The gross receipts tax proposed by Illinois Gov. Rod Blagojevich, while a welcome step in tackling the state's budget shortfall, is a flawed approach to taxation, according to a University of Illinois expert.
The proposed tax, which would be levied on transactions between businesses and between businesses and consumers, is a textbook case of an "inefficient tax" that penalizes smaller businesses that depend on outside vendors, J. Fred Giertz, an LAS professor of economics and in the Institute of Government and Public Affairs, wrote in the newsletter State Tax Notes.
"A small firm would have to pay taxes on its payments to lawyers, accountants, and janitorial services, while a large firm that provides for these activities in-house would escape the tax," Giertz wrote.
At the same time, by exempting firms with $2 million or less in yearly sales, the plan would create "equity problems," according to the Illinois tax expert.
He gives the example of a lawn-care company employing 40 low-wage workers that would be subject to the gross receipts tax if its annual sales exceeded $2 million, but a four-partner law firm with annual receipts of $7.9 million could escape the tax by becoming four independent practitioners sharing an office.
A gross receipts tax would especially hurt Illinois businesses whose purchases and production are in-state. These companies would be subject to "pyramiding effects" as the tax is imposed "on the same input again and again through the production process." By contrast, an out-of-state vendor selling into Illinois would only have to pay the gross receipts tax once-at the final sale.
Giertz confirmed that Illinois does have a significant fiscal problem. "For the last five years, continuing state revenue sources have failed to cover expanding state spending." Gov. Blagojevich and the state legislature have repeatedly used short-term fixes, such as selling off state assets and underfunding state pensions, to balance the budget.
"Illinois is now facing a structural deficit problem of several billion dollars," Giertz noted. "It cannot pay all its current obligations with continuing revenues, and revenue growth in the future will likely not keep pace with expenditure needs because of the relative unresponsiveness of the state's tax system," Giertz explained.
Overhauling the current tax system would make better sense than resorting to an untried and uncertain new tax, Giertz wrote.
"A modest rate increase in the income tax (individual and corporate), accompanied by an increase in the exemption level to protect low-income taxpayers and the expansion of the sales tax base to include consumer services, would generate sufficient funds for the state to address its fiscal imbalance if the extra funds were accompanied by spending discipline," the Illinois scholar concluded.
