The difference between computers and massages is why Illinois is broke

What the State of the State’s “simple math” misses

During his State of the State speech on Wednesday, Governor Bruce Rauner listed a number of policy changes that he believe will lead to job creation and economic growth. And that economic growth, would in turn, lead to balanced budgets:

We must remember that to keep budgets balanced in the future, our rate of economic growth must be higher than our rate of government spending growth. It’s just simple math.

This seems fairly straightforward, but there’s actually a bit to unpack here. First, let’s look at recent GDP growth in Illinois. According to the Bureau of Economic Analysis, Illinois’ GDP grew by 1.8 percent in 2015. However, at the same time, Illinois cut all General Fund spending by 9.2 percent from FY2015 to FY2016. (Spending on General Fund current services — education, healthcare, human services, and public safety, as opposed to payments on things like debt — was cut by 18.3 percent.)

So what’s going on here? Economic growth went up, and state spending went down — and our budget still isn’t anywhere close to balanced. Turns out the math is a little more complicated than the Governor let on.

For starters, the state lost revenue in both FY2015 and FY2016 — totaling more than $5 billion — when our 5 percent income tax was returned to its old level of 3.75 percent. So even though the economy was growing, the state captured less of that growth because it was taxing income at a lower rate. In other words: tax policy matters.

And Illinois’ tax policy is flawed. In fact, it’s flawed in fundamental ways that lead to both underfunding of core state services like education and public safety and an $11 billion deficit.

As CTBA has pointed out for over a decade, Illinois’ flawed tax policy causes the state’s General Fund budget to consistently generate deficits, even when spending on services is held constant from one fiscal year to the next in inflation-adjusted terms. In part, this happens because revenue doesn’t grow with our modern economy over time, whereas the cost of providing public services — even when service levels are not increased — do. The ongoing mismatch in the state’s General Fund between the lower rates of growth for revenue and the cost of maintaining service levels from one fiscal year to the next is called a “structural deficit.”

Below, you can see CTBA’s model of our structural deficit, projecting forward revenues and expenses based on current law and population growth projections.

Illinois State General Fund Structural Deficit

There’s a lot that’s wrong with Illinois’ tax policy, but a good example is the state’s sales tax. Illinois is one of 46 states with a sales tax, but it is one of the only states that excludes most services from being subject to the state sales tax. (That means that when you buy a good, like a computer, you pay sales tax — but when you buy a service, like a massage, you don’t.)

That’s a problem, because services have been rapidly growing as a proportion of the economy. By 2012, the service sector made up nearly 73 percent of the state’s GDP, while goods were just 17 percent. In other words, Illinois’ sales tax was missing three-quarters of the state’s sales.

Revenues of Goods and Services as a Percent of Gross Domestic Product: Illinois

Source: SIC 1965–1985, NAICS: 1987–2012

In other words, the state’s sales tax hasn’t been responsive to the way that the private sector economy has grown. And because of that, a growing economy doesn’t mean growing revenue — and schools, hospitals, mental health facilities, and public safety are hurt as a result.

And that’s how the state’s deficit grew in 2015, even though the economy grew and spending fell. Our math isn’t quite as simple, but it happens to tell more of the real story.

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