We’re in the heart of sales tax holiday season now.  Despite cooler heads prevailing in DC and Georgia, where sales tax holidays have been scrapped due to gloomy budget projections, Massachusetts and North Carolina have recently decided to move ahead with their holidays, and Illinois has decided to join the party for the first time.

By now, you may be familiar with all the reasons why sales tax holidays are a bad idea (read this ITEP policy brief if you’re not).  Aside from those groups with a vested interest in the holidays (e.g. retailers looking for free advertising, politicians looking to build their anti-tax credentials, and confused parents thinking these things actually save them money), just about everyone seems to agree that sales tax holidays are a worthless political gimmick.  Stateline pointed out last week that analysts as varied as those at Citizens for Tax Justice and the Tax Foundation have come to an agreement on this point.

But as long as sales tax holidays remain popular enough to remain impervious to most state budget crises, we might as well take a moment to marvel at some of their more glaring absurdities.  For example, this year, Massachusetts’ sales tax holiday will apply to alcohol.  College students in the state clearly have quite an effective lobbying presence in Boston.  Interestingly, neither tobacco nor meals will be included in the holiday.

In Illinois, which doesn’t have any experience with sales tax holidays, one columnist speculates that his wife isn’t alone in erroneously believing that the back-to-school holiday applies only to children’s clothes.  Indeed, adult clothes are included as well; as are aprons and athletic supporters.  Work gloves, however, will still be subject to tax.  You’d think that the Illinois Department of Revenue already has enough on its plate without having to worry about such minutia.

Finally, in South Carolina, it looks like the state’s Tax Realignment Commission is going to recommend quite a few changes to the state’s tax holidays.  For starters, the state’s bizarre post-Thanksgiving tax holiday on guns has to go, according to the Commission.  And changes could be in store for the August holiday as well.  The State reports that if the Commission gets its way, “this could be the last year to get your wedding gown, baby clothes, pocketbooks and adult diapers at a discount on back-to-school tax-free weekend.”  Interestingly, the South Carolina representative who first introduced the sales tax holiday idea actually agrees, claiming that he wanted only the holiday to apply to stereotypical “back to school” purchases – that is, things other than wedding gowns and adult diapers.

Back-to-school time is just around the corner and with that comes the annual debate about sales tax holidays. States offering sales tax holidays typically won't collect sales tax for a specific number of days on items considered to be back-to-school items like school supplies, clothes, or even shoes. Of course, sales tax holidays do nothing to offset the regressivity of the sales tax the rest of the year, they are an administrative headache, costly for state governments, and very low-income people usually don't have the flexibility to shift their spending to take advantage of the holiday.

Despite recent headlines like "Illinois: Our very own Greece?" Governor Quinn signed legislation that allows the state to offer its first ever sales tax holiday for a ten day period in early August. The holiday is projected to cost the state between $20 and $67 million, which the state could certainly use right about now. It's hard to understand how offering this sales tax holiday is good fiscal policy.

In brighter news, Georgia is not having a sales tax-free holiday weekend this year. In a state facing its own budget crunch, the Speaker of the House said earlier this year, "What I hear Georgians say is they’d rather have their classroom teachers in the classroom teaching than have that sales [tax] holiday." This move is likely to save the state about $12 million.

For many states, the fiscal picture for the next year remains cloudy at best. After years of painful spending cuts, how can states balance their budgets without further damaging essential public investments? A new report from United for a Fair Economy (UFE) lays out a few important guidelines for budget reform.

Among the more interesting recommendations: States shouldn't be afraid to meet spending needs by borrowing or drawing down their rainy day funds — but should do each in a straightforward and rational manner. This means that states seeking to adequately fund public investments that benefit future generations (such as transportation spending) shouldn't feel bad about issuing general obligation debt to fund these needs, ensuring that future generations will pay part of the cost of funding these investments. (Of course, lawmakers generally don't need any help shifting costs to future generations, but it's important to remember that there is, in some areas, a sound rationale for doing so.)

On rainy day funds, the report is a reminder that when the rainy days come, the funds should be used — and that damaging cuts to education and health care spending are a far worse result than depleting state reserves.

Responding to a recent report from the Pew Center for the States that generated hysterical headlines about unfunded state pension systems, the UFE report also notes that in the short run, unfunded long-term liabilities of the sort documented in the Pew report are a far better alternative than the loss of vital public services in the present day.

As the report reminds us, virtually every state could avoid damaging spending cuts through progressive tax reform focused on the state income tax — but these other tools should also be considered before resorting to further across-the-board spending cuts.

Illinois Governor Pat Quinn reminded Illinoisans this week of the need for a tax increase by previewing a drastically reduced spending plan that would cut deeply into education, public safety, and human services while still failing to fill the state’s budget gap.  On Wednesday, Governor Quinn made clear that he plans to again push for a state income tax increase, though he has promised to make some refinements to the version he advocated last year.

During the FY10 budget debates last year, the Governor attempted to secure support for a progressive tax hike that would raise the state’s flat income tax rate while also increasing the personal exemption.  This plan represented a fair and practical solution, given the state’s constitutional restrictions on levying a graduated rate income tax.  While the Senate did pass a bill that both raised the state’s income tax and expanded the sales tax base, the push for tax reform died in the Illinois House where lawmakers insisted on using spending cuts and borrowing to ease the state’s budget shortfall.

But the lack of sustainable tax increases last year has only made Illinois’ current budget situation that much worse.  Illinois now has what is perhaps the worst fiscal situation of any state in the entire country.  As Ralph Martire of the Center for Tax and Budget Accountability put it earlier this week, "Any elected official or candidate who says you can solve this without a tax increase is either incredibly math-impaired or intentionally deceiving voters."

Given the dire situation of the Illinois budget, even the Civic Federation, a traditionally anti-tax, business-oriented group, has recently come to acknowledge the absolute necessity of raising the state’s individual and corporate income taxes.  While the group still considers such increases “distasteful,” it has finally realized, as have many Illinoisans, that the spending cuts alone cannot fix the state’s problems.

For more on tax reform in Illinois, be sure to read this recent ITEP report examining both short- and long-term strategies for improving the Illinois tax system.

Last week saw the conclusion to a bruising Democratic primary in the campaign for Illinois Governor. Both Democratic candidates, incumbent Governor Pat Quinn and Comptroller Dan Hynes, had plans for shoring up the state's long- and short-term fiscal crisis. Governor Quinn put forward a plan to raise the existing income tax rate of 3 percent to 4.5 percent and to increase the value of personal and dependent exemptions from $2,000 to $6,000. His plan would generate roughly $3 billion per year. Comptroller Hynes proposed a rate structure that would leave the present 3 percent rate in place for all taxpayers with incomes below $200,000 but that would impose rates ranging from 3.5 percent to 7.5 percent on incomes above that amount, with the highest rate applying solely to income in excess of $1 million.

A recent report from ITEP describes both candidates' income tax reform proposals and argues that a combination of the two plans would be ideal. Governor Quinn narrowly beat Hynes in the primary and, assuming he wins the election, there is real hope that fundamental tax reform in Illinois is not just possible, but likely.

Quinn and Hynes are not alone in their commitment to progressive tax policy. A bipartisan task force on Illinois property taxes recently recommended several policy options that could be combined with proposals that Quinn supports. The task force's recent report suggests rebalancing the state's revenue sources, consolidating government services and functions, and enhancing the circuit breaker program.

Michigan gubernatorial candidate State Representative Alma Wheeler Smith is calling for the restructuring of the state's tax structure. Michigan is one of a handful of states with a flat income tax, and its fiscal woes are infamous. Rep. Smith feels that now is the time for a complete restructuring of the state's tax system, including making Michigan's income tax graduated and lowering the state's sales tax rate while extending the sales tax base to include more services.

Representative Smith isn't the only person running for Governor who is turning to income tax reform in these difficult times. Both Democratic gubernatorial candidates in Illinois have also called for significant changes to the Illinois tax structure, including reforming their state's flat rate income tax. For more on Illinois Governor Pat Quinn and Comptroller Dan Hynes' tax reform plans, see ITEP's report. Progressive income taxes are an important tool for states struggling in this current economic downturn. Read more about the benefits in ITEP's Policy Brief on progressive income taxes.

This week, the Institute on Taxation and Economic Policy (ITEP), in partnership with state groups in forty-one states, released the 3rd edition of “Who Pays? A Distributional Analysis of the Tax Systems in All 50 States.”  The report found that, by an overwhelming margin, most states tax their middle- and low-income families far more heavily than the wealthy.  The response has been overwhelming.

In Michigan, The Detroit Free Press hit the nail on the head: “There’s nothing even remotely fair about the state’s heaviest tax burden falling on its least wealthy earners.  It’s also horrible public policy, given the hard hit that middle and lower incomes are taking in the state’s brutal economic shift.  And it helps explain why the state is having trouble keeping up with funding needs for its most vital services.  The study provides important context for the debate about how to fix Michigan’s finances and shows how far the state really has to go before any cries of ‘unfairness’ to wealthy earners can be taken seriously.”

In addition, the Governor’s office in Michigan responded by reiterating Gov. Granholm’s support for a graduated income tax.  Currently, Michigan is among a minority of states levying a flat rate income tax.

Media in Virginia also explained the study’s importance.  The Augusta Free Press noted: “If you believe the partisan rhetoric, it’s the wealthy who bear the tax burden, and who are deserving of tax breaks to get the economy moving.  A new report by the Institute on Taxation and Economic Policy and the Virginia Organizing Project puts the rhetoric in a new light.”

In reference to Tennessee’s rank among the “Terrible Ten” most regressive state tax systems in the nation, The Commercial Appeal ran the headline: “A Terrible Decision.”  The “terrible decision” to which the Appeal is referring is the choice by Tennessee policymakers to forgo enacting a broad-based income tax by instead “[paying] the state’s bills by imposing the country’s largest combination of state and local sales taxes and maintaining the sales tax on food.”

In Texas, The Dallas Morning News ran with the story as well, explaining that “Texas’ low-income residents bear heavier tax burdens than their counterparts in all but four other states.”  The Morning News article goes on to explain the study’s finding that “the media and elected officials often refer to states such as Texas as “low-tax” states without considering who benefits the most within those states.”  Quoting the ITEP study, the Morning News then points out that “No-income-tax states like Washington, Texas and Florida do, in fact, have average to low taxes overall.  Can they also be considered low-tax states for poor families?  Far from it.”

Talk of the study has quickly spread everywhere from Florida to Nevada, and from Maryland to Montana.  Over the coming months, policymakers will need to keep the findings of Who Pays? in mind if they are to fill their states’ budget gaps with responsible and fair revenue solutions.

Read ITEP's New Report: Who Pays? A Distributional Analysis of Tax Systems in All 50 States

By an overwhelming margin, most states tax their middle- and low-income families far more heavily than the wealthy, according to a new study by the Institute on Taxation & Economic Policy (ITEP).

“In the coming months, lawmakers across the nation will be forced to make difficult decisions about budget-balancing tax changes—which makes it vital to understand who is hit hardest by state and local taxes right now,” said Matthew Gardner, lead author of the study, Who Pays? A Distributional Analysis of the Tax Systems in All 50 States. “The harsh reality is that most states require their poor and middle-income taxpayers to pay the most taxes as a share of income.”

Nationwide, the study found that middle- and low-income non-elderly families pay much higher shares of their income in state and local taxes than do the very well-off:

-- The average state and local tax rate on the best-off one percent of families is 6.4 percent before accounting for the tax savings from federal itemized deductions. After the federal offset, the effective tax rate on the best off one percent is a mere 5.2 percent.

-- The average tax rate on families in the middle 20 percent of the income spectrum is 9.7 percent before the federal offset and 9.4 percent after—almost twice the effective rate that the richest people pay.

-- The average tax rate on the poorest 20 percent of families is the highest of all. At 10.9 percent, it is more than double the effective rate on the very wealthy.

“Fairness is in the eye of the beholder.” noted Gardner. “But virtually anyone would agree that this upside-down approach to state and local taxes is astonishingly inequitable.”

The “Terrible Ten” Most Regressive Tax Systems

Ten states—Washington, Florida, Tennessee, South Dakota, Texas, Illinois, Michigan, Pennsylvania, Nevada, and Alabama—are particularly regressive. These “Terrible Ten” states ask poor families—those in the bottom 20% of the income scale—to pay almost six times as much of their earnings in taxes as do the wealthy. Middle income families in these states pay up to three-and-a-half times as high a share of their income as the wealthiest families. “Virtually every state has a regressive tax system,” noted Gardner. “But these ten states stand out for the extraordinary degree to which they have shifted the cost of funding public investments to their very poorest residents.”

The report identifies several factors that make these states more regressive than others:

-- The most regressive states generally either do not levy an income tax, or levy the tax at a flat rate;

-- These states typically have an especially high reliance on regressive sales and excise taxes;

-- These states usually do not allow targeted low-income tax credits such as the Earned Income Tax Credit; these tax credits are especially effective in reducing state tax unfairness.

“For lawmakers seeking to make their tax systems less unfair, there is an obvious strategy available,” noted Gardner. “Shifting state and local revenues away from sales and excise taxes, and towards the progressive personal income tax, will make tax systems fairer for low- and middle income families. Conversely, states that choose to balance their budgets by further increasing the general sales tax or cigarette taxes will make their tax systems even more unbalanced and unfair.”

Implications for State Budget Battles in 2010

“In the coming months, many states’ lawmakers will convene to deal with fiscal shortfalls even worse than those they faced last year,” Gardner said. “Lawmakers may choose to close these budget gaps in the same way that they have done all too often in the past—through regressive tax hikes. Or they may decide instead to ask wealthier families to pay tax rates more commensurate with their incomes. In either case, the path that states choose in the upcoming year will have a major impact on the wellbeing of their citizens—and on the fairness of state and local taxes.”

Can’t we all just get along? 

Proponents of progressive taxation in Illinois might be wondering just that after listening to the main candidates for the Democratic nomination for Governor – incumbent Governor Pat Quinn and Comptroller Dan Hynes – criticize each other’s income tax plans over the past two months. 

As ITEP explains in its most recent report, both plans are progressive, as they would both require more affluent Illinoisans to contribute larger shares of their incomes to maintaining public services than individuals and families struggling to make ends meet. 

Sure, of the two plans, the one offered by Comptroller Hynes may be fairer, but it may also be less well-suited to meeting Illinois’ current and future revenue needs than the plan put forward by Governor Quinn in March.  The Hynes plan's only change to the income tax would be the creation of a graduated rate structure that would impose higher tax rates on upper-income taxpayers, an approach to taxation that is currently barred by the Illinois Constitution. 

Getting the Hynes plan off the drawing board and into the tax code could thus take several years, even though there is a clear need for additional revenue now. (The state's budget deficit for the upcoming fiscal year is projected to be $12 billion.)  What’s more, while the Comptroller asserts that his income tax plan would generate as much as $5.5 billion, ITEP estimates that it would yield only about $2.2 billion if in effect in 2011. 

Consequently, as ITEP suggests in its report, what is needed is an approach that combines the principal elements of both plans – the immediacy of the Quinn plan coupled with the fundamental reform embodied in the Hynes plan. 

If Illinois were to enact this spring an increase in its single income tax rate to 4.5 percent and to triple its personal and dependent exemptions – as Governor Quinn proposed earlier this year – it could generate roughly $1 billion for FY10.

Those changes could then serve as a bridge to a graduated rate structure, a bridge that could be removed once that new structure is in place.  As the ITEP report points out, adopting a graduated rate structure ranging from 3 to 7.5 percent, while leaving in place the higher personal exemptions recommended by the Governor, could ultimately generate in excess of $4 billion annually, while reducing taxes for nearly three out of every five Illinois taxpayers. 

Though it seems like most legislative sessions just ended after laborious budget battles, many lawmakers are looking to the future and one word is coming to mind -- grim. In many states, revenue isn't keeping up with projections. As a result, this week alone, lawmakers in Illinois, Mississippi, and Washington State have said revenue-raisers must be on the table.

Spending cuts have their consequences and there is only so much cutting that is possible or reasonable. A recent Peoria Journal Star editorial calls on lawmakers to respond to a report from the Commission on Government Forecasting and Accountability. The report discusses various revenue-raisers, including a sales tax base expansion. The Journal Star says, "This structural deficit is not going away by itself. To declare discussion about alternative revenue options DOA would just be foolish."

Meanwhile, lawmakers in Mississippi are likely to review lists of fee increases put together by state agencies to show how some revenue could be increased. 

In Washington, Governor Chris Gregoire earlier this week said that she would consider tax increases, saying that Washingtonians may have had their fill of cuts, "At some point, the people, I assume, don't want us to take any more spending cuts. I mean, I'm already hearing about, 'Why did you cut education?' Well, there weren't any options. We're without options.''

There’s a lot that can go wrong when a state turns to legalized gambling as a source of revenue.  This is a fact that Kentucky, Pennsylvania, and others should keep in mind during their continuing efforts to push for expanded gambling as a solution to their budget woes

For starters, a poor economy, opposition by local residents, legal challenges, and a number of other factors can delay the opening of newly legal gambling establishments.  And without functioning gambling venues, there’s no money for the state.  Recent stories out of Maryland and Pennsylvania demonstrate the very real nature of this threat.  Additionally, recent polling done in Illinois suggests that opposition to gambling at the local level – fueled in part, no doubt, by the Not-In-My-Back-Yard (NIMBY) syndrome – could cause similar delays there.  And legal challenges in Ohio indicate that the Buckeye state could be in for delays in gambling implementation as well.

But even after a state manages to get its gambling operations up and running, the revenue stream produced by gambling may not be as lucrative as advertised.  A recent New York Times story details the degree to which gambling revenues (from casinos, racetracks, lotteries, etc) are disappointing states this year.  The most obvious culprit in this case is the slumping economy, though some experts believe that increasing competition for gamblers both between states, and within states – known as “market saturation” – may be at least partially to blame.  Worries about market saturation have been on full display in Ohio, where racetrack owners are on edge about the effect that casino legalization (to be voted on by Ohioans this November) could have in cutting into their profits.

In other cases, it may simply be the case that gambling just isn’t as popular as first expected.  The perceived need among many states to legalize slot machine gambling as a means of drawing gamblers back to struggling racetracks is evidence of this problem.  Unfortunately, the failure of this method in Indiana has drawn into question the wisdom of this revenue-raising strategy as well.

Other methods, such as loosening the restrictions on betting limits or alcohol sales (which were originally imposed to secure support for gambling from reluctant lawmakers) are being tried as well.

Ultimately, the fact is that gambling is far from a fiscal panacea for the states, and given the tendency for implementation delays, is exceedingly unlikely to result in much revenue to fix the current round of state budget shortfalls.  Take a look at this ITEP policy brief for more on the gambling issue.

In his bid to be reelected Governor of Illinois, the incumbent Pat Quinn will face a primary challenge from Dan Hynes, the Illinois Comptroller. The two both see a need to move the state's tax system in a more progressive direction, but apparently disagree on how to get there.

Earlier this year, Governor Quinn championed an income tax increase plan which would have raised the state’s constitutionally mandated flat rate from 3 to 4.5 percent, while also increasing the state’s personal exemption from $2,000 to $6,000. Governor Quinn deserves credit for having the courage to talk about raising taxes in a progressive way, given the state’s recent reliance on one-time spending and severe budget cuts. The Governor was obviously aware that, because of constitutional restrictions, he didn't have the option of introducing a graduated income tax (which would have to be approved by the legislature and a vote of the people) and have it become law in time to help solve the state's nearly $12 billion budget shortfall.

Comptroller Hynes unveiled his extensive budget and tax plan on Wednesday citing support for instituting a graduated income tax on Illinoisans with incomes over $200,000. The Hynes plan also calls for various belt-tightening strategies, higher cigarette taxes, closing coporate loopholes, and some sales tax base broadening to include luxury services. It’s undoubtedly good news that the major candidates running for Governor both see the need for progressive income tax reform. 

But points of contention remain. Hynes is denying Quinn’s claim that "In 2004, [Hynes] opposed a graduated income tax. Maybe he's flipped and he's flopped over to our side.''  Hynes is countering that Quinn’s income tax proposal is a “regressive ... 50 percent tax hike on all Illinois families,” a claim that doesn’t hold up to analysis. Let’s hope that the candidates don’t continue to beat up on each other so much that the victim in the debate becomes income tax reform.

After much debate, Illinois Governor Pat Quinn signed a budget last week. Despite Governor Quinn initially advocating for an income tax increase to help balance the state's $11.6 billion shortfall, the budget that passed didn't include a tax hike and instead relied heavily on borrowing, delaying payment to vendors and spending cuts. The Senate voted 45-10 for the key funding piece of the budget, while the House supported it 90-22. Despite this disappointing news, Senate President John Cullerton has said that his "primary purpose" starting next year is an overhaul of the state's tax structure. Here's hoping Senator Cullerton gets some inspiration from ITEP's recent report: Ready, Set, Reform: How the Income Tax Can Help Make the Illinois Tax System Fairer and More Sustainable.

Tax reform hopes in Illinois were crushed (at least temporarily) on Sunday when the state House of Representatives rejected Governor Pat Quinn's proposal to increase the state income tax from 3 to 4.5 percent and the corporate tax from 4.8 to 5 percent in order to avoid a $7 billion budget cut. The 42-74 vote came a day after Senate Democrats led passage of a measure that would raise personal income taxes, boost the income tax from 3 to 5 percent and impose $1 billion in sales tax for the first time on many services. The House opted not to vote on the measure passed by the Senate.

Facing a midnight deadline, Illinois lawmakers instead passed a makeshift spending plan that provides for only 50 percent of the funding for state agencies laid out in Quinn's original budget and is not expected to last much more than 6 months. On Wednesday, State Senate President John Cullerton used a parliamentary maneuver to block the budget and hold it in the Senate. The action was considered mostly symbolic since Governor Quinn claims he won't sign the budget anyway because it does not solve the deficit problem.

Governor Quinn has stated before that he believes "in the tax based on the ability to pay: the income tax." Last month ITEP published its own report, agreeing with the governor's call for an income tax increase and recommending other reforms to help raise revenue and even out one of the most unfair tax systems in the nation.

Illinois lawmakers can continue this dance for only so much longer, since the budget currently in effect expires on June 30 and the state faces a deficit of $11.6 billion. Tax reform in Illinois is long overdue, but it remains to be seen whether or not lawmakers are serious about balancing the budget in time to avoid what one called an "apocalyptic series of funding cuts."

After years of relying on gimmicks and borrowing schemes to balance the state budget, Illinois elected officials are now signaling that they're prepared to think constructively and wisely about how to fill the state's $11.6 billion shortfall. Governor Pat Quinn, Cook County Assessor Jim Houlihan, and Senator James Meeks have each proposed tax reforms built around an increase in the state's personal income tax -- and have also proposed providing targeted income tax reductions for middle-income families.

Now ITEP has released its own tax reform proposal. In a new report, ITEP shows that an income tax rate increase, in combination with targeted tax credits, could raise $3.6 billion in new state revenues while actually cutting the overall taxes paid by the poorest sixty percent of Illinoisans.

There's good reason for this emphasis on income tax reform. The Illinois income tax is undeniably one of the lowest income taxes in the nation. Its 3 percent flat tax rate is the lowest top income tax rate in the U.S. And of the 41 states that levied broad-based income taxes in 2006 (the most current year for which data are available), only four states' income tax collections were lower, as a share of personal income, than Illinois.

For too long Illinois has chosen to balance its budget on the backs of low and middle income taxpayers. Progressive revenue-raising options (like those discussed in the ITEP report) that alter the income tax are key if Illinois lawmakers want to solve the state's budget crisis.