Though you wouldn't know it from their recent back-and-forth on the airwaves, when it comes to the need for fundamental tax reform in Illinois, Gov. Pat Quinn and Democratic gubernatorial challenger Dan Hynes actually agree more than they disagree. Both understand that the state has borrowed far too much. Both realize that our inefficient and unfair tax system places a disproportionate burden on poor and working people and generates far too little revenue to cover core services and debt obligations. And they've both put forward competing proposals that, while far from ideal, would improve the state's fiscal strength and the lives of Illinois residents. (In his first budget proposal, Quinn sought to increase the state's 3 percent income tax rate to 4.5 percent and offset the impact by hiking the personal exemptions from $2,000 to $6,000; Hynes has proposed amending the constitution to just raise the income tax on those making more than $200,000.)  The question voters really need to focus on is which candidate can more effectively usher their plan through the state legislature.

A DC-based think tank says Illinoisans shouldn't have to choose. In a new paper (PDF) released this week, the Institute on Taxation and Economic Policy (ITEP) argues that the best policy approach would be to combine the two proposals.

In theory, it's an interesting and balanced idea. But as Capitol Fax noted yesterday, it's likely unrealistic considering the current political climate. Furthermore, Quinn's original proposal has no real support at this point. When he introduced it early last year, it represented a political non-starter for every major constituency in Springfield. Even Quinn's modified, temporary plan failed to generate sufficient support in the House. So why would lawmakers return to it now?

Jeff McLynch, ITEP's state policy director and the lead author of the report, told us today that his organization chose to analyze the original Quinn plan because it has become the focus of a recent and misleading advertising blitz by the Hynes campaign.  (Their early spots falsely claimed that Quinn sought to raise taxes on every family in the state by 50 percent.)

Unfortunately, ITEP failed to also consider HB 174 -- State Sen. James Meeks' tax plan -- in this context. After all, that proposal already passed the Senate last spring, has garnered broad support on the left, and would generate new revenue in a more progressive fashion. Moreover, there are plans to reintroduce the measure in coming months and Gov. Quinn has indicated that he may support it. Larry Joseph of Voices for Illinois' Children told us via email yesterday that, upon receiving a draft of the ITEP report, he suggested that an analysis of HB 174 would be much more helpful.  "Needless to say, they didn't follow my advice," he wrote.

But the paper does reveal an apparent problem with the Hynes plan -- one that local news organizations have totally overlooked.  ITEP asserts in the report that the amount of revenue the Hynes campaign projects their tax package will generate ($5.5 billion annually) is dramatically overstated.  By contrast, ITEP projects that his plan would only generate $2.2 billion.  Here's their explanation:

ITEP’s projection of the amount of revenue that the Hynes proposal would generate in 2011 is significantly lower than the amount anticipated by the Hynes campaign. Campaign materials downloaded from www.friendsofdanhynes.com on September 8, 2009 and entitled Leading Illinois Forward: The Hynes Plan for Tax Fairness & Fiscal Responsibility claim that the graduated income tax plan put forward by Comptroller Hynes would produce $5.5 billion on an annual basis. ITEP has been unable to establish the basis for such a claim. The principal factors in determining the amount of revenue future income tax changes would generate are the rates of growth for different forms of income such as salaries and wages, dividend and interest income, and capital gains, which taken together comprise nearly 90 percent of adjusted gross income in Illinois. ITEP projects that these three sources of income will grow, in the aggregate, by roughly 4 percent in nominal terms between 2009 and 2011 in Illinois; its tax revenue projections are, in turn, based on these growth rates.

Some local budget experts agree that the Hynes plan uses overblown revenue projections. According to Ron Baiman, director of budget and policy analysis at the Center for Tax and Budget Accountability, the campaign appears to have overlooked how the wealthiest Illinoisans shield large chunks of their money from state income taxes.

The Hynes plan proposed taxing those who make over $1 million each year at 7.5 percent.  But many of these wealthy taxpayers shelter much of their income in S-Corporations, which are exempt from income taxes.  Under this legal structure, income is passed through a small number of "shareholders," who are only required to pay a 1.5 percent replacement tax (under Illinois law).  Furthermore, some of these high-earners create their S-Corporations in states with even lower tax rates. 

Using 2007 tax liability data supplied by the Illinois Department of Revenue (IDOR), Baiman estimates that approximately half of the income generated by the richest Illinoisans is actually taxable here.  Hynes' projection, however, seems to assume that most of their income would be subject to his higher tax rate.

IDOR has not publicly released specific details regarding how many people use S-Corps and where the money goes. Until they do, the Hynes campaign appears to be standing by the $5.5 billion figure.  We reached out to them today for a response to the ITEP findings, but are still waiting to hear back.

Regardless, if the amount of taxable income in the $1-million-plus bracket is actually $60 billion -- rather than the $130 billion Hynes estimates -- his package would certainly fall far short of his revenue projections.  As Baiman notes, "He should really make it much more public and clear."

UPDATE (Friday, 10:10 am): Commenter Steve offers some more details on S-Corps, correcting some loose language I used in our original reporting:

S corporations pay the 1.5% replacement tax on their income at the corporate level. The income is then passed through to the shareholders and the shareholder includes the income on their IL 1040 to be taxed at whatever the personal rate is (currently 3%). For example an s corportation with two equal shareholders that has $100,000 in taxable income would pay $1,500 replacement tax. The shareholders would then each pick up $49,250 ((100,000-1,500)/2))on their personal tax returns to be taxed at the applicable rate.

That should clear up any confusion about how S-Corps operate. But it still leaves the question open about why the available taxable income figures used by ITEP,CTBA, and other budget experts is so different than those used by the Hynes campaign. Part of the problem, as we point out in our post, is that the wealthy in Illinois might be incorporating in other states, meaning they would not be required to pay the replacement tax or personal income tax in Illinois. So far, IDOR has been quiet about those details. There could be other reasons, as well. But we've yet to hear back from the Hynes campaign about their methodology. 

Full Disclosure: The SEIU Illinois State Council, which sponsors this website, has endorsed Pat Quinn in the Democratic primary for governor.

Image courtesty of Illinois State Comptroller website.