Illinois has had a tough time hanging on to its citizens, and the problem is about to get worse. A study published September 6 by the Cato Institute shows that motivating residents to stay will become more difficult for high-tax states, thanks to a $10,000 cap on state and local tax (SALT) deductions that Congress passed in December.With this cap in effect, Illinois is bound to suffer, as it’s already losing one citizen every 4.6 minutes to other states.
Understanding why a deduction cap will cause an exodus from Illinois requires understanding how taxes influence human decision-making. Essentially, folks will hand over their hard-earned cash when they believe the benefit of having a particular thing is greater than what it costs to get it. And getting to live somewhere has a cost—in the form of taxes.
Because taxes are the closest thing to a price that state and local governments have, people deciding where to live will do so in the same way hungry people choose restaurants––evaluating how much they’re getting versus how much they have to give up. We can evaluate how much bang the state is giving residents for their buck by whether they are sticking around. If they’re leaving en masse, chances are the public’s money is not being well spent.
Migration patterns within the United States reflect Tiebout’s findings. States with higher taxes than their neighbors tend to lose migrants to those with lower tax rates. In 2016 alone, the 25 highest-taxed states and the District of Columbia lost a net 286,431 households and $33 billion of taxable income to the 25 lowest-taxed states. For example, California experienced a net out-migration of over 25,000 households in 2016. A majority of those people moved to Texas, Washington, and Nevada—all states with below-average tax burdens and no state income tax.
Illinois is no exception. Its taxpayers send over 10 percent of their incomes to the state through income, sales, and property taxes—only eight states in the nation collect more. In 2016, the land of Lincoln lost nearly twice as many households as it gained, losing $4.8 billion in taxable income. And a too-hefty share of these Illinois expats are young people with long lives of productivity ahead of them. The aging population they leave behind shrinks the labor force, thins the tax base, and leaves the housing market in limbo—all of which exacerbates Illinois’ financial struggles.
The GOP’s new cap on SALT deductions makes it harder for Illinois and other high-tax states, such as New York and California, to solve their migration issues. Those SALT deductions swallow some of the costs of living in such places. For example, if a state were to increase its income tax by $1,000 for families in the 35 percent federal income tax bracket, the deduction would bring federal taxes down by $350—meaning these families would only face an effective cost increase of $650. The SALT deductions help citizens by subsidizing non-federal taxes, which lets states raise rates without taxpayers fully feeling the effects. Now, according to Cato, the cap forces 25 million more unsuspecting taxpayers to bear the full brunt of their states’ income taxes, meaning the high cost of living in these areas just got even higher.
To compete for its citizens, Illinois must get its fiscal policy under control. Although the Illinois Constitution requires a balanced budget, state lawmakers have had to rely on accounting tricks to square the numbers since 2001. And, in August, the state finally admitted it has been running a billion dollar budget deficit—even following the largest permanent income tax hike in state history.
But all is not yet lost if state policymakers use federal tax reform’s destructive changes as a wake-up call and start developing their own real budget reforms. Pension payments already constitute over a quarter of the Illinois’ budget, and lawmakers should prioritize tackling this crisis. Over the past 15 years, Illinois’ unfunded pension promises have more than quadrupled— leaving public workers’ long-term welfare in limbo, crushing Illinois’ credit rating, and raising financing costs.
Policymakers’ first step to a solution could be transitioning away from the public sector’s defective “defined-benefit” pension system. Based on a formula based on years worked and an employee’s ending salary, defined-benefit plans calculate what the employer––Illinois, in this case––owes an employee after retirement. This is an inherently risky system because the employer is obligated to pay the pension regardless of whether it has the funds to do so. On the other hand, defined-contribution plans rely on incremental investments made during the employee’s service, which make pensions more predictable. It’s no surprise the private sector overwhelmingly favors the defined-contribution system, which would be a more sustainable pension system for an Illinois trying to keep its people.
Illinois must become serious about fiscal reform, and Congress’ SALT deduction cap makes the need for that progress more urgent than ever. Sustainable spending will cut the need for new and higher taxes, allowing lawmakers to focus on making their state more affordable to live in. Mending the crisis will take time, but in service to those sticking it out in Illinois, it’s the least our state can do.
This essay was originally written on October 29, 2018.