One of the nation’s leading credit rating agencies said Monday adopting a graduated income tax system in Illinois probably would provide some much-needed revenue, but whether state’s credit rating would be improved depends on how the state uses the new money.
The report, by Moody’s Investors Service, came in response to a proposed constitutional amendment that proposes to replace the state’s current “flat” income tax rate of 4.95 percent with a graduated system where higher rates would apply to people with higher incomes.
The Illinois Senate voted last week to approve the amendment. It is now pending in the House and, if approved there, would be placed on the November 2020 general election ballot for voter approval.
“If the constitutional amendment ultimately passes, its impact would depend on the degree to which the state derives new resources and uses them to address core credit challenges, most prominently pension obligations,” the report stated.
“To be sure, a neutral outcome is possible if a new tax system yields only minimal revenue gains and has little effect on the state's economy or budget,” according to the report. “A positive outcome for the state's credit standing would require that the new system yield substantial net new revenue, without material damage to the economy, and that the new revenue be largely allocated to addressing the state's retirement benefit liabilities on a recurring basis.”
“A negative outcome — characterized by growing economic challenges and scant progress addressing pension funding needs — is also possible,” the report stated.
Moody’s rates Illinois bonds as Baa3, the lowest investment-grade rating available. Any further downgrade would put the state into what many refer to as “junk bond” status.
In addition to the proposed constitutional amendment, the Senate last week also passed a bill establishing new income tax rates that would take effect in 2021, provided voters approve the amendment. Those new rates would generate an estimated $3.3 billion in new general fund revenues, plus additional money earmarked for expanded child care tax credits and property tax relief.
The bill does not specifically earmark any new revenues for pension obligations or paying down the state’s backlog of past-due bills.
The Moody’s report also noted adopting such a system could expose the state to additional risks of revenue volatility. That’s because such a system would increase the state’s reliance on income taxes overall to fund its budget, and in particular on the incomes of upper-income individuals whose incomes can fluctuate widely from year to year, depending on market conditions.
“Some states that depend heavily on income-tax revenues also have a heightened reliance on their highest-earning taxpayers,” the report said. “These states tend to face greater revenue volatility.”