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What an Iowa income tax might look like with a fresh start.

We've talked about why Iowa's tax law is bad for business, and about some easy fixes to make it a little better. But let's dream bigger. What would Iowa's tax law look like if you could start over from scratch?

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If Iowa's income tax were a car, it would look like this.

I would start with the Tax Foundation's Principles of Sound Tax Policy, including

Simplicity: Administrative costs are a loss to society, and complicated taxation undermines voluntary compliance by creating incentives to shelter and disguise income.
 
Neutrality: Taxes should not encourage or discourage certain economic decisions. The purpose of taxes is to raise needed revenue, not to favor or punish specific industries, activities, and products.
 
Broad Bases and Low Rates: As a corollary to the principle of neutrality, lawmakers should avoid enacting targeted deductions, credits, and exclusions. If tax preferences are kept to a minimum, substantial revenue can be raised with low tax rates. Broad-based taxes also produce relatively stable tax revenues from year to year.
 
I would add:
 
Business income should be taxed only once, unless avoiding double taxation does violence to simplicity, neutrality, and broad bases with low rates. 
 
A system designed from scratch would apply the ultimate simplification to Iowa's corporation income tax: it wouldn't have one. Iowa's corporation income tax is rated the very worst, with extreme complexity and the highest rate of any state. 
 
Eliminating the corporation income tax would eliminate the justification for almost all of the various state incentive tax credits, all of which violate the principles of neutrality and simplicity in the first place. For its astronomical rates and complexity, it generates a paltry portion of the state's revenue, typically 4-7 percent of state receipts.
 
For S corporations, a from-the-ground-up tax reform might tax Iowa resident shareholders only on the greater of distributions of S corporation income, or interest, dividends, and other investment income earned by the S corporations. The investment income provision would prevent the use of an S corporation as a tax-deferred investment. The effect would be to put S corporations on about the same footing as C corporations.
 
The Individual Income Tax couldn't be eliminated without radically restructuring both state spending and other state taxes, but it can be made much better.
 
I would start by basing the individual tax base on adjusted gross income -- taxable income before personal exemptions and itemized deductions. That would put non-itemizers on the same footing as itemizers.  I would allow only deductions for gambling losses, non-employee business expenses deductible on federal returns, and investment interest expense, to prevent grossly unfair anomalies that would otherwise result. That's it.
 
It would eliminate all other deductions and credits and put the savings into lowering rates. The Iowa 1040 would then just take federal adjusted gross income, with a few lines for deducting Treasury interest and the some other minor adjustments.
 
There would be no alternative minimum tax. There would be a generous exemption for low-income earners. If the new system keeps an earned income tax credit, the exemption would be high enough to keep taxpayers in the "phase out range" of the credit from paying income tax on top of their credit loss. If there were an earned-income credit, there would be no other credits except for taxes paid in other states and countries.
 
There would be no deduction for federal taxes. This deduction would be built into lower rates. Iowa is almost unique in allowing a deduction for federal taxes, and it makes Iowa's income tax look worse to outsiders than it really is. It is the opposite of simplification.
 
Put all of these things together, and you should be able to get Iowa's individual rate under 5% -- perhaps close to 4% -- without reducing individual tax collections.
 
0% corporate rate, sub-5% individual rate -- now that's a lot easier sell to a business pondering an Iowa location than a 12% corporation rate, 8.98% individual rate, and the occasional tax credit to ease the pain.
 
Of course, we aren't starting with a clean slate.  We have a tax system now that is encrusted with decades of breaks that seemed like a good idea at the time. People who have good deals now will fight to keep them, even if they mean other people have to pay more. But even if we can't reach the promised land of a completely clean, simple and neutral income tax, we can get to a better place if we try heading that way. And a good start is to not head in the wrong direction, by at least not enacting any more special breaks and tax credits.

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