost the state some $150 million in lost revenue.

Besides the discouraging unemployment projection, the lower inflation rates expected in the future will slow revenue growth. No longer will Illinois coffers swell by 10 percent each year thanks in part to rising prices (sales tax) and cost-of-living salary adjustments (income tax). As for annual revenue growth during the rest of Thompson's term, "We'll be lucky to see 5 percent," Mandeville believes.

Changing patterns

And now stirring in Illinois are currents deeper than the crests and troughs of the unemployment and inflation percentages of the moment.

During the 1970s Illinois' population became older, less white and less likely to live in a husband-wife family, according to an analysis of 1980 census data. More people left Illinois than came to the state, and those who moved out tended to be white, husband-wife families of higher income, who presumably paid higher taxes. In fact, during the 1970s Illinois may have lost as much as 10 percent of its white population through out-migration, while as many as 400,000 more non-whites may have moved into the state than left it. (See Cheng H. Chiang and Richard Kolhauser, "Who are we? Illinois' changing population," Illinois Issues, December 1982.)

These migration patterns could be analogous on the state level to the changes large urban areas have seen in the last few decades. If so, the impact on state government, while impossible to measure precisely at this time, is sure to be enormous.

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At the same time, the state's economy also is evolving, reflecting the likely passing of the age of smokestack industry and perhaps foreshadowing a coming age of high-tech, information and service-oriented activity.

The structure of employment in the state is shifting away from higher paying manufacturing jobs to lower paying trade and service jobs, according to an analysis by the Illinois Economic and Fiscal Commission. In 1971, 31.3 percent of the state's nonagricultural workers were employed in manufacturing, while the wholesale and retail trade sector employed 21.7 percent and the service sector's share was 15.6 percent. By last fall, the trade sector accounted for the largest piece of the employment pie, 23.5 percent, while manufacturing slipped to 22 percent, and services climbed to 21.1 percent, the legislative study showed.

While the state lost more than 350,000 manufacturing jobs during that period, it gained about 134,000 trade and about 288,000 service jobs. But the annual average wage in manufacturing is more than $7,000 greater than that earned by trade or service workers, and the gap has been widening, the study noted. To replace the wages of every two lost manufacturing jobs, according to the study, three new trade or service jobs would have to be created.

"In spite of any foreseeable offsetting increases in trade and service employment," the study concluded that the relatively much higher wages and more generous pay raises in manufacturing meant that as these jobs decline, so will the growth rate in wages and salaries, thus slowing down future revenue gains.

Given the foregoing factors, the governor concluded that only a massive infusion of new dollars could put Illinois on a solid fiscal foundation for the future. And only a hefty boost in income tax rates — unchanged in 14 years — could provide enough dollars.

Convinced of the "Why," Thompson faced the "How" of an income tax increase. Or, in more precise terms, putting 30 green lights on the Senate toteboard and 60 green lights on its House counterpart. It is an awesome task, more so for a governor who could not move even his "lousy penny-a-drink" liquor tax in the past.

Awesome, but not impossible.

Although the final roll call on the plan is probably still weeks, if not months, away, some reasonable assumptions already can be offered about its makeup, if it's to reach the magic numbers. It will be bipartisan, perhaps more so than in 1969, which as a practical matter means that Chicago's mayor must be on board. It will be composed largely of lawmakers in relatively safe districts, meaning city Democrats and suburban Republicans are prime candidates. It will represent the culmination of an intensive lobbying effort by an exceptionally broad-based coalition of interests, abetted by a level of gubernatorial suasion Thompson has yet to employ. And the legislation it passes will not be Thompson's precise plan. Those assumptions suggest the broad outlines for the campaign that must be mounted if the tax hike proposal is to succeed.

The initial task, of course, is to dispel as much as possible the taboo surrounding any talk of income tax hikes, bringing the issue "out of the closet," as it were, after more than a decade of silence. To that end, Thompson has been on the road around the state, trying to convince local opinion leaders there is no other way to provide responsible levels of state services.

"The governor's responsibility will be to explain the alternatives, and why he came to the point where the alternatives were unacceptable," said Gregory W. Baise, Thompson's patronage chief, who is running the tax hike campaign. Though the governor doesn't expect a 90 percent approval rating, Baise believes he'll get the reason across, "especially to voters who voted for him because they thought he was a good fiscal manager." If he can do that, it should help make the climate back home less hostile for the idea, a key concern for lawmakers skittish about their next election.

To the same end, the governor is working to galvanize educators, health care providers, human services advocates and others with a stake in in creased state spending to bear down on their legislative allies for a favorable vote.

Of course, accord must be reached with Chicago.

Not that anyone expects city leaders to oppose the proposal; Chicago's schools and mass transit system sorely need new money, and city finances would suffer directly under a no-new-revenues fiscal 1984 state budget. Instead, negotiations will focus on questions like: How large a slice of the new pie should Chicago get? How many votes must Democratic leaders provide in return?

At the same time, Thompson has to recruit the requisite number of Republicans, probably starting with those representing districts housing large state institutions, for example, universities, prisons or mental health facilities.

And finally, when it gets down to the last couple of GOP votes, the really tough ones, Thompson must be mentally prepared to be downright nasty, if need be.

One hoary theory of how a bill becomes a law that you'll rarely see in the civics texts is based on the conviction that everyone has a lever. The secret of legislative success, according to one veteran devotee of this philosophy, lies in identifying those levers and being willing to pull them. Though Thompson in the past has been reluctant to pull any levers, top aides now assure skeptics that he's strengthening his grip. "He'll do what it takes to get it passed," said one.

Thompson's game plan

In all other respects, meanwhile, the governor appears to have fashioned a game plan that seems suitable to the chore.

In presenting a no-new-revenue budget for fiscal 1984, Thompson hopes to hammer home the dire consequences of failure: carving more than $800 million from programs already too deeply scarred, in the minds of some, from this year's economies. The big bucks to cut, of course, are coming from the largest programs, like education,

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public aid and mental health. Perhaps it's no coincidence that they also happen to include some of the programs most vital to Chicago, most attractive to suburbanites or best supported by well-organized lobbies.

In the original list of "horribles" accompanying his State of the State message, Thompson included:

• Cutting $200 million from local school aid, resulting, he said, in school closings, larger class sizes, a $25 million slash in programs for handicapped children and increased pressure on local real estate taxes. Chicago schools could lose $60 million or more, by some estimates.
• Cutting $100 million from higher education, which, the governor warned, would force 1,000 faculty lay-offs, elimination of some programs, less job training and the loss of 30,000 state scholarships, most of which would have helped make college possible for city and suburban youngsters.
• Eliminating the General Assistance welfare program that provides income support and medical care for more than 128,000 persons in Illinois, almost 90 percent of them in Cook County.
• Eliminating state-paid medical care for more than 50,000 of the state's working poor, almost 60 percent of them outside Cook County
• Cutting deeper into mental health and child care outlays, causes popular even with conservative suburban lawmakers.
• Releasing prison inmates before their sentences are completed because of a 1,000-bed loss in system capacity. In addition, supervision of some 9,000 adult parolees would be lost. In both cases, Thompson warned, public safety would be endangered.
• Eliminating local government's one-twelfth slice of income tax proceeds, a program which will send some $230 million this year to local communities, including $63.9 million to Chicago.
• Losing "our only chance" for the Regional Transportation Authority's operating subsidy so critical to mass transit service in the Chicago area and an item always high on the city Democrats' shopping list.

Though the list is not all-inclusive, it still has enough specific pain in it, the governor hopes, to convince both interest groups and the lawmakers they influence that an income tax hike is preferable.

While Thompson has been brutally explicit in detailing the "horribles" without a general funds tax increase, he's been less descriptive about just what the new money can buy. In broad strokes, the governor said: "I mean this to be a four-year plan for Illinois, under which we will pay off our recession debts, gain the ability to restore 1983 cuts in critical areas, avoid massive disruption to vital services and give us the strongest foundation. . .to revitalize our economy and re-employ our people."

Thompson also suggested that education would have a strong claim on whatever new dollars were left after human services programs were healed and spending obligations met. In particular, he said, more money is needed to prepare Illinois youngsters for the jobs of tomorrow, to retrain permanently unemployed workers and to strengthen engineering and other technology-oriented programs.

But the governor initially mentioned no dollar amounts for the new revenues, perhaps, as one insider suggested, to preclude scrapping over divvying up the pie before all interest groups were locked in to push for the increase. Too, the relative size of the slices can be an important tool in wooing legislators.

The uncertainty, however, may have helped to generate some early complaints, particularly about the tax relief slice that was not there. "My immediate reaction is that it's a lot of tax increase and only a little tax relief," said Douglas L. Whitley, president of the Illinois Taxpayers' Federation, a private watchdog group. Indeed, besides the $200 increase in the individual exemption, the only tax relief Thompson proposed was a $20 million expansion in the circuit breaker property tax relief program for elderly and disabled persons.

Would he remove the final two state-imposed sales tax pennies from food and drugs? Only if the legislature increases the current sales tax rate on other goods, or broadens the base to include some services, the governor said, because the income tax hike alone could not support that relief.

Would he swap, dollar for dollar, income taxes for local school district real estate taxes? If and when the revenues became available, and only if coupled with education reforms, Thompson said.

So much for two of the major recommendations of the Tax Reform Commission he appointed, critics carped.

While reaction seemed generally in sympathy with Thompson's proposed highway funding package, perhaps reflecting a consensus that will carry the proposal to fruition, his income tax plan drew additional complaints.

Some legislators were troubled by what they viewed as the inequity in raising individual rates 60 percent, while corporations, which currently pay only about 15 cents of every $1 the state receives in income taxes, escaped with a 40 percent hike.

The sheer size of the general funds hike — $1.6 billion is big money, even in Springfield — also raised some eyebrows, even among some lawmakers who already had concluded an increase was needed. Senate President Philip J. Rock (D-8, Oak Park), for example, worried that "it might be too much." Others questioned whether a temporary increase, a surcharge, might not be preferable. House Speaker Michael J. Madigan (D-30, Chicago) argued that the state's current problems stem from a depressed national and international economy, and could be expected to ease when economic conditions recover. "If the problem is short-term," Madigan said, "there's merit in considering a short-term solution rather than something Illinois will live with forever." And some Democrats suggested Thompson was holding back, intending to use the revenue windfall they see coming, once the current crisis ended, for massive tax relief — carrying the GOP label — just in time for the next legislative elections.

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Administration number-crunchers scoff at those suggestions, however, confident that more detailed analysis will convince the critics that, in the words of one fiscal wizard, "There's less there than meets the eye." Indeed, it's not hard to imagine Thompson with little or no "mad money" for the fiscal 1984 budget. Just add it up: the IOUs Thompson enumerated, restoration of this year's human services and education cuts, return of the state's reserve account to a healthy level and the RTA subsidy sure to be part of Chicago's price. And consider other spending obligations he didn't mention: for example, local government grants would increase by $124 million, including $27 million more for Chicago, and refunds by $63 million as a result of the tax increase.

Amazing how fast the money goes, right?

In fiscal 1985, however, it could be another story. Even modest growth of 2.5 percent would generate some $250 million in new revenues, and some $500 million in one-time, fiscal 1984 obligations would drop from the spending base, freeing a total of about $750 million for other purposes. By historical standards, that's not unusually large; in 1981, for example, spending jumped by $851 million.

And Thompson's flexibility will be hampered by some unavoidable spending increases: In 1985 the interest tab on unemployment fund borrowing is slated to jump by $100 million, and pension contributions should be hiked. Even so, Thompson seems sure to have more budget leeway than at any time since the recession struck. The latitude could prove helpful in the bargaining vital to his package's fate; for example, the governor might be forced to promise more tax relief, or extra dollars for someone's pet program, to sweeten the pot for balky lawmakers. While some changes seem inevitable in Thompson's proposal, if for no other reason than to satisfy the legislature's need to have a hand in the lawmaking process, such substantive concessions may provide another indispensable ingredient, an excuse for an "aye" vote, in the view of one long-time political strategist. "Everybody has to have a rationale why he did it," he said. "For the school kids, for mental health, for more tax relief."

In the final analysis, however, suggested one Thompson aide, lawmakers may find themselves voting to increase state income taxes for the same reason the governor proposed the hike: There simply is no other alternative.

Other agenda items

While the inevitability of an income tax hike remains to be seen, there are other issues before the legislature. Other key items on the agenda include:

• Restoring to fiscal health the state's unemployment insurance program, now drowning in red ink.
• Stimulating economic development, perhaps by providing venture capital for high-risk, high-tech operations or by innovative retraining programs for jobless workers from declining basic industries.
• Responding to consumer distress over soaring utility rates, perhaps by requiring election, instead of appointment, of the rate-setting Illinois Commerce Commission, or by creating a Citizens Utility Board, funded by consumer contributions, to hire legal and technical experts to fight rate hikes.

Like myriad other concerns before the 83rd General Assembly, each of these topics involves complex issues sure to elicit, if not understanding, then certainly intense feelings, among legislators, affected interest groups and the public. But no matter how the legislature ultimately deals with them, those decisions seem destined to be overshadowed by the fate of the income tax proposal. That is the issue which has placed the 83rd General Assembly at the cross-roads of history.□

Charles N. Wheeler III is state government correspondent in the Springfield bureau of the Chicago Sun-Times.

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