Tax reform seems to be a priority at the legislature even as Iowa continues to carry the albatross of lower than expected revenues. In her Condition of the State Address, Governor Kim Reynolds made tax reform a priority, especially after Congress passed the Tax Cuts and Jobs Act in December. The resulting federal tax cuts will have implications for Iowa. Iowa taxpayers will see tax relief on the federal level, but it is likely that they will pay more in state taxes because of Iowa’s ability to deduct federal tax payments from state income taxes. This is one factor why Governor Reynolds argued the legislature must enact tax relief in Iowa, so taxpayers are not paying higher state taxes. In addition, Iowa will see increased revenues because of the Tax Cuts and Jobs Act, and although this has been described as a “windfall” for Iowa, the revenues should only be used to lower state tax rates.
Iowa suffers from a high and complex tax system. Iowa’s corporate tax rate is one of the highest in the nation with the top rate at 12 percent. The top individual income tax rate is 8.98 percent. It is not only high tax rates, but Iowa has a significant number of tax credits. “We have the most complicated system in the nation,” stated State Senator Randy Feenstra (R-Hull), who chairs the Ways and Means Committee in describing Iowa’s tax structure. “Taxes, regulations, and excessive red tape and fees are all business and job killers — and often have a disproportionate effect on small and new businesses,” noted economist Richard W. Rahn.
It is not just an overly complicated tax structure that is hurting Iowa’s economic competitiveness, but to make matters worse, the Mercatus Center at George Mason University recently reported Iowa is burdened with massive regulations. In examining the Iowa Administrative Code (IAC), it found Iowa has a complex and burdensome level of regulations. The Mercatus analysis IAC “contains 160,306 restrictions and 10.1 million words.” Also, it would “take an individual 563 hours—or more than 14 weeks—to read the entire IAC.” This is on top of the federal regulations that businesses in Iowa must follow. Regulations are not just rules, but they also have an economic factor upon business.
The Mercatus study of Iowa regulations confirms two other studies that demonstrate that Iowa needs to reform its tax and regulatory structure. The Tax Foundation and the Small Business and Entrepreneurship Council (SBE) both published studies comparing how the fifty states rank regarding their business climate. Both studies compare states using a variety of tax comparisons. The SBE Small Business Policy Index 2017 measures not only taxes but other factors such as regulations that impact business. Iowa is ranked 40th in the Tax Foundation’s 2018 State Business Tax Climate Index and 42nd in the SBE’s Small Business Policy Index.
States are not only competing in a globalized economy but often face significant competition with each other for businesses and entrepreneurs. The tax and regulatory climate of a state has a tremendous impact on the economy. Iowa policymakers should examine what states such as North Carolina, Indiana, and Wisconsin are doing in terms of lowering their tax rates.
At this time no specific proposals have been introduced in the legislature to address tax reform, but it is necessary the legislature work to lowering tax rates and providing meaningful tax relief for all Iowans. Any tax proposal should be comprehensive, that is, work to lower rates for both individual and corporate income taxes.
Lowering tax rates will not be easy, and will require the legislature to address state spending. During the last session, the Senate passed a constitutional amendment that would strengthen the 99 percent spending limitation amendment. This amendment if enacted would have saved taxpayers close to $500 million. A prudent tax reform policy also includes lowering spending to avoid deficits. Because of Iowa’s revenue situation, lower tax rates and spending reductions may have to be phased-in over time.
The legislature has a unique opportunity to enact tax relief by lowering rates across-the-board and begin the process of controlling spending with the 99 percent spending limitation amendment. This fiscal policy would strengthen Iowa’s economy, create economic growth, and increase revenues.