By The Financial Times

Illinois' legislature approved tax increases of up to 67 per cent on Wednesday - a move that has angered companies in the cash-strapped state - just hours ahead of a new legislature being sworn in.

Proponents of the tax increase say it will help the state tackle a $15bn budget deficit, unfunded pension liabilities of at least $80bn, and more than $8bn of unpaid bills to contractors, educational institutions and social welfare providers.

The increases - a jump in income tax from 3 per cent to 5 per cent and a rise in business taxes from 7.3 per cent to 9.5 per cent - are lower than originally proposed, but have angered business groups, which have warned that the state will forgo investment and job creation as a result. These state taxes are paid in addition to federal taxes.

"When making investments, businesses have to consider the costs," Doug Oberhelman, chief executive of Caterpillar, the world's biggest manufacturer of earth-moving equipment, warned in an opinion article.

"States with lower-cost environments provide an opportunity for businesses and their employees to succeed," continued Mr Oberhelman, whose company is based in Peoria, Illinois. "That's not the type of environment we are creating in Illinois with these tax proposals ... Such dramatic in-creases in income taxes will stifle economic growth."

Bill Brodsky, chief executive of the Chicago Board Options Exchange, has warned that the state's poor finances will make it hard to attract employees to Illinois.

"Political leadership has let us down," he said. "We need to respond to these concerns, and so far the response has been dismal. I'm tempering my words."

The tax increase received a muted welcome in the bond markets. In the derivatives market, the cost of default protection on Illinois bonds fell on Wednesday, market sources said, an indication that the perceived risk of lending to Illinois is less.

"By no means is Illinois 'fixed'," said Matt Fabian, managing director at Municipal Market Advisors. "But they have taken a positive step for a state that has taken no positive steps for the last two years."

State and local governments in the US are in the spotlight amid concerns that years of fiscal mismanagement laid bare by the recession could lead to a spike in defaults.

The tax proposal initially called for combined business taxes to rise to 10.9 per cent, the highest of any state, a 75 per cent increase in income tax to 5.25 per cent and a $1-per-packet rise in cigarette taxes.

It passed only after the increases were moderated, the new cigarette tax was scrapped and spending limits were added. The proposal passed the Illinois House by 60 votes to 57 and the Senate by 30 votes to 29. No Republicans voted for the measure, arguing that the state needed to do more to cut its spending.

Democrats countered that lower spending would not be enough to solve the state's financial woes. "Illinois is in crisis, absolute financial crisis, and there is no way we can dig ourselves out of the crisis without increased revenues," said Barbara Flynn Currie, House majority leader. "There is no way we can cut our way out of the deficit we face."

Republicans were unmoved. "You may think you're stabilising the budget, but you're not," said Matt Murphy, a GOP Senator from Palatine, in the Chicago suburbs. "You're bankrupting our state."

During the debate, House Democrats twice failed to win support for a measure to borrow an additional $8.75bn to help pay overdue bills.