On Nov. 3, voters have the opportunity to ratify an amendment to the Illinois Constitution that will permit the state to use a graduated rate structure for its income tax. If the amendment is ratified, the new rate structure, called the “Fair Tax” by proponents because it raises revenue in a manner that corresponds to ability to pay, would impose higher income-tax rates on the wealthiest 3 percent in Illinois, while actually cutting income taxes for the bottom 97 percent.
In a normal economy, the Fair Tax would raise around $3.6 billion in new annual revenue. Of course, the current economy is anything but normal, as the nation continues to struggle through a record-setting recession caused by the pandemic. This has led those who oppose the Fair Tax to claim now is a particularly bad time to raise taxes, as doing so will make the recession worse. The research, however, indicates just the opposite is true.
Nobel Prize-winning economist Joseph Stiglitz reviewed how the various states dealt with their respective deficits caused by the Great Recession. He found that those states that closed deficits by raising taxes progressively — and used the new revenue from such progressive tax increases to maintain or enhance funding of core services — realized a positive private-sector multiplier of up to $1.50 for every tax dollar so raised and spent. This helped their economies recover faster from the recession than states that relied on spending cuts to resolve budget deficits.
The reason for this positive outcome has everything to do with consumer spending, which accounts for roughly 67 percent of all economic activity. See, the best spenders are low- and middle-income workers, whose earnings have been flat or declining after inflation over the last 40 years.
Because of that, they have what economists call a high “marginal propensity to consume.” That just means their spending generally increases or decreases in proportion to increases or decreases in their incomes. So when these workers receive a tax cut, as they would under the Fair Tax, they’re likely to spend every dollar of that tax relief buying stuff in their local economies.
Conversely, affluent individuals have very low MPCs — meaning an increase or decrease in their incomes does not generally result in a corresponding change in their consumption patterns. That isn’t surprising once you consider the tremendous growth in income they’ve realized over the last four decades.
For instance, the average, inflation-adjusted income of the wealthiest 1 percent in Illinois ballooned from $411,177 in 1979 to over
$1.4 million by 2017. In fact, the wealthiest 3 percent in Illinois — who are the only folks who would pay more under the Fair Tax — saw their disposable, after-tax incomes grow by over $16 billion between 2016 and 2017 alone. So it’s easy to see why taxing them more won’t reduce their spending.
Moreover, when the state government spends the newly raised revenue from the Fair Tax, most of that will go to the four core service areas of education, health care, human services and public safety, which collectively account for over 95 percent of all state spending on services.
Given that each of these areas are labor intensive, that spending primarily goes to cover the wages of the teachers, social workers, health care providers and correctional officers who provide those services in communities across Illinois.
This also stimulates the economy, because those public-sector workers are all middle income, meaning they have high MPCs. Hence the wages they get from the state government are spent in the communities in which they live. This in turn generates the positive private-sector economic multiplier that Stiglitz found stimulates job creation.
In other words, given how the data show that progressive tax increases that allow continued funding of public services actually help stimulate private-sector job creation in recessions, now is an especially propitious time to implement the Fair Tax.