By: Mark Glennon*

 

“Please, don’t go to the top of the curve!” That was the warning from a Wharton School professor of finance, Robert Inman, in a recent presentation he made at the Federal Reserve Bank of Chicago, speaking in general about tax rates for states and cities. What did he mean? Are Chicago and Illinois at the top of the curve?

Those questions may seem obscure, but they’re key to our future. Voters don’t just need to asks whether more revenue should be raised, they need to ask whether that’s even achievable.

And hang in there on this. Even if you hate numbers, graphs and economics, this is actually pretty simple, and you can probably answer those questions better than most economists.

Suppose you lived in a town where property tax rates were trivial, say, a few hundred dollars a year. If your town increased property tax rates by, say, five percent, it would probably also collect about five percent more total revenue for the whole town. Nobody would leave town or abandon their property.

But suppose your taxes were exorbitant, and people were fleeing, abandoning their houses and nothing new was being built. If that town increased your rates five percent they’d just make those problems worse, resulting in something less than five percent new total revenue. If problems were really extreme, they could even end up with less revenue.  Most state and local governments are somewhere in the middle. Raising taxes will generate more revenue, but not one-for-one with the percentage increase in rates.

laffer
The Laffer Curve

Put this on a graph and you have what economists call the Laffer Curve. It applies to property, income and sales taxes, for all units of government. There’s no controversy about the basic idea behind the curve, but lots of controversy about where any particular cities or states are on the curve. You might not like Arthur Laffer himself, the author of the curve, because he seems to think pretty much every government has gone past the brink so that tax cuts will generate more revenue. But the principle of the curve itself is sound, and actually pretty obvious.

Where are Illinois, Chicago and other troubled Illinois cities on the curve? You could probably find an economist to produce a study to support either side, but most of you who live here and follow the news are just as qualified to answer. It’s a matter of sensing whether taxpayers are truly fed up — questions like whether people and employers are fleeing or on the verge of fleeing, and whether they’re hesitant to invest locally. Or, are they just griping about taxes like always, and will stay put and pay up with further tax increases?

You decide, but my sense is that Illinois and Chicago are just about to the top of the curve. Maybe some additional revenue could be squeezed out through things like expansion of the sales tax to services, and maybe a few fees could be jacked up, but any major tax increase probably would backfire. Big tax hikes might bring in more revenue for a few years because the negative effects take a while to kick in,  but we are pretty close to being tapped out.

It might be different if we also fixed the big underlying problems — pensions, too many layers of government and bad leadership in Springfield. But as long as those problems go unsolved, taxpayers here will think any big increase in property or income taxes will go down a rat hole. They’ve had enough.

If that’s right, then the premise of the conventional narrative that treats more revenue as an option, or as an alternative to reform, is false.

Tax increases will be the biggest issue in the November election. Voters will be thinking about whether it’s necessary and fair for themselves or others to pay higher rates. Hopefully, they’ll also be considering whether a revenue solution is possible even if they want it.

*Mark Glennon is founder of WirePoints and Managing Director at Ninth Street Advisors.

 

 

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Andrew Szakmary
I am astounded by the lack of thought in this article. You have to look at Illinois taxes in the context of an already existing Federal tax system. Lets do a little reasoning here: assume a typical middle/upper-middle income taxpayer who is in the 25% Federal income tax bracket, pays 7.65% of salary on top of that into SS and Medicare, and now pays a 5% Illinois income tax, for a total marginal tax rate of 37.65% if the taxpayer does not itemize deductions on his/her Federal tax return; if the taxpayer itemizes the total marginal tax rate would be slightly lower. Now assume the Illinois income… Read more »
Mark Glennon
Professor- No, I am suggesting that a 20% rise in the state rate would raise far less than 20% more revenue. You do accept that there’s a curve in concept, I presume, and, as I said, where we are on the curve can fairly be questioned. That question should be debated yet I have seen nothing on it. I agree that the question has to be asked while considering the totality of Federal and state rates (our income tax rates are moderate). I would take that further and say it should consider the totality of all taxes in the state (we are very high) — and other… Read more »
anon.

Laffer is a supply sider nut.

Michelle A.

My husband and I have already decided to relocate as soon as our last daughter graduates from high school, and I know other families who will probably do the same. Really sad to see it. We would like to have our kids come back to visit the home they grew up in, but we just can’t justify the ridiculous property taxes we are paying on it, which is mostly paid for. So I sure think that we already passed the point where taxes have backfired, as you said it, and now it looks like much bigger increases coming, so more people will leave. Sad, sad, sad.

captainZ

Same for us.

JenniferBW

Nice explanation.

Anonymous

Excellent article, but the dumb ass voters who elected who they did will never understand.

rkaplan

We passed that inflection long ago. Don’t be misled by the revenue bump from the 2010 tax increase. These things are subject to a long lag, as you indicated, and revenue from that would have dropped off eventually had it not expired. Shrinkage in the workforce and number of jobs available is a consequence of tax policy.

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