What Happened to Illinois’ Economy Following the January 2011 Tax Increases? A Midwestern Comparison

Abstract

1.IntroductionIn January 2010 Crain's Chicago Business, a highly respected local business publication, described Illinois' fiscal condition as [meeting] classic definition of insolvency: its liabilities far exceed its assets, and state is not generating enough cash to pay its bills (qtd. in Dye, Hudspeth, and Merriman, 2011, p. 28). The State faced a projected budget deficit of nearly $12 billion Fiscal 2012. By end of Fiscal 2010, Illinois was 153 working days behind on paying its bills. Illinois was delaying payments to everything from pharmacies to social service providers, and state comptroller described fiscal conditions as the most dangerous...in recent history (qtd. in Dye, Hudspeth, and Merriman, 2011, p. 28). School districts, universities, and other institutions were forced to lay off employees. Some state workers were forced to pay medical providers up front due to State's delayed reimbursements to providers (Dye, Hudspeth, and Merriman, 2011).Illinois' inaction on dealing with its ongoing fiscal crisis was accompanied by a decline in economic performance. Unemployment was high and state population was declining as out-migrants greatly outnumbered in-migrants. The fiscal crisis left few options, and some observers believed that a tax increase was absolutely essential to maintain critical human services and education and prevent massive public employee layoffs. A January 2011 legislative session was held that included a number of Democratic legislators that either had been defeated or had not run in November 2010 election. This lame duck session, last before legislators elected in previous November were sworn in on January 12, 2011, allowed lawmakers to vote in a tax increase without electoral consequence (Dye, Hudspeth, and Merriman, 2012). Governor Quinn signed legislation, which was retroactive to January 1, next day (Long, 2011). Personal income tax rates were raised from 3.0 percent to 5.0 percent in 2011-2014, to 3.75 percent in 2015-2023, and 3.25 percent thereafter. Illinois also changed corporate income tax rates from 4.8 percent to 7.0 percent in 2011-2014, to 5.25 percent in 2015-2023, and 4.8 percent thereafter. Amid continuing debate and persis- tent fiscal crisis these tax increases began to phase out in January 2015.While it is not possible to assess impact of tax increases on economy without knowing what policy choices would have been made in absence of tax increases, we can at least assess how Illinois' economy performed relative to its historical record and to a control group of neighboring states that did not change fiscal policies. After a brief review of literature about impact of state tax policy on economic performance, we bring together available data to study this question.2.LiteratureA large literature in economics examines relationship between taxation and both economic activity and labor markets. Considerable variation exists in findings of these studies.2.1.Taxes and Economic ActivityTax increases may depress economic activity to extent that taxes raise cost of doing business relative to other states and, if taxes reduce after tax income, they also may depress household consumption (a key component of economic activity). Higher taxes may also discourage in-migration and ultimately lead to an erosion of a state's tax base. On other hand, if tax increases are used to finance desired public services, they could make a location relatively more desirable and result in increased economic activity. Empirical studies yield mixed results.Wasylenko and McGuire (1985) found that higher personal income tax rates and increases in overall taxation discouraged employment growth in a number of industries. Higher taxes might also discourage people from moving to a state, and thus diminish that state's economic growth over time. Saltz (1998) finds that for those states hunting revenues. …