by Adam Schuster, Senior Director of Budget and
Tax Research
Illinois Policy
In the annual governor’s budget address on Feb. 17, Gov. J.B. Pritzker presented a $41.6 billion budget for fiscal year 2022 that holds spending flat for education as well as most state operating spending.
Pritzker was tasked with closing a $4.8 billion deficit reported in November 2020, which would have grown to $5.5 billion including a $690 million payment towards recent borrowing from the Federal Reserve.
Pritzker’s budget relies heavily on nine different tax increases, mostly targeted at businesses, to raise $932 million in revenue. In his speech and in documents from the governor’s budget office the tax increases are branded as "closing corporate tax loopholes." However, none of the exemptions or credits Pritzker is proposing to limit or eliminate can be fairly described as "loopholes." Several do not apply exclusively to corporations.
For example, one Pritzker proposal would reduce the value of a tax credit scholarship program that helps disadvantaged students afford private school education through donations from both corporations and individuals. Another of the proposals does not pertain to any type of credit or deduction, but rather reimposes the states’ arcane “corporate franchise tax,” which is scheduled to phase out through 2024 under current law. And another is a new tax on gasolines that is expected to hurt Illinois farmers and add 20 cents per gallon of diesel.
The state budget law requires the governor to propose a budget that is balanced using only revenues in law at the time the budget is proposed. That requirement was ignored in Pritzker’s first and second budget proposals, and these nine new taxes mean it is in his third budget as well.
We urge the governor to stop championing policies that will put Illinoisans on the unemployment lines
Even with these tax increases, Pritzker’s budget proposal is not truly balanced. It includes no reforms to pensions or other structural overspending that would address the state’s long-term deficit. Instead, the budget makes liberal use of budget gimmicks such as changing the timing of payments – moving some debt service back to fiscal year 2021 while pushing other payments farther into the future – and sweeping $565 million from other state accounts. Instead of going to the road fund and capital projects, Pritzker would redirect sales tax revenue from gasoline sales and cigarette tax receipts to the general fund.
Changing the timing of payments allows Pritzker to avoid counting nearly $1 billion in costs toward this year’s budget – $276 million in interfund debt service that was delayed and the $690 million federal reserve borrowing that was moved forward. However, changing the timing of payments does not improve the state’s overall financial condition. It’s an accounting shell game to make the budget appear balanced on paper.
The rest of the deficit is covered by spending freezes worth $1.27 billion and significantly more optimistic revenue assumptions compared to those the governor’s office released in November 2020. Those spending changes are not actual cuts compared to prior-year spending, but rather canceling automatic spending growth that is assumed as part of the state’s baseline budgeting method.
More optimistic revenue projections account for the largest reduction in the deficit, on paper, at $1.88 billion. The governor’s office also raised revenue projections by $2.3 billion for the current fiscal year 2021, which “closes” this year’s $3.9 billion deficit if December’s $2 billion in borrowing from the federal reserve is counted as revenue. Illinois has a history of counting debt as revenue and relying on optimistic revenue projections to cover deficits on paper, but this optimism is often wrong. That helps explain why politicians claim to pass a balanced budget each year, but the budget has not actually ended a year in the black since fiscal year 2001.
While state and local revenue collections in Illinois and across the country have been beating estimates made early in the pandemic, the November revenue projections from the Governor’s Office of Management and Budget were already $2.2 billion higher than projected in April 2020. It’s unclear that economic conditions since November have changed enough to justify another large upwards revision.
All together, Pritzker’s budget proposal fails to offer the significant financial reforms needed to protect Illinois taxpayers, preserve services for the vulnerable in the long term and ensure the state has a strong recovery from COVID-19. Illinois’ personal income growth was the second worst in the nation following the Great Recession, in part because of tax hikes that hurt the recovery. Pritzker’s various proposed tax increases on businesses threaten to hold back Illinois’ ability to create good-paying jobs and grow wages for its residents as the state recovers from a pandemic-induced recession.
Lawmakers are largely expected to receive $7.5 billion in unrestricted aid for the state budget from the federal government under the $350 billion state and local bailout proposed by President Biden’s administration. This lifeline provides Illinois with breathing room to make the long-term changes necessary to stabilize state finances, starting with pension reform. The General Assembly should also use that aid to cancel all nine of the pandemic tax increases from the governor’s budget proposal.
Here are Pritzker’s nine tax increase proposals:
Cap, delay credits for business operating losses by three years: $314 million
When a company loses money in a given year, known as a net operating loss, federal and state tax laws generally allow at least some portion of that loss to be carried forward to future years as a proportional offset to future tax liability. In other words, if a business loses money in 2020 and 2021 because of the pandemic, but earns a profit in 2022, it can deduct the two years of losses from its earnings in 2022 and pay taxes only on the difference.
For purposes of state taxes, Pritzker wants to limit losses carried forward to $100,000 for the next three years. Businesses would still be able to carry forward losses above that amount but couldn’t claim the deduction until three years from now.
This change would reduce businesses’ cash on hand to make investments in equipment, new jobs or raises for employees. It would therefore hurt Illinois’ ability to recover economically from COVID-19. Because the full value of the credits is only delayed, it has the potential to create a significant revenue drop in the future when businesses try to collect on the full value of the credits.
Delay expensing of business investments: $214 million
Illinois automatically adopts certain changes in federal tax law as part of Illinois tax law through what’s called “rolling conformity,” meaning state law points back to the Internal Revenue Code and automatically updates certain provisions to match. Pritzker wants to decouple from federal provisions intended to promote pro-growth investments.
Federal tax reform in the Tax Cuts and Jobs Act included several changes intended to bolster business investments and promote economic growth. One of these changes was to allow full and immediate expensing, meaning companies can deduct the entire cost of an investment in the year it was made, rather than dragging out the expensing over the lifecycle of an asset.
The Tax Cuts and Jobs Act applied this concept, also called 100% bonus depreciation, to investments with a useable lifetime of 20 years or less, such as machinery and equipment. Long-term investments in buildings must still be expensed over time. The changes for short-term investments are scheduled to phase out beginning in 2022 and expire in 2026. The nonpartisan Tax Foundation has argued for making these changes permanent, because delaying deductions for investments increases the cost to businesses and discourages investments that help grow the economy.
"Stretching depreciation deductions for capital investment over time means a business can’t fully recover the cost of making the investment. This discourages businesses from making productive investments that would otherwise be worthwhile to pursue," the Tax Foundation stated.
Pritzker’s proposed change would immediately revert to the prior system of stretching out the deduction for Illinois taxes, discouraging the very investments that will help Illinois recover from the COVID-19 economic downturn.
Double-tax profits U.S. companies earn abroad: $107 million
Another aspect of federal tax reform in the Tax Cuts and Jobs Act was to move from a “worldwide” towards a “territorial” corporate tax system, in part to encourage companies to repatriate money held overseas. One of the most important aspects of this reform was to end double taxation on profits U.S. companies earned overseas by allowing a 100% deduction for foreign dividends paid to the parent company. Those profits would have already faced taxation in the country where the income was earned.
Pritzker proposes eliminating the credit for foreign dividends, which could discourage those profits from being repatriated and brought to Illinois if the profits would receive more favorable tax treatment overseas.
New sales tax on biodiesel gasoline: $107 million
Under current law, fuel with a biodiesel content greater than 10% or ethanol content of at least 70% is exempt from Illinois sales taxes. The exemption is scheduled to expire in 2024, but Pritzker would eliminate the credit immediately.
Illinois Fuel and Retail Association CEO Josh Sharp responded: “This change would add approximately 20 cents to a gallon of diesel fuel and is especially egregious considering that Illinois is one of only six states that already imposes a sales tax on motor fuels. Ending this incentive would also be incredibly damaging to our vital agriculture community in Illinois and hurt my small business members at a time when it’s so easy for customers to drive across state lines to fill up their vehicles.”
Limit retailers’ reimbursement for collecting state sales tax: $73 million
Retail stores in Illinois collect and remit sales tax on behalf of the state, which has an administrative cost. To reimburse retailers for this service to the state, current law allows retailers to keep 1.75% of the sales taxes they collect as compensation. Pritzker wants to limit retailers’ reimbursement to $1,000 per month.
The Illinois Retail Merchants Association said the current 1.75% amount already “only partially reimburses” store owners for their cost. The statement continued, “Shifting more of the cost of administration and collection onto retailers does nothing to support struggling businesses and indicates the governor fails to fully appreciate all that retail contributes to our state, which prior to the pandemic employed one-fifth of all workers in Illinois and served as the second largest revenue generator for state government and the largest revenue generator for local governments.”
Limit manufacturing equipment sales tax exemption: $56 million
The purchase of manufacturing machinery and equipment is generally exempt from Illinois sales taxes. In 2019, this exemption was expanded to include “tangible personal property” used in the manufacturing process, such as fuels, coolants and oil consumed in the manufacturing process. Pritzker is proposing to reverse that recent change.
According to the Sales Tax Institute, the expansion brought Illinois’ manufacturing credits more in line with nearby states.
Illinois’ manufacturing industry has consistently lagged other Midwest states since the Great Recession. Even before COVID-19, Illinois lost 13,100 manufacturing jobs in 2019 – the largest percentage loss of any job sector.
Steve Rauschenberger, president of the Technology and Manufacturing Association, singled out the elimination of this expanded exemption in his reaction to Pritzker’s budget proposal. "We urge the governor to stop championing policies that will put Illinoisans on the unemployment lines and force our job creators and innovators to leave our state to survive," Rauschenberger said.
Cancel phase-out of costly corporate franchise tax: $30 million
Only 16 states still have "capital stock taxes" which tax businesses on their net worth regardless of whether the business is profitable, according to the Tax Foundation. "These taxes impair economic growth in the best of times, but during an economic contraction they are particularly harmful to businesses struggling to remain viable," the Tax Foundation said.
Illinois confusingly refers to its capital stock tax as the “corporate franchise tax,” even though it has nothing to do with franchise businesses. Complying with the tax law is complicated and comes with high compliance costs that are particularly difficult for smaller businesses to manage. The cost of complying with the tax is more than many businesses owe to the state.
The tax was scheduled to phase out over four years before being fully eliminated in 2024 under a law passed in 2019.
Though Pritzker touted the elimination of this tax as an accomplishment of his first year, he is now proposing to reverse the change.
Eliminate credit for creating construction jobs: $16 million
The Blue Collar Jobs Act passed in 2019 created new tax credits to incentivize the creation of construction jobs. Eligible businesses would be able to take a credit worth 50% of the new payroll taxes withheld as the result of a construction job created. That credit rose to 75% if the job was created in an economically distressed area.
Reduce tax scholarship credit for disadvantaged students: $14 million
State lawmakers passed the Invest in Kids Act in 2017 as part of an overhaul of the education funding formula. The program is the state’s first-ever school choice program, and among the largest in the nation. It gives disadvantaged students a chance to go to private schools by giving scholarship donors a 75% tax credit for their donation towards state taxes, incentivizing those donations.
Only students within 300% of the federal poverty line are eligible for the scholarships, and the neediest students are prioritized first.
Pritzker wants to reduce the value of the credit to 40%, which would inevitably mean fewer scholarships available for low-income students.
Empower Illinois, a non-profit that helps match students with scholarships and the appropriate school, responded: "During this challenging time, kids need more quality education options, not fewer. And while Illinois’ financial challenges are significant, the State should not balance its budget on the backs of children from low-income and working-class communities or the schools that serve them so well."
Adam Schuster is the Senior Director of Budget and Tax Research at the Illinois Policy Institute, a nonpartisan research organization that promotes responsible government and free market principles. This story was originally published on February 24, 2021.
"If these trends continue, and we expect them to, then on Monday, February 28, we will lift the indoor mask requirements for the State of Illinois," Pritzker said at his 2pm press conference in Chicago. Currently, Illinois is one of nine states that still required masks inside public places.
After the 28th, masking will then be optional in grocery stores, bars and restaurants, public buildings, and non-scholastic sporting events - vaccinated or not.
There will be some indoor areas and venues where masks will still be required until further notice.
