The following is by bond analyst Steve Willson:
Illinois Pension Debt — the Tax Burden
Ted Dabrowski and John Klingner of Wirepoints modeled the Illinois pension and unfunded retiree health insurance liability as a “shadow” mortgage (reported in the McHenry County Blog on February 17, 2020).
Building on their work, I’ve modeled the increase in taxes that would be necessary to fully fund the liability.
A caveat is necessary: First, this analysis assumes that the liability is static and will not continue to grow with time.
We know this is false.
The longer the state keeps putting off paying the bill and rapidly increasing accrued benefits, the bigger the liability will become.
But the analysis still provides a useful staring point, not the least because eventually the bills will begin to mount and more revenue will be needed.
I’ve first modeled the total liability in terms of the required increase in income tax rates.
Even though the local portion is ultimately likely to be paid from property taxes, those taxes are paid from income and property taxes can be translated into effective income tax rates.
Then I model specifically the increase in income tax rates necessary to pay the state’s liability.
Finally, I model the increase in property taxes necessary to pay the local portion.
The liabilities are shown in this graphic from Wirepoints:
The top 30% of taxpayers are assumed to bear the entire burden both for political purposes (i.e., the majority will never support a significant increase in income taxes on themselves) and because that’s where the income is.
The bottom 70% of Illinois income taxpayers simply don’t earn enough to support the burden.
The Illinois Department of Revenue publishes information on income tax collections by income bracket that I used to model the income tax rates necessary to amortize the liability. The income tax information is available here:
Using this data, I calculated the annual payment necessary to pay off $431.4 billion over thirty years, assuming a 5% yield, to be $28 billion per year. I then spread this debt over the top 30% of all taxpayers in Illinois.
Below are my calculations of the income tax rates that would be needed to amortize this liability.
Note that the goal is only $25.8 billion, or 92% of the annual payment.
The reason for this difference is that about 8% of all Illinois income tax is paid by out-of-staters.
By my calculations, people making between $75,000 and $100,000 would see an increase in their income tax rate of 2.5 percentage points. People making $100,000 to $500,000 would see their tax rate increase by 7.7 percentage points. And people making more than $500,000 would see their tax rate increase by 10.71 percentage points.
If one considers only the state’s portion of this obligation, $320.8 billion, people making between $75,000 and $100,000 would see an increase in their income tax rate of 2 percentage points.
People making $100,000 to $500,000 would see their tax rate increase by 5.75 percentage points.
And people making more than $500,000 would see their tax rate increase by 7.85 percentage points.
Finally, below is my model of the increase in property tax rates that is needed to amortize the local liability.
The source for the assessed value and tax rate data is:
Politically, one may consider these income tax rate and property tax rates unachievable.
However, the liability is real and eventually it will have to be paid with real dollars because the state government can’t print money.
And states can’t go bankrupt.
So since the liability is constitutionally protected, taxes will eventually have to increase by these kinds of amounts.
Will higher income tax payers move out in increasing numbers, making the liability even more difficult to repay.
Absolutely.
Will higher taxes damage the Illinois economy in an increasing spiral?
Absolutely.
I wish I could say I see an affordable solution.
Unfortunately, I don’t.
As always, I value other eyes reviewing my work, double checking my facts, my calculations and my reasoning.
If you find any significant errors, please post them.
No end in sight! BANKRUPTCY!
What does the state do with all the taxes being paid by the lottery, increased gas tax, increased alcohol and tobbaco tax, bag taxes, gambling taxes, license plate and driver’s license fees and most of all Marijuana taxes?
Do they go into the general fund? If so, can’t the general fund start paying off some of the pension debt?
As you can tell, I am not a financial expert.
I just don’t understand how all the new tax dollars are distributed.
The numbers look correct.
If voters pass the Pritzker income tax scheme there will be a mass exodus out.
Remember, it is being sold as a tax only on high earners.
Yeah right, the same guy who doubled the gasoline tax.
Note on property tax increase analysis:
I don’t believe the EAV and extensions data cited reflect EAV attributed to TIF.
Therefore the amount necessary to fund benefits entitlements is higher than stayed.
This is because EAV in TIF districts must be taxed at current rates, but the money must be sequestered and by law cannot be used for community needs.
(TIF district slush funds receive windfall profits as property tax rates rise).
Using numbers from article, if 25% of COOK COUNTY EAV is in TIF:
TAXABLE implied market value: $521377 x .75 = $391,033
Dividing annual payment for entitlement indebtedness by the taxable property value we get:
$5913/$391033= .01512 or 1.51% nominal increase to current rates.
Quick check on cook county TIF revealed $1.2 billion tif incremental revenue 2018.
Using your numbers (assuming cook county property tax rates are now 1.75%) it looks like 13.2% of Cook County property value is “protected” by virtue of TIF from additional taxation for the public good.
Note: Woodstock il property tax rates have ranged between 4%-5% of fair market value for a decade.
Chicago home prices seem to be artificially inflated by artificially low property tax rates in Chicago.
Artificially low EAV (thanks to TIF) gives CPS disproportionate State aid.
Woodstock also has TIFs as a factor in its high property tax rate, but by law the school district cannot issue debt to cover operations as CPS is able to do in order to suppress annual levy demands.
So Woodstock has had to overtax the means of its community and home prices have been devastated as a result.
Chicago’s future looks like Woodstock’s past: property tax rates must double to 3.5%, at which time home values will plummet accordingly.
This crisis may finally provoke Chicago residents to challenge illinois political class status quo.
One math clarification needed:
On the property tax table, you state a 1.13% rate increase would represent a 39.37% increase…to 2.88%?
Do you mean to say that the current p-tax rate in Cook county is 2.88%?
I do not believe that is accurate.
If you meant that the necessary increase in property taxes to pay benefits entitlements would cause the current rate (1.75% sounds right) to rise to 2.88%, then the percentage “increase in tax rate” last column needs to be recalculated.
If 1.75% is current rate and must be increased additional 1.13%, the ‘increase in tax rate ‘ would represent a 65% rate increase.
What an absolute embarrassment is Illinois to the rest of the US and the world. Illinois is the worst State of 50 fiscally. What did we who live in Illinois do, or not do, to deserve this?
Have to pursue bankruptcy bringing severe haircuts for rich government pensioners and those to be. COLAs for pension funds need to be abolished.
Susan, the average tax rate shown in the table above is the most recent total tax levy divided by the estimated value of the tax base per the Illinois Department of Revenue.
The percent increase is the amount by which the levy would have to rise in order to amortize the pension and OPEB liabilities.
States can’t go bankrupt. Period.
First, the bankruptcy law doesn’t permit it. (Chapter 9 of Title 11 is the section of the law dealing with municipal bankruptcy.)
Second, the reason the law doesn’t permit it constitutional.
Under the constitution, states are sovereign.
They can’t even be sued by out-of-staters without giving their permission.
And they aren’t subject to federal bankruptcy laws.
Third, bankruptcy is for debtors that can’t raise more revenue.
States have the unlimited legal authority to raise taxes and Illinois is nowhere near the top of the total revenue curve.
Illinois can raise taxes and ultimately will have to.
It will damage the economy, but that’s a different issue.
P.S. The top tax bracket that I calculate for the state obligation is 12.8% (the current rat of 4.95% + 7.85% additional to pay for pensions).
Lest you think tax rates that high are unrealistic, please note that the tax rate for people making more than $108,000 in California is 9.3% and the top tax rate is 13.3%
In Hawaii, the top tax rate is 11.0%.
In New Jersey, the top tax rate is 10.75%.