Illinois, a Dynamic State?

Armed with the technology to finally refute the policies of tax-and-spend politicians, the Illinois Policy Institute has the tools to separate reality from fiction regarding Illinois’ state tax policies.

This week, Greg Blankenship, director for the Institute unveiled his first study using the State Tax Analysis Mapping Program (STAMP), a sophisticated computer model designed to calculate changes in the Illinois economy caused by changes in tax policy.

The STAMP model allows policy makers the opportunity to see their proposed changes prior to implementation. Time and time again, policy makers have made changes to tax policies and endured unintended consequences.

What are these unintended consequences? The most repetitive consequence is often the lack of revenue actually collected as compared to the estimated revenue collection expected. For instance, in drafting Illinois’ FY04 budget, lawmakers levied significant increases on business taxes and fees in anticipation of receiving $541 million in new revenue. Based on the Institute’s evaluation as provided by the STAMP model, the state is likely to only receive about $443.91 million in new revenue from these tax and fee increases, falling short by $97 million.

Why does the STAMP model come up with such drastically different numbers than those of the lawmakers? Tax policy is often scored in a "static" model. What this means is that the increased tax rate is simply just added on to current revenues and current business behavior, a very simple mathematical equation. What a static model does not evaluate is the change in business behavior as a result of the tax policy change. Evaluating behavior along with mathematical calculations is referred to as "dynamic scoring."

Think of the STAMP model’s performance like physics, "For every action there is a reaction." By imparting increased tax rates on a particular sector of the economy, and in this case the business sector, current economic analysis does not account for change in behavior. The STAMP model does.

For sake of argument, if a business’ corporate income tax rate is increased (and in the case of Illinois, increased significantly), the corporation’s behavior will change. The state’s action to increase tax rates on income will result in a number of reactions: employee lay offs (due to less income available to hire or retain employees); shifting the use of cash by the company (instead of keeping cash on hand or to be divvied out to shareholders, companies may increase capital investment in order to reduce its income tax liability or may not invest in capital at all). Or in a worst case scenario, the corporation may leave the state altogether in search of a lower tax haven.

Here’s where the unintended consequences come into play. Take the worst case scenario, resulting from an increase on corporate income tax: the company leaves the state. Not only does the state lose all the anticipated revenue from that particular corporation’s income, but employees are now jobless and the state also loses revenue from existing personal income tax revenues. On the flip side, the increased number of a now unemployed labor force puts an additional strain on state government social programs designed to keep the unemployed afloat until they find new employment. All of a sudden, the one action (the increased corporate income tax rate) has created a succession of reactions, all detrimental to the government’s intended revenue earnings.

The Institute’s first study provides information for two different policy changes, the current FY04 budget (which now faces some challenges in the upcoming veto session) and the economic proposals for the upcoming FY05 budget.

In brief, the FY04 budget, passed this spring by the Illinois General Assembly, will cause the following reactions if these tax and fee increases are not repealed, according to STAMP model results:

• 3,823 jobs will be lost
• $110 million will be lost in nominal investment
• Only $444 million will be collected as a result of the increased business taxes and fees, $97 million short of lawmakers’ expectations

The analysis provided by the STAMP model as presented by the Illinois Policy Institute should be taken to heart. As history and current practice in other states show, states that raise taxes during economic slowdowns fail to resolve budget shortfalls and no longer create an environment for economic growth and prosperity. In September 2003, the U.S. Bureau of Labor and Statistics reported Illinois as having the fifth highest unemployment rate in the country at 7.1%. It was one of only 12 states to realize an unemployment increase from the previous month.

To read the entire initial STAMP report, click here.

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