The Illinois Constitution reads, in part: "A tax on or measured by income shall be at a non-graduated rate" [Article IX, Section 3(a)]. And thus, since 1969 when Illinois first imposed an individual income tax, Illinois taxpayers have multiplied their individual taxable incomes by a flat rate. Much else has changed, however, since 1969.

While the Illinois income tax rate of 3 percent on individuals was made permanent this year, it is still a flat rate with no standard deduction and with a personal exemption of only $ 1,000. Maintaining this essentially proportional method of taxing individual incomes carries implications that need review. The tax is unresponsive to economic growth, and the tax violates common notions of fairness and equity by taxing the poor and the wealthiest at the same rate.

Responsiveness in state revenues has become an increasingly important concern in the last several years because the spending responsibilities of state governments have changed. State governments today more so than 15 or 20 years ago are primarily responsible for fast-growing health care, welfare and corrections spending. The revenue systems that state governments rely on have not been adapted to meet these new spending responsibilities. This is the so-called structural deficit problem facing most state governments.

As currently structured, with no changes in spending or tax policy, the long-term growth rate of state expenditures exceeds the long-term growth rate of state revenues. One way to increase the growth rate of state revenues is to make the income tax more progressive, that is, change the system so those with greater incomes are taxed at higher rates than those with less.

Illinois' current flat-rate income tax is not as responsive to growth in the underlying economy (growth in state personal income) as it might be. Since much of the growth in personal income is at income levels above the poverty line, and in particular in high-income brackets, a graduated income tax system would better track the growth areas of the economy.

As long as Illinois maintains its flat-rate income tax with a very low threshold for taxing income, relatively poor people will stay on the tax rolls. While Illinois' tax rate of 3 percent is not onerous, the idea of requiring a tax payment from individuals who qualify for a variety of state and federal income-support programs strikes many as unfair. A couple with an income of $ 10,000 would pay a tax of $240 (allowing for the personal exemptions of $2,000 for the couple and ignoring minor details of the tax code). Considering the compliance and administration costs of processing an income tax file in Illinois, it is questionable whether it makes sense for the taxpayer and tax administrator to bear the costs associated with collecting the $240 from this prototypical low-income couple.

This point is even more relevant since passage of the federal Tax Reform Act of 1986, which essentially removed most low-income individuals from the federal tax rolls. Since 1986 many low-income people have had to figure their income (adjusted gross income by federal definition) only because Illinois requires it to calculate their tax liabilities, not because they have been required to file federal tax returns. High-income people in Illinois, on the other hand, pay very low taxes relative to high-income taxpayers in other states (see table). Of the 41 states with income taxes, only one applies a rate lower than Illinois to the taxable income

One way to increase the growth rate of state revenues is to make the income tax more progressive

22/October 1993/Illinois Issues

of high-income taxpayers. (Bear in mind, however, that nine states impose no income tax.) Most states impose a top rate between 5.0 percent and 10.0 percent. The fact that high-income people pay relatively low income taxes in Illinois violates many people's sense of fairness and equity.

Illinois' flat-rate tax system is often defended for its simplicity. In fact, it is not the form of the tax schedule that contributes to complexity, but rather the definition of taxable income. State income tax systems are simple when their definition of taxable income conforms closely to a federal definition of income (either federal adjusted gross income or federal taxable income). Such is the case in Illinois where state law permits a few adjustments to federal adjusted gross income, as well as a few credits against tax liability, to arrive at taxable income.

What precisely is a graduated state income tax? Strictly speaking, it has a tax schedule (a series of rising rates) that apportions taxable income into successive tax brackets with higher marginal tax rates applying to the portions of income falling in the higher tax brackets. The federal income tax is a graduated tax. The 1992 federal tax schedule for a married couple filing jointly consists of three tax rates, 15 percent, 28 percent and 31 percent, with the lowest rate applying to the portion of taxable income under $35,800, the 28 percent rate applying to the portion of taxable income falling between $35,800 and $86,500, and the top rate of 31 percent applying to taxable income above $86,500.

A graduated income tax system contributes to equity or fairness because it results in a progressive distribution of tax burdens. A progressive tax system is characterized by average tax rates rising with income, that is, the ratio of tax liability to income rises as income rises. The average tax rate is an "average" of the marginal rates applied to a taxpayer's total income. Thus, a low-income taxpayer facing only the 15 percent federal rate would have a lower average tax rate than a high-income taxpayer facing all three federal rates on portions of his or her income.

Also consider that when a portion of income is exempt from taxation through either a standard deduction or personal exemptions, it is as if two tax rates, "zero" and the flat rate, are applied to income. Thus, the average tax rates for taxpayers facing a flat-rate income tax system are averages of zero and the flat rate, with average tax rates approaching the single flat tax rate as incomes rise. In Illinois, the "zero" rate could be considered to apply to the $2,000 personal exemption for a married couple. In essence, $2,000 is the top of a zero tax bracket, or the zero tax amount. The amount of the Illinois personal exemption is so low that the average tax rate for most taxpayers is essentially 3 percent.

Even a flat-rate income tax can achieve progressivity through deductions, exemptions and credits. Connecticut, which implemented its first income tax in 1991, has done that. Connecticut's 4.5 percent flat-rate income tax has a very large zero tax amount (nearly twice as large as the state with the next largest zero tax amount). For a married couple in Connecticut, the zero tax amount is $24,000,

State individual income tax rate structure, as of November 1992 (for a married couple filing jointly with no dependents) Amounts are dollars. Rates are percentages.
	Zero tax amount	Bottom rate	Bracket amount	Top rate
Alabama	$ 7,000	2.0%	$ 13,000	5.0%
Arizona	11,200	3.8	161,200	7.0
Arkansas	10,000	1.0	26,000	7.0
California	4,686	1.0	211,886	11.0
Colorado	10,600	5.0	Flat rate	Flat rate
Connecticut	24,000	4.5	Flat rate	Flat rate
Delaware	6,100	3.2	46,100	7.7
Georgia	6,000	1.0	13,000	6.0
Hawaii	3,780	2.0	24,280	10.0
Idaho	10,600	2.0	30,600	8.2
Illinois	2,000	3.0	Flat rate	Flat rate
Indiana	2,000	3.4	Flat rate	Flat rate
Iowa	3,220	0.4	50,920	9.98
Kansas	9,000	4.4	39,000	7.75
Kentucky	650	2.0	8,650	6.0
Louisiana	9,000	2.0	59,000	6.0
Maine	10,200	2.1	47,700	9.89
Maryland	6.400	2.0	106,400	6.0
Massachusetts	12,000	5.95	Flat rate	Flat rate
Michigan	4,200	4.6	Flat rate	Flat rate
Minnesota	10,600	6.0	57,710	8.5
Mississippi	12,900	3.0	22,900	5.0
Missouri	8,400	1.5	17,400	6.0
Montana	7,800	2.0	67,200	11.0
Nebraska	8,720	2.37	35,720	6.92
New Jersey	3,000	2.0	77,000	7.0
New Mexico	10,600	1.8	52,200	8.5
New York	9,500	4.0	22,500	7.875
North Carolina	9,000	6.0	69,000	7.75
North Dakota	10,600	2.1	97,100	4.34
Ohio	1,300	0.743	101,300	6.9
Oklahoma	4,000	0.5	13,950	7.0
Oregon	13,218	5.0	13,218	9.0
Pennsylvania	N.A.	2.95	Flat rate
Rhode Island	10,600	4.125	97,100	8.525
South Carolina	10,600	2.5	21,200	7.0
Utah	9,450	2.55	13,200	7.2
Vermont	10,600	4.2	97,100	10.54
Virginia	6,600	2.0	23,600	5.75: ••
West Virginia	4,000	3.0	64,000	6.5
Wisconsin	8,900	4.9	23,900	6.93
NOTES: The "zero tax amount" is the sum standard deduction and the personal excemption. The "top bracket amount" is the sum of the zero tax amount plus the level of income at which the tax payer enters the top bracket. In calculating the zero tax amounts and the top bracket amounts, tax credit and sliding scales for various excemptions and credits were ignored. These elements generally insert more progressivity into the tax structure. Three states, North Dakota, Rhode Island and Vermont, have piggyback tax structures in which the state tax liability is a percentage of the federal tax liability. Source: Significant Features of Fiscal Federalism, Volume 1, 1993, Advisory Commission on Intergovernmental Relations, Washington, D.C.

October 1993/Illinois Issues/23

which is high enough to push low-income people off the tax rolls and allow distinctions in the "average rate" between those with middle and upper incomes.

Comparing the tax rate structures of the 41 states with income taxes as of 1992 (see table) shows that some of the 34 states with a graduated rate structure have little progressivity because of their low top bracket amounts (as examples, Alabama, Georgia, Kentucky and Utah). Of all 41 states, including the seven with flat-rate income tax systems, most have zero tax amounts in the range of $6,000 to $12,000 for a married couple. Very few states have as low a zero tax amount for a married couple as does Illinois at $2,000. Reviewing the top rates among the states, 25 are 6.5 percent or higher. Only six states have a top rate less than 5.0 percent, and only Pennsylvania has a top tax rate lower than Illinois (2.95 versus 3.0). The bottom line is that Illinois has one of the least progressive income taxes in the country.

For most states the individual income tax is the engine of fairness in the state tax system. This is not the case in Illinois with its flat rate and its low zero tax amount. Changing the rate structure to impose higher tax rates on high-income taxpayers than those imposed on low- and middle-income taxpayers would make the income tax more progressive.

It would also make the tax more responsive to growth in the Illinois economy. A graduated rate structure, by applying higher tax rates to portions of income garnered by higher-income taxpayers would result in a faster growing revenue stream. (The other major state revenue source for Illinois — the general sales tax — could also be made more responsive to the economy by including a wide range of services in the base.)

To address adequately the fairness and responsiveness of the Illinois state tax system, it may be necessary to re-think the mix of revenues. Changing the mix of revenues to rely more heavily on a reformed individual income tax, one with a more progressive distribution of average tax rates, and less on the general sales tax would result in a more equitable and more responsive state tax system. This change in revenue mix might result in losses in efficiency and might harm Illinois' competitiveness vis-a-vis other states. However, it appears that there is room for Illinois to rely more heavily on a more progressive individual income tax without getting out of line with its neighboring states. *

Therese J. McGuire is associate professor of economics at the University of Illinois at Chicago where she holds a joint appointment in the Institute of Government and Public Affairs and the School of Urban Planning and Policy. In 1989 she directed a tax study and tax reform project for the state of Arizona.

24/October 1993/Illinois Issues