Plan to Tax Retirement Income Sparks Debate

By Kelly Soderlund

In a proposal to dramatically change how Illinois collects taxes, a Chicago think tank has recommended that the state tax all forms of federally taxable retirement income. If enacted, that would alleviate much of the state’s budget crisis, but also leave nearly 1.5 million retirees with less money in their pockets.

The Civic Federation, a nonpartisan government research organization, released a report in March outlining its proposal for how to make up for the state’s $5.4 billion in unpaid bills.

Taxing retirement income—including Social Security, pensions, 401(k)s and individual retirement accounts—to facilitate the gradual rollback of income tax rates was one of several recommendations.

“Broadening this base would provide greater equity among taxpayers,” said Laurence Msall, president of the federation.

Of those states with an income tax, Illinois is one of only three that do not tax pension income and one of 27 that exempt all federally taxable Social Security income. The state estimates that exempting all retirement income reduced tax revenues by about $2 billion in fiscal year 2012.

The Civic Federation notes that even if lower-income retirees were exempt, the new tax would still raise substantial revenue.

Currently, retirees do not pay federal income taxes on their Social Security benefits if the sum of half of their benefits combined with all other income is less than $25,000 annually for individuals. Couples who make less than $32,000 are also exempt.

AARP strongly opposes the Civic Federation proposal and plans to lobby against it if it gains traction in the state legislature. Bob Gallo, AARP Illinois state director, said he’s concerned because the recommendation targets one group—retirees, who haven’t planned for this type of financial setback.

“My initial reaction was concern for those individuals who are living on fixed incomes and struggling with rising costs in other areas, and this would be a double whammy for them,” Gallo said.

Looking for alternatives
Illinois ranked 48 out of 50 in 24/7 Wall St.’s survey on the best and worst run states in America in 2013, based on budget deficits and unemployment, among other factors.

The Civic Federation stresses that its plan is not the only way to deal with the state’s dire fiscal crisis. “We encourage legislators and other stakeholders to come forward with comprehensive plans of their own,” Msall said.

The proposal faces resistance in an election year. Gov. Pat Quinn (D) said he is opposed: “I will not tax the Social Security checks that our seniors on fixed income rely on. We shouldn’t balance our budget on the backs of our senior citizens.”

Richard Kaplan, a law professor at the University of Illinois and an expert on taxation and retirement benefits, doesn’t see the legislature taking up the issue, citing previous attempts that died quickly.

In 2011, Illinois Senate President John Cullerton (D-Chicago) proposed the same type of tax expansion to include retirees but it never came to fruition, Kaplan said. He also said a new state tax on retirement income could send retirees packing to states that have no income tax, such as Florida.

“I don’t think the only reason they’re moving down there is the weather,” Gallo said.

Under current law, the state income tax rate of 5 percent is set to be reduced in January 2015.

The Civic Federation also proposed delaying that reduction for an additional year. This would help the state reduce its unpaid bills, establish a rainy day fund and gradually roll back the income tax rates to 4 percent for individuals—including retirees—and from 7 percent to 5.6 percent for corporations, according to the report.

To read the full report from the Civic Federation, go to civicfed.org/iifs/publications/FY2015_StateofIllinoisRoadmap.
Kelly Soderlund is a writer living in Bartlett, Ill.