1 Closing Six Tax Loopholes, a Financial Transactions Tax, or a Graduated Income Tax, Could Easily Eliminate Illinois Pension Under-Funding Testimony to Illinois Legislative Pension Committee Hearing 160 N. LaSalle St., 6 th Fl., Chicago, IL July 3, 2013 Dr. Ron Baiman Dr. William Barclay Chicago Political Economy Group

2 Were in a Lesser Depression, State and Federal Public Spending Need to be Increased Not Cut The Feds should be increasing not reducing deficit spending to create jobs and increase taxes on the wealthy to support a much higher level of pre-deficit social spending. Illinois for decades has been taxing the wealthy and Corporations at much too low a rate to support even its very low level of social spending. Both need to increase dramatically. Illinois pension deficit is a state debt problem nota pension spending problem.

3 Illinois Structural Budget Deficit is a Result of too little Revenue not too Much Spending Illinois ranks 38 th in its state and local individual taxes as a share of Personal Income. It raises $ 4.4 billion less than the median or mid-ranking (between the 24 th and 25 th ranked) state relative to state income or capacity. Illinois also has the fifth most regressive level of overall (income, sales, and property) taxation of all the states (surpassed only by Washington, Florida, South Dakota, and Texas, all of which have no income taxes at all). Illinois taxes the bottom 20% of non-elderly families at 13.8% but the top 1% at only 4.9%. Illinois ranks 44 th in non-federally subsidized state spending on public services (net of pensions) and would have to increase spending as a share of state GDP by $12.9 billion to have a "median" level of spending on public services relative to its capacity. Illinois is last in state funding share of public schools.

4 Illinois Corporate Tax Rate is Lower than Wisconsin and Indiana and only 1/3 of Corps pay any CIT The Illinois Corporate Income tax (CIT) of 7% is lower than Wisconsin (7.9%) and Indiana (8.5%) net of Personal Property taxes. A Personal Property tax is assessed in addition to the CIT in both WI and IN and as an additional 2.5% added to the CIT and passed on to local governments in IL. Only about 10% (117,832) of Illinois establishments are C-corporations liable for corporate income tax. Of these only 33.3% (39,212) pay any CIT, and only 367 pay over $1 M in CIT Economic Census and IDOR data.

5 All of the Increase in Illinois Pension Payments are Due to Actuarial Pension Debt, Not Excessive Pension Costs or Real Debt Pension Normal Costs were only $1.6 B of the $ 4.1 B state pension payment in FY 2012 and only $1.6 B of the $5.1 B due in FY Normal Costs should be more than adequate to pay current pensions. Only 11.4% of the growth in unfunded pension liability is due to employee salary or benefit increases. 43% is due to falling employer contributions. Illinois average pension in 2011 was $ 27,000 comparable (for a wealthy state) to the $23,000 average among the states. See CGFA and CTBA pension reports.

6 Illinois State Pension Under- Funding Assumptions 8% Investment Return 3% Inflation 33 year (FY 2013 – FY 2045) time horizon June 30, 2012 estimate of the net present value of under-funding for Illinois five state pension systems is $ 94.6 B. Social Security is a pay-go system that does not have to accumulate a fund sufficient to pay 33 years of pensions.

7 Six Illinois Tax Loopholes 1.CME Income Tax Reduction ($85 million) - After vigorous lobbying by CME Group, the sales factor used in the formula to set its corporate income tax rate was arbitrarily lowered (by 1/3rd for FY2013 and to just 27.5% thereafter), significantly reducing its tax liability. 2. Foreign Dividends ($386 million)- Currently, foreign dividends are considered taxable income under federal law, but are exempt from taxation in the State of Illinois. This would allow Illinois to tax dividends that are earned by foreign companies and are transferred to companies that have taxable income in the State of Illinois to also be subject to the Illinois income tax.

8 3. Domestic Production Credit ($200 million)- The Domestic Production Credit is a tax credit that is awarded by the Federal Government that the State of Illinois is coupled with. What this means is that companies that have taxable income in Illinois are receiving a federal and state tax credit for domestic activity that is taking place outside of Illinois along with their Illinois activity. If like 22 other states, Illinois decoupled, companies in Illinois would still receive the federal tax break. 4.Online Hotel Purchases ($25 million)- If someone purchases a hotel from a website like Priceline, the only tax that is paid is based on the rate that Priceline pays the hotel. By taxing the final price that is being paid for the hotel room, the State of Illinois can increase revenues by $25 million annually.

9 5.Offshore Oil Drilling ($75 million) - Oil production activities that take place in the outer continental shelf are not taxed by Illinois although many other states now tax this income that can be apportioned to their state. 6.Retailers Discount ($109 million)- Originally intended to compensate Illinois shop-owners for the costs of collecting state salestaxes in the pre-computer era, the biggest beneficiaries are now the largest out-of-state retail chains like Wal-Mart (which receives over $8 million annually.). Unlike many other states, Illinois does not cap the amount a retailer can receive for transmitting sales tax funds.

10 Total 2013 Cost: $ 880 M Based on IDOR Estimates If those revenues were earmarked each year to pay off the states accrued liabilities to its 5 pension systems, and they were invested under the systems current assumptions (assumed investment return of 8%, and assumed inflation rate of 3%), and such assumptions proved to be reasonably accurate, the 2013 net present value accumulated by these funds over the next 33 years (2013 to 2045) would be be $70.5 billion. These assumptions are roughly comparable to those used for the latest June 30, 2012, FY 2013 to FY 2045 $94.6 B CGFA estimate of the Illinois unfunded pension liability. Based on these estimates roughly 74% of Illinois FY2013 unfunded pension liability over the next 33 years could be paid for by closing these six corporate tax loopholes. $ 302 M more in revenue would accumulate to 100% of the FY 2013 unfunded liability.

11 An Illinois Financial Transactions Tax (FTT) HB1554 sponsored by Rep. Mary Flowers would impose a Financial Transactions Tax on buyers and sellers equal to: –0.01% of the nominal value of contracts traded on the CME, the CBOT, and the CBOE. –the tax would be imposed on stock, futures, swap, credit default swap, and options contracts. –It would not include transactions involving securities held in retirement or mutual fund accounts.

12 Where do we find FTTs Today? CountryCoverageRate Revenue % of Total Gov Revenue AustriaStocks & bonds 0.15%NA AustraliaStocks & bonds 0.3% /0.6% stocks/bonds NA France (late summer) 2012 stocks0.1%TBD Hong KongStocks0.3%1.5 – 2% of GDP S. KoreaStocks and bonds 0.3%2- 3% S. AfricaStocks0.25%NA Switzerland`Stocks and bonds 0.15%NA Singapore stock 0.2%NA Taiwan Stocks/bonds,/futur es 0.3%/0.1%/0. 06% 6 – 8% UK Stocks 0.25%1%

13 Why do FTTs Make Sense? Willie Sutton philosophy: Because thats where the money is An FTT taxes the sector that caused the financial crisis that led to the Great Recession Good tax policy is designed to: –Levy taxes are rates that are small enough to be borne by those subject to the tax; and –Tax activity that we want to limit or discourage FTTs meet these criteria: –The rates are very low for investors planning to hold the asset (stocks, bonds, derivatives) for a significant period of time –However the tax would probably discourage short term traders, e.g. high frequency trading, some day trading, etc.

14 A Tiny Illinois FTT Could Raise an Enormous Amount of Revenue A 1$ per Contract Illinois FTT would raise from $6.3 – $ 7.4 billion per year. 1$ per contract would be on average % to % of the notional value of a contract. 1$ would generally be a small fraction of the minimal tick ($6.50 to $12.50) which is the smallest possible price change for trading on a contract.

15 Would Traders simply Move their Business? The stock index products are licensed to the CBOE and CME for trading and cannot be traded on other exchanges. The other products such as Eurodollars, T- Bonds, etc are not licensed but are not traded on any other exchange Another exchange could seek to trade these products but the liquidity is at the CME and The new exchange would first have to obtain regulatory authorization from the CFTC

16 Would the Exchanges Move? The first question is, Why would they? –The exchanges are not paying the tax Both the CME and CBOE have a large physical infrastructure in place in Chicago Their employees and most of their senior executives live in the Chicago region Their most important banking relationships are also in the Chicago area Is $1/contract enough to drive the high costs of relocation?

17 An Modest Illinois Graduated Individual Income Tax Could Raise $ 2.4 – $3.4 B More Revenue It would also cut overall state income tax burden for 94 percent of all taxpayersthat means on average, taxpayers with under $150,000 in annual base income would receive a tax cut. Despite shifting tax burden to affluent taxpayers, nonetheless keep the effective state income tax rate for millionaires at just 4.3 percent. stimulate the growth of at least 36,000 jobs in the states private sector through enhanced public and consumer spending. Effective rates would be 0% for incomes below $9,000 and slowly increase to roughly 6%.

18 34 of the 41 States with an Income Tax Have a Graduated Income Tax (GIT) Iowas GIT applied to Illinois would raise 42% more revenue than the roughly $15 B raised from Illinois current temporary 5% flat individual Income Tax (IIT) and still cut rates for most filers. KT, MO, and WI all have GITs that raise 11% to 24 % more revenue and cut tax rates for most filers. If Illinois had Oregons GIT the state would almost double its IIT revenue.

19 Illinois has a Revenue, not a Spending Problem: Cutting Public Pensions is Bad Public Policy It increases economic inequality, one of the main causes of the current Lesser Depression economy. It undermines secure pensions for one of the last segments of the workforce that still have defined benefit pensions, thus further undermining an already shredded U.S. retirement system, and an embattled and shrinking middle class. Cutting public pensions and impoverishing retirees is both unjust and bad public policy. Why are contracts for bond holders sacrosanct but contracts with workers are not? Which contracts have more impact on more people?