Taxing services would be start to fixing state’s structural deficit

It’s politically difficult to get tax policy right for one simple reason: No one really enjoys paying taxes, so most politicians disdain the subject. Paradoxically, sound tax policy is the only sustainable path to ensuring adequate investments can be made in the very core services — like educating children and caring for vulnerable members of society — that help build prosperous communities.

For proof, look no further than the projected $3 billion revenue shortfall facing the state’s General Fund next year. That shortfall means Illinois will be hard pressed to maintain its current investments in education, health care, human services and public safety, which collectively comprise over 94% of all General Fund spending on services.

The re-emergence of a significant deficit in Illinois’ General Fund is somewhat surprising, given the tremendous job Gov. J.B. Pritzker has done getting the state’s fiscal house in order after inheriting a hot mess from his predecessor. Recall that when Pritzker took office, he faced a backlog of over $8 billion in unpaid bills left by former Gov. Bruce Rauner, which meant roughly 20% of all General Fund spending on those core services during Rauner’s last year was deficit spending. Since becoming governor, however, Pritzker’s responsible fiscal stewardship completely eliminated the deficit Rauner left. Last year, the General Fund was actually balanced for the first time in decades.

Of course, part of the reason Pritzker was able to clean up the state’s finances was his prudent use of the billions in federal aid Illinois received during the pandemic. Rather than fritter that largesse away on new spending that would generate headlines and curry political advantage, Pritzker used the vast majority of federal pandemic bailout dollars to pay off old bills, prepay debt saving millions in interest costs, shore up the state’s rainy day fund, prepay pension obligations and get Illinois’ Unemployment Insurance Fund solvent. Pritzker’s responsible handling of the state’s finances was recognized with nine different credit rating upgrades.

Unfortunately, there are no more federal bailout dollars coming down the pike. And despite Pritzker’s sound fiscal management, the state still has a structural deficit. A “structural deficit” exists whenever a tax system fails to generate enough revenue growth over an extended period of time to cover the cost of both: maintaining delivery of the same level of services from year-to-year, adjusting solely for inflation; and repaying existing debt service.

The main reason for Illinois’ structural deficit is the state’s tax policy isn’t designed to work in the modern economy. While there are many reasons for this, one key principle of sound taxation Illinois lacks is having a stable tax that maintains revenue generation during poor economic cycles. The typical way state governments build this stability factor into their tax systems is by having a sales tax that’s imposed on most transactions actually occurring in the consumer economy.

That creates stability in revenue generation for a number of reasons. First, consumer spending is the largest segment of the economy, accounting for around 68% of total GDP. Second, consumer spending usually doesn’t decline substantially during major economic downturns. For instance, during the Great Recession, consumer spending remained relatively constant, with real personal consumption expenditures declining by less than 1%. So a sales tax that broadly applies to most transactions in the consumer economy typically provides stability to a fiscal system, even when other more volatile revenue sources decline rapidly.

Unfortunately, Illinois taxes less consumer spending than any other state with a general sales tax. That’s because Illinois’ sales tax applies primarily to the sale of goods, not services. That’s a loser proposition, considering about 74% of Illinois’ economy — and around 68% of all consumer spending — are transactions involving services, not goods.

Simply expanding the state’s sales tax base to include the same consumer services already taxed in our neighboring states of Iowa and Wisconsin would generate over $2 billion in annual revenue for Illinois. That’s good tax policy, which would go a long way toward eliminating Illinois’ structural deficit.

• Ralph Martire, rmartire@ctbaonline.org, is executive director of the Center for Tax and Budget Accountability, a fiscal policy think tank, and the Arthur Rubloff Professor of Public Policy at Roosevelt University.