Iowa has the 46th-best best state tax environment for business in the country. That's a nice way of saying it has one of the worst. High rates leavened with complex loopholes for the well-lobbied make our tax environment poisonous for entrepreneurs.
It's easy to imagine a better tax world: the world of the Quick and Dirty Iowa Tax Reform. It looks like this:
1. Eliminate the Corporation income tax. The Iowa
corporation income tax has the highest stated rate in the country, and
one of the highest effective rates. The only reason it doesn't destroy
Iowa's economy altogether is that it is so riddled with loopholes that
collections are very low - well below 5 percent of the state budget. Yet it is
a very expensive tax to administer and to comply with. Eliminating the
tax would send a powerful message to companies looking for a place to
invest for the long term.
2. Reduce the Iowa individual income tax to 4 percent or less.
3.99 percent would be much more attractive to entrepreneurs and executives
considering Iowa locations. It would bring our rate decisively below
all of the border states except for Illinois and South Dakota. Only a
low rate will enable Iowans to give up the large number of special
breaks that make compliance and tax administration expensive.
3. Strip down the Iowa tax law. To get the rate
down to this level, Iowa will need to strip its tax law of a host of
politically-motivated tax breaks. These include, among others:
- All economic development tax credits - ethanol,
films, research and development, "targeted" jobs and the like, they all should go. Low
rates are more important than any of these, all of which serve
primarily to fund the well-connected.
- The deduction for Federal income taxes. If the
rates are low enough, the deduction doesn't matter nearly as much. If
its built into the rates, you protect poorly advised taxpayers who have
a big once-in-a-lifetime income item - say, from selling a business -
and losing the value of the deduction by paying the tax when it is due,
rather than prepaying in the year of sale.
- The exclusion for ten-year capital gains.
- The credits for tuition funds, community foundations, and the like.
- The special pension and tuition breaks for old folks.
Any breaks for poor folks should be in the form of a generous
low-income exemption. Old folks with low income aren't necessarily more
worthy than younger folks. In fact they often are much more wealthy
than their younger counterparts.
Just because a break isn't mentioned here doesn't mean I want to keep it.
4. Make federal taxable income the starting point for Iowa taxable income.
If you use federal AGI as the starting point, you can achieve even
greater simplification and lower the rates further. Unmodified AGI as
a tax base can create grossly unfair results, but it if you allow a
deduction for gambling losses and Schedule A investment interest, you
get a decent base. Federal changes in income computation would
automatically be incorporated in Iowa's tax code, absent a vote of the
legislature otherwise. It also makes Iowa's tax forms potentially
5. Make Iowa's tax forms into a reconciliation format,
starting with Federal taxable income. Have lines to back out federal
Treasury income, which the state can’t tax. If Iowa chooses to tax muni
bond income, have a line for that. Have one last line for all (any)
other addbacks and subtractions, which would feed from separate detail
6. The most difficult issue is taxation of S corporations.
I would allow S corporations to elect to be Iowa C corporations and
make Iowans taxable on distributions from the corporation as if they
were C corporations. Electing corporations would have to report
distributions to Iowa shareholders to the state, and the shareholders
would be taxed as if the distributions were taxable dividends;
otherwise electing corporations would pay no tax on Iowa-source income.
Iowans owning Non-electing S corporations would be taxed in Iowa on all
their S corporation income. This would achieve near-parity between Iowa
C and S corporations.
For every business that loses a chance to shake down the state for new credits, a hundred will be better off for not having to deal with high rates and complexity. When the legislature sits down this month to tweak the tax system to pay for their spending, ask them for a tax system that benefits you instead of the out-of-staters with the expensive lobbyists.