Income Taxes – Create a City Income Tax

Revenue: $500 million
The City currently receives revenue from the income tax the State of Illinois imposes on all State residents.  Prior to 2011, the State income tax was three percent and municipalities received ten percent of the total tax collected, through the Local Government Distributive Fund (LGDF).[1]  The LGDF distributes tax revenue to municipalities on a per capita basis.  In 2011, the State raised the income tax to five percent, but froze the amount distributed to municipalities, thus effectively reducing the percent of state income tax revenue distributed to municipalities to six percent.[2] Under this option, the City would impose a one percent City income tax, structured similarly to the State income tax. To estimate how much revenue such an income tax would generate, the OIG examined Illinois Department of Revenue (IDOR) data regarding the adjusted gross income (AGI) of City residents.   In 2009, the total AGI for City residents was $60.19 billion and their reported income tax liability was $1.57 billion.[3]  Thus, City residents were effectively taxed at a rate of 2.61 percent.[4]  For comparison, the Chicago AGI is a little over 18 percent of the total Illinois AGI of almost $330 billion, while Chicago represents 21 percent of the State’s population. In 2009, the State income tax, at a rate of three percent, raised $1.57 billion from Chicago residents.  If the City were to impose an income tax at a rate of one percent, assuming the same AGI as in 2009, it would raise approximately one-third of $1.57 billion, or $500 million. Importantly, in order to create a City income tax, the City would first need authorization from the Illinois General Assembly.[5]
Proponents might argue that an income tax is one of the fairest ways to raise revenue because the amount each resident pays is commensurate with his or her ability to pay.  The more income one earns, the more taxes one pays.   A proponent might also note that New York City has long had a local income tax.  Additionally, administration of the tax would be simple because the City could just piggyback on the State’s income tax structure and have State collect the tax and remit it to the City (this is how the New York City income tax is administered).  Finally, none of the revenue raised by the State’s recent income tax increase will be transferred to Chicago through the LGDF.  The State’s Commission on Government Forecasting and Accountability, estimates that the income tax increase will raise $6.7 billion annually for the State.[6]  If the increase were subject to the LGDF, $670 million (10 percent) of this revenue would go to municipalities across the State and because Chicago has 21 percent of the State’s population, it would receive almost $140 million annually.  A local income tax would replace this lost revenue.   Opponents might argue that a local income tax would incentivize City residents to move to the suburbs to avoid paying additional taxes.  Others might argue that the City’s revenue should not be dependent on income taxes because income taxes are more responsive than other taxes to the fluctuations of the national economy and therefore create a more volatile revenue base.  This volatility could create larger budget shortfalls during economic downturns.
  Discussion and Additional Questions The most important consideration in deciding whether or not to implement this option is what impact this option would have on the decisions of current residents to continue to live in Chicago and the decisions of potential future residents to relocate here.  An economic theory first proposed in 1956, called the Tiebout model holds that people “vote with their feet” and choose “to live in a jurisdiction that best fits their (tax and spending) preferences”.[7]  Researchers have found evidence to support the idea “that local public services and taxes play an important role in determining the choice of a community of residence”.[8] Under this model, if the City were to institute an income tax, it would become less attractive, from a tax perspective, than other municipalities within the region.  Conversely, if the income tax revenue is used to provide some valuable public service, it might be that the City is more attractive to current and potential residents than it would be without the income tax.  For example, New Jersey and Massachusetts both have high property tax burdens that are tolerated by their residents because they have the highly ranked public education systems.[9] Budget Details
Fund: NA Type of Revenue:  NA
The revenue appropriations begin on page 16 of the 2011 Annual Appropriation Ordinance. http://www.cityofchicago.org/content/dam/city/depts/obm/supp_info/2011BudgetOrdinance.pdf
   
 Supporting Documents  
[1]Illinois Municipal League. “IML Legislative Update: Timely LGDF Payments.” April 2011. http://www.iml.org/page.cfm?key=4647&parent=63
[2] Chicago Metropolitan Agency for Planning. “Understand the State Income Tax Increase.” January 13, 2011 http://www.cmap.illinois.gov/policy-updates/-/blogs/understanding-the-state-income-tax-increase
[3] The calculation of the AGI for City residents comes from Illinois Department of Revenue data that details AGI by zip code. To obtain an estimate of AGI for all City residents, we simply added up all the AGI for zip codes within the City. That data is available on our website while the source data is available here: http://data.illinois.gov/Economics/IDOR-2009-Illinois-Individual-Income-Tax-AGI-Zip-C/gsp6-dpce
[4] The effective tax rate is likely lower than the 3% income tax rate that was in place in 2009 due to exemptions for children and spouses.
[5] See Ill. Const. art. VII § 6(e); see also Commercial Nat’l Bank of Chicago v. City of Chicago, 432 N.E.2d 227, 229 (Ill. 1982).
[6] Commission on Government Forecasting and Accountability. “FY 2012 Economic Forecast and Revenue Estimate and FY 2011 Revenue Update.” March 10, 2011. pg. 20. http://www.ilga.gov/commission/cgfa2006/Upload/FY12econforecastrevestimate.pdf
[7] Cordes, Joseph J.; Ebel, Robert D.; Gravelle, Jane G. “Tiebout Model” The Encyclopedia of Taxation and Tax Policy: Second Edition. pg. 437.
[8] Id.,. pg. 438.
[9] Post, Kevin. “Property taxes, education rank high in New Jersey.” Press of Atlantic City September 27, 2009. http://www.pressofatlanticcity.com/news/press/new_jersey/article_2991d8c2-ab14-11de-8d29-001cc4c03286.html