Illinois lawmakers pass massive tax hikes

NEW YORK (CNNMoney) -- Illinois lawmakers on Wednesday approved major personal and corporate income tax hikes to bring the state's budget back from the financial abyss.

The state is facing a $13 billion budget deficit that must be resolved by the end of the fiscal year on June 30. This includes $6 billion in unpaid bills to social service agencies, schools, contractors and others. In addition, the state's pension plan is severely underfunded.

To address these shortfalls, the Illinois House and Senate approved:

• Temporarily raising the personal income tax rate to 5%, from 3%.
• Temporarily hiking corporate income taxes to 7%, from 4.8%.
• Imposing a moratorium on new programs with spending growth capped at 2% per year, with the exception of increased school aid of more than $700 million.

The House postponed a vote on increasing the tobacco tax to $1.99 per pack, up from 98 cents. And lawmakers defeated a proposal to borrow $8.75 billion to clear the current stack of unpaid bills.

The state's Senate also approved a measure allowing the state to borrow $3.7 billion for the fiscal 2011 pension payment. The House approved this debt issuance last May.

Democratic lawmakers were racing to pass the tax hikes before the newly elected legislators are seated later Wednesday. Republicans, who gained ground in the November election, are firmly opposed to hiking taxes, preferring instead to cut spending.

The fiscal package remained in flux until the end. To gain support, Democrats scaled back the personal income tax spike to 66%, down from an initial proposal of 75%, and also reduced the jump in the corporate tax rate, which was originally set to rise to 8.4%.

The tax hikes, steep as they are, won't eliminate the state's deficit, since they are only expected to raise about $7 billion. Complicating matters is the defeat of the bond measure to cover the unpaid bills.

Deficits and unpaid bills

Illinois is not alone in its budget problems. States are facing a collective $41 billion budget gap, according to a recent survey. California's new governor, Jerry Brown, just unveiled a budget proposal that will slash funding for social services, universities and aid to the needy.

But the Illinois budget crisis, which has been decades in the making, is arguably among the worst in the nation. The state's income tax rates have not risen since 1989.

"This is unprecedented," said Richard Dye, professor at the Institute of Government and Public Affairs at the University of Illinois. In a recent report he co-authored, he wrote it is hard to overstate the depth of the fiscal hole the state is in.

With the tax hikes' passage, recently re-elected Gov. Pat Quinn, a Democrat, will still have to find a way to close the remaining deficit, which could include cuts.

Borrowing may not be a solution because investors are growing increasingly skittish. Illinois relies on borrowing more than most states because it is allowed to use debt to fill budget shortfalls.

Republicans, meanwhile, say that raising taxes will hurt businesses and discourage new ones from moving to Illinois.

"While Illinois' budget problems are grave, the answers lie in first attacking the excessive spending and enacting structural reforms that are needed before any new revenues are even considered," the Illinois Republican Party said in a statement over the weekend.

The governor has promised to deal with the state's financial problems very soon.

"We will pay our bills," he said in his inaugural address Monday. "We will stabilize our budget."