PI Original Adam Doster Monday May 24th, 2010, 1:22pm

Preserving Our Most Progressive Tax

Despite our flat income tax rate, Illinois does have some progressive elements -- most notably, our estate tax, which only affects the wealthiest local families.  But unless either Congress or the General Assembly takes action soon, we're going to forgo that revenue in 2010. 

Illinois House members are returning to Springfield today to finalize the state's FY 2011 budget before the end of the month. While few statehouse observers expect negotiations to carry over into June, thus triggering a three-fifths majority requirement for passage, nobody is optimistic that the body will fully address the state's systemic fiscal problems.

The most ominous problem facing the General Assembly is the issue of pension payments. In all likelihood -- and for no good reason -- the spending package is unlikely to include a pension borrowing plan, which means the annual contribution to the pension system will be delayed until January (at much greater expense to us taxpayers).

On top of that, there's a another potential revenue shortfall looming which lawmakers have spent far less time thinking about: the elimination of Illinois' estate tax.  We covered this development last November, but here's a brief refresher.

The estate tax applies to the transfer of one's estate after they die.  Both the federal government and the state impose the tax on the wealthiest Illinoisans, for years, their respective laws worked in tandem.  To avoid double-taxing the estates in question, the federal government would offer filers a dollar-for-dollar credit that offset their state estate tax payments (up to a specified amount).  In essence, the two governments would share the revenue derived from the tax.

Things changed in 2001, however, when Congress approved President Bush's first round of tax cuts. From our previous post:

That bill phased in a full repeal of the federal estate tax over a 9-year period. It also gradually increased the federal estate tax exemption -- the amount of money that the wealthy were allowed to shield from the tax. (It was raised to $1 million per individual in 2002, $1.5 million in 2004, $2 million in 2006, $3.5 million this year.) And it phased out the state credit, thereby depriving state governments of the "pick-up tax" revenue. If they didn't want to forgo that money, lawmakers were forced to decouple from the federal statue and establish their own, independent estate taxes.

In 2003, Illinois lawmakers decoupled from Washington's gradual phase-out of the estate tax, but only through the end of 2009.  This means that, unless the U.S. Congress passes a fix or the General Assembly again decouples from the federal system, there will be no local tax imposed on the estates of Illinois residents who die this year.

The absence of that revenue will only add to the state's fiscal insecurity. From Larry Joseph's budget report last month:

Aside from the effects of the recession, the state’s inheritance tax, which is tied to the federal estate tax, expired on January 1, 2010. Because of delays in estate settlements, state revenues will not be significantly affected for about nine months. In the absence of legislation to reinstate the inheritance tax, CGFA estimates that the revenue loss in FY 2011 will be about $200 million.

But there is still time to capture that revenue.  Now that the U.S. Senate has finished debating financial regulatory reform, the resurrection of the estate tax looks like an issue that could move to the top of the docket. So far, negotiations have been acrimonious. Sens. Blanche Lincoln (D-AR) and Jon Kyl (R-AZ) have been fighting to cut the latest estate tax rate (from 45 to 35 percent) and increase the amount of assets filers can exempt from taxation. They've even started cobbling together $60 to $80 billion in budget offsets that could fill the hole their tax break for the uber-wealthy would create. Senate progressives, to their credit, have started pushing back, justifiably questioning why a government so concerned about rising deficits would offer breaks to the richest 0.2 percent of households nationwide. A compromise is still likely, but no way assured.

If Congress balks, the odds of state action are very long. Illinois House Majority Leader Rep. Barbara Flynn Currie (D-Chicago) told us two weeks ago that lawmakers have not discussed the estate tax since January and are instead waiting on Washington to act. If nothing materializes on Capitol Hill, she said, Illinois Democrats will probably craft a bill on their own and take it up during the veto-session later this year -- before Republican Bill Brady would have the chance to issue a veto (if elected governor in November).

When asked whether there's an appetite in tax-averse Springfield to extend the state law, the Chicago Democrat was not confident. "I think that's going to be hard," she said, "but we will see."

Keeping in place Illinois' inheritance tax should be a no-brainer.  After all, it's the most progressive element of our extremely regressive tax structure.  It applies to a very select number of very wealthy individuals, most of whom face an extremely low tax burden to begin with. Plus, the state recently approved legislation giving filers plenty of flexibility in how they deal with the law.

Illinois is $13 billion in the red.  That's no time to give the richest among us a tax break.

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