Why the High Tax? Going Deep on Chicago’s New Rate

It’s the kind of ranking most cities don’t want to top: a recently announced Cook County tax hike will make Chicago’s sales tax rate the highest in the nation.

The new combined tax rate of 10.25 percent pushes the county ahead of the previous high sales tax leaders — a three-way tie at 10 percent by the Alabama cities of Birmingham, Montgomery and Mobile.

Why does the Windy City need such a high tax rate? There are really two answers, but only one of them is getting much discussion in Chicago and national media: Cook County’s underfunded pension system. Most of the new tax’s estimated $474 million in additional revenues will go straight to pension obligations, a move that Moody’s Investors Service called a “credit positive.”

The other reason is often overlooked: Illinois’s reluctance to make services taxable. When the state started charging sales tax in 1933, it (like most states at the time) only applied the tax to physical goods.

This tax system worked pretty well … until the city’s economy started moving away from its history as a manufacturing and agricultural processing hub. Today, data centers and office spaces are the lifeblood of the city, not meatpacking plants and rail yards. According to the Center for Tax and Budget Accountability, services now represent 72 percent of the state’s economy — and nearly all of those sales are sales tax exempt.

All of its neighbors tax more services than Illinois. With so much money left on the table, and the service economy expanding all the time in relation to the goods economy, it’s no wonder that the state’s cities and counties are scrambling to fund their obligations by creating taxes wherever they can, like the new cloud tax. For more on why states are starting to charge sales tax on services, read Avalara’s Rules of the Road.

State and local officials have floated the idea of expanding sales tax to a wide range of services, but so far, no bill has managed to make it to the governor’s desk.

Cook County residents shouldn’t think local tax changes are finished. While the sales tax hike will help the county’s coffers, the government still needs to make up more revenue. If the state doesn’t start allowing broad taxation of services soon, local governments may have to get even more creative.

Keeping up with all the changes doesn’t mean you need to become a sales tax expert in Illinois—or any state for that matter. Today, business leaders are saying goodbye to rate tables and complicated tax data and hello to outsourcing and automation.