Moving to graduated income tax rates could lay the groundwork for Illinois to rebuild its credit quality if it uses the new revenue to tackle core problems, particularly pension funding, Moody’s Investors Service said in a review of Gov. J.B. Pritzker's centerpiece fiscal proposal.
“A positive outcome for the state’s credit standing would require that the new system yield substantial net new revenue, without material damage to the economy, and the new revenue be largely allocated to addressing the state’s retirement benefit liabilities on a recurring basis,” lead Illinois analyst Ted Hampton said in a statement that accompanied the report.
Moody's rates Illinois at the final notch above speculative grade: Baa3 with a stable outlook.
Pritzker is asking state lawmakers to put a constitutional amendment on the November 2020 ballot to eliminate the requirement for a flat income tax rate. The Democratic-led Senate approved such legislation last week, and it now faces a vote in the House where Democrats hold the supermajority needed to pass it if they avoid too many defections. Pritzker, a Democrat, wants to win passage before the session ends May 31.
The governor is not offering to put much of the forecast revenue toward the state’s $133.7 billion unfunded pension tab. Pritzker has offered to put only $200 million annually from the roughly $3.4 billion in newly anticipated revenue under his proposed structure toward pensions.
At the same time, Pritzker has proposed in his fiscal 2020 budget shorting the funds by $1.1 billion this year by pushing out the current funding schedule by seven years and extending a pension buyout program.
The state's fiscal 2018 contributions to its pension plans amounted to $7.75 billion — about $3.5 billion short of the amount needed to prevent further growth in unfunded liabilities, assuming investment returns and other actuarial targets were met, Moody’s noted.
The tread-water figure and need to whittle away at the bill backlog that currently stands at $6 billion underscore the state’s need for additional revenue or cuts which Moody’s puts at about $5 billion “depending on the desired scale and speed of backlog reduction and other budgetary factors.”
The income tax change has risks, Moody's noted. A negative outcome — characterized by growing economic challenges and scant progress addressing pension funding needs — is possible.
The change would also add volatility to state revenue collections.
“While the new flexibility to impose higher tax rates on wealthier residents…it would also leave the state more vulnerable to the volatility inherent in financial market performance and other sources of revenue that drive high-income tax payments,” Moody's says. Illinois already relies on income taxes for about 44% of revenue.
Moody’s says the state can afford tax hikes given its economic and revenue strength, “even though it already ranks above the 50-state average in terms of state and local government tax revenue as a share of GDP.”
The state's economy is the fifth-largest among states, at $865 billion in 2018. It was one of only two states to lose population in each of the past five years. While rising state tax burdens would likely have some impact, migration between states is more likely to reflect demographic or employment factors, Moody’s says.
Moody’s also provides fodder for GOP opponents who believe the change will make it easier to raise taxes in the future.
“The current single-rate requirement impedes efforts to win political support for income tax increases, and it has therefore likely deterred revenue increases that might have helped the state address past budget imbalances,” says the report.
Moody’s anticipates the measure will win House approval but questions whether voters will buy in.
If approved, Illinois would join 32 others that use a graduated rate structure, among the 43 states that impose an income tax. Since the 1970 Illinois constitutional convention, 14 amendments to the document have been approved.
