4/28/1982  
Joseph R. Oldani 
230 Wabash Street 
Manhattan IL 60442

Subject:  Comments regarding the Illinois Department of Revenue's suggested structure features and related problems for a local tax district income tax

The following article states the Illinois Department of Revenue's view of problems and suggested structure features of a local income tax based on the assumption that the department of revenue administer it. 

My linked comments are not intended to find fault with the department of revenue's position but only to expand ideas and further promote the replacement of real estate property tax with a local income tax. 

Some consideration should be given to the idea of local governments administering the tax based on sharing information on the state income tax forms with the department of revenue. However, I will limit my comments on the article as it is written.

The department of revenue has listed three categories A, B, and C and has stated problems for each. I will key my comments according to the same format. (Click the links provided in the article to read my comments).  

 

LOCAL TAX DISTRICT INCOME TAX 

The problems of imposing local government income taxes are varied, but divide into three basic categories: 

A. those of a purely administrative nature

B. those of a purely policy nature 

C. those of a dual policy/administrative nature

On the assumption that the Department of Revenue would administer a local income tax, the Department has over the years described certain features in the structure of such a tax which would simplify the administrative burden. These include:

A. Those of a purely administrative nature 

A-1. That the tax fall only on individual taxpayer's. In early 1978 the Department conducted a survey of several states that either imposed local income taxes or collected income tax data by local district. These states included Kansas, Iowa, Maryland, Minnesota, Nebraska, Wisconsin and Missouri. All of the states concern themselves with individual taxpayers only because, given the complex structure of corporations and the inability to pierce the "corporate veil," states lack the ability to determine where corporate income is earned and how much is earned in a given location. States, instead, have chosen to attribute income from multistate corporations to activity within state borders through apportionment factors which are based upon primary indicators of business activity; i.e., sales, property and/or payroll. Since states cannot without apportionment determine income attributable to them as one of fifty states, it is virtually impossible for anyone state to do so, by itself, for thousands of entities. For example, Illinois has approximately 1,200 school districts, 1,300 municipalities, and 102 counties each requiring distinct allocations. Even using the three factor formula to allocate income could require many millions of distinct allocations of income. Placing this kind of burden on corporations and the Department seems unrealistic, especially since the Department does not have the capability to verify income reported by intrastate location.   Comment on  A-1 

A-2. That income subject to local taxation have the same definition as income for state income tax purposes. This provision is for uniformity in that if income definitions among districts vary, the Department would have to establish different collection criteria for each definition, amounting to a different form, audit structure, and collection system for each taxing district. Comment on A-2 

A-3. That the rates 'which local districts can levy be, at maximum, confined to a specified range with pre-established increments of increase. For example, taxing districts may impose a tax at a rate no greater than x% in increments of y%. For maximum administrative ease, a flat rate for all districts would, of course, be best. However, to allow for district differences the former approach allows for flexibility without" running the risk of having separate rate structures for each taxing district. The districts can at least be grouped.  Comment on A-3 

A-4. That the taxing district where the taxpayer resides (as of a date certain) be the taxing district which can impose the tax. Such a provision prevents double taxation by districts of like kind. It also solves the problem of dealing with taxpayer mobility by, in effect, allowing for no apportionment of income among districts.  Comment on A-4 

A-5. That there be no withholding. Taxes should be paid with the final return. It would be extremely difficult to set up different withholding schedules for individual taxing districts and extremely burdensome for employers to comply. Also, the mobility of taxpayers from job to job would make the reconciling of payments difficult. Part of the reason for imposing a residency criterion is to reduce the problem of locating taxpayers to a one-time-a-year effort. Withholding would destroy that convenience.    Comment on A-5 

B. The pure policy questions are perhaps more interesting in that in many cases decision makers must weigh the values of competing goals against each other. For example:

B-1. Should local districts be autonomous? The above-outlined tax structure assumes that local taxing districts must impose the tax and that the state must collect the tax and distribute' it to the appropriate districts. It might be simpler to impose a state surtax and distribute the proceeds to local districts based upon some formula. Each of these solutions has good and bad features. The former has the advantage of placing the responsibility for raising revenues with the people who spend those revenues, but it is administratively somewhat cumbersome. The latter runs the risk of creating a "free money" concept and loose spending habits, but is administratively simpler and can allow for redistributions of wealth among districts based upon whatever factors are deemed desirable.    Comment on B-1 

B-2. If taxing districts impose such taxes, should they be voter approved? Should increases and/or decreases be voter approved?       Comment on B-2

B-3. Should such taxes be in addition to existing taxes or a replacement for existing taxes?    Comment on B-3

B-4. Should all local taxing districts or just selected ones be allowed to impose income taxes?    Comment on B-4 

B-5. Some concern should be shown for the redistributive effects of the income tax. The property tax is imposed upon one-third of the value of real non-farm property assets. * The income tax would be imposed upon the income derived from a much broader definition of economic activity including individual income derived from property, sales, and employment (labor), among others. . A taxpayer having large property holdings but low income would probably benefit from switching from the property tax to the income tax. However, a taxpayer with high income and little in the way of property holdings would likely be hurt by the switch. The mix of these offsetting changes will determine whether the change is perceived as a "good" one or a "bad" one.        Comment on B-5

* Except for counties which classify property for assessment purposes. 

B-6. One has to keep in mind that for the state effectively to administer one or more local income taxes, the general provisions of the tax law have to be uniform among all taxing districts. Otherwise the advantages of centralized administration are largely lost. This uniformity could create several areas of concern for local taxing districts. For example, the state will treat all taxing districts and taxpayers alike. The flexibility afforded by the property tax system in the area of policy decisions, (e.g. classification, abatement) are simply not available through the income tax. Comment on B-6 

C. The final list is of questions having both administrative and policy implications: 

C-1. The theoretical nature of the property tax structure is that taxing districts should make an attempt to estimate their budgetary needs and levy for that amount. An income tax offers no such relationship between revenue needs and revenue yield.    Comment on C-1

C-2. While the income tax over time should grow faster than the property tax, the between-year changes will be more volatile than for the property tax, especially when we consider that we will be dealing with economic areas of relatively small size. Thus, taxing districts run the risk of missing their expected revenue yields from year to year. What should be done with excess revenues when yield is greater than need? What should taxing districts do if yields are less than need? Should reserve funds be established; should refunds be made to taxpayers, etc.?    Comment on C-2 

C-3. Courts have declared that states must provide equal educational opportunity to students. We attempt to do this through the school aid formula. If income taxes replace property taxes, the school aid formula will have to be modified to an income-based formula. Should we have both income and property taxes, the formula will have to account for both factors.    Comment on C-3

C-4. If property taxation is maintained for corporations and local income tax levied on individuals, the following should be considered.    a) For the first time counties will have to classify property by ownership, not just by use, to determine what property is part of the property tax base and what property is not. This and other necessary local procedural changes may be formidable task. b) Does establishing ownership as the criterion for type of tax imposed influence decisions regarding business organization, i.e. whether to be a sale proprietor (and pay local income tax) or a corporation (and pay property tax)? If it is an influence, is it a matter of concern? c) Does the different tax treatment of, say, a sale proprietorship shoe store vs. a corporation shoe store result in tax inequities? Comment on C-4 

C-5. Finally, to administer a local income tax the Department needs time to modify income tax forms, to identify taxing districts, and to allocate income by districts. The Department will have to work with the educational community to establish school district identifying codes and prepare forms to compute taxes for the individual districts. Taxing districts will need time to impose their taxes. One possible time frame would be:     Comment on C-5

a) The Department begins in January to work with IDE and others to code school districts. It also makes plans for forms modifications. 
b) The bill becomes effective July 1. 
c) Taxing districts pass their ordinances before September 1. 
d) The Department sends its forms to the printer before September 1. 
e) Forms are mailed to taxpayers in December. 
f) Taxes are collected in the spring.

Some very important features could delay this process:

1. The tax liability should be effective for taxable years beginning on or after some January 1. Passage of the law and/or ordinances after the date by which forms can be designed and sent to the printer delays implementation by one full year. 
2. Immediate implementation may produce significant non-compliance which will delay collection of and disbursement of taxes due.
3. Cost of development of local district income information is expected to exceed $3 million. This money should be available at the beginning of the start-up process, meaning either providing the funds before the tax is passed or allowing for the full start-up time for implementation after passage of the law. What may prove desirable is first, to provide the funds to develop income data by taxing districts which will put the basic information system in place; second, to allow time to assess the effects of such a tax on taxing districts; and finally, to pass a law.

If such a plan were followed, the Department could begin planning in January and continue planning, systems development, and forms design from the passage of the appropriation to completion. The appropriation would, we hope, come soon enough to meet printing and systems development deadlines so that the information could be gathered from returns for the current year. The data could be gathered in the spring (filing time), presented to the legislature in the fall, and appropriate legislation could be passed the following spring. The total time from inception to passage would approximate 30 months. Total time to tax collection would approximate 47 months.    Comment on C-5