Budget Holes Loom After Voters Reject Some Tax Hikes

After voters last week rejected his signature tax proposal — which he promoted with $58 million from his own pocket — Illinois’ governor was blunt.

“There will be cuts, and they will be painful,” Democratic Gov. J.B. Pritzker said.

The proposed constitutional amendment, approved for the ballot by Illinois lawmakers, would have created a graduated income tax with higher rates for wealthier residents, bringing in an estimated $3.4 billion in one year for the state. It needed 60% voter approval to pass but got 55%.

Illinois, a state with a near junk-level bond rating, has $137 billion in unfunded pension liabilities and a current budget deficit of at least $6 billion. Next year’s deficit could be as high as $14 billion.

State budgets have taken a hit in the economic downturn sparked by COVID-19. But voters mostly rejected tax ballot measures, leaving state and local officials to grapple with other fiscal fixes during their 2021 legislative and budgetary debates.

Voters in California, for example, rejected a billionaire-backed property tax measure that would have taxed business properties worth more than $3 million at higher rates than residential properties.

Facebook CEO Mark Zuckerberg and his wife, Priscilla Chan, backed the measure with a $10.8 million advertising campaign, but it wasn’t enough to overcome opponents’ arguments that businesses would pass on increased costs to consumers. It was expected to raise between $7.5 billion and $12 billion per year, with the bulk of the money going to schools and local governments.

Nationwide, state tax collections for fiscal 2020, which ended for most states on June 30, will finish down more than 5% from the previous year and then decline another 6% in fiscal 2021, according to a September report from Moody’s Investors Service.

The Urban Institute, a left-leaning think tank based in Washington, D.C., calculates an even steeper drop: It says that state taxes declined 12.8% in June 2020 compared with a year earlier.

In Arizona, voters approved an income tax hike on the wealthy, but in Colorado, an income tax cut won at the polls.

Colorado’s ballot measure will lower the state income tax rate from 4.63% to 4.55%. Previously under state law, money was refunded to taxpayers if collections exceeded a certain cap, but that policy created uncertainty from year to year. The ballot measure sets a fixed rate.

The only revenue-raising ballot measures that won widespread support were proposals to legalize and tax marijuana. Voters in Arizona, New Jersey, Montana and South Dakota voted to legalize and tax recreational marijuana, while voters in South Dakota and Mississippi approved taxable medical marijuana.

Supporters tout the marijuana taxes as a way to partially plug pandemic-induced budget holes, but the expected revenue won’t come close to making up for the losses. The New Jersey measure, for example, is expected to raise $126 million annually, a very small amount in a $32 billion budget with an estimated $5.3 billion deficit.

Despite the pandemic, voters behaved mostly true to form on tax issues, said Jared Walczak, vice president of state projects at the Tax Foundation, a libertarian-leaning group that advocates for lower taxes spread over a broader base.

“Perhaps the most surprising outcome of election night on taxes is how mundane the results were,” he said in a phone interview. “In a cycle where everything seemed different, we saw tax results that could have come out of any other year. Voters seem to prefer the lower tax position but are willing to consider taxes for things they care about [as well as] excise taxes on new markets like marijuana.”

For example, the Arizona income tax hike on the wealthy was directly tied to money for K-12 education. The new system will create an 8% top rate on income over $250,000. The current rate is 4.5%.

The Illinois proposal would have replaced the flat 4.95% income tax with a series of higher steps up to a top rate of 7.99% on individuals earning over $750,000. But the measure didn’t say how the revenue would be used.

“Illinois is already a high tax state where there are long-standing concerns about tax outmigration,” Walczak said. “Arizona is a growing state. And voters have signaled that they want more and better teachers. It’s easier to say, ‘more money for teachers’ than ‘there is a need for more money in Illinois.’”

But Meg Wiehe, deputy executive director of the progressive Institute on Taxation and Economic Policy, said that is an oversimplification. She said wild speculation in opposition ads about what Illinois might do with the extra money, as well as ads that used the “nose under the tent” metaphor to imply that the income tax hike on the rich was a precursor to other taxes on the middle class, fomented fear and votes against the proposal.

“[The ads were] claiming that if the fair tax got enacted, retirement income would be the next thing to be taxed, which wasn’t really the case,” she said. “The consequence of Illinois is that it will be quite a long time before the state will be able to take up another initiative to fix the unfairness of the flat tax. The state is now going to face drastic budget cuts or tax increases that are going to impact everyone and not just the wealthy in the state.”

In Arizona, by contrast, proponents of the higher taxes on the wealthy did a better job of making the case and connecting the dots on how to get the state back to pre-pandemic levels of education funding, she said.

In Illinois, Pritzker poured his Hyatt Hotels fortune into supporting the failed effort, but hedge fund billionaire Kenneth Griffin nearly matched him by spending $53.8 million to defeat it.

Lucy Dadayan, senior research associate at the Tax Policy Center, a joint project of the Urban Institute and the left-leaning Brookings Institution, also suggested that the wording of the referendums affected how they fared. “I think if Illinois had worded the proposal more precisely,” she said in an email, “it would have had a better shot of approval.”

Illinois’ ballot measure said that a “yes” vote “gives the State the ability to impose higher tax rates on those with higher income levels and lower income tax rates on those with middle or lower income levels.”

Arizona’s said the revenue would be distributed to “teacher and classroom support staff salaries, teacher mentoring and retention programs, career and technical education programs, and the Arizona Teachers Academy.”

Another factor was whether voters have trust in government, which is particularly hard to come by in Illinois, according to Chris Mooney, professor of political science at the University of Illinois Chicago.

“Americans hate taxes and don’t like government,” he said in a phone interview. “And people don’t like state government in Illinois,” he added, noting that four of the state’s past seven governors have gone to prison, though there are no allegations against the current governor.