Illinois Policymakers say: “The deal is, they take three months of grocery money in exchange for chips and a sandwich”

Hard work must have killed somebody

In a saga that falls into the category, “you just can’t make this stuff up” . . . Illinois policymakers recently enacted one of, if not the largest, tax hike in state history only to find themselves faced with threats of companies leaving the state. The response, give away special tax breaks of course!

Both Sears and the Chicago Mercantile Exchange have threatened to leave Illinois if something isn’t done about their tax burden. So now the legislature is debating SB 397 which would carve out special tax treatments for Sears and CME (pdf).

Included in this discussion is a proposal to increase the state’s Earned Income Tax Credit from to 15 percent from 5 percent of the federal EITC (though the specifics are still in flux). However, the EITC is a deeply flawed policy that hurts the working poor more than it helps. My latest study on the EITC proposal published by the good folks at the Illinois Policy Institute (pdf) finds:

Because taxpayers lose out on the earned income tax credit as their income increases, there is incentive for workers to keep their income under the “phase-out” level. Specifically, the only time during which the government rewards the worker for earning more money is when the worker’s income is moving from zero to $12,750. The federal earned income tax credit only encourages work effort in the phase-in income range where the effective marginal tax rate is negative 40 percent.

The taxpayer is, at best, indifferent during the plateau stage where the effective marginal tax rate is 0 percent. During the phase-out state – $41,000 for a single person and $46,000 for a married couple – the taxpayer is actually penalized with an effective marginal tax rate of 21 percent. Since the income range of the phase-out (21,800 to $46,000) is twice as large as the income range of the phase-in ($0 to $12,750), the federal earned income tax credit is spreading more work disincentive than incentives.

The state earned income tax credit, since it is an add-on to the federal earned income tax credit, only serves to exacerbate the work disincentives. The current state earned income tax credit is worth 5 percent of the federal earned income tax credit, which creates an effective marginal tax rate during the phase-out of 22 percent (versus 21 percent under the federal earned income tax credit alone). When the proposed state earned income tax credit worth 15 percent of the federal earned income tax credit takes effect in 2013, the effective marginal tax rate during the phase-out will increase to 24 percent. Expanding the state earned income tax credit will only serve to further discourage work.

Compounding the work disincentive related to the phase-out of the earned income tax credit are other federal, state and local taxes and other government welfare programs. These other factors increase the effective marginal tax rate faced by people in the earned income tax credit’s phase-out income range. Other taxes add to the tax burden on each additional dollar earned while, at the same time, the money received from other government welfare programs begins to phase out at approximately the same income range that the earned income tax credit begins to phase out.

In fact, a more comprehensive effective marginal tax rate estimate found that the effective marginal tax rate can reach as high as 65 percent! Faced with an effective marginal tax rate that high, many people will find themselves trapped by the earned income tax credit rather than helped by it. Expanding the state earned income tax credit will only dig the hole deeper for those people working desperately to better their economic situation.

Illinois would be better off using this money to lower the personal income tax rate or increase the exemption for all taxpayers, rather than expanding the deeply flawed earned income tax credit.

This was a fun study for me as there was a good deal of nostalgia since it was based on work from one of my first studies that I ever published for the Tax Foundation: “Growth of the Earned Income Tax Credit” (pdf) co-authored with Arthur P. Hall

Additionally, the EITC does nothing for Illinois’s middle class which has gotten clobbered by the recent tax hikes.  Watch the video below from Kristina Rasmussen of the Illinois Policy Institute which explains how “the deal is, they take three months of grocery money in exchange for chips and a sandwich.”  It’s no wonder why taxpayers are fleeing Illinois.

Taxes Matter V: Illinois Taxpayers Flee State

Today the Illinois Policy Institute released my study on the migration of people and income out of Illinois: “Leaving Illinois: An Exodus of People and Money.” (pdf)  Here is the Executive Summary:

Migration between the U.S. states is the ultimate expression of “voting with your feet.” People move for many reasons, but, when examined en masse, it’s clear that public policy significantly influences where people choose to live. This study undertakes a thorough examination of Illinois’s migration patterns to better understand progress on important public policy issues. Key findings include:

  • Illinois lost a net of 1,227,347 residents to other states between 1991 and 2009, or slightly more than one resident (1.22) every 10 minutes.
  • The top states that people from Illinois move to are Florida, Indiana, Wisconsin, Arizona and Texas.
  • Illinois lost 86,021 taxpayers between 1995-2007 to its border states: Wisconsin, Indiana, Iowa, Missouri and Kentucky. This represents $4.1 billion in lost Adjusted Gross Income (AGI) and $26.8 billion in cumulative AGI loss.
  • Illinois lost people and taxpayers to 40 states and the District of Columbia, and Illinois lost net income to 42 states and the District of Columbia.
  • The total net income leaving the state averaged over $1.8 billion between 1995 and 2007 with a total loss of $23.5 billion. Had this income stayed in Illinois, state and local governments would have collected an estimated $2.4 billion in additional tax revenue.
  • When a resident moves out of Illinois, the state doesn’t just lose income and taxes for that one year; rather, the state loses any income and taxes that resident would have generated for all future years. Compounding these figures over the 13 years assessed in this study – without adjusting for inflation – the state has lost $163.6 billion in net income and $16.9 billion in state and local tax revenue due to out-migration.
  • People move from Illinois to states with lower taxes (especially estate taxes), lower union membership, lower population density, lower housing costs and warmer weather.
  • The most significant driver of out-migration, on a percentage basis, is the estate tax. This is especially important considering that the number one destination state for former Illinois residents is Florida, a state with no estate tax (or individual income tax).

Conclusion: Without action, out-migration will continue to reduce the ability of both the private and public sectors to ensure Illinois’s economy becomes strong and vibrant.

In breaking news, the Wall Street Journal reports that Illinois Legislature just passed an enormous tax hike raising the individual income tax rate from 3 percent to 5 percent and the corporate income tax rate from 4.8 percent o 7 percent.  If you think the exodus from Illinois was bad in the past, this tax hike is going to send the exodus into over-drive . . . especially the out-migration of income which is more mobile than people.

Update: The Tax Foundation weighs in as well on the Illinois tax hike . . . in their State Business Tax Climate Index Illinois falls from 23rd to 36th, that’s quite a fall.