Research & Commentary: Iowa Tackles Tax Reform
In this Research & Commentary, Matthew Glans examines two tax reform proposals in Iowa that would lower the state's income tax, which is among the highest in the nation.
Iowa’s tax rates are currently higher than most other states in its region. Iowa’s complex tax code creates high administrative costs for the government and high compliance costs for businesses and individuals, creating an economic environment in which the state lags behind its neighbors in creating a friendly business climate. Iowa currently ranks 40th in the Tax Foundation’s “State Business Tax Climate Index.” Lowering Iowa’s personal and corporate income tax rates could dramatically improve the state’s economy and generate new jobs.
Two major tax cut proposals are now being considered in Iowa. The first, the Iowa Working Families Tax Act, would reduce individual and corporate tax rates, reform the sales and use tax code to capture internet sales tax revenue, end federal deductibility, and eliminate or reform several tax credits. Specifically, the bill would reduce the number of tax brackets in Iowa from nine to five and reduce the top tax rate from 8.98 percent, the fourth highest nationally, to 6.6 percent. The bill would also reduce Iowa’s corporate tax rate of 12 percent, the highest in the country, to 7 percent.
The second reform plan, advocated by Gov. Kim Reynolds (R), would also reduce the state’s personal income tax and phase out federal deductibility. Reynold’s plan does not cut the corporate income tax, but it does eliminate the Alternative Minimum Tax and doubles the standard deduction, from $2,070 to $4,000 for single filers and from $5,090 to $8,000 for married filers. This plan, now being considered in Iowa’s House of Representatives, would cut the top income tax rate to 6.9 percent by 2023 and includes economic triggers allowing for future tax cuts when tax revenues grow substantially. Unfortunately, the plan advocated for by Reynolds does not address Iowa’s sky-high corporate income tax.
Personal and corporate income taxes are generally considered to be the most destructive taxes because they disincentivize production, innovation, and risk-taking. Recent studies have shown states with no income tax or with lower income taxes perform better economically and achieve greater job and population growth than those with higher income taxes. High income and business taxes deter economic development by discouraging higher-income-earners and new capital from moving into a state, remaining there, or investing their money. A study by the Americans for Tax Reform Foundation found, “Each positive 1 percentage point tax burden differential between states decreases the ratio of income migration into the high-tax state by 6.78 percent in a given year.
One key weakness in the tax plans now under consideration is a move to strengthen internet sales taxes. Supporters of online taxes argue these taxes are needed to restore a balance between online and bricks-and-mortar retailers. However, the imposition of taxes on internet sales would slow the growth of the e-commerce industry, one of the few sectors of the economy that has seen growth in recent years. In addition, requiring online retailers to charge a sales tax in states in which they do not have a physical presence would force consumers to pay a tax to a government with which they have no political voice and from which they receive no government benefits or services.
Instead of forcing out-of-state businesses to serve as government tax collectors, state legislators should implement a sales tax system based on where the product was sold, known as an origin-based tax system. This would truly level the playing field because online and brick-and-mortar retailers would pay the same tax.
A state’s tax policy should focus on bringing in enough revenue to cover the costs of necessary functions of government in the least economically distorting way possible. Cutting the personal and corporate income tax would improve Iowa’s economic competitiveness by leaving more money in the pockets of the state’s citizens and businesses to spend, save, and invest.
The following articles examine state income tax reform from multiple perspectives.
Ten Principles of State Fiscal Policy
The Heartland Institute provides policymakers and civic and business leaders a highly condensed, easy-to-read guide to state fiscal policy principles. The principles range from “Above all else: Keep taxes low” to “Protect state employees from politics.”
Rich States, Poor States
The 10th edition of this publication from the American Legislative Exchange Council and authors Arthur Laffer, Stephen Moore, and Jonathan Williams offers both individual-state and comparative accounts of the negative effects of high income taxes.
Institute Brief—No Income Tax: The Key to Economic Growth
The Public Interest Institute examines how states with no income tax are doing compared to those with income taxes: “Studies show that states without an income tax have greater economic growth rates than states with an income tax, including greater rates of income growth, population growth, and job growth, and are more attractive to businesses looking for locations to build or expand.”
State Budget Reform Toolkit
The American Legislative Exchange Council outlines a set of budget and procurement best practices to guide state policymakers as they work to solve the budget shortfalls. The toolkit will assist legislators in prioritizing and more efficiently delivering core government services by advancing free markets, limiting government, and promoting federalism and individual liberty.
The Historical Lessons of Lower Tax Rates
Examining the historical results of income tax cuts, Daniel Mitchell of the Heritage Foundation finds a distinct pattern throughout American history: When tax rates are reduced, the economy's growth rate improves and living standards increase.
Policy Tip Sheet: Corporate Income Taxes
In this Policy Tip Sheet, Taylor Smith examines corporate income taxes and their effects on economic development. Smith suggests how legislators can limit or eliminate their corporate taxes.
Balancing State Budgets the Smart Way
Joseph Henchman of the Tax Foundation examines an array of options states can use to remedy both short-term and long-term fiscal woes and put their budgets back on sounder legal footing.
Five Steps Toward a Balanced Budget
The Commonwealth Foundation argues lawmakers can pass a balanced budget that respects three important principles: “Protect families and business from tax increases. Avoid overspending. The state should not spend more than it collects in revenue. Limit spending growth to the Taxpayer Protection Act index of inflation plus population growth.”
Personalizing the Corporate Income Tax
Gerald Prante and Scott Hodge discuss in this Fiscal Fact article the effect of corporate income taxes on individual households. “Examining income groups, Chamberlain and Prante found that low-income households pay more in corporate income taxes than they pay in personal income taxes. Geographically, households in largely urban congressional districts and metropolitan areas bear a disproportionate share of corporate income taxes today and, thus, would receive a significant boost in living standards if the corporate tax burden were reduced,” they write.
Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Tax News website, The Heartland Institute’s website, and PolicyBot, Heartland’s free online research database.
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