The Illinois Tax Increase: Why Investors Around the Country Should Care

Are you thinking about the markets, or do you have a fixation on politics?

The politics versus investing theme is familiar to readers of "A Dash."  Why do I keep beating this drum?  Because it is so important.

A Small Digression

I enjoyed Josh Brown's wonderful advice on blogging: 

If your visitor clicks a link, hits your page and is greeted with a wall of text, that visitor is gone.  No one wants to read something that looks like homework, no matter well written it is.  Your first paragraph should never be more than one or two sentences.  Each paragraph thereafter should be 3 to 4 sentences maximum.  If you're over 500 words for the whole post, you better be writing something important or brilliant, otherwise just stop.  The markets are moving and people won't even give your post a chance if it looks unconquerable.

Josh has a finger on the pulse of the market, and I am also enjoying his TV stints.  We accord him our highest office honor by taking the TV off of mute and backing up TIVO when he is on!

With respect to my blog, it is pretty obvious that I regularly fail to take his advice.  The Old Prof cannot seem to do anything in 500 words!  I also do not follow his other advice, although I agree that it is very wise.

I plan to think about this more — perhaps by doing a few more brief pieces.  Many of my topics require more extensive analysis — -Meanwhile

If you cannot spend two minutes reading an article, you may not be a good candidate for my material!  Put another way, if you have at least two minutes to spend, you might gain an edge over investors with ADD!

End of Digression

Illinois raised its income tax from 3% to 5% on a temprorary basis, with an eventual 3.5% rate.  There are few deductions, so this is bigger than it seems.  What does the Illinois story really mean?

The Illinois decision reflects what I expect to happen around the country, and at a national level.  I have watched the Illinois debate very closely for years.  I have many roles — as a taxpayer, a voter, a member of the Citizens Financial Advisory Committee for a major school district, and as a former Public Finance Professor at a major university.  I have had a front-row seat.  I voted for Governors of both parties, including those who are now in prison.

The last Governor of Illinois who was loved by everyone, and who could have won the election had he run, made it clear that the deficit problems could not be solved without a tax increase.  In the context of last year's election, a tax increase was off of the table.  This was typical of national politics.

The tax increase was enacted by the lame-duck legislature.  While the Democrats will have a majority next year, it will be less powerful.  Some question the legitimacy of this decision.

Separating Investing from Politics

There is one conclusion that should be crystal clear for investors:  The Illinois decision is bullish.  Increasing taxes helps the credit rating for the state, Illinois cities, school districts, and other taxing districts.  It makes Illinois debt in all forms more attractive than it was yesterday, and it also should reduce the national concern about municipal defaults.

I expect other states to follow this approach.

I note that some observers who predicted widespread state and local defaults have now shifted gears.  They complain that Illinois should have cut spending.

This is what I mean about confusing politics and investing — something that seems commonplace in 2011.  [I note that I am, once again, over 500 words.]

We are all familiar with the taxing versus spending debate.  No matter what the formula, a state that makes good on its obligations is doing the right thing.

Investment Implications:  Bullish for Muni Bonds, suitable for some of my clients, and a general market positive.

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  • MikeinMN January 13, 2011  

    I have been following your blog for years. I enjoy 95% of everything you write, regardless of the length.
    I would not encourage you to become too preoccupied with the number of words in your posts. You have a wonderful gift for writing about investing. I imagine counting your words will only serve as a distraction.
    Naturally, Mr. Brown has a point. However, I don’t recall much of your work being guilty of over-indulgence.
    Thank you for sharing your wisdom.

  • Jim January 13, 2011  

    Interesting argument. However, I come to the opposite conclusion. Indeed, if I were investing in a mutual fund made up of S&L bonds, I would want one that excludes Illinois (and a few other states and cities). My reasoning is as follows: the Illinois governor proposes to deal with his state’s severe and chronic deficit mostly through increased tax revenues; he did not show any courage by going after spending or the pension system for state workers. My concern is that tax revenues will come in below what the governor expects and that spending will continue to grow. History has shown us that when governments get more tax revenue they cannot help themselves but to spend more.

  • Paul Nunes January 13, 2011  

    Jim; that is confusing politics versus investment; the relevent question is “are you being compensated for that risk?” Let is say you are letting history be your guide; at what price would you assume the (obvious) risk of govt. continual overspending? Ignore the fact of the 10 plus year decline in muni rates; also ignore that an Illinois or California default risk would probably impact pricing in other muni issues; why would you exclude contracts purely on the basis of location?

  • Robert Jones January 13, 2011  

    I work for a very large national accounting and tax audit firm. (Top 5) Our firm recently sent out a national email balst to all tax and nontax professionals discussing how to help our clients switch residency from IL to FLA or TX. This email was generated in response to a huge influx of inquiries form our IL based clientel since the law passed.
    The writing is on the wall, if even a small percentage of the taxpayers contacting our firm leave IL, they will take a disspraportianate share of taxed income with them.
    These are not Joe Lunchpail types of individuals, these are CEO’s, hedge fund managers, and other sophisticated high income, high wealth, high productivity people.

  • Jeffrey January 13, 2011  

    I haven’t read the legislation thoroughly but history tells us that when legislative bodies increase tax rates they eventually increase spending. Government does an incredibly poor job of allocating capital and the tax and spend antics are absolutely a drag on investment returns over the long-term.
    Of course I would welcome your additional comments on this subject.
    With that said, don’t limit yourself to 500 words. Write what you think is appropriate for the subject matter. You do fine work and this is evidenced by the intellectual rigor that you put into it, which isn’t found often.

  • muckdog January 14, 2011  

    Dr. Jeff, I always read your blog. I believe folks who are interested in investing and economics are more likely to enjoy a nice Wall of Text.
    If they want to see pictures of hot women, or find the scores of the college hoops games, it doesn’t matter how many words are in your blog…
    Keep on!
    As far as the Illinois tax hikes, I agree completely. That’s the way states will do it – if they can.
    Here in CA, we’re going to be asked to vote to tax ourselves. Arnold tried this and it failed at the ballot box. I think Jerry will have a similar experience. Then what….?

  • Jim January 14, 2011  

    I agree with your comments. In short, the assumption in my original post is that the plan Illinois announced last week is a bad sign and that I would require a substantially higher interest rate to invest in that state’s bonds, perhaps 200 basis points over the current (already relatively inflated) rate. I guess my outlook for Illinois is far more pessimistic than the market’s. I think you have to jointly consider politics and finance in a case like Illinois or California where governments with no credibility are at the helm.

  • Paul Nunes January 14, 2011  

    Jim; thanks for explaining your thoughts. this is why Jeff has a great blog; great readers! (plus a great writer)

  • david January 18, 2011  

    Jeff, if you post anything LESS THAN 500 words, then you will probably have lost me. I’m a little slow at understanding “soundbites”!!