Illinois is one of only three states that has an income tax but exempts all retirement income. And politicians, along with advocacy groups, have long pushed to keep it that way. 

But amid the spiraling state budget and public pension crisis, even some anti-tax groups are open to giving the idea a closer look provided, they say, it is woven into a comprehensive and acceptable spending and taxing plan, a BGA Rescuing Illinois report finds.

Yet for Illinois’ dysfunctional government, drafting that blueprint is a very tall order, especially now. The budget stalemate between Republican Governor Bruce Rauner and the Democratic leadership of the General Assembly has been going on nearly a year.

And even if lightning strikes and the budget logjam snaps, odds are that imposing a retirement tax would still face heavy grassroots hostility and some key lawmaker opposition. A bipartisan group of House lawmakers have already introduced a non-binding resolution expressing opposition to taxing retirement income, to counter growing support for the concept.

“It’s being pushed – there’s no doubt about it,” says Republican State Rep. David McSweeney, the lead sponsor of the anti-retirement income tax resolution. “There have been discussions of secret working groups, and outside groups are calling for a retirement tax. I wanted to get ahead of it. I think it’s a real threat. We need a budget in the state; I’ve been one of the most vocal proponents of a budget. But we do not, repeat not, need to raise taxes. A retirement tax would be a disaster.”

By some estimates a retirement tax could generate $2 billion or more annually. The money would likely land in the state’s general revenue fund and could be tapped for any number of needs, including helping to pay for the state’s major pension funds, which are hugely underfunded by $111 billion and counting. 

Backing retirement tax

Influential budget experts are forging ahead with their ideas.

For example, the Chicago-based Civic Federation , a 122-year-old non-partisan think tank representing corporate and professional leaders, in its 2017 state budget roadmap called for taxing retirement income but exempting Social Security and income under $50,000.

The civic organization estimated this would raise an additional $1.72 billion in FY2017.

At the conservative Illinois Policy Institute, policy chief Ted Dabrowski said taxing retirement income would be conceivable as part of larger reforms including pension overhauls, spending cuts and reductions in other taxes

“Overall the Institute would not be against retirement income being taxed as it is everywhere – but only if it was part of an overall tax-neutral plan to reduce the overall income tax rate,” he said. “I don’t believe this is a time we should be giving the legislature even more money to mismanage and misspend.”

Even the AARP Illinois, one of the most influential lobbying forces in the county and state and a strident opponent of retirement income tax, does not give a hard “no” on the issue

Robert Gallo, state director of AARP, told the BGA that his group remains staunchly opposed to the idea as an isolated tax solution to the budget crisis.

However, Gallo would not say that AARP Illinois opposes taxing retirement income completely. He appeared to leave the door open to that possibility if it is part of a larger package of needed budget reforms.

“Our position is that everything really needs to be put on the table,” Gallo said. “The state shouldn’t solve its budget situation by targeting just one group of individuals. And that seems to be how this is discussed – ‘Oh we don’t tax retirement income, so let’s just do that.’

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“That seems to be the low-hanging fruit out there…we need a comprehensive solution, not a one-off, which seems to be what’s happening in Springfield on a daily basis,” Gallo added.

Like the Civic Federation, the more liberal Center for Tax and Budget Accountability is calling for a tax on retirement income above $50,000.

A budget reform proposal put forth by the group in September calls for taxing retirement income between $50,000 and $150,000 at a graduated rate, and retirement income above $150,000 at Illinois’ regular flat rate, currently 3.75 percent for individuals.

A temporary income tax increase to 5 percent expired in January 2015. The CTBA proposes increasing the overall rate to 4.75 or 5 percent. The Civic Federation also calls for a retroactive increase to 5 percent stretching back to January 1, 2016.

The CTBA report describes its plan to tax some retirement income as a graduated tax, with retirement income between $50,000-$75,000 taxed at 25 percent of whatever the regular income tax rate is at the time; income $75,000-$100,000 at 50 percent and income $100,000-$150,000 at 75 percent. The center estimates this structure at a 5 percent tax rate would mean $1.1 billion in extra revenue annually.

Illinois’s Constitution forbids a graduated (or progressive) tax, so it could be argued that the CTBA’s proposed retirement income tax would require a constitutional amendment, according to Dabrowski and others.

 However CTBA budget director Bobby Otter counters that the tax could be implemented without an amendment.

“Our proposal would be structured so that our most vulnerable retirees would receive a tax credit based upon their income,” after paying the full tax rate, Otter said – hence the tax would not technically be a graduated one.

Who pays? How much?

One nagging question about implementing a retirement tax, especially if it exempts those making under $50,000, is: Who ends up paying?

Last year, the Taxpayers’ Federation of Illinois, a non-partisan fiscal watchdog group focused on efficiency and stability, published a report showing that in 2012, one quarter of Illinois filers claimed a retirement income tax exemption, worth a total of $2.3 billion.

And many of those people were below age 65, according to the analysis by former Illinois Revenue Department research director Natalie Davila. (See November-December 2014 issue at this link.)

That’s because people can begin drawing income from 401Ks, IRA’s and other retirement sources before they hit 65.

“Poor seniors who have to work pay income tax on their wages. Retirees who do not have to work because they have sufficient retirement income do not pay income tax,” Davila wrote.

She found that 45 percent of the tax exemptions for retirement income went to people with adjusted gross incomes of more than $100,000.

Retirement tax opponents

All this conversation is rallying the hardcore anti-retirement tax forces.

At the forefront of that effort is State Rep. McSweeney (R-Barrington Hills) who in December proposed the resolution opposing an amendment of the Illinois Income Tax Act to allow taxing retirement income. The resolution (HR 890) is a bipartisan effort also led by Democratic State Rep. Brandon Phelps (D- Harrisburg), with 61 other co-sponsors.

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House Speaker Michael Madigan’s (D-Chicago) spokesman said the speaker would not comment on the issue, and Senate President John J. Cullerton’s (D-Chicago) office did not return messages. Republican Senate Leader Christine Radogno (R-Lemont)  has said lawmakers will likely consider taxing retirement income, before increasing the sales tax or taxing other services. House minority leader Jim Durkin (R-Western Springs) states that no tax hike would be “tolerated by taxpayers” unless accompanied by significant across-the-board tax and spending reforms.

McSweeney said the resolution was necessary in light of back-room discussions among supporters of taxing retirement income. He declined to say who those supporters might be.

McSweeney thinks that many retirees would leave the state if their income is taxed.

“I’ve spoken to a lot of people in my district and statewide,” he said. “Illinois is a place they still want to stay, but if their retirement income is taxed – my biggest concern is that people will leave the state and that will be a negative development for economic growth.”

Gallo noted that Florida – a popular destination for Midwestern retirees because of the weather – is among the state with no income tax at all.

Pennsylvania and Mississippi, like Illinois, do not tax any retirement income. Other states exempt portions of retirement income, like Social Security benefits.

“Illinois has already lost population; this would be just another reason for people to say, ‘I give up’” and leave, Gallo said.

Otter counters that most retirees have family nearby or other strong reasons to live in Illinois, and would not leave because of taxes.

“Considering the average pension doesn’t even hit the $50,000 threshold at this point, most pensioners wouldn’t be hit” under the CTBA and Civic Federation plans, Otter added.

 “And public pensions being in the state they’re in, the state needs more revenue to continue funding the pensions at the level they’re at while still funding services.”

As debate around taxing retirement income heated up last fall, AARP Illinois surveyed 1,000 residents age 50 and up on the concept.

Eighty-nine percent of the respondents said they would oppose proposals to tax retirement income, and 72 percent said a tax would have a “major impact” on their ability to plan for a secure retirement.

However 40 percent were not aware that retirement income is not currently taxed; 60 percent said they would consider moving to a more tax-friendly state, according to the survey.