The aggressive and unrepentant tax avoidance of Republican presidential candidate Donald J. Trump has become a major flashpoint in the presidential campaign, but it also underscores a broader debate about the fairness and wisdom of tax codes riddled with special breaks.
In Illinois, a plethora of 257 separate categories of breaks—tax expenditures in the parlance of experts– cost the state $9.4 billion in fiscal 2015, according to state records. That’s more than the gaping $8 billion budget hole the state is now struggling to fill.
There are specially targeted breaks for business, breaks for the wealthy, breaks for the poor, breaks for mom and pop and breaks for grandma and grandpa — all jealously protected by deep-seated constituencies that can render any attempt at reform a minefield for political leaders.
Together, they vastly complicate a tax system that in theory is simpler than most because the prime revenue generator, the income tax, imposes a flat rate for individuals of 3.75 percent and 5.25 percent for corporations.
Business tax breaks are typically fraught with the most controversy, but collectively they cost $1.8 billion in fiscal 2015, less than 20 percent of the potential revenue that the state has chosen to forego. Indeed, the single costliest break, worth more than $2 billion a year in lost revenue, is targeted for seniors.
In Illinois, all qualified retirement income is exempt from the state income tax — earnings from Social Security checks, pensions, 401k and IRA withdrawals and the like. Such income is subject to taxation by the federal government and, either in part or in full, by most other states.
Advocates for some categories of tax expenditures would vigorously dispute any attempt to characterize them as giveaways. Indeed, some breaks have been added to the tax code over the years in attempts to compensate for double taxation of income, address inequities in the tax structure, and grant a measure of relief to low-income wage earners.
That latter program, the Illinois Earned Income Tax Credit, sliced $234 million off potential state revenues in fiscal 2015, according to the Illinois Comptroller’s office. The credit is modeled after a similar, and even more valuable, federal income tax credit for low income workers.
Ralph Martire, executive director of the Chicago-based Center for Tax and Budget Accountability, said once tax expenditures are approved their effectiveness and fairness is rarely if ever reviewed and are almost politically impossible to repeal.
Martire argues that the blanket, extremely expensive retirement income exemption “needs to go.” However, low-and-moderate income seniors should continue to be exempt, he said. The issue, he concedes, is likely a non-starter now in Springfield.
Business tax breaks, while often controversial, also have proved difficult to upend once approved. Some were sold as mechanisms to help businesses from being taxed twice on earnings or activity, while others were created by lawmakers as subsidies to promote economic development. Critics contend that such subsidies are targeted deals that favor large companies and, in essence, let the state pick winners and losers.
Among big breaks available to business is the Economic Development for a Growing Economy tax credit, typically known by the acronym EDGE, which cost the state $137 million in fiscal 2015. Under EDGE, companies can qualify for state tax credits if they add jobs or in some instances, simply don’t downsize.
In 2013, the program came under a harsh public spotlight amid news reports how lawmakers had carved out special deals for some companies allowing them to retain tax withholdings from employee paychecks rather than remit the money to the state as is generally required.
Other big state tax loopholes for businesses include the Net Operating Loss Deduction, which allows for any losses to be carried forward for 12 years to mitigate or eliminate the tax consequences of future earnings. The deduction shrunk the state’s corporate income tax revenues by $48.7 million in fiscal 2015. Illinois’ deduction is similar to a federal loophole used by Trump, who has acknowledged avoiding tax payments for nearly two decades after claiming a $916 million loss in 1995.
Other loopholes give businesses a break on sales tax, such as the exemption for the purchases of manufacturing and farm machinery and equipment. Those two breaks cost the state $217 million in fiscal 2015.
Sales tax breaks are also broadly available for individuals. While the state portion of the sales tax, 6.25 percent, is levied on the purchase of most retail goods, the rate drops to 1 percent on many foods, drugs and medical appliances.
With the state awash in red ink, many tax experts now argue for the repeal or modification of some tax expenditures — for example imposing a means test to reduce burdens on low income taxpayers. At the same time, however, some of those same experts also argue that the fastest, simplest and most transparent route to fixing Illinois’ finances is to raise income and corporate tax rates, which were lowered at the beginning of 2015.
Norton Francis, a senior research associate with the Urban Institute’s State and Local Finance Initiative, noted that tax hikes can be political dynamite. To avoid them, Francis said, politicians groping for added tax revenue typically resort to workarounds like tinkering with deductions, further complicating the tax code.
“Real simplification is complicated,” Francis said.