By Richard Borean, The Tax Foundation
State would fall from 23rd to 48th on State Business Tax Climate Index
A recent proposal to transform Illinois’s income tax system could lead to small businesses facing state income tax rates as high as 11.25 percent, the third highest rate on pass-through businesses anywhere in the nation, according to a new report from the nonpartisan Tax Foundation.
The proposal (HB 689) would transform the state’s flat individual income tax rate of 3.75 percent into a graduated, four-rate system topping out at 9.75 percent. Because many small businesses file under the individual tax code, rather than the corporate code, and because they must also pay a 1.5 percent “personal property replacement tax”—which is, in fact, a second income tax—their new top marginal income tax rate would be 11.25 percent. Since this is a considerably higher rate than what traditional c-corporations would face, the proposal would result in a disparity in the way Illinois treats small businesses compared to larger businesses in the state.
The legislation is contingent on ratification of a constitutional amendment and would transform the state’s middle-of-the-pack business tax climate into the 3rd least competitive state tax code in the U.S.
“Were this proposal enacted, it would result in the state falling from 23rd to 48th on the State Business Tax Climate Index, ahead of only New York and New Jersey,” said Tax Foundation Policy Analyst Jared Walczak. “Illinois ranks below average on corporate income, sales, unemployment insurance, and property taxes. This proposal would eliminate the most attractive element of the state’s tax code, its competitive and flat income tax system, and replace it with one of the worst individual income tax systems in the nation, resulting in the substantial drop in overall rank.”
Some proponents of the legislation contend that the proposal is consistent with the goal of shoring up the state’s business climate. However, uncompetitive tax systems can have a deleterious effect on economic growth. Billed as a tax increase on only the richest Illinoisans, HB 689 would dramatically increase tax burdens on the state’s job creators and entrepreneurs.
The report’s key findings include:
A proposal under consideration in Illinois would convert the state’s single-rate individual income tax into a four-bracket tax with a top rate of 9.75 percent on individuals and 11.25 percent on small businesses.
The proposal is contingent on ratification of a constitutional amendment authorizing a graduated-rate income tax, which could also permit alternative graduated-rate income tax rates and brackets in the future.
Under the proposal, Illinois would impose the second-highest state rate in the country on pass-through businesses, after only California. Illinois would be third after the state of California and New York City when local income taxes are also taken into account.
By changing one of the most competitive elements of the Illinois tax code, the state would fall from 23rd to 48th on the Tax Foundation’s State Business Tax Climate Index.
Source: The Tax Foundation