Higher Taxes in Illinois and the Beauty of Federalism

Blog, Taxation, Ben Eisen

Yesterday, the state of Illinois approved an increase in the state’s personal income tax from 3 percent to 5 percent. Corporate taxes are also set to increase.

I’m not familiar enough with Illinois’ budgetary circumstances to say whether the tax increases are a good or necessary step. But the reaction to the tax hike from leaders of neighbouring states like Indiana and Wisconsin illustrates one of the most important advantages of a federal system of government such as exists in Canada and the United States. The governors of Wisconsin and Indiana have both stated that they will try to benefit from the tax hike in Illinois- working to woo people and businesses to their jurisdictions.  Wisconsin’s governor, Scott Walker promised to dust off an old slogan the state once used to promote tourism.“Years ago, Wisconsin had a tourism advertising campaign targeted to Illinois with the motto, ‘Escape to Wisconsin,’“  said the governor. “Today we renew that call to Illinois businesses, ‘Escape to Wisconsin.’ You are welcome here.”

This illustrates a great benefit of a federal system of government with a large degree of power over taxation and spending devolved to sub-national governments. If the government of one state or province makes policy choices that make the state a worse place to live and work, people and businesses can easily pick up and leave. The presence of multiple jurisdictions within a country that have broad policymaking authority is beneficial, as it forces those jurisdictions to compete with one another by making themselves as attractive as possible to residents and employers.

To be clear, it’s not just taxes that we’re talking about. If Illinois’ state government had tried to balance their books by dramatically cutting infrastructure investment or taking money out of public schools, this too could have the effect of pushing residents to neighbouring states. Jurisdictions need to compete with one another across a number of different dimensions, offering the best possible public services at the lowest possible rate of taxation. This competition is particularly helpful at the sub-national level because it is relatively easy for individuals to move within a country, and considerably harder to immigrate abroad. Federalism sharpens the competition between jurisdictions by making it very easy for dissatisfied residents to pick up and leave.