End of state budget impasse brings stability, disappointment for business

July 08--Illinois' bruising two-year run without a state budget is over, but business leaders are left feeling they got the short end of the stick: higher taxes with virtually none of the regulatory and political changes they sought.

The $36.1 billion budget plan increases the corporate income tax rate to 7 percent from 5.25 percent and the personal rate to 4.95 percent from 3.75 percent. In addition to spending cuts, it ends three corporate tax breaks and, on a business-friendly note, reinstates a research and development tax credit. Lawmakers voted Tuesday and Thursday to override Republican Gov. Bruce Rauner's vetoes.

While the fiscal stability is welcome, some business leaders say they lost out because the budget does not address their long-standing concerns about rising property taxes and the high cost of workers' compensation insurance. Those are policy priorities for Rauner, a former private equity investor whose election was cheered by many CEOs and small-business owners.

"The fact that there are no reforms at all is an incredible missed opportunity," said Todd Maisch, CEO of the Illinois Chamber of Commerce.

Adding to companies' causes for concern, the state's corporate tax incentive program has expired and a bill that would gradually raise the minimum wage to $15 an hour is sitting on the governor's desk.

For Bob Goray, whose company performs exterior maintenance on commercial and industrial buildings, the budget battle was a last hope that some of Rauner's pro-business agenda would succeed.

The high cost of workers' compensation insurance makes it difficult for Goray, president of Wauconda-based J.S. Goray, to compete with out-of-state firms that enjoy lower rates because those companies can afford to charge less. High property taxes make it difficult to hire good employees because they don't want to move to Illinois, he said.

The costs have driven companies out of the state, Goray said, and that has affected his business because no one pays to maintain vacant buildings. He doesn't plan to leave, but he is considering opening an office in another state where he sees more growth potential.

The higher income tax rate will divert more money from growing his business. "It makes us think twice about adding a vehicle, adding employees, marketing budgets, all of that," Goray said.

The corporate income tax increase, retroactively effective July 1, is expected to generate $460 million in new revenue annually, while the personal income tax increase will bring in about $4.3 billion. The vast majority of businesses pay at the personal rate.

While the corporate tax rate will be 7 percent, the effective rate will be 9.5 percent because of an additional 2.5 percent state tax unique to Illinois, called the personal property replacement tax. That revenue flows to local governments, which can't impose business income taxes of their own. At 9.5 percent, Illinois will have the fourth-highest corporate tax rate in the nation, after Iowa, Pennsylvania and Minnesota, according to the Tax Foundation, an independent tax policy organization.

However, other states impose local personal property taxes on businesses not reflected in their state rates, so it isn't an apples-to-apples comparison.

Businesses that don't have corporate tax status, such as limited liability companies and sole proprietorships, will pay the 4.95 percent personal income tax plus a 1.5 percent personal property replacement tax, so their effective rate will be 6.45 percent, which is modest compared to many other states, according to the Tax Foundation.

The new budget averts further meltdown, but Illinois' fiscal health remains dire.

Moody's Investors Services, which several weeks ago gave Illinois the lowest bond rating on record for a state, warned in a note Wednesday that it was considering downgrading Illinois' credit rating to junk because the budget plan may fall short of addressing the underlying financial problems, including massively underfunded public pensions and a nearly $15 billion backlog of unpaid bills.

To be sure, having a budget after weathering more than two years without one provides businesses with longed-for certainty and could help restore parts of Illinois' reputation, said the Chamber's Maisch, whose organization opposed the budget package. But without changes to help improve its business climate and political system, the state remains an inhospitable place to operate, he said.

Maisch -- whose group sought a property tax freeze, reduction in workers' compensation costsand small-business incentives -- hopes the adoption of more business-friendly policies will be the next step, and he plans to hold legislators who promised as much accountable.

But with the political pressure lifted, others think the leverage is gone and the chance for change is lost.

"I'd be amazed at something like that happening, but I don't think it will," said Mark Grant, Illinois state director of the National Federation of Independent Business, which represents about 11,500 small businesses.

Grant said his membership is "extremely unhappy" that more pro-business measures were not part of the deal. Among those business groups pushed were changes to workers' compensation insurance that make employers responsible for only their share of their workers' injuries.

"If those reforms came through in a big way, I think they would have been OK with an income tax increase, as long as they saw relief on the other side," he said.

There are several other proposals awaiting different levels of approval that Democrats say address Rauner's agenda.

Two Democratic-backed bills to address workers' compensation passed the General Assembly and are awaiting action by Rauner, including one that designates $10 million in seed funding to create a government-backed insurance company to compete with private insurers.

But the business interest groups oppose those bills, saying they won't significantly reduce costs for employers.

Under the new budget, some firms will see their cost of doing business rise because the plan discontinues three tax breaks, worth a combined $125 million a year, that had allowed companies to shift profits to out-of-state subsidiaries, claim state deductions for production not occurring in Illinois, and avoid taxation on oil drilling in the outer continental shelf.

However, in practice, the corporate tax hike will likely make little difference to most companies.

About 70 percent of businesses that filed a state income tax return in Illinois in 2010 paid no corporate income tax, and 92 percent paid $5,000 or less, according to a 2014 report from the Chicago-based Center for Tax and Budget Accountability. Only 0.3 percent of filers -- 303 companies out of 110,557 -- paid $1 million or more, and they contributed two-thirds of the corporate tax revenue.

Many take advantage of numerous legal exemptions, credits and deductions that eliminate their tax liability, said Ralph Martire, executive director of the nonprofit research and advocacy think tank.

The companies likely to be most affected are those that primarily sell their product or service in Illinois because the state calculates corporate income tax based on sales within the state.

That means some Illinois-based companies pay the bulk of their state corporate taxes elsewhere. Chicago's Boeing, for example, pays more in Washington, where the company builds and delivers most of its airliners, spokesman Chaz Bickers said.

Corporate income taxes accounted for 3 percent of state general revenue nationwide in 2014, according to data from the U.S. Census Bureau. Personal income taxes accounted for 18 percent.

That's partly because the majority of businesses in America -- and Illinois -- are small businesses and pay taxes on income at a personal rate, said Caroline Bruckner, managing director of the Kogod Tax Policy Center at American University.

Of the country's 26 million businesses in 2014, 95 percent were taxed at an individual rate, according to data from the Brookings Institution. This can include businesses from mom-and-pop shops to lawyers operating with small or independent firms.

The remaining 5 percent were C-corporations, which pay taxes at the corporate level.

Jared Walczak, policy analyst at the Tax Foundation, said Illinois' last experience with a 9.5 percent corporate tax rate -- in 2011, when the state implemented a temporary hike that began rolling back after four years -- did not bode well. Sears Holdings and Chicago's financial exchanges threatened to leave the state, forcing the General Assembly to give them tax breaks.

"You could see more of the same, where a rate that high could pressure some companies to consider relocating," Walczak said.

While industries usually factor tax rates into the location equation, they tend to fall lower on the priority list than the things taxes can pay for, like good infrastructure and public schools, said Richard Auxier, a research associate at the Tax Policy Center, a Washington D.C.-based nonpartisan think tank.

"No one personally gets any enjoyment out of having their taxes raised," Auxier said. "But when you consider all of those other things that they're going for, not to mention having a budget, you realize these are things that could be beneficial to the state."

States with the lowest tax rates are not the most successful, said Robert Weissbourd, president of RW Ventures, a Chicago-based economic development firm. More important to economic growth is the value proposition: What do you get for your money?

"You want to compete on quality," Weissbourd said. "Are we providing the infrastructure and the workforce and the research that make us a competitive place where businesses want to be and people want to work?"

When the state raised the tax rate in 2011, it was unnoticable to John Terzis, owner of Oakton Investment Management, a financial planning firm in Skokie. He said he thinks the state should have left it high rather than letting it roll back.

That's not to say the state's business environment isn't frustrating. He is greatly concerned about a proposed tax on investment firms that he thinks would put small companies like his out of business.

Still, he said, the benefits of stability outweigh the budget's shortcomings.

"A current budget is better than no budget at all," Terzis said. "At least it gives us a playing field."

Mark Denzler, vice president at the Illinois Manufacturers Association, said he is disappointed that the budget does not include policy changes to make Illinois more attractive to manufacturers, such as a property tax freeze.

Illinois has seen a 40 percent drop in manufacturing jobs since 2000, while nearby Michigan, Indiana and Ohio have added manufacturing jobs, he said. He blames property taxes for driving much of that loss, particularly in Cook County.

Businesses have faced escalating costs from several sides, including paid sick leave laws and minimum wage increases in Chicago and Cook County (though more than half of the suburbs have opted out of the county laws).

State lawmakers have also been working to overhaul the state's premier corporate tax incentive program, which closed to new applications May 1.

The EDGE tax credit program -- short for Economic Development for a Growing Economy -- raised concerns that it was too expensive, particularly given the prolonged budget crisis. Without it, however, many fear jobs could be lost to neighboring states.

A proposed overhaul of the program was approved in the House and is awaiting passage in the Senate. That program, which would expire June 30, 2022, offers credits for new jobs and incentives for projects located in needy areas of the state, among other benefits.

The new budget has some business-friendly provisions. Among them, it retroactively reinstates a research and development tax credit through Jan. 1, 2022.

The state had a similar credit that ended in 2016. Manufacturers accounted for 60 percent of its use between 2010 and 2014, according to an analysis of state data by the Illinois Science and Technology Coalition, which counts firms such as Caterpillar, AbbVie and Archer Daniels Midland -- , plus labs and universities -- among its members.

Mark Harris, president and CEO of the Chicago-based nonprofit, said investing in research and development drives companies' growth and, as a result, can strengthen the regional and local economy.

"Research and development is sort of the lifeblood of innovation," he said.

But putting that credit up for renewal every five years gives businesses and innovators another area of uncertainty, Harris' organization has argued, especially when some of those businesses are planning 10 to 20 years out.

In west suburban DuPage County, high school and community college graduates head into manufacturing apprenticeships, and precision engineering firms produce items ranging from cake decorating supplies to parts for companies like Boeing.

The stability that comes with a budget will be good for business, said John Carpenter, president and CEO of Choose DuPage, the public-private partnership responsible for the county's economic development.

But they need more, he said. It's not time yet for the legislature to claim victory and go home.

"It's not over," Carpenter said. "This is just the beginning."

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