Illinois Open for Business?

by Jeff Fleischer

(Jewish Business News Chicago, March 31, 2011)

The last time Illinois raised taxes was in 1989, when Gov. James Thompson passed what was then among the highest state tax increases in American history: 20 percent. That was exactly 20 years after the state income and corporate taxes were created, and it was another 22 years before a huge budget deficit drove the state to raise taxes again.

When it ultimately did so, on Jan. 12, Illinois raised those rates dramatically. Such a huge increase, all coming at once, can’t help but have a serious impact on both consumers and businesses – and therefore the future of Illinois business. In the weeks since the tax hike, local business owners have had to contend with the new reality and what it will mean for their ledgers.

“The biggest thing we’re going to see is the tax increase will definitely affect the bottom line for most companies,” says Tomer Laks, president and CEO of Phasecorp, a business consulting firm on Chicago’s north side. “And that will affect their decision-making processes, whether that’s hiring employees, buying equipment, or buying real estate – and all that will impact their growth.

“The problem is businesses, like most entities, like to be able to plan ahead. They don’t like surprises. And such a substantial increase all at once was a major, major surprise.” With the increase, the state tax rate on individuals shot up by two thirds, from 3 percent to 5 percent, while the corporate tax went from 4.8 percent to 7 percent. And both rates were passed retroactive to Jan. 1 of this year.

The Illinois corporate tax rate was introduced in 1969 by then-Gov. Richard Ogilvie, at a rate of 4 percent. The existing 4.8 percent rate had stayed constant since July 1, 1989. However, that rate doesn’t include the state’s personal property replacement tax – a 2.5 percent tax on corporations (1.5 percent on partnerships and S-corps) that passed in 1979. The state department of revenue collects the replacement tax, though the revenue goes to local (rather than state) governments.

So, from a business perspective, the new 7 percent rate will feel more like 9.5 percent. And because Illinois’ individual and corporate income taxes use a flat rate, small local businesses face the same percentage increase as multimillion-dollar corporations that can more easily absorb the costs. (Fourteen states have progressive corporate taxes with lower rates for corporations below certain income levels).

Larger companies can also benefit from specific tax breaks that often aren’t available to small business. For example, in early February, Illinois announced $29 million in tax incentives over 10 years for Mitsubishi, which employs about 1,300 people at its downstate plant in Normal, to ensure the company would keep the plant here. The state has previously used large tax-break packages to attract businesses such as Boeing.

The Chamber of Commerce and other business lobbying groups have expressed concern that the new rates will hurt Illinois’ ability both to recruit and keep businesses.

“For most of us, it’s going to be a case of we are where we are,” says Tom Sodeika, president and CEO of Oakbrook Terrace-based Precision Payroll of America. “But it depends on the type of business. If you’re operating a call center or are dealing with a not-highly-skilled workforce that can be easily replaced, maybe you go somewhere else.

“In our case, we built our business on the quality of our people, andI know I would never be able to move and find the same quality of people I have right now. We wind up in kind of a Catch-22.”

Shortly after the tax increase passed, a few businesses openly spoke of moving out of state. For example, the founder of the nationwide sandwich shop Jimmy John’s – which employs about 100 people in Champaign, where it was founded – said he would consider moving the company to Florida. New Jersey Gov. Chris Christie has already started a marketing campaign aimed at recruiting Illinois businesses, while the city of Indianapolis ran a full-page ad in the Chicago Tribune encouraging companies to move there.
However, it’s still unclear how real those threats will be, and whether out of-state pastures will prove greener.

The Washington-based Tax Foundation – a nonpartisan think tank that advocates for lower taxes – dropped Illinois from 23rd to 36th among states in its State Business Tax Climate Index after the passage of the Jan. 12 tax hike. Even still, it ranks the state ahead of neighbors Wisconsin, Iowa and Minnesota, though lower than Indiana and Missouri (which it ranks 10th and 19th, respectively). While New Jersey has made a fair number of headlines for its recruitment efforts, that state faces its own budget deficit of about $10.5 billion this year. It was such a deficit – estimated at $13 billion dollars – that caused Illinois to pass the tax hike (as well as borrow additional funds).

What’s also hard to measure is what opportunity costs the increased tax burden will have for Illinois business as a whole. There’s no way to know how many out-of-state or even international businesses would have been recruited to set up shop here, or how many jobs those businesses would have created. At the start of the year, the Illinois unemployment rate sat at 8.8 percent – down from the high of 12 percent it had hit in February 2010, but still high for any point in the last two decades.

“With unemployment where it is, there are a lot of entrepreneurial and talented folks who’ve been out of work and could use their skills to start small businesses,” Precision Payroll’s Sodeika says. “With the tax rate where it is now, that creates a higher barrier to entry for those people who are looking to start up.”

While obviously difficult on the business community, the tax hike was inevitably going to be high after 22 years without an increase. Former Gov. Rod Blagojevich, for example, repeatedly vowed not to raise income or corporate taxes, instead borrowing record sums to cover the state budget. That left Illinois with the lowest credit rating among all states (tied with California, according to Moody’s Investors Service), unpaid balances to key recipients like schools and hospitals, and a deficit roughly half its total general-fund budget. The low credit rating also increased the cost of insuring the state against default. And while the $13 billion deficit got a lot of attention, the state also had an additional $6 billion in unpaid bills and $4 billion in underfunded pensions.

The state also had limited flexibility in terms of spending cuts. According to data from the Chicago-based Center for Tax and Budget Accountability, Illinois’ spending ranked 43rd among states in 2010 as a percentage of state GDP, and the state already had a low level of funding public services compared to other states.

There’s no question the bill is now coming due, though it will be some time before we know if the tax hike did enough to address the shortfall or whether it prevented additional growth in the business sector. As of now, the increased rates – both for individual and corporate taxes – are scheduled to stay in place through 2015, at which point they’re expected to drop down to 3.25 percent and 5.25 percent. They’re scheduled to drop again in 2025, and the tax package did include state spending caps that – if violated – would trigger a lower tax rate.

“In a couple years, we are going to be able to review the data of the tax effect, and see what this has done in terms of reducing the number of viable business in the state,” Phasecorp’s Laks says. “The worry is that, at a time when the economy on the global scale is starting to recover from the recession, this tax cut will lead to economic stagnation in the state. If that happens, it’s a big problem.”

Jeff Fleischer is a Chicago-based journalist and author who has written for publications including Mother Jones, the Sydney Morning Herald, National Geographic Traveler, the New Republic and Chicago Magazine.

Tags: , , , , , ,