Retirement income tax could boost IL bucks, but also spawn court challenges, exodus of retirees

By Cook County Record | Feb 27, 2018

CHICAGO — With the state running billions of dollars in the red, and debt and pension liabilities continuing to rise, politicians across the state are seeking new ways to raise revenue.

While most Democrats in the state are pushing to reshape Illinois' tax code to allow for a progressive income tax designed to make the wealthy pay more, one Democratic candidate for governor, Bob Daiber, has suggested the state tax retirement income.

However, while such a proposal may seem plausible, it would be a hard sell - and could even be challenged in court by the same groups that to this point have used the courts to stymie virtually all attempts at public worker pension reforms.

Given the limited funds many retirees live on, it has been commonly agreed that taxes on retirement income should only extend to those who have a surplus of funds to live on, said Dick Simpson, professor of political science at the University of Illinois at Chicago and a former Chicago alderman.

Bob Daiber  

"If we're going to tax retirement income, we should do it only on people who (receive) income beyond a certain amount," Simpson told Cook County Record.

Even so, taxing retirement income would have a significant effect on retirees, as that income is currently free from state taxes, Simpson explained. 

Additionally, there is the matter of public opinion surrounding the highly unpopular idea. Orphie Divounguy, chief economist at Illinois Policy Institute, said the tax would likely lead to many retirees simply choosing to leave the state. At a minimum, such a tax likely would create a great deal of pushback against the state government.

"Taxing retirement income won’t fix Illinois’ deep-rooted budget problems," Divounguy said. 

He pointed to census and migration data indicating there is good reason to believe retirees may not fight the tax, but simply leave.

"In 2017, nearly 115,000 Illinoisans moved out of the state to flee the tax burden. Further taxation could mean decreased state population – leaving fewer and fewer Illinoisans to pay the bills – and decreased investment by businesses, meaning fewer job opportunities in the state," Divounguy said. "What’s to stop retirees from leaving Illinois, too?"

Simpson agrees such a change in legislation would create a great deal of strife among retirees.

"Obviously, every retiree would oppose it, or at least a majority would," Simpson said. "State legislators and governors don't usually want to make that many people mad."

But despite the threat of pushback, Daiber, unlike most of the leading candidates for governor, is pushing for the taxation of retirement income, believing it will help boost the state's revenues and reduce its indebtedness.

Simpson said taxing retirement income could help.

"It's a little hard to predict how much that would be in amounts, but it would certainly be hundreds of millions if not billions of dollars —that's money the state needs," Simpson said. 

Divounguy, however, said such a tax, even if it were allowed, would make little more than a dent in the state debt, given the history of budget mismanagement in Illinois.

"The state’s budget and pension woes are too big to be fixed by a retirement tax," Divounguy said. "There isn’t enough retirement income to fill the gaps. And even if the state started taxing retirement income, there's no reason to believe new revenue would keep up with politicians’ penchant for spending. Politicians enacted a $5 billion tax hike last July and even that didn’t stop the budget from being $1.5 billion out of balance today."

Looming above any discussion of taxing retirement income, however, would be the threat of court challenge.

Given the Illinois Supreme Court's history in interpreting the state constitution's so-called "pensions clause," which forbids the state from "diminishing" or "impairing" retirement benefits, to cut down most attempts at pension reform, a successful challenge to a retirement tax on such grounds could leave only retirees from the private sector holding the bill. 

"The Illinois Supreme Court's unwillingness to allow foundational pension reform has obstructed progress on reforming Illinois' single-largest budget and debt obstacle," Divounguy said. "Essentially, only a constitutional amendment would make it possible to fix the pension debt."

David Primo, an affiliated senior scholar at George Mason University's Mercatus Center and an associate professor at the University of Rochester, believes that the taxation of retirement income is unlikely to be enacted, given the wording of the pension clause. 

"Illinois’s restrictive pensions clause gives the state few options, and it may take federal intervention for any meaningful reforms to occur," Primo told Cook County Record. "It’s a safe bet that any attempt to tax pensions will be met with a court challenge, and it would be an uphill battle for the state to defend such a tax, as it is plainly a state-initiated reduction in benefits."

Primo's assessment is echoed by the Illinois Policy Institute who believes there are better ways to balance the budget that do not involve the government taxation of retirement income. 

"Lawmakers could provide new employees with a 401(k)-style plan instead of forcing them into the broken pension system. This step alone would stop the state from racking up more pension liabilities," Divounguy said. "Now is not the time to hand lawmakers more money. They’ve already proved they can’t be trusted to live within their means and pay down the state’s bills. Instead of taking money from Illinoisans’ retirements, lawmakers should focus on addressing root cost-drivers."

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Cook County Daiber for Governor George Mason University Illinois Policy Institute Illinois Supreme Court State of Illinois

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