At 1:20 AM CT, the Illinois Senate passed a controversial deficit reduction planto address the massive state red ink. By a vote of 30-29, they increased individual taxes from 3% to 5% and they increased the corporation tax rate from 4.8% to 7%. Now, the effective corporate tax rate is 9.5%. The law is expected to raise $6.5 billion a year. Illinois needs to patch a $15 billion gap in their budget, including $8 billion in overdue bills.
The only significant Illinois spending change was to limit future increases to 2% annually. They skipped a $1 billion a year Chicago casino plan, they skipped a proposal to overhaul the state’s worker compensation laws and they skipped making any significant cuts to state pensions. "Illinois is in crisis, absolute financial crisis, and there is no way we can dig ourselves out of the crisis without increased revenues," said House Majority Leader Barbara Flynn Currie (D-Chicago), the bill’s chief House sponsor according to the Suntimes.
According to President Obama’s former top economist Christine Romer, tax increases have a negative multiplier effect of about 3:1. According to the Illinois Policy Institute, the early estimates on job losses from the tax plan are around 200k. It is not surprising that Indiana has billboards near the Illinois border touting their lower rates and welcoming Illinois residents and businesses to move to the Hoosier state.
Like all states, Illinois hopes that stronger growth can return to fuel tax receipts.
In the short run, this plan will likely get approval of the ratings agencies which place Illinois last in their state rankings. In the long run, it will discourage work and discourage investment into the state from new businesses. According to ALEC, Illinois ranked 48 out of 50 for economic performance and 47 our of 50 for economic outlook and this was before the tax hikes.
Contrast this with what is happening in New Jersey. Governor Chris Christie capped the detrimental property tax and cut popular programs to reduce the budget deficit. In his state of the state address, he pushed for a comprehensive tax reform plan and for making more headway with the state's pension and health benefits according The Hill. While all is certainly not perfect there, New Jersey is approaching the problem in the most growth favorable manner.
The difference in approaches is critical to keep in mind as the US federal government must soon tackle the fiscal deficit problem. President Obama must distance himself from his Illinois legislative roots and follow the "cut spending" model when he decides to back a deficit/tax reform plan. It will be the defining issue for the 2012 election.
Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.